Almost three months into the Russia-Ukraine conflict there remain many uncertainties, but some trends that our region will have to deal with are becoming clear. It will be a troubled time for less powerful countries, including those in Southeast Asia: Expect a hardening of big power hostility against each other; growing insecurity for other nations as the big powers raise their military profiles in the regional backyard; and a higher chance that political tussles will create economic challenges such as protectionism and inward-looking policies.
But as the Western bloc led by the US and the opposing bloc centred around China each pursue their game plans to outdo the other, there will be opportunities as well as headaches for us in the region. How our neighbourhood fares in the end will depend on regional leaders having the wisdom to ensure a more unified regional response.
The region faces a harsher world
The impact of war in Eastern Europe goes beyond just a conflict involving a US-Europe alliance against Russia. It has crystallised a series of manageable scuffles between the US and China over trade, intellectual property and military positioning into what is likely to be a prolonged contest for supremacy in the world. Thus, each bloc will pursue strategies to strengthen their defences and keep their adversaries at bay, including the following:
- A major military build-up is underway and it will probably expand to include stepped-up spending on research and development (R&D) into high-tech weaponry and cyberwarfare;
- Further sanctions and other forms of trade, financial and alternative pressures on each other;
- A stronger focus on potential threats will lead the big powers to worry more about their supply chains, how dependent they are on exports and imports from rivals, and how secure the transport routes that convey supplies of food, energy and critical components are. Policies will be introduced to encourage their private companies to amend their strategies so as to reduce these risks.
- The risk of decoupling is growing. There have already been persistent US, European and Japanese measures to reduce reliance on Chinese supplies of equipment in sensitive areas. Now China is also doing the same — its recent instruction to government agencies to ditch all their foreign-made personal computers and software in favour of home-grown ones is a sign of things to come.
- Each side will also be keen to co-opt more members into their military alliances while wooing neutral countries to ensure they do not fall in with their rivals. The benign form of this approach could be more aid and assurances of trade and investment benefits. But, there could be less benign tactics as well, such as buying over corrupt elites in those countries where possible and using money as well as social media and other propaganda tools to subvert citizens to support them. Countries that straddle important sea lanes of communications such as the Straits of Malacca and the South China Sea could be targeted. China’s alternative routes via Pakistan and Myanmar will also become more important. That might make China less willing to adopt a hard line with Myanmar’s military junta and make a resolution to that sad country’s predicament all the more difficult.
What should Asean members then expect?
First, each of the blocs will step up efforts to win over countries in the region. The recent US-Asean Special Summit is an example — indeed, how that event went tells us something about the state of affairs the region should prepare for.
- After a period of neglect, the US is showering the region with lots of love. Ambassadors have been named to most of the Asean countries — unlike in the Trump years when many ambassadorships in Asean went unfilled. The key American departments overseeing relations with Southeast Asia, such as defence, state and the National Security Council, are now manned by regional experts. The Biden team makes it a point to send high-level officials to attend key regional forums. One of the achievements of the US-Asean summit was the US agreeing with Asean to upgrade their ties to a comprehensive strategic partnership in November.
- But the summit also showed up the limits of American engagement. The US$150 million in assistance on offer seemed pitiful in comparison with what China has proposed for the region through its many initiatives, including the Belt & Road Initiative. China is also a member of the Regional Comprehensive Economic Partnership and is applying to join the Comprehensive and Progressive Trans-Pacific Partnership, meaning that it will be in a position to offer greater market access, something that Asean’s economic managers are keen on. In contrast, domestic politics makes it virtually impossible for the US to offer expanded market access through trade agreements. The US has instead proposed an Indo-Pacific Economic Framework, whose details will only be known in a few weeks’ time. But the four pillars it comprises seem to reflect America’s particular interests rather than Asean’s. For example, one pillar — “fair and resilient” trade — seems like a code phrase to impose American standards on labour and the environment on Asean.
- Polite Asean officials have said in public that the American initiatives are a good starting point. But some, like Malaysia’s Trade and Industry minister, have added that what Malaysia wants is things like market access, which China offers and which can enhance its attractiveness to foreign investors.
