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BeyondFactory AsiaFuelling Growth in a Changing World


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BeyondFactory AsiaFuelling Growth in a Changing World

Background Paper for the Asian Development Bank2013 Annual Meeting Governors Seminar


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2013 Asian Development Bank

All rights reserved. Published 2013.Printed in the Philippines.

ISBN 978-92-9254-047-0 (Print), 978-92-9254-048-7 (PDF)

Publication Stock No. RP135512-3

Cataloging-in-Publication Data

Asian Development Bank.

Beyond Factory Asia: Fuelling growth in a changing world.

Mandaluyong City, Philippines: Asian Development Bank, 2013.

1. Factory Asia. 2. Asia. I. Asian Development Bank.

Te views expressed in this publication are those o the authors and do not necessarily refect the views

and policies o the Asian Development Bank (ADB) or its Board o Governors or the governments

they represent.

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ADB encourages printing or copying inormation exclusively or personal and noncommercial

use with proper acknowledgment o ADB. Users are restricted rom reselling, redistributing,

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o ADB.

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his paper was prepared by hiam Hee Ng, Senior Economist([email protected]), Oice o Regional Economic Integration(OREI), Asian Development Bank (ADB) and Ramesh Subramaniam,Senior Director, OREI ([email protected]), with support romGuy Sacerdoti (Economics Editor); Mitzirose Legal (EconomicsOfcer), Carol Ongchangco (Associate Operations Coordinator)and members o the Asia Regional Integration Center (ARIC). Tepaper was prepared under the overall guidance o Changyong Rhee,Chie Economist o ADB and Ofcer-in-Charge o OREI. Te paperalso beneted rom the comments by Masahiro Kawai (Dean, ADBInstitute); and other ADB sta including Iwan Azis, Maria SocorroBautista, Sekhar Bonu, Douglas Brooks, Hans-Peter Brunner, AlisaDi Caprio, Benno Ferrarini, Shintaro Hamanaka, Rana Hasan,Xinglan Hu, Haruya Koide, Junkyu Lee, Christopher MacCormac,Erwin Nierop, akaaki Nomoto, John Stuermer, Hsiao Chink ang,and Betty Wilkinson.


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iii

Contents

Foreword iv

Section I: Introduction 1

Section II: Asian Manuacturing and Global Production Networks 4

Section III: Key Issues and Challenges in Moving Beyond Factory Asia 16

Section IV: Beyond Factory Asia 31

A. Strategic Options or Developing Asian Economies 31

B. Specic Policy Recommendations or Developing Asian Economies 33

C. Policy Implications or Developed Economies 36

Section V: Conclusion 38

Appendix: Role o the Services Sector 41

Reerences 45


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iv

Foreword

Factory Asiathese two simple words help dene Asias phenomenal economicgrowth over the past 2 decades. A growing population eager to earn more providedrelatively cheap and abundant labor in the last decade o the 20th century andthe early part o the current century, producing many o the manuactured

consumer goods the world needed. East Asias exports surged, particularly nalgoods destined or the United States (US) and eurozone economies. Te array ogoods produced and traded evolved rapidlyrom agricultural to (low-value)manuacturing, and into services in a ew cases.

Te beginning o East Asias remarkable transition in the 1970s and 1980s wasinitially powered by major Japanese multinational investments, which establishedsubsidiaries across the region. But it was the unprecedented economic reormsunleashed by the Peoples Republic o China (PRC) in the late 1980s that provided

the odder or exponential expansion. Production networks were born, coupledwith a complex web o intermediate goods increasingly produced and tradedamong developing countries in Asia. Te PRC led the charge as nal assemblero manuactured goods, with Southeast Asia beneting considerably rom theregional nature o many production processes. Along with this rapid growthcame new jobs, higher incomes, and relative prosperity. Millions o people werelied out o poverty. Factory Asia catapulted Asia back on the world map withits share o global output quickly rising. Several recent studies proclaim the AsianCentury is upon us, but only i the region can sustain its growth momentum

and structural economic transormation continues. Key to its success will beembracing policies that ensure emerging Asia is not caught in the so-calledmiddle income trap.

Did the global nancial crisis and ensuing Great Recession change that prognosis?Dual track growthemerging economies expanding above levels in the US andeurozoneappears to be well-entrenched. Tis is dramatically aecting Asiastrade patterns. Clearly, there is ar more intraregional trade within Asia. But thereis also rapidly growing inter-regional and South-South trade, with huge potential

or uture expansion. Tese changes pose a myriad interesting and complexquestions:


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Foreword v

1. Will Factory Asia continue to be the dominant driver o growthin Asia?

2. How will the increase in domestic and regional demand transormFactory Asia?

3. For those rmly embedded in current regional production networks,what adjustments will be needed in the overall growth strategy?

4. It appears that larger rms dominate production networks in Asia. Whatcan be done to encourage small and medium enterprises (SMEs) to joinproduction networks and benet rom greater integration?

5. For the many countries outside Factory Asiaor on its periphery

are there emerging opportunities up or grabs? Will they become newpartners and join regional production networks, or will they leaprog theearly stages entirely and enter at higher levels o the value chain?

6. How will regional and global investment fows adjust to the changingroles and importance o agriculture, manuacturing, and services toeconomic growth?

7. How will countries balance environmental and growth challenges; andhow can they ensure growth is more inclusive and equitable as they movebeyond the Factory Asia model?

8. And, importantly, should the region build a common, coordinatedstrategic vision as a guide toward uture transormation? Is theresucient political will? Or is a strategic vision even necessary? Is thewhole more than the sum o its parts, or should dominant economiescontinue learning and competing, drawing others along in their wake?

Te bottom line is this: What lies beyond Factory Asia? Te region is home to2.6 billion people; so this is a very important question. As the global economyreadjusts, as the region needs to sustain growth and create new jobs, betterallocate its large nancial resources toward more productive and socially equitableinvestment, what lies in store?

Te 2013 ADB Annual Meeting Governors Seminar aims to debate these issues.Te range o policy, institutional, legal and regulatory reorms needed to driveAsias economic and social transormation to the next level are all part o theNew Factory Asia model.

Bindu N. LohaniVice PresidentKnowledge Management and Sustainable DevelopmentAsian Development Bank


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1

SECTION I

Introduction

Asia has shown tremendous dynamism over the last 5 decades, despite wideintraregional diversity. Most o the enviable economic growth has been driven

by a relentless ocus on exports. In several Asian economies, success in export-led manuacturing took gross domestic product (GDP) per capita to the levels odeveloped countries. Asias transormation has run through ve phases:1

1. Japans ascent in the 1960s, which helped its rapid recovery rom post-war destruction.

2. Export driven growth initiated in the 1970s by the original AsianigersHong Kong, China; the Republic o Korea; Singapore; andaipei,China.

3. A cooperative approach to development pioneered in the 1980s by theAssociation o Southeast Asian Nations (ASEAN).

4. Economic liberalization in the Peoples Republic o China (PRC)beginning in the late 1980s, aided by the rapid development oproduction networks, creating the moniker Factory Asia (Box 1).

5. Early reorms in the 1990s gave credence to Indias large growthpotential, which began to bear ruit in the 2000s.

Troughout these ve phases, there was a remarkable transormation in globalmanuacturing, characterized by the rapid rise o manuacturing in Asia. Arecent study showed that in 1970, the United States (US), Germany, and Japandominated the sector globally, accounting or 52% o total value added inmanuacturing.2 From 1970 to 2010, the Group o 7 lost 24 percentage pointsin world share (rom 70% to 46%), with 18 o those 24 points lost since 1990. 3Te big winner was the PRC, whose share rose 18 percentage points rom 1970to 2010with 16 o those percentage points coming since 1990. Six otherdeveloping nationsincluding our rom Asia (India, Indonesia, the Republic oKorea, and Tailand)4saw each o their shares rise by more than 0.5 percentage

1 Tis typology is drawn rom Gyohten (2006).2 See Baldwin and Lopez-Gonzalez (2013).3 Te Group o 7 includes Canada, France, Germany, Italy, Japan, the United Kingdom, and the US.4 Te other developing nations were Poland and urkey.


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2 Beyond Factory Asia

Box 1: What is Factory Asia?

Factory Asia refers to the model of regional production networks connectingfactories in different Asian economies, producing parts and componentsthat are then assembled, with the final product shipped largely to advancedeconomies (see Ando and Kimura 2005). These networks form part of regionaland global value chains. While production networks are an important part ofmanufacturing in Asia, they have generally been confined to East Asia. Physicalproximity, ease of tradeand many other factorsshape production networks(see Johnson and Noguera 2012). There are countries with large or emergingmanufacturing sectors outside these production networks. Their manufacturing

output is primarily aimed at domestic markets, while some countries have beensuccessful in finding a niche in exporting intermediate or final goods directly.The main premise in this monograph is that developing Asia can build on thesuccess of the Factory Asiamodel, and significantly strengthen manufacturingin general.

