Reform or perish: Asian factories must shape up or ship out in the face of Chinese export aggression

Beyond electronics exports, other sectors are being undercut, leading several governments to announce targeted support measures for firms and consumers, even as headline growth has headed higher.

At the same time, policymakers across the region have scrambled to negotiate trade deals with the US to secure a lower tariff rate than their competitors.

These tensions are set to persist as the US and China continue to rely on trade policies to advance their strategic objectives. While the Trump administration frames lower bilateral trade deficits as a way to strengthen national security, China is supporting advanced manufacturing for self-reliance in critical technologies and growth. Neither has much regard for the economies caught in between.

The regional spillovers are large. Consider tariffs. In the US, domestic substitution to offset costlier imports is constrained by the absence of a mature manufacturing ecosystem, which may take years to develop. And even then, cost considerations may keep low-value-added manufacturing offshore. Thus, import demand is likely to be redistributed among trade partners, benefiting those with advanced abilities and lower tariffs.

This is what happened when massive US tariffs put China at a disadvantage vis-à-vis other Asian economies. Asean countries offset 55% of the decline in China’s share of US imports and India accounted for another 8%. Although re-routed Chinese goods accounted for some of these flows, a product-level assessment shows that such transshipments accounted for at most 12% of total US imports from Asean members.

Whether Asia excluding China will continue to play this role depends on US-China trade talks and Washington’s response after the Supreme Court struck now many of its tariffs. Since US tariffs are unlikely to be eliminated, a much narrower differential between China and its neighbours will probably push demand for traditional goods back to China.

This would be another shock for Asian manufacturers that are already contending with Chinese competition. Faced with demand moderation in the West and a slump at home, China has redirected exports to Asia.

Since 2019, Asean’s imports from China have exceeded those from within the region, eroding its manufacturing base. Thailand has been hard hit, with its steel industry a major casualty. Indonesian textiles, Indian toys and Taiwanese machine tools have faced the same problem.

In contrast, advanced electronics has thrived, owing to the AI boom. Trade measures have limited China’s participation in the US high-tech sectors, opening a strategic for other Asian countries like Taiwan, South Korea, Singapore and Malaysia.

The same can’t be said for Asia’s traditional manufacturing sectors at risk of being hollowed out. Without policy interventions, US protectionism and Chinese overcapacity could accelerate deindustrialization in countries like Indonesia and India.

To do and not to do: The path to addressing these pressures without aggravating trade tensions is narrow. Cheap Chinese imports threaten others’ prospects, but also reduce cost pressures for downstream industries. Raising trade barriers therefore is not a solution as it may provoke retaliatory measures from China.

Regional governments have tried to resolve the situation by courting Chinese investment. The stock of Chinese foreign direct investment (FDI) in major Asean economies has more than doubled in the last decade. But this option, too, has problems. Chinese firms tend to source most inputs locally, while using others mainly as an assembly base. Also, it attracts US attention.

Instead, the policy response should focus on addressing the root causes of manufacturing weakness. Though Beijing is often blamed for sustaining excess capacity and lowering export prices, this is only partly true. China’s low prices also reflect its highly automated production processes and strong productivity, factors that more than offset Asean and India’s labour-cost advantages.

Economies that launch reforms to close the productivity gap with China and lift their factory sector’s competitiveness will thrive. This path will not only help them gain market share, but also enhance their appeal as a ‘China Plus One’ FDI destination.

Infrastructure spending, targeted skills development, faster adoption of digital technologies, enhanced labour mobility and knowledge transfers within the region are essential.

Deepening trade integration is equally important. Recent breakthroughs in long-stalled trade talks may not yield benefits immediately. But they will expose domestic industries to greater international rivalry and drive innovation and efficiency gains over time. In turn, these forces will lift competitiveness and unlock new markets.

As tempting as it is to lean on industrial policies, they should be used judiciously. Asian economies cannot match the scale of China’s industrial support, which the International Monetary Fund estimates at around 4% of GDP. They would be better off allocating scarce resources to reforms.

Some are already moving in this direction. Malaysia has leveraged its existing ecosystem to strengthen its position as Asean’s semiconductor hub. Vietnam is undertaking reforms to upgrade, though it has yet to establish itself as a highly productive manufacturing base, as opposed to a cost-effective one. Finally, India has resumed reforms, starting with its long-overdue labour codes. Still, it has significant ground to cover to close the gap not only with China, but also with its Asean peers.

Rising US-China frictions and worsening global imbalances have triggered a basic reordering of Asia’s manufacturing landscape. New tariffs, subsidies and industrial policies, and the redirection of trade and investment flows will likely hollow out traditional manufacturing in some Asian economies. Countries that are embedded in critical tech supply chains will outperform. But so can countries that move decisively on reforms aimed at manufacturing success. ©2025/Project Syndicate

The author is director and principal economist at Asia Decoded.