The middle step: An economy heavy on manufacturing undergoes a gradual transition

On the economic road from farms to factories to services, Thailand has come a long way. Through a combination of low costs, sound policy, a good work ethic and a relative lack of labour activism, the country has managed to make the transition from an economy based on agriculture and commodities to become one of the most industry-oriented nations in the world.

Manufacturing makes up 34% of the economy by value added as a portion of GDP, a larger slice than in all of its regional competitors, including Malaysia (24%), Indonesia (24%) and Singapore (21%). As the world’s 17th largest manufacturer and ninth largest maker of motor vehicles, Thailand has become a model of economic transformation to many developing countries. Much like Japan before it, the country has built an industrial base from almost nothing in a short space of time. Not least, it has been able to resist the temptations of resource wealth and avoid the Dutch disease.

Thailand is also facing considerable headwinds, and a cross-breeze from political protests. These are weakening consumer confidence, stopping the government from conducting business and beginning to worry international investors. To be sure, the country has faced protests (and even coups) before, but the current round is lingering so long that it is starting to have a material impact on industry. Even if a resolution is reached, Thailand will face other winds: rising costs, competition from emerging regional players and integration with the ASEAN Economic Community (AEC), all of which may threaten its success. It has advanced well from agrarian to industrial to an international power. Its next move may be more of a challenge: it must transform itself from a low-cost exporter to more of a middle-class nation that creates and sells products of higher value.

Steady Rise

The Thai economy has largely followed the arc of development seen in many Asian countries. Before the Second World War, it had very little industry to speak of. Besides saw and rice mills, it had a number of factories producing basic goods such as soap, tobacco, paper, textiles, beer and building materials.

After the war, development came on faster. A period of reconstruction was followed by one of import substitution (about 1958-71), and a third phase saw the development of export-oriented industries. Since then, it has been a steady climb upwards: industry value added rose from 18.5% of GDP in 1960 to a high of 44.7% in 2007, according to the World Bank. Exports grew from 15.7% of GDP in 1960 to a high of 76.9% in 2011. Agriculture value added, meanwhile, declined from 36.4% of GDP in 1960 to a low of 9.0% in 2009.

Free Wheeling

The development of the Thai auto sector illustrates how Thailand has promoted industry through selective support and targeted incentives. Until 1960, the local market was dominated by imports; Thai companies only did repairs. In that year, however, the government began a series of policies to encourage local manufacturing. The Industrial Investment Promotion Act of 1960 lowered corporate taxes and import-export tariffs, allowed foreign ownership of land for approved investments and eased visa rules for technical experts. As a result, Thai Motor Industries began assembling Ford cars from imported kits in 1961. A second law, the Industrial Promotion Act of 1962, halved import duties on knock-down kits.

Thus began Thailand’s golden age of auto making.

Between 1962 and 1964, 12 foreign makers planted roots in Thailand – seven Japanese, three European and two American. “The reason GM chose Thailand as an ASEAN manufacturing hub was down to a number of factors, including promotion by the Board of Investment (BoI), decent domestic demand, central geographic location and a strong supply base,” Khanchit Chaisupho, director of GM Thailand, told OBG. Ford and GM pulled out some operations in the 1970s. Since then, the sector has been dominated by the Japanese.

Industrial policy, which played a major role in development, was continually tweaked and updated. In 1975, to encourage domestic suppliers, new rules were added requiring finished products to contain certain thresholds of locally made components. The rate for cars was set at 25%, and later increased to 54%, where it stayed until it was revoked in 1999. Other protectionist measures, such as tariffs on imported parts, were adopted.

After the turn of the century the market was greatly liberalised. Yet the results of earlier efforts seemed to hold. A large supplier base has remained and local content has stayed high despite the lifting of the domestic requirement. After all, Japanese automakers had invested a great deal in building the sector, supplying capital for subcontractors and training workers.

Despite foreign dominance of the sector, government policies have over time led to a good deal of local participation. According to a 2013 report by the BoI, all of the sector’s assemblers are foreign-owned, but only half of tier-one suppliers are, and all tier-two and tier-three suppliers are local. Most of all, policies have given the sector size. By 2013, Thailand was Southeast Asia’s largest maker of vehicles, producing more than 2.45m, of which 1.13m were exported, and generating an estimated 12% of GDP.