Source: ADB staff.

point o the global total. ogether, these 6 risers gained 7 percentage points oglobal manuacturing; with 5 o these happening since 1990.

Building on this success, Asia is now poised or a possible Asian Century. Givenits current growth trajectory, by 2050 Asia can expect to attain living standardscomparable to that o Europe today. Furthermore, its share o the global economycould swell to more than hal(Box 2). However, as the Asian Development Bank(ADB) noted inAsia 2050, published in 2011, Asias continued ascent is not pre-ordained. Indeed, Asia must grapple with many issues, not the least o which are

regional and global economic crises.

Te impact o the 1997 Asian nancial crisis lingers, and the aermath o the 2008global nancial crisiswith the sluggish US recovery and eurozone nancial orscal restructuringwill be elt or years to come. While Asia has thus ar provenits resilience, and its share o the global economy and wealth continue to rise, itmay be time or the region to enter a new development phase.

Te continued weak economic prospects in advanced economies necessitate a

rethinking o the Factory Asia modelas traditional demand will likely remainweak. Also, Asian economies ace rising labor and actor costs, which graduallyerode their price advantage. New technologies and processes could potentiallytransorm manuacturing and leave developing countries at a disadvantage.


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Introduction 3

Box 2: Asias Rise

The pace and scale of Asias rise have been nothing short of staggering. In aregion rich in cultural, social, political and economic diversity, peoples liveshave been transformed just as the globe has been transformed. Hundreds ofmillions of people have been lifted out of poverty, parts of the region haveexperienced a halving in their infant mortality rates and decades have beenadded to life expectancy.

Nearly all the high-performing economies in Asia deliberately set out to supportprosperity by reforming their policy and institutional settings. Many economies

within the region have invested heavily in their people and created a climatethat has supported capital investments. With the benefit of a good education,growing shares of young people have found jobs as they have reached primeworking age.

Open global trading systems and infrastructure to reduce transport costs havedriven regional and global integration. More broadly, a global system of rules hasallowed for greater stability and spurred increasing levels of interdependence.

Source: Government of Australia (2012).

Tis monograph, prepared or the Governors Seminar at the 2013 ADB AnnualMeeting, aims to summarize some recent developments and issues; and poseseveral strategic questions or senior policy makers. Section II provides anoverview o Asian manuacturing, analyzing key trends in production andtrade across all economies (both in- and outside Factory Asia). Section IIIanalyzes the key issues and challenges acing Factory Asia, many o which

apply to manuacturing as a whole. Section IV oers strategic options orFactory Asia economies and those on the periphery, providing specic policyrecommendations to address major challenges. It also examines several issuesrelevant to advanced economies. Finally, Section V concludes by attemptingto answer the questions raised earlier. ADB plans urther analytical work andpolicy consultations based on the discussions and eedback generated at theGovernors Seminar.


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4

SECTION II

Asian Manufacturing and GlobalProduction Networks

Manuacturing will remain an important contributor to wealth in Asia in the nearuture. What is special about the sector is that its productivity growth generallytends to be higher than other sectors. Most ast growing Asian economieshave beneted rom shiing labor rom low productivity agriculture to higherproductivity manuacturing. Yet, as the region becomes richer, manuacturingsshare may tend to decline as consumption patterns shi more toward services.Nevertheless, manuacturings role extends beyond its contribution to GDPitdrives productivity growth and innovation. By its very nature, manuacturingcombines assorted intermediate inputs to produce a nal product. Hence, it has

strong spillover eects on other parts o the economy.

Hausmann et al. (2011) have shown that richer countries tend to manuacturesophisticated goods that ew other countries produce. Tis is because theyhave accumulated knowledge and capabilities that other countries lack. Tisaccumulated knowledge can be leveraged into related areas and achieve higherincomes. Factory Asias value chain ragmentation allowed the regions economieseasier entry into producing more sophisticated manuactures.

Baldwin and Lopez-Gonzalez (2013) argue that the production networks thathave been the bedrock o Factory Asia will prolierate urther, oering a wayor less developed countries to move into manuacturing (Box 3). While unableto build entire networks rom scratch, several o these countries can join themas they can bypass several critical skill-setssuch as design, engineering,procurement, and distribution. Instead, these countries can concentrate onthe processes themselves and leave the rest to other suppliers. Tis lowers therequirement or joining a value chain, thus allowing countries to more easily gaina oothold in manuacturing.

Asian economies are increasingly important in global manuacturing as measuredby value-added (able 1). Te rise o the PRC and the Republic o Korea was aidedby the growing importance o production networks. Te same applies to Indonesiaas well to a considerable extent. However, India has also shown impressive


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Asian Manufacturing and Global Production Networks 5

Box 3: Some Key Facts about the Global Supply Chain

Supply chains undoubtedly have given a new meaning to industrialization.That a country could export domestically-designed high value products wasa testimony to its rich-nation status. It is no longer true, for exporting asophisticated manufactured good is no longer the hallmark of having arrived. Itmay simply reflect a nations position in an international supply chain.

A few facts related to supply chains are noteworthy.

The primary fact on manufacturing is that it is astoundingly concentrated.The United States (US), the Peoples Republic of China (PRC), Germany

and Japanthe Giant-4 manufacturersaccount for about 60% of allmanufacturing output.

International supply chains are mostly regional rather than global. Mostsupply chain trade happens within what have been called Factory Asia,Factory Europe, and Factory North America.

Over the last decade or so, supply-chain trade has shifted heavily towardsFactory Asia and away from Factory North America and Factory Europe.

Headquarter economiesthose that tend to be technology leaderstend to be diverse in terms of partners on both the sourcing and sales side.

Factory economiesthose that tend to followtend to be heavily relianton the closest high-technology manufacturing giantthe US, Germanyand Japan.

About half of the worlds output of goods and services are sold asintermediate inputs.

The importance of services trade is not yet appreciated. Intermediate servicestaken together account for 28% of world supply-chain trade flows (allintermediates). The global pattern for intermediate industrial goods is moreregionalized than the pattern for intermediate services. Thus, there remain

significant opportunities for economies such as India. The world is still more globalised for final goods than it is for intermediates;

the domestic-sales-to-export split is about 6040 for final manufactures whileit is about 7030 for intermediates (70% sold locally and 30% exported).

Overall, world production remains mostly national. The share of importedintermediates in total world manufacturing is 16%; for the production of allgoods and services, it is 8%.

Source: Excerpts from Baldwin and Lopez-Gonzalez (2013); except reference to India andimplications for technology advances, which were added by the authors.

gains in manuacturingwhich has ocused more on serving its relatively largedomestic markets. Te increasing importance o Asian manuacturing can alsobe seen in the rankings o the top manuacturing exporters (able 2). In 2011,


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the PRC edged out both the US and Germany to become top global manuacturingexporter. Similarly, the Republic o Korea has moved rom outside the top

10 to rank 5th. Hong Kong, China; and Singapore are also among the top 15manuacturing exporters; but as major shipping hubs, they handle large amountso trade or their neighbors.

Te rise o Asian manuacturing is also evident in the increased share o value-added in global manuacturing (Figures 1, 2). Te most spectacular rise has beenin the PRC, which overtook Germany, Japan, and then the US to top the list.While impressive, other Asian countries have also been grabbing a larger share othe global manuacturing pie.

Te shi toward Asia both refects the role o manuacturing as a driver o growthand the move o industries rom developed economies to Asia. Most economiesin the region continue to industrialize, while many developed economies haveseen their manuacturing sectors shrink (Figures 3, 4). Te region has rapidly

able 1: Country Rankings by Manuacturing

Nominal Gross Value AddedRank 1980 1990 2000 2011

1 United States United States United States PRC

2 Japan Japan Japan United States

3 Germany Germany PRC Japan

4 PRC Italy Germany Germany

5 France France United Kingdom Italy

6 Italy United Kingdom Italy Republic of Korea

7 United Kingdom PRC France Brazil

8 Brazil Russian Federation Republic of Korea Russian Federation

9 Spain Spain Mexico France

10 Mexico Brazil Canada India

11 Canada Canada Brazil United Kingdom

12 Australia Republic of Korea Spain Mexico

13 Netherlands Mexico India Indonesia

14 India Turkey Turkey Spain15 Switzerland India Russian Federation Canada

PRC = Peoples Republic of China.

