Rise of intra-regional trade in Asia

Karel Eloot, senior partner in McKinsey’s Shanghai office and co-author of the Future of Asia, discusses the rise of intra-regional trade and network flows in Asia, and how CEOs must change their operational model to stay ahead of the development curve.

What are the top trends influencing Asia’s rising share of global flows and networks?

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Let me dive a bit deeper into the industrialization that is shaping up in Asia. The main takeaway is that different parts of Asia have complementary characteristics in terms of working age, labor, capital, investment flows, innovation, and demand.

So first, while working age population of Advanced Asia and of China is declining, Emerging Asia, and Frontier Asia and India will add more than 400 million people to their labor pools in the next two decades.

Second, Emerging Asia and Frontier Asia and India’s growth potential are a real big draw for investments from Advanced Asia and also increasingly, China.

Third, Advanced Asia and China have developed large innovation capacity and they rank high on the global innovation index.

So, in this respect, the other two Asia’s lag behind. Last but not least, of course, there is a lot of demand growth in this region where Advanced Asia may be slowing down, but Emerging Asia, Frontier Asia, and also continuously China, have a potential of four to five percent each year of continued growth in the next two decades.

So, these four complementary trends will create stronger networks for industrialization, for innovation, for integration, across Asia.

So, industrialization and innovation networks in Asia are going to become more intense and also deeper in the next decades.

We see four major developments in this process. First, China is reducing labor-intensive manufacturing and others are taking up the slack— notably, the economies in Emerging Asia.

Second, developed Asia tends to invest heavily in R&D, and they are creating a strong technological and innovation foundation for our region. And China is stepping up its own efforts in this space.

Third, Advanced Asia has been investing heavily into other parts of Asia. And China is also gradually stepping up its role as an investor into the Asia region.

Fourth, Frontier Asia and India have a largely underdeveloped industrial base. This, compared to the rest of Asia, means a lot of untapped potential. Especially in electronics, we have for instance, seen changing dynamics of industrialization across the four Asias.

How should companies and governments prepare for this next phase of globalization?

So for companies to be successful in a more integrated Asia, and an Asia with stronger Asia for Asia dynamics, we have a couple of recommendations.

First, adapt your operating model to cover the complementary characteristics of the different parts of Asia.

So, the complementary roles that are played by different parts of Asia, open up new partnership and new collaboration opportunities along the supply chains. And companies need to ensure to be relevant to Asia by being part of some of these intra-regional flows and networks.

And One example of this is in logistics where China’s Alibaba is developing a digital free trade zone in Malaysia to make cross-regional shipments more affordable for smaller and medium-sized companies. and This could be a model that could spread across the region.

Second, think not only in terms of countries, but rather in terms of cities and city clusters and integrate them in these local ecosystems. Some unknown cities can become destinations for your investment in the future.

New cities across Asia are developing as dynamic industrialization hubs and they typically receive support from the national and provincial governments in terms of strategy, in terms of investment. And they are also attracting through that large domestic and multinational businesses. One example of such a city is Jamnagar in India. It is known as India’s oil city, it is located on the west coast of the country, and it is driven by investment in heavy industries, oil petrochemicals, cement, fertilizers. And and the city’s overall industrialization index is growing very rapidly, at a compound rate of 40 percent each year.

And thirdly, you need to invest in closing skill gaps and get your workforce ready for sustainable growth.

Many developing economies in Asia are dealing with very serious skill gaps. For Emerging Asia and also for Frontier Asia—India in particular—there is an imperative to boost their pools of available labor, available skills in order to be able to benefit from this growing industrialization, and then from later on innovation, to tackle inequality.

With digital becoming more and more important for manufacturers across the region, the scarcity of skilled and semi-skilled IT workers is particularly a big issue. For instance, the Philippines are only able to fill one quarter of the vacancies that they have for IT graduates.

Now, all regions and in particular, of course Advanced Asia and China, need to switch occupational categories due to automation and also shifts in the type of labor and type of skills—and more workers in the automation age will require new skills—new social skills, cognitive skills, creative skills Is that are relatively less likely and less easy to be automated.

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