Such success has been building on itself, and the sector holds its own both regionally and globally. “Thailand is the largest pick-up truck market in the world after the US,” Sanjay Mishra, CEO of Tata Motors Thailand, told OBG. “What works well is innovations, designed specifically for the Thai market, that can be applied two or three years later to emerging markets that are slightly behind the curve, such as India.” As for exports, Thailand sells not only to ASEAN markets but also to some of the most advanced in the world. In August 2013, Mitsubishi shipped its first Mirage models to the US (it was already selling them to Japan). Japanese firms use Thailand as a global export base, making it the number seven exporter of cars. “Thailand is an export hub,” said Eiichi Umekita, vice-president of Jetro Bangkok. “Car makers are not just here for the Asian markets.”

A Broad Base

Thailand’s success has not been limited to vehicles. Its industrial base is both large and diverse, with major production in steel, food and electronics. Another strong industry, textiles and garments, traces its origins to the 1930s, when the military began producing uniforms on a large scale in state-owned factories. The Investment Promotion Act of 1960 further boosted this segment, which grew rapidly when private entrepreneurs took over and expanded state-owned factories. The sector grew to a peak of 18% of manufacturing value added and, despite competition with low-cost production in other countries, has held ground by moving up the value chain and by embracing fashion development and marketing (see analysis).

In steel production, too, Thailand has been active for decades. It started with rebar fabrication after the war and moved up the value chain from the 1960s on. Demand from construction and industry has driven an almost continuous trade deficit in steel (though some is exported regionally). The sector accounted for as much as 7% of manufacturing from 2002 to 2006, but has since fallen to 2% in 2012. The country is also a major manufacturer of canned tuna. A sector established in 1977, as of 2001 it has led the world in terms of volume canned. Spain and the US vie for second place.

Electronics is one of the largest and fastest growing subsectors of industry. In just under two decades, its share of manufacturing grew from 6% in 1990 to 16% in 2009. Such rapid growth has added much to the economy’s broader development. As with automobiles, the building of Thailand’s base for electronics manufacturing was much the result of official policy. The industry therefore grew far larger than one would expect from a country of Thailand’s size. Its first growth spurt came out of import substitution policies, when Sanyo, Toshiba and Hitachi began making devices in what was then a relatively closed economy. As policy shifted more towards exports, Japanese makers stayed and made Thailand a centre for fabricating many of their products. They were joined by those from other parts of the world, who found it an efficient place to make and export devices of increasing sophistication.

The range of products it now makes is wide. Thailand puts out hard disk drives, printed circuit boards, RFID chips, automotive electronics and consumer appliances such as cameras, refrigerators and air conditioners. In all three categories of electronic products, it has for years achieved a trade surplus.

Foreign Direct Investment (FDI)

In the development of Thai industry, FDI has been an active force. Foreign investors have for years been pouring money into the country, and in 2013 Thailand attracted more FDI than at its recent peak in 2007. According to the Bank of Thailand, FDI in 2013 was BT390bn ($11.81bn), up from BT334bn ($10.12bn) in 2012 and BT270bn ($8.18bn) in 2011. Japan is still by far the chief investor, committing BT233bn ($7.06bn) in 2013. Manufacturing was the number two recipient of FDI that year, after finance and insurance, though it has historically received more than any other industry. Within manufacturing, automobile-making was the top recipient, at BT83.7bn ($2.53bn) in 2013; it usually leads, though in some years it has been exceeded by electrical products.

Foreign investment is restricted, but there are many loopholes. While the law generally requires local majority control for businesses, this may be waived for firms deemed good for the country. The Foreign Business Act of 1999 liberalised much of the manufacturing sector, and in restricted segments companies may apply for a special licence. The categories for such favoured treatment, once limited mostly to export industries, have since expanded to a wider range of activities, some of them domestic in nature. Recent additions include software, nanotechnology, solar panels, flat panel displays and pre-fab housing. Despite complex laws, Thailand has generally welcomed firms keen to invest in industry. Nor have the various restrictions greatly hampered their domestic activities; rather, such companies have benefitted from incentives and, on balance, the state has been supportive of their efforts.