Note: The PRC data for 1980, 1990 and 2000 refers to Mining, Manufacturing and Utilities.Former Union of Soviet Socialist Republics is not included in the rankings.

Source: UN National Accounts Main Aggregate Database.


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able 2: Country Rankings by Value o Manuacturing Exports

1998 2000 2011

China, People's Republic of 7 5 1

Germany 2 2 2

United States 1 1 3

Japan 3 3 4

Korea, Republic of 12 10 5

France 4 4 6

Italy 6 7 7

Netherlands 11 12 8Hong Kong, China 9 9 9

Belgium 10 11 10

United Kingdom 5 6 11

Singapore 14 14 12

Canada 8 8 13

Mexico 13 13 14

Spain 15 15 15

Note: Data for Belgium in 1998 refer to BelgiumLuxembourg.Source: UN Comtrade.

Figure 1: Manuacturing Value Added as Share o otalValue AddedSelected Advanced and Asian Economies

PRC = Peoples Republic of China, US = United States.

Note: $ in current prices.

Source: ADB calculations using data from UN National Accounts Main Aggregate Database.

PRC US Japan Germany Republic of Korea

1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 20110

5

10

15

20

25

30

%


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Figure 2: Manuacturing Value Added as Share o otalValue AddedSelected Asian Economies

Note: $ in current prices.


0.0

0.5

1.0

1.5

2.0

2.5

1982 1986 1990 1994 1998 2002 2006 2011

India Indonesia ThailandMalaysia Singapore

1970 1974 1978

%

Figure 3: Manuacturing Value Added Share o GDPor Selected Economies

PRC = Peoples Republic of China, GDP = gross domestic product, US = United States.


0

5

10

15

2025

30

35

40

45

PRC

1970 2011

Republicof Korea

US Japan Germany

%


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become a production base or many global rms. Much manuacturing moved toAsia in search o lower production costs. Over time, they have also become morecompetitiveand in more technologically advanced industries. Well-known,large emerging Asian brands such as Acer, Lenovo, Huawei, Hyundai, Inosys,Samsung, ata and scores o others are now challenging the dominance o thosepreviously well-entrenchedrom the US, Europe, and Japan.

One way to illustrate the manuacturing dynamism in Asia is to examine theevolving pattern o manuacturing trade balances in the region. FollowingMcKinsey Global Institute (2012), manuacturing output is divided into vedierent categories (able 3). Te types o products produced under theFactory Asia model are more likely, but not exclusively, to all under the last twocategoriesglobal technologies/innovations and labor intensive tradables.

Data are available on value added in the ve manuacturing categories or thePRC, India, Indonesia, the Republic o Korea, and Japan (able 4). While there

are some variations within countries over time, there is considerable variationacross countries. Japan continues as a pioneer in globally innovative productsmanuactured locally (or example, automobiles). More recently, the Republico Korea has excelled as a leader in global technology, holding the largest shareamong the ve countries or this category. Te PRC leads in energy intensive

Figure 4: Manuacturing Value Added Share o GDPor Asian Economies

GDP = gross domestic product.


0

5

10

15

20

25

30

35

India Indonesia SingaporeMalaysia Thailand

1970 2011

%


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able 3: Categories o Manuacturing

Sector Key Traits Examples of Industries

1. GlobalInnovationfor LocalMarkets

p High research anddevelopment (R&D) intensity;with competition driven byinnovation and quality

p High trade intensity, butassembly and production canbe regionalized

p Geared towards servingcustomers located nearfactories

p Chemicals andpharmaceuticals

p Transport equipment,including automotive

p Machinery, electricalappliances

2. RegionalProcessing

p High local contentrequirement, and locatednear sources of raw materialsand final demand

p Highly complex and costlylogistics

p Low tradabilityp Automated production, with

little R&D

p Rubber and plasticsp Fabricated metalsp Food and beveragesp Printing and publishing

3. Energy/ResourceIntensiveCommodities

p Intermediate inputs to othersectors; low tradability

p Price competition with littleproduct differentiation

p Wood productsp Paper and pulpp Basic metalsp Minerals-based productsp Refined petroleum, coke, and

nuclear products

4. GlobalTechnologies/

Innovators

p High R&D intensity, withcompetition driven by R&D

p Highly tradable, with veryhigh value to weight ratiowhich makes it economicalfor the products to bemanufactured far from thesource of final demand

p Computers and officemachinery

p Semiconductors andelectronics

p Medical, optical, and otherprecision equipment

5. Labor IntensiveTradables

p High exposure to pricecompetition

p Highly labor intensivep Globally traded, with

low proximity needs forproduction

p Textiles, apparel, leatherp Furniture, jewelry, toys, and

other manufactured goods

Source: McKinsey Global Institute (2012).


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manuacturing, ollowed by global innovation or local markets. While Indonesiaholds the largest share in labor intensive products, during 20012010 it also

positioned itsel as a manuacturer o globally innovative products and regionallyprocessed goods. It has also sharply reduced production o energy intensivecommodities. Indias manuacturing has shied toward global innovation orlocal markets and away rom labor intensive tradables.

Te changing production structure is also refected in a countrys manuacturingtrade balance (Figures 59). Te ve countries examined show that a rising tradesurplus in any particular category indicates improved competitiveness in thecorresponding manuacturing category.

For the PRC, there is a considerable shi in composition o the trade balancebetween 2000 and 2011 (see Figure 5).5 While labor intensive tradables remainimportant, there has been a huge rise in the share o global technologies andinnovation, evident through the increasing importance o electronics. Te PRCnow has a trade surplus in global innovation or local marketsas it boostsproduction in machinery and transport equipment. It is interesting that, whilethe PRC has moved up the value chain into more technologically advancedproducts, it nonetheless remains competitive in relatively low technology labor

intensive tradables.

5 Athukorala (2011) maps out the evolution o manuactured trade in several countries, includingthe PRC, and its rapidly evolving role in parts and components trade.

able 4: Sector Share o otal Manuacturing Value Added (%)

Sector

PRC India Indonesia JapanRepublicof Korea

2000 2010 2004 2010 2001 2010 2002 2009 2001 2011

Global innovationfor local markets

25.5 29.6 35.5 36.7 28.0 36.0 42.8 41.2 36.3 38.5

Regional Processing 15.5 14.8 17.5 17.7 30.7 35.4 26.9 29.3 18.9 15.4

Energy intensivecommodities

46.1 43.6 32.5 32.7 23.4 14.3 14.5 13.0 16.0 15.8

Global innovation

for local markets5.6 4.8 3.8 3.2 3.6 2.6 10.7 11.8 19.0 25.5

Labor intensivetradables

7.2 7.2 10.8 9.7 14.4 11.7 5.0 4.7 9.4 4.8


Source: ADB calculations using data from national sources and Industrial Statistics Database2012, United Nations Industrial Development Organization.


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Figure 5: Manufacturing Trade BalancePeoples Republic of China

Source: ADB calculations using data from UN Comtrade.

For the Republic o Korea, the change in the pattern o manuactured exportshas been equally dramatic (see Figure 6). From having a large trade surplus inlabor intensive tradables, it now has slight decit. Tis is not surprising as higherwages made labor intensive industries less competitive. Instead, the country hasmade the transition into more technologically advanced products. It has greatlyincreased its trade surplus in global innovation or local markets given the large

gains made (mainly) in automobile manuacturing. It also sustained its largesurplus in global technologies and innovation as it retained its lead in electronics.

As an advanced industrialized country, Japan has shown ew shis in thestructure o industrial production (see Figure 7). Nevertheless, there is someimpact o Factory Asias rise in Japanese manuacturing. In 2000, there was alarge trade surplus in global technologies and innovation. However, as muchelectronics production migrated abroad, the trade surplus in those sectorsdropped considerably. Japan still maintains competitiveness in machinery and

automobile manuacturing, seen in the larger surplus or the global innovationor local markets category.

In contrast with the other countries, manuacturing in India is more inward-oriented and caters more to domestic demand (see Figure 8). While the PRC,

40

20

0

20

40

60

80

100

2000 2011

%

Labor intensive tradables

Global technologies/innovation

Energy/resourceintensive commodity

Regional Processing

Global innovation forlocal markets


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Figure 6: Manuacturing rade BalanceRepublic o Korea


20

0

20

40

60

80

100

%

2000 2011




Regional Processing


Figure 7: Manuacturing rade BalanceJapan


40

20

0

20

40

60

80%

2000 2011




Regional Processing



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Japan and the Republic o Korea hold large trade surpluses in manuactures, Indiahas a small decit. Tere has been little change in the composition o these tradepatterns. India continues to hold a surplus in labor intensive tradables, refectingits low labor costs. Tis may indicate signicant potential or the country shouldit reorient its trade strategy in the uture.

