What Can Southeast Asia Get Out of China’s— and Everyone’s—Shift to the Region?

Southeast Asia has been thrust into the crosshairs of geopolitical competition these past few tumultuous years, necessitating choices about how to handle the movement of economic activity emanating from China.

This movement is not entirely new. Roughly a decade after China’s accession to the World Trade Organization solidified its status as the “world’s factory”, wages in the country began rising – a natural consequence of improving living standards and greater competition for increasingly skilled workers.

Southeast Asia became the first port of call for global companies that had relied on China as a production base as well as for Chinese contract manufacturers themselves, who – like the Japanese and Taiwanese companies before them – sought comfort in geographic and cultural proximity as they competed on cost.

Myanmar’s modest opening, Vietnam’s accelerating reforms and the political stability – albeit deeply authoritarian – of Laos and Cambodia all proved attractive, in what many saw as the latest iteration of the “flying geese” model of shifting production, by which anchor firms lead suppliers to new production bases, flying in V-formation towards greater efficiency.

What has happened over the past decade, however, is different from this market-driven migration. The flock has kept flying, certainly, but now in pursuit of resilience rather than efficiency.

A succession of seismic shocks – Donald Trump’s initiation of a trade war in 2018, the Covid-19 pandemic and China’s debilitating lockdowns, mounting security concerns over increasingly digitised and “weaponisable” goods, and Beijing’s full-scale tilt towards indigenous innovation and preferencing domestic firms – all fuelled governments’ desire, and firms’ need, to diversify production and avoid tariffs, scrutiny, risks or all three. 

Firms scrambled for “China plus one” strategies, wrangling with buyers’ somewhat arbitrary diversification demands. The road again led to Southeast Asia. Vietnam, alongside Mexico, has been the biggest beneficiary of production shifting out of China, while Singapore has cleaned up as the safe haven of choice for knowledge-intensive sectors like finance and technology, attracting both Chinese and global firms.

Yet Southeast Asian nations now find themselves caught between competing demands, with everyone wanting things their own way.

Trump’s onerous “Liberation Day” tariffs pushed most Asean members to sign bilateral framework agreements with the US, in which relationships with China figured prominently, not least because of Washington’s vague insistence that “transshipped” goods face higher duties.

The thorny part of that demand is clarifying precisely how much of a product must be made locally to avoid the transshipment label. Such rules of origin are incredibly complex and negotiated through the kind of sustained diplomatic attention that the second Trump administration lacks.

China, meanwhile, is demanding that countries not agree to clear rules on transshipment at all. It has also upgraded its free-trade agreement with the Association of Southeast Asian Nations as its firms continue to simply invest.

The lack of clarity and enforcement of rules of origin has left the door wide open for firms to move into the region without worrying too much about the geopolitics.

Rule-making gap

For Southeast Asia, this mess of competing political demands and market desires is a challenge but also an opportunity. Previous attempts to build trade blocs capable of rivalling China’s regional economic influence have failed due to domestic US politics and the difficulty of agreeing on rules of origin. Neither problem is likely to be resolved in the short or medium term, which leaves a rule-making gap. 

Chinese firms, even the largest and most successful, still want to access global markets and Southeast Asia is their bridge to reach them – a fact that gives the region leverage. In short: Southeast Asian countries can, and should, set the terms of domestic and regional investment, ideally through an Asean regional framework.

When geese migrate, they leave things behind. Conventional wisdom holds that countries benefit from hosting migratory manufacturers as they can pull local firms into global value chains and provide valuable skills upgrades for local labour. But this movement can just as easily be extractive if firms import their own personnel, source inputs exclusively from their home country and do little to improve local labour, infrastructure or industrial ecosystems.

As “rule makers” rather than “rule takers”, Southeast Asian governments can set requirements that let them capture sustained economic benefits from this transfer of production, such as local sourcing, skills training and gaining production know-how. 

Moreover, the imperative for resilience opens a space for rules to become an advantage rather than an additional cost. Knowing that their Southeast Asian partners take sourcing and production requirements seriously can reassure firms that their supply chains will be less vulnerable to weaponisation. 

The apparent chaos of the second Trump administration shows no signs of abating, nor does China’s effort to protect its centrality to global production. The region cannot wait for rules or clarity and neither can the Chinese firms flocking south. It is up to the governments of Southeast Asia to draft creative rules that ensure this geopolitical moment yields economic benefits. 

This is important not just for the region’s growth but also its stability. Putting guardrails in place to ensure that Southeast Asia gains sustained benefits from China’s regional economic engagement would help to build support from both elites and regular citizens for political stability across Asia.

While it is now fashionable to look derisively on the idea that economic interdependence generates peace, the peace has been a fact, even if it is imperfect and has brought popular frustration and concerns about security in the West. Southeast Asia can learn from those frustrations and vulnerabilities to craft the current moment into something economically sustainable and politically palatable far into the future.