Wage Increase

In recent years, manufacturing has come under intense pressure, and concerns are building that Thailand’s rise as a manufacturing centre may have peaked. Wages are one reason why. The minimum wage law was applied nationwide as of January 1, 2013, setting the minimum at BT300 ($9.81) per day. This has raised costs for businesses: according to the National Economic and Social Development Board, it hiked wages by 22.4% nationwide, and in some provinces by as much as 70%. Businesses and academics disagree on the true cost. Companies say it has hurt business and caused closures. They point to the more frequent bankruptcies that occurred as the new law was rolled out across the country starting in 2012. Voices in academia, however, argue that the law has increased productivity.

Though wages are still lower than in the West, and many neighbour countries are facing similar pressures, Thailand still finds itself squeezed. According to the Philippines’ National Wages and Productivity Commission, Thailand’s monthly minimum wage is about $273.13, higher than in Myanmar ($50-60), Cambodia ($80), Vietnam ($89-127), Indonesia ($99-201), China ($165-265) and the Philippines ($169-231). It is even nudging up to some of the region’s more advanced countries, such as Malaysia ($240-308).

The minimum wage, however, obscures both the larger picture and the trend. Average wages in Thailand are now BT12,163.15 ($368.58), since many jobs pay more than the minimum. They have also been rising quickly – up 50% since 2007, according to figures from the National Statistics Office. For many, what matters is not the minimum wage increase, per se, but the speed at which it rose and, indeed, the possibility that will be raised further in the future. “The problem is too much too quickly,” said Cheng Niruttinanon, managing director of Thai Union Manufacturing, a manufacturer and exporter of canned tuna. “We just hope there will be no more jumps for three years.”

The China Factor

Like most of South-east Asia, Thailand has also felt strong pressures from China. As Western economies weakened in the wake of the global financial crisis, China shifted attention to its regional neighbours. For some, that has been devastating; in Thailand, it has been felt acutely in the steel sector. Recently, the country has levied anti-dumping duties on Chinese imports of the metal. Other problems have also been sizeable, if coincidental. Agricultural industries have been hit particularly hard. A disease known as early mortality syndrome has devastated Thailand’s shrimp stock, harming production. The poultry sector faced over-capacity, but has since recovered.

Natural & Human Resources

The biggest issues for business in the short and medium term are protests and natural disasters. In many ways, Thailand is benefitting from others’ ills. The Fukushima meltdown, the slowing of the Chinese economy, increased tensions between China and Japan – these have all spurred the Japanese to accelerate the transfer of industry outside China. Thailand is historically one of the top choices.

Even so, the forces drawing industry toward Thailand have been offset by minuses on the home front. In recent years, the country has seen events that have shaken consumer and investor confidence: the 2006 coup, the 2009 protests, the 2011 floods and the 2013-14 protests. In each instance, production took a hit as consumer spending and FDI weakened. In some cases, the drop was sharp: in January 2009 the manufacturing production index (MPI) fell 25.8%, and in November 2011 by 45.4%, according to the Bank of Thailand.

Yet manufacturing rebounded after every setback: in March 2012 the MPI was up 33.0% and in November 2012 it was up 81.3%. Japanese investors reaffirmed their confidence in the country, even after floods shut down many of their factories. Despite the nation’s troubles, they felt it was still among the more developed and politically stable in the region. The supply chain in particular, which is deep, reliable and hard to replicate in other countries, has stiffened their resolve. After the floods, the Japanese backed their words with their wallets. They increased investments in factories, equipment and capacity and put money into measures for flood protection. As for the protests, Thai industry has in most cases kept humming regardless of what happens in the capital. Crowds and traffic jams notwithstanding, its factories can still churn and its products reach their international markets. For these reasons, manufacturers have been little concerned.