Another domestic-oriented manuacturer is Indonesia (see Figure 9). It had anoverall trade surplus in manuactured exports in 2000. However, it now holdsa decit as the economy relies more heavily on commodity exports. Also, thetrade decit likely refects rapid economic growth, which increased imports ocapital goods. Similar to India, Indonesia continues to hold a trade surplus inlabor intensive tradables and regional processing.

In sum, it appears that the PRC and the Republic o Korea managed to gain strongand niche positions in the global production networks or high-tech products.

However, economies such as India and Indonesia have not shown much shitoward more high-end goods. While the spread o global production networkshas drawn in new participants in Factory Asia, this does not guarantee thatcountries can easily make the shi into manuacturing sophisticated products.

Figure 8: Manuacturing rade BalanceIndia


60

40

20

0

20

40

60

80%

2000 2011




Regional Processing



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It is important to note that the share o imported intermediates in globalmanuacturing output remains quite lowat 16%. Tis suggests the world isnot yet fat and distance has not diedespecially when it comes to internationalproduction networks (see Box 3). For developing Asia, this may have somecritical implications should it embrace new advances in inormation andcommunication technologyattempting to reap the gains o emerging

technologies such as 3D printing.

Given the potential o global production networks to jumpstart manuacturingin developing economies, several important questions ace Asian policy makers.Should nations strive to set up their own international production networks?Which supply chains should they join? What role can government and policyplay in helping promote entry into a global production network? What is theoptimal technology policy a country should pursue to acilitate knowledgetranser? How important is the size o the domestic market in attracting oreign

direct investment? Can smaller nations mimic what the PRC has done indeveloping manuacturing?

Figure 9: Manuacturing rade BalanceIndonesia


80

60

40

20

0

20

40

60

80

%

2000 2011




Regional Processing



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16

SECTION III

Key Issues and Challengesin Moving Beyond Factory Asia

Asia has thrived under the Factory Asia growth model. However, with changingglobal trends, the uture o manuacturing could look quite dierent rom what itis today. Asia aces a number o issues i it is to transorm manuacturing. Tesecan be viewed as challenges as well as opportunities.

Te key issues the region is expected to ace all under three main categories(able 5). Te rst includes issues that may aect the demand or Factory Asiasproducts. In particular, the protracted slower growth in advanced economiesollowing the global nancial crisis means demand or Factory Asias output will

likely shi to developing markets. In the second category, issues with implicationson the cost structure o Factory Asia are examined. echnological changes thataect manuacturing production are discussed under the last category. For eachissue, a subjective assessment is given o the impact on manuacturing andprobability o its likelihood.

Once again, the analysis must be understood in the context o Asias vast diversity.Countries are at dierent levels o development. Some manuacture goods atthe rontier o technology, while others are simply trying to gain a oothold in

global production networks. Hence, the key issues reerred to below may notapply similarly to all countries. However, the issues covered are relevant to mosto countries in the region, including those that have not yet adopted the FactoryAsia model.

Issue #1. Economic Prospects afer the Global Financial Crisis. One keyissue is the slow recovery and continued weak outlook in advanced economiesaer the 2007/08 global economic crisis. For now, most Asian economies runtrade surpluses with the US, Europe and Japan. Tis is possible because the US

economy was able to grow despite large trade decits. However, continued weakeconomic conditions and high scal decits limit its ability to run large tradedecits in the uture (Figure 10). Similarly, the eurozone will also struggle withcontinuing weak economic prospects. Furthermore, over the medium-term,an ageing population in many advanced economies will also signal signicant


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Key Issues and Challenges in Moving Beyond Factory Asia 17

able 5: rends and Issues FacingFactory Asia

Trends Issues Impact Probability

I. Changing globaleconomiclandscapeand evolvingconsumertastes will affectdemand forFactory Asiasproducts

1. Weaker growth in advanced countries willsee demand shifting away from developedmarkets to emerging economies

High High

2. Factory Asia will have to learn to caterto the demand of growing middle classconsumers in the region

High High

3. Asias manufacturers need to build strongbrand identity to compete globally

Low toHigha

High

4. Weak economic growth and highunemployment may give rise toprotectionist tendencies in advancedeconomies

Low Low

II. Risingproduction costsgradually erodestraditionalFactory Asiaadvantage

5. Long and complex supply chains arebecoming more vulnerable to naturaldisaster and reputational risks

Medium Medium

6. Wages in Asia have been rising faster thandeveloped countries, narrowing the costdifferential

Medium High

7. Exchange rates have become morevolatile, making it harder to manageproduction networks across severalcountries

Medium High

8. Shortage of skilled workers could hamperthe regions drive to produce moresophisticated products

High High

9. Changing demographics in somecountries will result in a smaller labor pool

High High

10. Production has been shifting from high-cost to lower-cost countries

High High

III. Newtechnologiesare changingthe nature ofmanufacturing

11. Software is becoming more important inmanufactures and comprise a larger shareof value

Medium High

12. Advances in robotics and additivemanufacturing could herald a new era inmanufacturing

Medium High

a The impact is likely to be minimal for low-value products, where branding and quality is less

important. However, for medium- to high-value products (for example, consumer durablesand medium or high technology products), quality and branding are very important. Qualitycontrol will become more important even for generic suppliers of brand name productsdemonstrated in the garment sector where some countries have lost out in competition withemerging new players.

Source: Analysis by ADB staff.


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changes in consumption patterns, resulting in lower demand or manuactured

products and greater demand or health and medical services. In addition, therise o Factory Asia was accompanied by alling trade barriersboth worldwideand regionallycheaper transportation costs, improved capital mobility, andar more ecient communication. While some o these advantages will remainand perhaps deepen, others may not, leaving the export-led model o FactoryAsia acing uture headwinds. Asia will have to adapt and take advantage o thesechanging global trends i it is to reinvent itsel.

So, who will buy the products Asian actories are churning out? Asias income

growth will likely continue to outpace that o the developed world in the comingdecades. As part o rebalancing the sources o growth, the shi away rom exportstoward greater domestic demand will intensiy. Tis could redirect some currentexports. But this implies some countries will likely run smaller surpluses or evendecits as demand grows or other countries exports.

Issue #2. Asias Expanding Middle Class. Demand rom the rising middle classcould help sustain Factory Asias output. Asia could reach a point where themajority o its population reaches middle class status. Between 1990 and 2009,

the middle class population share rose 38 percentage points, more than doublingrom 21% to 59% (Figures 11a, 11b). In absolute terms it has risen more thanthree-old over the same periodrom 563 million to 2 billion. Te demandor consumer durables will continue to grow rapidly. Car ownership in the PRCand India has sharply increased. In act, the PRC now tops the US as the worlds

Figure 10: Te United States Current Accountand Merchandise rade Balance

Source: Haver Analytics.

Merchandise Balance Current Account Balance

900

800

700

600

500

400

300

200

100

0

1997 1999 2001 2003 2005 2007 2009 2012

$ billion


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OECD = Organisation for Economic Co-operation and Development.

Notes:

Developing Asia = Armenia, Azerbaijan, Bangladesh, Cambodia, the Peoples Republic ofChina, Georgia, India, Indonesia, Kazakhstan, Kyrgyz Republic, the Lao PDR, Malaysia,Mongolia, Nepal, Pakistan, the Philippines, Sri Lanka, Tajikistan, Thailand, Turkmenistan,Uzbekistan, and Viet Nam.

Developing Europe = Albania, Belarus, Bosnia and Herzegovina, Bulgaria, Latvia, Lithuania,Macedonia, Moldova, Poland, Romania, Russian Federation, Turkey, and Ukraine.

Latin America and Caribbean = Argentina, Brazil, Chile, Colombia, Costa Rica, DominicanRepublic, Ecuador, El Salvador, Guatemala, Honduras, Jamaica, Mexico, Nicaragua, Peru,Uruguay, and Venezuela.

Middle East and North Africa = Algeria, Djibouti, Egypt, Iran, Jordan, Morocco, Tunisia, andYemen.

OECD = Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy,Luxembourg, the Netherlands, Norway, Portugal, Slovak Republic, Spain, Sweden, theUnited Kingdom and the United States.

Sub-Saharan Africa = Botswana, Burkina Faso, Burundi, Cameroon, Central African Republic,Ethiopia, Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Madagascar, Malawi,Mali, Mauritania, Mozambique, Niger, Rwanda, Senegal, Sierre Leone, South Africa,Swaziland, Tanzania and Uganda.

Source: Chun (2012).

