The Chinese government has made much of the fact that it is working to create a domestic service-oriented economy, going so far as to enshrine the goal in its newest five-year plan. The country’s leaders have said repeatedly that their aim is to create a more sustainable growth model for the country that’s less susceptible to external shocks.

Communist Party officials have worked to make the plan sound quite high-minded, but the reality is that it’s more a recognition of a trend already in place.

While higher valued-added manufacturing continues to do reasonable well in China thanks to the country’s well-educated workforce, over the past decade Chinese wages have more than quadrupled, making the country less attractive to low-end manufacturers who primarily compete on cost. So while China remains the world’s largest exported of low-end goods, it’s quickly losing ground to other Asian nations.

Countries such as Vietnam are picking up quite a bit of that work, because it’s politically stable, its labor costs are extremely low and it has easy access to the largest Asian consumers such as China and India.

Cambodia is also undergoing a radical transformation. A number of textile manufacturers have relocated to the country from China, largely due to the fact that Cambodia’s labor costs are just a third of the Middle Kingdom’s. Because the country has a relatively small population of 15 million, even just a few new factories have a serious impact on the Cambodian economy.

It’s estimated that Cambodia received nearly USD1.5 billion in foreign direct investment last year, largely due to new factories setting up in the country, providing serious growth for an economy valued at just USD36.6 billion annually.

But I see the greatest industrial growth potential in island nations such as Indonesia.
While Indonesia has a serious infrastructure deficit, it makes perfect sense that it would transition away from being a commodity exporter to become a manufacturer.

With a population of about 240 million and labor costs that are just a fraction of China’s, Indonesia has a deep pool of cheap labor that also happens to be quite young on average. The country is also stuck between a rock and a hard place. Slowing Chinese demand for raw materials and Indonesia’s inability to utilize its own resources, given its current lack of an industrial base, has the potential to create an economic slowdown there.

But the country also has abundant natural resources, such as oil and gas, lumber and rubber, and numerous natural harbors that allow easy access to strategic shipping lanes. With time and planning, Indonesia could easily become an industrial hub in the region.

Companies such as Japanese automaker Toyota Motor Corp (NYSE: TM), which has sunk $337 million into establishing a new manufacturing plant in the country, have clearly recognized Indonesia’s potential. Not only can they tap into Indonesia’s growing consumer market, the country is a natural export base.

However, Indonesia lacks adequate transportation networks in most rural and many urban areas outside of major cities such as Jakarta. Part of that has to do with the obvious challenge of developing infrastructure across an archipelago of more than 17,000 islands, but general lack of investment has posed the biggest challenge.

Indonesia also doesn’t have the basic infrastructure required to process its own mineral wealth. What’s more, power generation and transmission remain spotty across the island chain and its port system leaves much to be desired, despite the existence of a number of terrific natural harbors.

The country recognizes its shortcomings though.

Late last year, President Susilo Bambang announced a spate of new infrastructure projects, including a container terminal in Balikpapan, improvements to airports, a port and a number of industrial complexes.

A new deep water port facility is also under development on Tanjung Sauh that aims to rival the shipping and logistics capabilities of Singapore. The 2 kilometers of wharves to be built will be capable of handing 4 million shipping containers when the project is completed in 2015.

Indonesia’s infrastructure deficit was also the driving force behind the higher export duties and caps the country implemented last year. The measures were poorly received and Indonesia paid a price in the short term, but the reality is that almost every commodity exporting country has resorted to such tactics at some point. If Saudi Arabia hadn’t taken similar steps in the 1970s, it would probably still be a desert kingdom dominated by nomads and herders.

By taking raw materials that have historically served as exports, and keeping and processing at least some portion in Indonesia, the country is not only creating jobs at home but moving a step up the value chain, thereby laying the foundation of a more industrialized base.

On top of that, if managed properly Indonesia’s infrastructure development efforts will provide an excellent countercyclical economic tool, allowing the country to compensate for any weakness in commodity demand. It will also put in place the means for even stronger future growth.

A strong belief in more infrastructure development is also proving a key theme for the upcoming elections in 2014. While Indonesian electioneering is a bit more tumultuous this time around than in cycles past, most of the parties have expressed a keen interest if not a commitment to continuing the country’s infrastructure investment.

Portfolio Roundup

Taiwan Semiconductor (NYSE: TSM) has announced its monthly sales for February and, while they were down 13.2 percent compared to January, they were up 21.5 percent on a year-over-year basis. Year-to-date sales jumped by nearly 30 percent, compared to the same period last year.

Most of that sales increase was attributable to strong chip demand for smartphones and tablet computers, which are picking up slack in the PC market. It’s also an excellent indication that Taiwan Semiconductor’s business shouldn’t suffer much adverse impact from Intel’s (NSDQ: INTC) entrance into the foundry market. That’s largely due to the fact that Intel isn’t likely to do business with companies that could prove to be direct competitors, limiting its pool of potential customers.

Continue buying Taiwan Semiconductor under 20, despite the new competition.