Quotes of the Day

In the midst of a steaming-hot Malaysian jungle, sweat-stained factory workers bend over their looms, threading copper into bales of cable wire that gets so hot, it must snake through culverts of water before it can be touched. The factory floor is awash in tea-colored light from windows smeared with soot. The grinding of machines creates a constant, earsplitting din. There is no air-conditioning. "It would cost too much," says Alvin Mui, president of P.I.E. Industrial, which operates the factory.

The roar from this Dickensian forge in the port of Penang is part of a greater reverberation across Asia. Call it the China Effect. As China progresses from a low-cost manufacturer dependent on exports to a service-oriented economy driven more by domestic demand, wages there are rising. As a result, the lowest-end factory work once done in the Middle Kingdom, like wiremaking, is now being done in neighboring countries, from Malaysia and Thailand to Vietnam and Bangladesh.

After ferociously sucking jobs and investment out of Southeast Asia over the past two decades, the China Effect is now lifting once declining industrial hubs like Penang out of their long economic slump. The northern Malaysian state attracted $4 billion in investment for its manufacturing sector in 2010, according to the Malaysian Investment Development Authority, a 465% jump from 2009. "It's been rocky at times," admits Lim Guan Eng, Penang's chief minister. "But being an underdog has kept us on edge and made us work harder."

Penang's nascent boom is partly fueled by Western manufacturers wary of China's rising costs. It also stems from dramatic changes in China's economy that are redirecting trade flows across the region. Not all of the companies relocating to places like Penang are Western multinationals; in fact, many are Chinese firms. As salaries and spending power in China rise, the Chinese are importing more goods from the rest of Asia. At the same time, those rising salaries are forcing China to outsource more of its low-end manufacturing. According to a 2010 Citigroup ranking of 12 Asian countries by manufacturing wages, China was the seventh least expensive and Malaysia the eighth. "The pure-cost reason for being in China for certain economic activities is being eroded," says Sanjeev Nanavati, CEO of Citigroup Malaysia.

The result is a virtuous trading circle for Asia as the Chinese outsource more to and import more from the region. According to HSBC, intra-Asian trade is forecast to grow at an average annual pace of 12.2% until 2020, 40% higher than the rate by which Asia's trade with the U.S. is expected to grow in the same period. Nearly 50% of Asian exports (excluding Japan's) now go to other Asian countries, according to Credit Suisse. That's more than the current demand for Asian exports in the U.S., the E.U. and Japan combined.

P.I.E. Industrial's copper-wire factory is an example of the growing synergy between China and its Southeast Asian neighbors. The factory is a subsidiary of Taiwanese electronics giant Foxconn International (part of the Hon Hai group), one of the largest assemblers of Apple's iPhone and one of the biggest electronics companies in the world. For a multinational like Foxconn, it is as cheap, if not cheaper, to use factories like P.I.E.'s to assemble low-tech products like cable wire or even products like bar-code scanners and mobile-phone chargers in Malaysia rather than China. Foxconn pays its 1,500 workers in Malaysia and Thailand roughly $260 a month, comparable with the wages it offers in China, and says that over the next few years it plans to grow its Malaysian workforce by a third.

In spite of the near parity between Chinese and Malaysian manufacturing wages at the moment, company executives expect future wage increases in China to significantly outpace those in Southeast Asia. Says Rajesh Purushothaman, managing director of National Instruments' Penang operations: "What mattered to us was the predictability of future costs. We felt there was more predictability in Penang than in China." That's another reason Foxconn is sending more low-end work to places like Penang. "A few years ago, there were a lot of vacant factories around here," says P.I.E.'s Mui, gesturing toward an empty factory building that his company will soon move into. "Now they're full. The tide has started to turn."

Foxconn has seen worker suicides, labor protests and subsequent wage rises at its factories in China. Those experiences, according to Dong Tao, chief Asia economist for Credit Suisse, underscore the fact that "this is the beginning of the end of an era for China as the world's factory." By 2014, China will cease to produce a surplus labor supply for its low-wage factories, according to Credit Suisse. Not even salary hikes of 30% to 40%, the rate at which average factory wages rose in China in 2010, will be enough to alleviate increasingly acute labor shortages from 2017 onward in the southeastern coastal regions where most of China's manufacturing is done.

Will all multinationals flee China as this labor shortage looms? Of course not. To an extent, rising wages on China's southeastern coast will simply prompt companies to move their factories to China's western hinterland, where cheaper labor is available and where the government is building an elaborate infrastructure of roads and railways to speed goods to and from the country's seaports. For makers of certain products — like laptop computers, of which 70% of the world's supply comes from China — it would be foolhardy, if not self-destructive, to leave China completely. Because the chain of components is so heavily concentrated there, leaving would be like cutting off one's own blood supply.