Figure 11a: Change in Middle Class Population Share, 19902009(percentage points)

Figure 11b: Change in Middle Class Expenditure, 19902009($ billion)

10 0 10 20 30 40 50

Developing Asia

Developing Europe

Latin Americaand Carribean

Middle East andNorth Africa

OECD

Sub-Saharan Africa

500 0 500 1,000 1,500 2,000 3,0002,500

Developing Asia

Developing Europe

Latin Americaand Carribean

Middle East andNorth Africa

OECD

Sub-Saharan Africa


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largest automobile market, with annual sales o nearly 12 million, up rom just1 million in 1992 and 2 million in 2000.

Issue #3. Quality and Branding. Firms in Asia thus ar have competed mostlyon price. However, to sustain and continue growing in the uture they willneed stronger brand identities. Higher prots and margins can be sustainedonly through building long lasting, well-acknowledged brands. Tis meansAsian manuacturers will have to ocus on longer term reputations or qualityand innovation rather than a short-term ocus on price. As incomes rise andrebalancing continues, consumers will consider product quality and saety alongwith cost. Firms will have to adapt to this strategic shi. It is beginning to happen.While Western brands may still carry stronger brand recognition, Asian brandsare becoming globally recognized in their own right.

Issue #4. Protectionism. Te rise o Factory Asia has been helped by theincreasingly liberal global trade regime. Falling taris and reduced trade barriershave made it easier to ship products to marketnot just or developed economiesbut or developing Asian economies as well. Tis helped promote the growth oproduction networks.

However, this liberal trade regime may be challenged. Governments in advancedeconomies are acing pressures to protect domestic industries as unemploymentremains high or rising. As a result, protectionist sentiments have grown inadvanced economies. For instance, hundreds o discriminatory measures havebeen introduced worldwide since November 2008.6 And the sectors most aectedby these discriminatory measures have been in manuacturing. Hence, access todeveloped markets could easily become more dicult, at least until economicconditions in these markets improve considerably.

Issue #5. Rising Complexity in Managing Supply Chains. rade has boomedon the back o alling transportation costs. However, with these rising and likelyto remain elevated, there may be a shi toward shorter supply chains. Tis islikely to be aggravated by problems in managing long supply chains, related toadherence to saety and core labor standards. Industries with low density valuewill be more aected by higher transportation costs.

Global value chains are also exposed to disruptions caused by natural disasters,

as painully demonstrated by Japans 2011 ohoku earthquake and tsunami, andfooding in Tailand later that year. In the uture, manuacturers companies mayneed to prioritize between economies o scale in concentrating production in one

6 See Evenett (2012).


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area and spreading production over several locations to ensure greater resilience,given the trade-o between eciency and risk o disruption.

Troughout the 1990s and 2000s, Asia benetted rom stable commodity prices,particularly uel. However, commodity price trends in the uture may not be asavorable as in the past. Rapid population and income growth globally will raisedemand or raw materials. Not only is it likely that commodity prices will rise,but they could also be much more volatile (Figure 12). Tis will pose seriouschallenges to manuacturers whose products are intensive in commodity inputs.Besides becoming more volatile, commodity price movements have also becomemore correlated. Price increases in one commodity tend to spread to others.

Several global companies aced with the challenge o managing complex supplychains are transerring some o their production operations back to their homecountries (the US in many cases) (Box 4). It is still too early to say this is a long-term trend. Nonetheless, companies are increasingly recognizing that outsourcedrelationships can be convoluted and insecure, leaving them vulnerable toreputational risks and supply disruptions.

Issue #6. Narrowing Wage Dierentials. One primary driver o manuacturinggrowth in Asia has been the vast pool o cheap labor. But with incomes rising ast,the wage gap is closing. Asia can no longer solely rely on cheap labor as a source ocomparative advantage. Recent trends suggest that while real wages in developed

Figure 12: Long-erm rends in Commodity Prices (2005 = 100)

Source: International Monetary Fund data on Primary Commodity Prices; accessed11 March 2013.

0

50

100

150

200

250

300

Jan-92 Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13

Food and Beverage Agricultural Raw Materials Fuel


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Box 4: On-shoringrend or Fad?

After years of off-shoring manufacturing by developed economies to Asia, thereappears to be a slowdown or reversal in trend. Relocating manufacturing goesby several termson-shoring, reshoring or inshoring. Some global companiesare planning to transfer to some of their production operations back to theUnited States (US) from Asia. It is difficult to gauge its extent, and the evidenceso far has been mostly anecdotal.

Some of the reasons include narrowing wage differentials, difficulties ofmanaging complex supply chains and volatile shipping costs. Long delivery

routes increase costs of holding inventories and leave firms vulnerable to rapidlychanging demand. Producing close to consumers allows for faster turn-aroundtime and allows for greater flexibility in meeting demand.

In the traditional model of off-shoring, production is separated from design andresearch and development. However, as manufactured products grow moresophisticated and development time for new product models is compressed,there may be a need for closer collaboration between design and production.This favors relocating production close to the design base. It can sometimeslead to improving production processes as well. The General Electric Company

is reported to have been able to lower costs of manufacturing water heaters byrelocating production to the US through redesign (see Fishman 2012).

The US is also benefiting from cheap energy driven by advances in hydraulicfracturingor fracking. Natural gas production from shale gas has soared inthe US, and energy costs have plummeted (Figure). Cheap energy will benefitall industries, but the main beneficiaries will be heavy natural gas userssuchas chemical manufacturers.

Source: Analysis by ADB staff.

Shale Gas Production in the United States

Source: The United States Department of Energy; accessed 11 March 2013.

2007 2008 2009 2010

6,000

5,000

4,000

3,000

2,000

1,000

0

billion cubic feet


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economies have remained stagnant, they continue to climb in Asia (Figure 13).Between 2000 and 2010, wages rose by 6% in developed countries but surged 86%in Asia (see International Labor Organization 2012). Rising real wages are a signo successul development and should be welcomed as they increase the livingstandards. Yet, i wage growth outpaces productivity gains, it will reduce the costadvantage and may drive companies to relocate manuacturing.

In addition, as the region accelerates the pace o rebalancing toward moreregional and domestic demand, wage dierentials across Asia will be smallerthan wage dierentials with advanced economies. Tereore, low wages may nolonger be an important source o cost advantage. I their only advantage is lowwages, less developed countries will nd it dicult to join supply chains. At thesame time, the ability o countries to invest and absorb emerging technologieswill have major implications on how Asia can position itsel in internationalizingproduction andmore importantlyor job-creation.

Issue #7. Managing Exchange Rate Fluctuations. Prior to the global nancialcrisis, the regions exchange rates were relatively stable against the US dollar.With the ragility o the US and European banking systemsand interest rate

Figure 13: Real Wage Growth in Asia and Developed Economies

Note: Computed using population weights. Asia includes the Peoples Repubic ofChina, India, Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand.

Developed Economies includes Austria, Canada, Czech Republic, Estonia, Germany,Hungary, Italy, Latvia, Lithuania, Poland, Slovak Republic, Spain, Sweden, Switzerland, theUnited Kingdom, and the United States.

Source: ADB calculations using data from Global Wage Database 2012, InternationalLabour Organization.

7

6

5

4

3

2

1

0

%

2008 2009 2010

Developed EconomiesAsia


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dierentials between advanced and emerging marketsthe regions currenciesappreciated as capital infows spiked. However, the trend is not uniorm. Fromthe beginning o 2007 to the end o 2012, the Japanese yen gained against the USdollar mainly due to its sae haven status. Tis hurt Japanese manuacturingcompetitiveness. Japans new monetary policy is trying to change that. Otherswhose currencies have appreciated include the PRC, Malaysia, Tailand, andthe Philippines (Figures 14a, 14b). Meanwhile, other currencies such as theVietnamese dong have depreciated against the dollar. Te divergence and

volatility in exchange rate movements have made it more dicult to plan andmanage manuacturing operations across several exchange rate regimes.

Issue #8. Shortage o Skilled Workers. Rising real wages and skills shortages arehurting several developing economies in Asia. As noted earlier, rising real wageshave begun to bite as total landed cost advantages diminish. Te lead timerequired or upgrading skills is long, and Asian economies may get squeezed romboth ends unless concerted eorts are taken to improve technical and vocationalskills. Te changing nature o manuacturing also means manuacturing jobs willbe dierent in the uture. Work will most likely be a lot more skill-intensive. Yet,while much attention is given to producing scientists, engineers and researchers,ensuring the availability o skilled technicians and hands-on shop-foor typetalent is equally important in developing advanced manuacturing capabilities.

