Much attention has centered on the potential of China in recent years as the globe's most attractive locale for foreign investors. But in focusing so intensely and sometimes exclusively on China, another important market for investment, sourcing, and exporting has tended to be overlooked-a market that has also demonstrated strong growth rates: Southeast Asia. What's more, because leading Southeast Asian nations feel squeezed by China in the race for foreign investment, they are fighting back aggressively to woo foreign firms by slashing red tape, inking free trade deals, upgrading infrastructure, and offering important incentives to foreign businesses.

To be sure, there is little doubt that China is a solid bet for many kinds of investment, which is why it received the most foreign direct investment of any country in the world last year.

The reasons are clear. China's low-cost workforce, a result of the country's large, mobile workforce and downsizing from state enterprises, provides foreign investors with a cheap pool of manual labor (in low-end manufacturing, wages average 60 cents per hour). This is unlikely to change since, as Shen Dingli of Fudan University in Shanghai predicts, the Chinese government's major priority in the coming years will be to maintain high economic growth rates high in part by doing whatever is necessary to keep wage rates relatively low. Furthermore, with its currency undervalued because the yuan is pegged to the dollar, exports from China are even more competitive. And, in terms of providing a direct market for manufactured goods, China boasts a huge, and growing, market for consumer goods (Chinese yuppies, for example, eagerly snap up high-end cell phones encrusted with jewels).

But there is another Asia, which may pose even greater opportunities for direct investment and certain kinds of offshore manufacturing.

Asean's appeal

Southeast Asia, whose economies began to take off in the 1960s and 1970s, well before China opened for business, retains some advantages over the Middle Kingdom. The more advanced countries in the Association of Southeast Asian Nations (Asean, the regional grouping of ten Southeast Asian countries), boast far better legal systems and intellectual property protections than China. The implications of this can be seen in a report by the Organization for Economic Cooperation and Development, an international economic group, that showed China less successful in attracting high-value investment than low-end manufacturing, in part because advanced technology companies have concerns about IP protection and Chinese regulatory structures.

While the Chinese legal system is improving in large, cosmopolitan cities like Shanghai, World Trade was told by several China-based lawyers that foreign companies still have almost no chance of winning disputes with Chinese partners in most areas of the country. “Doing business in China isn't a piece of cake-they have a lot of transparency problems,” agrees Walter Lohman, one of the leaders of the U.S.-Asean Business Council, a trade group.

By comparison, Asean's biggest players, like Singapore, Malaysia, and Thailand, have relatively well developed judiciaries that provide a relatively level playing field for foreign companies. Leading Japanese carmakers who had invested in China and found their auto designs knocked off by local joint venture partners, have correspondingly upped their investments in Thailand, now known as the “Detroit of the East” because of its thriving automobile sector (Toyota is closing whole plants in Japan and moving them to Thailand, while Honda is nearly doubling the output at its plant in Thailand).

Southeast Asia's most developed economies also boast better-educated, more sophisticated workforces than China, making them more able to handle niche markets and higher-value goods. (Singapore, Malaysia, and the Philippines, former colonies of Britain and the U.S., also have large numbers of people fluent in English.) To put it another way, as a report by Australia's Department of Foreign Affairs and Trade notes, China's comparative advantage is in labor-intensive products like clothing, toys, and footwear. Additionally, the physical infrastructure for transporting goods is more reliable in Thailand, Singapore, the Philippines, Malaysia, and Indonesia than in many parts of China. In the interior of China, road conditions often are almost medieval-single-lane dirt roads, no logistics providers, and virtually no one who speaks English.

This translates into a higher rate of return on American direct investment in Malaysia and Indonesia than in China in 2002, according to the U.S. Department of Commerce.

Thad Hooker, co-owner of Asian Art and Animals, a Florida-based supplier of luxury furniture and other high-end housewares, understands Southeast Asia's advantages. “Because we do decorative accessories-a higher-value business-it's stuff unique enough to come from Thailand, where quality is high,” Hooker says. “The kind of quality we get in Thailand makes it worth it” to source there, even though China's labor costs are lower. In fact, Hooker still sources nearly all his furniture in Thailand, though he has made forays into neighboring Laos and Myanmar (the former Burma).