On the other hand, we believe that China will exploit the US weakness in the economic sphere. It would not surprise us to see a revised Belt & Road Initiative, which would shower Southeast Asia with more money and higher priority. China is also in a position to use its existing free trade agreements with Asean to offer better provisions. Somehow, the US will have to improve its offerings to Asean or lose out. The competition between the two big powers will therefore deliver better benefits to the region.
Second, multinational companies with facilities in China will now have to think hard about the geographic allocation of their production centres. Even through Trump’s trade wars, many MNCs were reluctant to move production out of China, reliant as they were on the super-cost-efficient ecosystem of Chinese component suppliers. But as their home countries’ governments become warier about China, the risks of a large allocation to China will grow. The appeal of diversifying into Southeast Asia will increase, even if a price has to be paid in terms of higher costs and less efficiency. The US will know that if it cannot provide Asean with more market access, it can at least nudge its companies with incentives to relocate production out of China and into this region — as Japan has started to do. With regional economies improving their competitiveness through labour market reforms, better infrastructure, reduced restrictions on foreign ownership and weaker currencies, Asean is anyway looking better as an investment location. There is a good chance of a stepped-up pace of production being shifted to Southeast Asia.
Other implications may not be so congenial. What is clear is that China’s leaders must be deeply concerned about the Western powers’ capacity to impose sanctions, virtually expropriate foreign exchange reserves and cut off access to critical financial networks such as SWIFT (Society for Worldwide Interbank Financial Telecommunication). What is not as clear is what China can do in response — given its substantial dependence on exports, and its vast foreign exchange reserves that can realistically only be mostly invested in US Dollar assets. But something tells us that China’s vulnerability is so unacceptable that China’s leaders will find ways around this, even at a high cost. Our expectation is that there will be major policy changes in China as it works out how best to improve its strategic capacity to withstand Western economic pressures:
First, China has been contemplating a shift away from exports to emphasising domestic demand, as enshrined in President Xi Jinping’s “dual circulation” approach. Now, what is likely is a bigger push to expedite that move. But to do so, China’s leaders will need to reform policies it has been cautious about changing. For example, they need to allow the close to 300 million migrants more rights so they can command higher pay and spend more — but this will involve overcoming the opposition of the powerful large cities. It also means getting state enterprises to distribute more of their profits back to the state so that the government can expand social safety nets — that would help reduce China’s sky-high household savings rate.
Second, there is likely to be an inward turn in Chinese policy. Across many products deemed sensitive for military or other reasons, China will strive to reduce reliance on components produced outside China. Semiconductors are one obvious example. But there will be many more areas where domestic production will be subsidised to displace foreign imports.
Third, China will also need to move faster on opening up its capital account and making the yuan more flexible and market-determined if it is to eventually reduce its exposure to a US-dominated financial system and create its own. Several senior officials such as retired central bank governors have advocated this for years only to be rebuffed by a government wary of the risks of free flows of capital and a volatile currency.
All these strategies will take time to be implemented. But the net effect eventually will be reduced Chinese demand for components that Southeast Asian countries currently export to China. The price of the reforms mentioned above, which China cannot afford to keep postponing, could be a more volatile and risky Chinese economy — as capital flows are liberalised and the yuan becomes more of a floating currency.
Conclusion: Asean has to improve its own act
The above is only a selective flavour of the many changes that will be wrought as the big powers restrategise. There are benefits to Asean as well as risks in this process. What the net effect will be will depend on how the region — collectively as Asean and individually — responds. If it can achieve the following, then there will be a higher chance that the overall outcome is a favourable one:
- Asean has to act with greater solidarity and cohesion than it has been capable of in recent years. The external situation has changed and requires greater unity to face up to the big powers’ likely strategies, some of which may not be benign. For this to happen, Indonesia, the region’s giant and natural leader, will have to take on a greater leadership role than it has been willing to. This is possible but will not be easy.
- Individual countries will have to step up the pace of reforms so that their economies gain greater dynamism and more substantial resilience in what will be a rougher global setting.
- They will also need to strengthen their capacity to deal with subversion and efforts to co-opt opinion makers and officials — through a stronger anti-corruption drive, stronger checks and balances such as a freer press and more transparency.
The stakes are high and we can only hope that Asean rises to the challenge.
Manu Bhaskaran is CEO of Centennial Asia Advisors