Issue #9. Demographics. Japan and the original Asian tigers have birth ratesbelow replacement levels. Teir populations are projected to shrink. Even thePRCwhich benets rom a large supply o rural laboraces the prospect o ashrinking labor orce. Das and DNiaye (2013) notes that the PRCs working agepopulation will soon peak and then sharply decline. In act, the PRCs working-age population ell in 2012 and the trend is expected to accelerate. Excess labor

supply rom rural areas may be drying up, causing manuacturing labor shortagesin the uture. Tis could place urther upward pressures on wages. Yet othercountries in the regionsuch as India and the Philippinesmaintain young andgrowing populations. Nonetheless, wages are rising in those countries as well.

Issue #10. Taking Domestic Strengths Abroad. In addition to wage anddemographic actors, countries also aspire to consistently move up the valuechain, also to avoid the middle-income trap. Tis has begun in the PRC, orexample. Tis portends some major changes. First, there may be geographic shis

within or between countries in producing lower value products. In the PRC,there has been a move to relocate actories to less developed inland provinceswhere wages are lower. Yet, while the PRC may no longer be considered a low-cost producer, it is also dicult or manuacturers to look elsewhere in the shortterm given the PRCs inrastructure and skilled worker advantage. Hence, theremay be more emphasis by PRC companies toward targeting the domestic rather


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Figure 14a: Exchange Rate Movementsin Selected Asian Economies

($ against local currency, January 2007 = 100)


Source: ADB calculations using data from Datastream.

170

160

150

140

130

120

110

100

90

170

160

150

140

130

120

110

100

90

Jan-07 Nov-07 Sep-08 Jul-09 May-10 Mar-11 Jan-12 Mar-13

Malaysia ThailandJapan PhilippinesPRC

Figure 14b: Exchange Rate Movementsin Selected Asian Economies

($ against local currency, January 2007 = 100)

120

110

100

90

80

70

60

120

110

100

90

80

70

60

Jan-07 Nov-07 Sep-08 Jul-09 May-10 Mar-11 Jan-12 Mar-13

Republic of KoreaIndia Indonesia Viet Nam


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than overseas market. Te rising value o the renminbi may urther accelerate thetrend by making exports less attractive.

Faced with rising labor costs, the PRC will also move away rom labor-intensiveproduction, transerring it to lower cost countriesthe leading dragonphenomenon (Chandra, Lin and Wang 2013). Tis holds the potential ocreating jobs in other countries in the region. Tere is already a rising trend ooreign direct investment by the PRC within Asia, similar to Japan in the 1980s(Figure 15). In addition, Japanese corporations also appear to be investing inmergers and acquisitions, estimated at $65 billion in 2011, a record high (seeIinuma 2012).

Lower cost manuacturing will continue as rms migrate to countries likeViet Nam and Bangladesh. But inrastructure bottlenecks may limit the type omanuacturing that could be transerred, and the level o product sophistication.Also, many countries have recently enacted minimum wage increases. Viet Namraised its minimum wage by up to 18%, Tailand 35% and Indonesia by anaverage 40%. Malaysia recently introduced a minimum wage or the rst time.While this may be good rom a welare perspective, it could hurt competitivenessin industries with a high proportion o labor costs. Tere are several competingactors that will infuence the industry and product conguration.

Figure 15: Share o the PRC, Japan, and the Republic o KoreaFDI in otal Asian FDI Infows

PRC = Peoples Republic of China, FDI = foreign direct investments.

Note: ADB calculation using the Asia Regional Integraiton Center (ARIC) Database on FDI.http://www.aric.adb.org/indicator.php. Accessed on 12 March 2013.

Source: ARIC, ADB.

0

2

4

6

8

10

12

14

1997 1999 2001 2003 2005 2007 2009

%

PRC Japan Republic of Korea


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Issue #11. Growing Importance o Sofware. Te requency o hardwarereplacements (or example, computers and mobile phones) will likely slow indeveloped countries, with soware and applications gradually dening themarket. Another uture trend is a potential backlash against built-in obsolescenceand product upgrade cycles. Currently, electronics consumers appear lockedinto 2 year upgrade cycle. Te regions manuacturers have benetted rom theshortening o product cycles. However, as hardware becomes more powerul, itmay eventually reach a point where consumers are satised with the hardwarethey have and will simply upgrade soware. As a result, margins or hardwaremanuacturers will get squeezed. A good example is the iPhone, which typicallyretails or $600. Out o that, it has been reported that about $200 goes to hardwaremanuacturers, while $400 goes to Apple or design and soware (able 6).

able 6: Estimated Cost o iPhone 5 (16 GB) Components ($)

Retail Price 649.00

Cost of Components 199.00

Manufacturing Cost 8.00

Components and Manufacturing Cost 207.00

Estimated Cost of Components

Memory

NAND Flash 10.40

DRAM 10.45

Display and Touchscreen 44.00

Processor 17.50

Camera(s) 18.00

Wireless Section 34.00

User Interface and Sensors 6.50

Bluetooth and Wi-Fi 5.00

Power Management 8.50

Battery 4.50

Mechanical/Electromechanical 33.00

Box Contents 7.00

Source: Rassweiler, Andrew (2012). Accessed on 9 April 2013.


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Also, as consumers become more auent, a greater premium is placed ondesign and customized products. Tus, there could be a shi away rom themass-produced products where Asia does so well. In addition, electronic chipsor sensors are increasingly embedded into a vast array o products. In theautomobile industry, or example, there is growing dependence on electronicsand soware to enhance saety and eciency. Vehicles with automated parkingsystems are already available while sel-driving cars have been extensively testedand could become the wave o the uture. Contemporary cars such as the ChevyVolt holds around 10 million lines o codemore than a Boeing 787 airliner (seePaur 2010).

Issue #12: New TechnologiesRobotics, Additive Manuacturing, DesignerPharmaceuticals andWhat Else? Tere is clearly a move toward greatereciency and productivity o actor inputs, shaped by the pressure to producegoods at the lowest possible price while meeting consumer demand. Greater useo advanced techniquesincluding robotswill gain momentum. Adjustmentsto rising wages and changing demographics have increased actory automationin Asia. For example, the Foxconn echnology Group recently announced itsplans to use more robots in its plants in the PRC (see He 2013). Estimates romthe International Federation o Robotics show there has been a steady increasein industrial and proessional robots over the last 20 years (Figure 16). Asia hasbecome the largest market or industrial robotics, led by Japan, the Republico Korea, and the PRC, with the latter growing astest over the past 5 years(Box 5).

Figure 16: Worldwide Shipments o Industrial Robots

Source: International Federation of Robotics Statistical Deparment.

0

20

40

60

80

100

120

140

160180

1994 1996 1998 2000 2002 2004 2006 2008 2011

'000 of Units


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Ever since the dawn o the Industrial Age, manuacturing has been equated withactory production using large machinery and an ample workorce or economieso scale. But additive manuacturing processessuch as 3D printingallow orcustomized production at low cost. Tis means production could potentially takeplace without large machine tools or assembly lines. Long and complex supplychains may no longer be necessary as the entire products can be built romscratch without the assembly o dierent components (Box 6).

Box 5: Emergence o Industrial Robots

There was a strong increase in the shipment of industrial robots in 2011, drivenmainly by strong demand from automotive and metal industries. Asia is now thelargest market for robots, accounting for more than half of shipments globally.Japan and the Republic of Korea are the largest markets. But the PeoplesRepublic of China (PRC) is fast catching up, with robot shipments growing51%. The rapid growth reflects growing sophistication in manufacturing. Mostof the robots are destined for the automotive and electronics industries, areasin which the PRC continues to target. The increased use of robots could be away for the PRC to maintain its competitiveness as labor costs rise.

As they have for decades, robots are becoming ever-more sophisticated, ableto handle increasingly complex tasks. In the near future, robots could becomemore ubiquitous in Asias manufacturing as demand for higher precision canno longer be met by humans. This could pose challenges for new entrants tovalue chains if low labor cost will no longer be an advantage.

Source: ADB staff, based on information from Industrial Federation of Robotics and othermaterials.

Box 6: Tree Dimensional PrintingOne Exampleo Additive Manuacturing

It is analogous to the inkjet printer, which squirts minute particles of ink ontopaper. In manufacturing, a 3D printer creates a solid object from tiny particlesof raw materialscurrently mostly polymers. It is an additive rather than asubtractive process, which consumes less raw materials. The proliferation ofinkjet and laser printing brought printing technology to homes. 3D printing isnow doing this for rudimentary manufacturing.