With investors it is otherwise. As the protests wore on into 2014, they began to weary, finding the issues this time more than usually permanent in nature. The country has a long history of instability, observers noted, but opposing sides have tended to put aside their differences quickly and move on. Since 2006, however, the Thai people have been able neither to resolve their disputes nor get beyond them. What worried investors was not so much the troubles themselves as that they seemed insoluble. They could also worsen. In late 2013 Shigekazu Sato, the Japanese ambassador to Thailand, encouraged the two sides to resolve the conflict quickly. That comment, despite its diplomatic language, was seen as a rare criticism from a country traditionally upbeat about Thailand.

Thailand Plus One

However much Thailand has benefitted from “China plus one” strategies, as doubts about China’s growth increase the Japanese have begun mulling “Thailand plus one”. Central to this shift of view are the rapid changes elsewhere in the region.

Investors are not only motivated by the push of problems in Thailand but also by the pull of positive advances in other countries. Once upon a time, Thailand was the only game in town; no other country could offer its combination of political stability and low costs. Now, investors have many options: Indonesia, Vietnam, Cambodia, the Philippines and Myanmar are all valid alternatives for manufacturers. While each has its own set of problems – Indonesia lacks good infrastructure, Myanmar skills and Cambodia is relatively small – on balance, they are real possibilities. Especially attractive of late is the prospect of having assemblers and suppliers in multiple ASEAN countries, which flattens and spreads out the supply chain. This would do much to reduce risk, as manufacturers would have no single bottleneck.

Myanmar is top of the list. It is near Thailand, has very low wages and is reforming fast. Though some investors are holding off, waiting for 2015 elections before declaring full commitment, recent events in Thailand have refocused their attention and could push capacity across the border at a faster pace. The Dawei Special Economic Zone, for example, went from a project that was losing support to one quickly regaining momentum. The main argument against it had been it would benefit Thais more than Myanmar or, for that matter, Japan, the country that was to supply most of the financing. That Japanese manufacturers are still pushing to get the project moving even though this remains the case attests to how much – and how soon – they want to see low-value-added manufacturing capacity there.

The Upside Of Down 

While many see the higher wages and tumult in Thailand as a threat to industry, others see a time of opportunity. The country is transitioning from a low-value-added economy to a more high-value-added and services-based one. Consumer demand is on the rise (though it has taken a hit from the protests), productivity is increasing and companies are investing in new technologies. Like many countries before it – Japan, for one – Thailand at first resisted this sort of change, only to fast embrace it later on.

Thai companies, in turn, are aggressively moving their manufacturing capacity to the near abroad and making global acquisitions. In a telling move, the BoI plans to open a special office for Thai companies wishing to set up operations in Myanmar. After all, Thailand is more heavily weighted toward manufacturing than any other large economy in the region. That has served it well for a long time, but is proving ever harder to maintain. The country is discovering the perks of moving capacity abroad and then managing it from home.

The transition will be challenging. Higher wages do not lead neatly and smoothly to higher demand. Nor does productivity rise automatically with higher wages. The move overseas, too, is seldom easy. “Thailand is in a transition period,” said Kevalin Wangpichayasuk, head of the Kasikorn Research Centre. “We have to find a new economic model to replace our old industrial structure.”

A final challenge will be ASEAN integration. Though the expanded market will bring many benefits, it threatens the economy in a number of ways. One is a version of the middle-income trap. Other member countries have higher levels of technological development and better English, so their companies could sap market share at the high end and threaten Thailand’s ascent up the value chain. Meanwhile, those at the lower end will more easily be able to make cheaper manufactured goods. Thailand’s former strength as an in-between could, with the arrival of the AEC, become its weakness. Besides this, there is the chance that multinationals will gain easier access to the Thai market by incorporating in another member country.

Outlook

Manufacturing will be a mainstay of the Thai economy for many years to come, but will change in its dimensions and scope. No longer will growth simply be a matter of bulking up on more production and building more factories. The country may in fact have hit its peak in manufacturing as a portion of GDP. Growth is now rather more a matter of managing industries shrewdly, picking and choosing, shifting production to where it is most suited, creating value on-shore, and welcoming those who offer technology and expertise. If Thailand can move gently to the next generation of production, great rewards await. It will go from a country that churns out cheap goods for foreign brands to one that makes high-value products for domestic firms and then sells them globally through brands of its own.

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The Report: Thailand 2014

Industry & Retail chapter from The Report: Thailand 2014

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