Asean competes for investment

Recognizing that China could move up the value-added ladder, Southeast Asia has begun to compete intensely for foreign investors. “Competition with China is felt…When you see one big market...you realize you cannot compete as ten mini markets,” says Simon Tay, head of the Singapore Institute for International Affairs, a think-tank focusing on regional affairs. Indeed, the ten countries in Asean have slashed intra-regional tariffs to less than five percent on most goods, begun discussing liberalizing air cargo in the region, and, in October 2003, identified eleven “priority sectors,” including electronics and information technology, on which they will push even harder to remove barriers to investment and trade.

Liberalization produces results. As the Thai embassy in Washington notes, intra-Asean trade has more than doubled since 1993.

Most important, the Southeast Asian countries have agreed to make Asean a single economic community like the European Union by 2020; an Asean economic entity would be a region of more than 500 million people, with trade worth more than $700 billion annually. “There's acute awareness now that if you don't hang together, you're going to hang separately, given the competition from China and, later on, India,” Singaporean Prime Minister Goh Chok Tong told the Far Eastern Economic Review. Lohman agrees. “Southeast Asia sees the way to compete with China is to create a larger market,” he says.

Pushing for faster, closer integration, the leaders of Thailand and Singapore this year declared that they would speed up economic integration between their two nations, prompting even greater region-wide liberalization. “We want to tango first, and we will open up the floor for all to join. We will inspire them-[the other Southeast Asian states],” Thai Prime Minister Thaksin Shinawatra told an Asean meeting in October. “Free trade and the benefits of integration [in Southeast Asia] are a bit like a buffet dinner,” Tay remarks. “We all agree to go and eat there…[But] there is no real harm for two or more to go ahead first…perhaps begin with appetizers if the others are running late.” What's more, both countries have upped their fiscal stimulus, reviving their economies with increased state spending.

Thailand and Singapore also have aggressively pursued bilateral free trade agreements with a range of nations outside Southeast Asia. In November, Bangkok and Washington opened negotiations on a bilateral trade deal that would eliminate tariffs on nearly all goods. (In preparation for freer trade, Prime Minister Thaksin has launched a national strategy to boost Thailand's competitiveness in a range of industries, and has hired foreign consultants to analyze how Thai firms can boost their competitive advantage). Singapore, meanwhile, has signed bilateral free trade deals with the U.S., Japan, Australia, and New Zealand, and has announced that it plans to ink similar agreements with Jordan and South Korea. The country has also considered launching deals with China and India.

In the battle with China, Southeast Asian nations have offered incentives targeted at specific foreign companies as well. “All Asean countries have understood the need for an industrial policy and…have instituted one-stop agencies in their government to attract foreign direct investment,” Tay says. Thailand's Finance Ministry has proposed new tax incentives designed to foster private investment and cut import duties on a range of products. Singapore, which is trying to become a regional hub for financial services, pharmaceuticals, and electronics, has lowered its corporate tax burden to 22 percent (China's corporate tax rate, by comparison, is roughly 33 percent), offered foreign companies that set up regional headquarters in Singapore tax rates of only 15 percent, and put aside nearly $2 billion in government funds to give to foreign biotech companies. As a result, “Singapore is getting some higher-value [biotech] research and development,” says Linda Lim, an expert on Southeast Asia business at the University of Michigan Business School. Malaysia, meanwhile, has proposed relaxing laws favoring domestic firms over foreign companies, while the Philippine island of Cebu, the country's economic engine, has waived corporate taxes for many foreign companies, replacing the corporate levies with a very low flat tax. Indonesia has inked investor-protection agreements with over 50 nations, drafted a law that will give foreign businesses equal rights and protections afforded local companies, vowed to liberalize state-run parts of the economy and slash red tape, and even offered foreign companies the opportunity to lease entire islands in the massive archipelago and set up manufacturing operations on them.