Traditional 3D printing has been used for making prototypes, but it may soonbecome inexpensive enough for making custom products. Initially it will likelybe limited to making high-cost components, but it could eventually be used

continued on next page


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for producing for the mass market. Additive manufacturing has the potentialto transform the industry by increasing flexibility, reducing turnaround time,and cutting back on excess inventories. It can also reduce raw material wastagecompared with the traditional subtractive processes

A key advantage of 3D printing is the variety of products produced by a singlemachine. This compares with traditional processes where a production linemust be retooled (at high cost) to produce another product. So 3D printingoffers much greater flexibility. It may also make it much easier for new entrantsto jump into the market, as several steps in the supply chain such as sourcingand warehousing can be eliminated.

3D printing remains relatively new, but could herald an era of significantproduction decentralization. Key inputs would be the designwhich wouldbe fed into the printers computerand the products produced. Factoriescould become obsolete. Customized products could be built on demand. Therevolution could be similar to that of on-demand book printing, where thereis no longer a need for a large print run to justify the cost of setting up theprinting machine.

Further hurdles must be overcome before additive manufacturing is widelyadopted. At the moment, the technology is not cost effective and raw materialcosts remain prohibitive: the cost of raw plastic needed for 3D printing isaround 30 to 100 times the cost of material used in injection molding.

While the exact impact of additive manufacturing is hard to predict, severalscenarios are possible. First, it is likely that the time-lag between product designand delivery will be considerably reduced. Customers will also demand productscustomized to their tastes and preferences. 3D printing allows for additionalbatches to be produced at minimal additional cost. Most relevantly for Asia,

3D printing has the potential to challenge the low cost production model byallowing for just-in-time manufacturing near the point of sale. These featureswill likely revamp the supply chain.

A key question is: will 3D printing and other additive manufacturing solutionstake away or add new jobs? There may be short-term redundancies, but over themedium-term, skills will have to adjust to meet the design and printing needs.Worker productivity could skyrocket, as it did when the vast army of newlycomputer-literate workers joined the labor force. Countries and companiesneed to continually invest in skills upgrading. There is no short-cut.

Source: ADB staff, based on various materials.

Box 6 continued


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31

SECTION IV

Beyond Factory Asia

A. Strategic Options or Developing Asian Economies

Asian manuacturing is at a critical juncture. Factory Asia has brought largedividends or parts o the region and helped secure Asia on the global economiclandscape. Te gains made will be a major contributor to the potential AsianCentury, just as the Industrial Revolution shied the balance o economic powerto the Western world. Yet, the global nancial crisis has been a loud wake-upcall or the region to adjust, just as the Asian nancial crisis was a turning pointin addressing nancial distortions and macroeconomic restructuring. In theimmediate uture, rebalancing toward domestic and regional demandwhich isalready well underwaywill be supported by the newly emerging middle class.

However, the regions economic growthand hence that o the middle classis ar rom pre-ordained. Unless all countries in the regionlarge and smalladdress the myriad challenges acing them, the Asian Century may become apipedream. Te issues considered in this paper are among those challenges.

In this subsection, several strategic options are posited in order or countriesand economies to move beyond Factory Asia. Options have been classied orve dierent country categories (able 7). Investment in education and training,inrastructure, and strengthening links between services and manuacturing

will be crucial or all in moving beyond the Factory Asia model. For countriesalready a part o Factory Asia, their main goal is to urther move up the valuechain and expand markets. Meanwhile, or countries currently outside themodel, there may be advantages in joining production networks. Manuacturingremains a key driver o growth, and being part o a production network enablescountries to obtain access to technology and new markets. Countries withlarge domestically-oriented manuacturing could leverage their strengths toleaprog traditional technologies and move up the value chain by joining theproduction network.

Regional cooperation is vital to the continued success and evolution o FactoryAsia, given its complex challenges. Te smooth fow o goods and investmentthroughout the regiona necessary part o Factory Asiahas been underpinned


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able 7: Strategic Options Beyond Factory Asia

Large Domestic Markets Small Domestic Markets

CountriesAlreadyWithinFactoryAsiaM

odel

Group 1(Notable Examples: Peoples Republic ofChina and Indonesia)

Move up the value chain to producehigher value-added and sophisticatedproducts to supply both domesticand global markets

Leverage knowledge gained todevelop home grown technologies

Support small and mediumenterprises (SMEs) for investing innew technology

Build up domestic brands that can beexpanded to other markets

Invest in education to upgrade thequality of the workforce

Group 2(Notable Examples: All NewlyIndustrialized Economies)

Shift from production to knowledgeeconomya

Invest in research and development,innovation, and strive to be atechnology leader

Expand to new emerging markets

Group 3(Notable Examples: Cambodia;Malaysia; Philippines; Thailand;Viet Nam; and to some extent,Bangladesh and Sri Lanka)

Solidify current position inproduction networks (for middleincome)

Aim to move up on value chain (for

middle income) Aim to carve out a niche in lower

value manufacturing as othercountries progress up the value chain(for lower income)

Improve investment climate, andattract foreign direct investment tofurther strengthen and expand theindustrial base

Improve skills and training forworkers to increase productivity

C

ountriesThatAreOutside

FactoryAsiaModel

Group 4(Notable Examples: India and Pakistan)

Use large domestic market potentialto attract manufacturing investmentand technology, by continuouslyimproving the investment climate

Leverage knowledge and experiencein domestic manufacturing toleapfrog to higher value chain levels

Support small and medium sized

manufacturers in joining productionnetworks

Group 5(Notable Examples: All Central AsianRepublics; and Pacific Island and othereconomies)

Identify constraints to joiningproduction networks

Improve infrastructure and logisticsto reduce transportation costs.

Strengthen existing manufacturingsectors while diversifying into new

areas

a See Asian Development Bank (2013).


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Beyond Factory Asia 33

by enhanced regional cooperation, resulting in trade liberalization and theopening o markets. I anything, this momentum will have to be deepened inthe uture.

B. Specic Policy Recommendationsor Developing Asian Economies

Building on the strategic options or the dierent country groups, one cansummarize the challenges and oer some indicative policy measures to movebeyond Factory Asia (able 8).

For reasons outlined earlier, markets within the region will have to be a strongtarget or the regions manuacturers. Tere will need to be a change in mindsetrom producing or western to eastern markets. Given the diversity in conditions,income, tastes, and cultures across countries in Asia, the importance o designand customized products will grow in importance.

At the same time, the region will have to ensure that the benets rom uturegrowth will be more evenly shared. As the region transorms itsel, countries

need to ensure training and skills upgrading or existing workers intensies sothey can compete in the new environment. Small and medium scale enterprisesshould be encouraged to participate in production networks that have beentraditionally dominated large multinationals.

Global trends will continue to have a major impact on manuacturing in theregion. In the past, policies have generally ocused on making the region anattractive low-cost base or global manuacturing rms. In the uture, however,there may be a shi toward locating production sites closer to uture consumers.

In this sense, Asia is likely to benet as a growing source o demand or its ownmanuactured output.

Policymakers will also have to change their mindset and view other developingAsian economies as potential customers. While the private sectoras it has donethus arwill lead economic ties through investments, major economies needto boost regional cooperation. Beyond generalities, countries may need to adoptspecic measuressuch as policy and nancial incentives or rms to ventureinto nontraditional markets within the region. Governments may also help

manuacturers build connections in ast-growing markets. Addressing behind-the-border challenges and making trade reer at regionally and globally shouldbe among the priority government eorts in the region.


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able 8: Policy Recommendations or Moving Beyond Factory Asia

Issues Policy Recommendations

1. Weaker growth in advanced countrieswill see demand shifting from developedmarkets to emerging economies

p Support domestic demand

p Forge effective regional and south-southcooperation, while multilateralizing freetrade

p Provide smart incentives for targetingregional markets

2. Factory Asia must cater to growingmiddle class consumer demand in theregion

p Ensure investment is adequate, asconsumption demand rises

p

Support inclusive and environmentallysustainable growth

3. Asias manufacturers need to buildstrong brand identity to competeglobally

p Ensure country labor and safety standardscomply with international norms, andinvest in lumpy facilities (standardslaboratories) for quality testing andassurance

p Facilitate public-private dialogue to boostcountry and product identity (throughsector or industry promotion facilities)

4. Weak economic growth andhigh unemployment may lead toprotectionism in developed countries

p

Regional (ASEAN; SAARC) and globalgroups (G20) to cooperate to keepprotectionist tendencies in check

5. Long and complex supply chains arebecoming more vulnerable to naturaldisasters and reputational risk

p Private sector to adopt effective +1strategies to diversify risk away from singlecountry focus, and public sector to adoptenabling policies to both attract andpromote regional FDI

6. Wages in Asia have been rising fasterthan developed countries narrowing thecost differential

p Adopt accommodative policies to supportprivate sector efforts to move up the valuechain