Yet for makers of lower-end goods like those P.I.E. churns out as well as higher-end products for which intellectual property plays a key role, the impetus to move from China to cheaper and more legally hospitable climes is growing ever greater. The industrial parks clustered around Ho Chi Minh City in southern Vietnam, for instance, are drawing increasing investment from electronics firms like Intel, which is planning to spend up to $1 billion on a vast semiconductor assembly and testing plant there. Similarly, Bangladesh has come to control 6% of the $200 billion global garment and textile market by taking much of the low-end work from China, notably the stitching of T-shirts and blue jeans.

It's easy to see why. According to Citigroup, the minimum wage for a factory worker in China's Guangdong province is roughly $150 a month. In Bangladesh, by contrast, the minimum wage comes to roughly $40 a month, even after violent strikes by workers recently forced apparel makers to hike wages there nearly 80%.

Not surprisingly, the manufacturing belt that stretches from Bangladesh's western capital, Dhaka, to its southeastern port in Chittagong has begun to lure investors who sense a mini China in the making. Brummer & Partners, a $10 billion hedge fund and private-equity firm based in Stockholm, recently spent an undisclosed sum to obtain a minority stake in a Bangladeshi garmentmaker that counts such retailers as Gap and H&M among its customers. "We're starting to see these kinds of companies take an interest in Bangladesh," says Kiron Bose, the chief investment officer for Brummer's Bangladesh-focused private equity fund. From stitching jeans and T-shirts, Bangladesh hopes to crack the more complex and lucrative business of making sneakers for companies like Nike and Adidas. "Shoes are still a China story," says Bose. "That's where Bangladesh has to compete next."

But the Bangladeshis will also have to compete with the Malaysians, not to mention the Vietnamese, Cambodians and Thais. As always, a large chunk of the equation determining who will win is cost. But that's not the sole factor driving Penang's recent boomlet. If it were only a matter of cost, the Bangladeshis, who are the least expensive in the region, would win the contest hands down. But Malaysia has a host of additional competitive advantages in the new manufacturing race, from logistics to geography. The island of Penang, for instance, has wide roads, a steady stream of university science graduates, an efficient power supply and a modern airport from which goods are flown around the world. "From Penang, we can get our products anywhere in 48 hours," says Purushothaman of National Instruments, which is currently building an $80 million factory close to the airport.

In addition, Penang has inherited the British legal system from its former colonial masters, which gives those doing business there a degree of comfort. "If you look at the region, companies feel comfortable with the intellectual protection measures and legal system in Malaysia," says Lee Kah Choon, chairman of Invest Penang, a government-run investment-promotion agency. "Whereas in China, they're very uncomfortable that whatever is introduced there can be copied."

The importance of intellectual-property protection is echoed by a wide range of technology executives who operate in both Malaysia and China. Almost universally, there is unease about the latter's commitment to copyrights and patents. "It's not as transparent as we want it to be," says Steven Siaw, a co-founder of Penang-based Vitrox Corp., an 11-year-old tech start-up that produces automated vision-inspection systems and has a presence in China. "There's a certain degree of respect for intellectual-property rights in Malaysia. We want peace of mind."

"We're paranoid about intellectual property," says Atul Bhargava, managing director of Intel Malaysia. How paranoid? Consistent with its global practices, Intel severely restricts media tours of its Penang factory lines: permission is rarely granted, and cell phones are always banned, lest illicit photos be secretly snapped. Any employee who leaves the firm is told, in a less than collegial fashion, that any proprietary work done at Intel does not leave the building. "You have to make sure there is a firewall," says Bhargava. Malaysia's commitment to intellectual-property protection, he says, is one of the reasons Intel employs roughly 10,000 people in Penang — the semiconductor firm's single largest bloc of workers outside the U.S.

Penang's recent economic momentum will continue, claim senior government officials. "We've worked our butts off to get investment in," says chief minister Lim. The effort appears to be paying off. National Instruments, Citigroup and health-equipment company St. Jude Medical are all poised to significantly increase their Penang headcounts over the next few years. Online job postings in Penang, according to Kuala Lumpur — based Jobstreet.com, soared 80% in 2010 over the previous year. According to Chook Yuh Yng, Jobstreet's country manager, postings for this year are looking pretty good too.

To be sure, the decaying Victorian mansions along the island's northern seashore are vivid reminders that booms can end in busts. Penang's burst of early glory as an 18th century global trading hub under the British was followed by an extended eclipse. Still, those forlorn mansions also show how a place that squandered its competitive advantage, as Penang did several times, can regain it. And that may be the China Effect's most surprising legacy. The conventional wisdom has always been that China's rise would be the story of Southeast Asia's fall. We are now seeing that the Middle Kingdom can help rekindle a boom in a region that it once appeared to doom.

• Neel Chowdhury / Penang
• As the country's economy matures, multinationals look elsewhere in Asia for low-cost manufacturing