Some problems, but a brighter future

Foreign investors do not have trouble free experiences in Asean. The four poorer nations of the grouping-Vietnam, Laos, Cambodia, and Myanmar (Burma)-all are extremely state-dominated, unfriendly business environments, and could slow down regional integration. In particular, Myanmar and Laos, two extremely authoritarian, opaque nations, are essentially no-gos for American firms, as the U.S. government has sanctions on investment in Myanmar and does not have normal trade relations with Laos.

Some economists are concerned that Thailand and Singapore's increased fiscal stimulus will result in excessive public debt. Corruption remains a major problem in Indonesia, which ranks low on global studies of graft by Transparency International, an international research organization. Political risk is also a serious threat in Indonesia, the world's biggest Muslim nation, and the Philippines, which has a persistent separatist movement in its Muslim-majority south. Islamist terrorist groups, in fact, have targeted both nations. The Philippines has experienced terrorist attacks on the southern island of Mindanao, as well as scattered violence in Manila. Indonesia has witnessed a series of terrorist bombings in Jakarta, as well as the horrific blast on the resort island of Bali in October 2002. Many foreign companies with operations in the Philippines and the Indonesian archipelago now take extensive security precautions, though most foreign residents of Jakarta and Manila say they feel relatively secure.

Despite these reservations, foreign companies are beginning to understand Southeast Asia's advantages. Driven in part by foreign direct investment and exports, Thailand's economy grew by nearly 6 percent in the second quarter of 2003, while Singapore's industrial production is skyrocketing, and Malaysia and Indonesia are projecting solid growth for 2004. “Thailand is doing very well, because of agrobusiness and auto manufacturing,” says Lim. Japanese firms, often the most savvy investors in Asia, actually invested more in the five richer Asean nations between 1996 and 2001 than they did in China. Flush with higher growth rates, consumers across Southeast Asia are spending much more freely than they have in years, according to studies by market research firm AC Nielsen.

What's the biggest sign that Southeast Asia is far from counted out? China, the regional giant, is actually pursuing countries in Southeast Asia itself. In fact, talks preparing for a China-Asean free trade deal are proceeding rapidly. “The Southeast Asian countries have been very productive in wooing Chinese business…The Asean-China free trade agreement negotiations are serious negotiations,” says Lohman. “We can expect trade between our two nations [Malaysia and China] to continue to grow,” new Malaysian Prime Minister Ahmad Badawi told the Malaysia-China Business Forum in September. “In addition to tremendous prospects for trade, there is significant potential for investment between our two countries.”

Side bar: Asian Art and Animals

When Thad Hooker was downsized from his job as a marketing director at an American insurance company in 2001, he decided to try something completely different. He and his wife purchased Asian Art and Animals, a small Florida-based high-end furniture and house ware supplier. To provide higher-end, hand-made products, they decided to import from Southeast Asia, and took their first buying trip to the region in late 2001.

They found Thailand extremely friendly and alluring. “A driver of a tuk-tuk, [a distinctive Thai three-wheeled taxi,] saw us standing outside Starbucks in Chiang Mai [a city in northern Thailand,] and knew we were Americans,” Hooker says. “He told us he liked cappuccino and then took us around the city for the rest of our trip [as we sourced furniture.] We met his whole family … and then hired him and set him up as our local contact.”

Since that first productive trip, Hooker's respect for doing business in Thailand continues to grow. “The infrastructure - the packing and customs in Thailand - are pretty smooth,” Hooker says. What's more, he says, the Thai Ministry of Commerce has reached out to his company and other foreign small and medium-sized enterprises. “We have a good relationship with the Thai trade office [in Miami], which is a branch of the Thai Ministry of Commerce … They are proactive and aggressive in selling Thailand to investors,” he says.

Hooker has even bigger plans for the future. Since 2001, he and his wife have made eight buying trips to Thailand, and he hopes to grow his company's gross sales by 50 to 70 percent annually over the next few years. Currently, Asian Art and Animals handles wholesale business and sells some unique items to retail investors out of its Florida warehouse, but Hooker “plans to expand our retail clientele, advertising in design magazines and opening a new retail store.” What's more, Hooker has become a co-investor in a Thai restaurant in Florida and even, in conjunction with the Thai trade office in Miami, is looking at opening a Thai Cultural Center in Miami.