7. Exchange rates have become morevolatile making it harder to manageproduction networks across countries

p Develop financial markets and products tohelp private sector manage risk

8. Shortage of skilled workers couldhamper move toward producing moresophisticated products

p Adopt public sector measures to supportskills development, directly througheducation as well as enabling privatesector to continuously re-skill workers

9. Changing demographics in somecountries will result in a smaller laborpool

p Countries in the region to cooperateamong themselves and facilitate privatesector efforts to align skills to boostcompetitiveness

continued on next page


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Issues Policy Recommendations

10. Production has been shifting from highcost countries to lower cost countries

p Support the entry of small and mediumenterprises into production networks

p Governments to launch public-privatedialogue to facilitate private sectorpositioning of investments or industriesin appropriate lower cost locations inthe region

11. Software is becoming more importantin manufactures and absorbing greater

share of value

p Support continuous skills upgradingto facilitate value chain and product

sophistication

12. Advances in robotics and additivemanufacturing technologies couldherald a new era in manufacturing

p Countries to invest directly in research anddevelopment as well as absorption of newtechnology

ASEAN = Association of Southeast Asian Nations, FDI = foreign direct investment, SAARC =South Asian Association for Regional Cooperation.

able 8 continued

As the labor cost advantagethe most important or the region in the last25 yearsnarrows, countries will have to nd and build other advantages. While

demographics are shiing in a ew major economies, there is abundant laborin others. Future manuacturing will be more skill-dependentensuring thesupply o highly-skilled workers will be key to its success (ADB 2013). Besideshigher education in science and technology, technical and vocational educationmust be prioritized to ensure school-leavers are well-equipped to join modernmanuacturing industries. With advances in inormation and communicationtechnology, students must be shown the trends and opportunities that can steerthem toward subjects that will be in great demand in the uture. Countriesaced with the prospects o losing jobs to other, more cost-eective locations,

should invest more in education and inrastructure to move up the value chain.Manuacturing jobs have traditionally been seen as less prestigiousthehigher skills required in the uture should negate those preconceptions. Teprivate sector also needs to invest in continuous skills upgrading. Faced withevolving technologies, continuous and strategic support or skills developmentcan help the region to be more fexible and adaptable to an uncertain uture.Regional cooperation will help acilitate skills mobility. Te ASEAN EconomicCommunity 2015 ramework provides or this, and these eorts must be nurturedby policymakers.

World-class inrastructure is crucial to attract manuacturing giants. Te PRCin particular has made tremendous strides in improving inrastructure. Withdeclining taris in the region and the world, the private sector has shied itsocus rom taris to reducing transport and transaction costs, along with other


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nontari barriers such as border procedures and logistics services. Tese arecritical or sustaining manuacturing growth in the uture. Asia has indeedmade progress in providing inrastructure, but remaining gaps and nancingneeds are huge. Logistics, so vital or manuacturing, remain ar behind that oNorth America or Europe, or example. Investing in inrastructure and logisticsacilities is critical or the smaller Southeast Asian economies and almost allSouth Asian economies, as they strive to redene their manuacturing landscape.Unless addressed, the short-term wage and cost advantages these economies havewill dissipate with low value manuacturing production moving to Latin Americaor Arica.

While this Monograph has ocused on Factory Asia, there is a strong nexusbetween manuacturing and services. Tere are many critical service unctionsrequired or successul manuacturing. In addition, Asia must develop whatkind o balance between manuacturing and services it believes will suit it bestin 20202030. As noted in ADBs 2012 Asian Development Outlook Update,one strategy is to create domestic demand and expand intraregional trade.7 Tisis already happening. Te other is to strengthen the relatively underdevelopedservice sector across the region. Asia clearly put its best oot orward bytransorming itsel into Factory Asia. Now the regions hidden backward legservicesrequires exercise to restore symmetry and enable the region to standon its own two eet. Tere is still considerable room or growth. Between 1990and 2010, developing Asias services share o GDP grew only marginallyrom45.2% to 48.5%the slowest shi in comparison with other regions in the world.As logistics and inormation and communication technology-related servicesbecome more vital to boost manuacturing, Asian economies have much workahead to strengthen services (Appendix).

C. Policy Implications or Developed EconomiesTe current shis in the Factory Asia model will inevitably have implications ordeveloped countries as well. In the short-run, adjustments will aect consumersin those countries as domestic and regional demand builds up. While the PRCsmanuacturing value-added surpassed the US or the rst time in 2010, at $1.9trillion, there are major compositional dierences. Te US, Japan, and severalEuropean countries clearly lead in advanced research and development. Tus ar,the division o manuacturing has been generally thought o as Asia producing

mostly lower value goods, while the developed world exports more sophisticatedproducts. Tere have been prominent examples o Asian manuacturers drivinginnovation and moving up the value chain. In the medium-term, there will be

7 See ADB (2012).


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intense competition as manuacturing shis in Asia. Developed economies willneed the markets that developing Asia (and other regions o the world) oer,while competing with it on several ronts. At the same time, both developed anddeveloping economies generally realize they need to cooperate and promotenancial and trade fows. Te next generation o changes in regional andglobal architecture will also need to be become as sophisticated as the world omanuacturing.


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38

SECTION V

Conclusion

Tere were seven questions posed in the Foreword to this monograph. Someanswers are posited hereno means denitive, given the complexity o the issues

and challenges, and the policy choices countries will have to make. Progress alsohinges considerably on how eective public and private sectors dialogue andwork together, and how countries will cooperate within the region and beyond.

1. Will Factory Asia continue to be the dominant driver o growth in Asia?

While changing global trends will have an impact on Factory Asia, it is likelyto continue as an important source o growth or the region. Asia can sustainits position as manuacturing powerhouse i it adapts to the trends andtransorms itsel. A considerable part o the region remains outside FactoryAsia and could benet rom joining. As early participants o Factory Asiamove up the value chain, there are opportunities or other economies to llthe gap.

2. How will the increase in domestic and regional demand transormFactory Asia?

raditionally, Factory Asia ocused on manuactured products exportedto developed economies. However, consumer demand rom the West willlikely be weaker with slower growth in advanced economies. Hence, thenew Factory Asia will have to evolve toward serving customers within the

regionwithout appearing to become Fortress Asia. Asias growing middleclass is a large potential market. o succeed, the regions manuacturers mustcontinue to invest and improve quality, design, marketing, and branding.

3. For those rmly embedded in current regional production networks, whatadjustments will be needed in the overall growth strategy?

Economies that are part o production networks should use the skillsand experience acquired to move up the value chain and produce higher

value-added products. Te Republic o Korea has succeeded in becoming a

technological leader in electronics, while the PRC is also making impressiveheadway. Japans technology dominance will continue. ogether, these threeare likely to dene the uture landscape. Te new growth strategy will bemore knowledge-intensive and require more investment in human capitaland R&D.


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Conclusion 39

4. It appears that larger rms dominate production networks in Asia. Whatcan be done to encourage small and medium enterprises (SMEs) to joinproduction networks and benet rom greater integration?

SMEs are typically bypassed in public-private sector dialogues. Specialmechanismsand not necessarily subsidiesare needed to boost SMEaccess to regional production networks. Well-tried recipessuch ascommon acility clusters that support SMEsmay need to be revisited withthe specic goal o helping them join global value chains. Dedicated supportor value chain nancing will help. Te evidence shows transport corridorswork, and thus need to become more integrated within overall economic

planning. Tat way SMEs can play a larger role in producing intermediategoods or providing logistics and other supporting services.

5. For the many countries outside Factory Asiaor on its peripheryare there emerging opportunities up or grabs? Will they become newpartners and join regional production networks, or will they leaprog theearly stages entirely and enter at higher levels o the value chain?

Tese countries should look or ways to participate in networked productionvia the Factory Asia model. Tose who dominate early have the potentialto direct their investments and technology into other economies (in Group4 or 5). o acilitate the process, governments must improve inrastructureand liberalize trade to acilitate fows o goods and services across borders.Greater inter-regional (South-South) cooperation could help countrieslearn rom others experience in production networking. Countries joiningproduction networks aresh would not necessarily have to start at the bottomo the value chain. Tey can leverage existing strengths and experience tostart higher up on the value chain.

6. How will regional and global investment ows adjust to the changing roles

and importance o agriculture, manuacturing, and services to economicgrowth?

Labor mobility will continue rom agriculture to manuacturing to takeadvantage o the higher productivity. As countries urther develop,services will grow in importance. Factory Asia got its start when Japanesemanuacturers (and others) invested and set up actories abroadas theywere aced with rising labor costs. oday, global and regional investmentsare heading toward emerging economies with competitive cost structures.Services can play an important complementary role in helping develop

manuacturing capabilities. Countries in Groups 3, 4 and 5 need tocontinuously impro

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