Despite Cross-Strait Political Standstill, Trade as Usual

FEWER TOURISTS — The number of Chinese visitors to Taiwan dropped by more than 40% in the first half of this year, though total inbound tourism was down by only 5.7%. Photo: AP

Where business has slowed, the main reason appears to be economic factors.

Ever since Beijing angrily terminated official communications with Taiwan’s then newly installed Tsai Ing-wen government in June last year, political relations with China have plunged to their coolest point in nearly a decade. But the cross-Strait political chill over Taiwan’s unwillingness to accept a one-China formula so far seems to be having relatively little impact on the island’s economy.

China remains Taiwan’s number-one trading partner, and the trade volumes continue to rise. Exports to the mainland in the first seven months of this year grew 21.3% to reach US$47.2 billion, while imports increased 10.6% to US$28.3 billion. Together with Hong Kong, China takes almost 40% of Taiwan’s total exports. The bulk of those exports are electronic parts, including components for assembly into Apple and other finished products destined eventually for overseas markets.

Taiwan is also the second-largest foreign investor in China after Hong Kong, notes Tan Ching-yu, director of the Emerging Market Development Center at the Taiwan Institute of Economic Research (TIER). The Investment Commission under the Ministry of Economic Affairs puts Taiwan’s accumulated approved investment in China at US$167.4 billion, but the real figure is certainly much higher. Since China’s economic opening in 1979, Taiwanese companies have tended to invest in China through subsidiaries in other countries such as the British Virgin Islands and Hong Kong, for reasons ranging from avoiding Taiwan government scrutiny to taking advantage of other nations’ free-trade regimes (owing to Chinese diplomatic pressure, most countries have been reluctant to sign free trade agreements with Taiwan).

Largely as a result of that investment, as many as 1.5-2 million Taiwanese businesspeople (known as Taishang) and their families are believed to be living in China, says Tan.

For years, China has been the leading destination for Taiwan’s foreign direct investment, as companies have sought to lower production costs while still operating within a familiar cultural and linguistic environment. According to figures from China’s Ministry of Commerce, Jiangsu Province, adjacent to Shanghai, has attracted a full 31% of the Taiwanese investment by value, followed by Guangdong Province with 19%, Shanghai 15%, Fujian Province 8%, and Zhejiang Province 6%.

Although most of the investment is in manufacturing, an increasing amount has been going into China’s service sector. Financial services, including insurance, account for 7% of the Taiwanese investment, and wholesaling for 6%.

Recently, however, the rate of Taiwanese investment in China has been slowing. Last year’s US$9.67 billion worth of new projects was down 11.9% from a year earlier, according to Taiwan’s statistics, and a further drop of 22.2% occurred from January to May this year.

The main factors behind the slowdown appears to be economic rather than political, especially the rising wages in China that are causing Taiwanese manufacturers in more labor-intensive industries like textiles and furniture to seek cheaper overseas bases such as Southeast Asia. Bloomberg columnist Noah Smith has noted China no longer has its once unbeatable cost advantage driven by cheap labor, cheap energy, and lax environmental regulations. A decade ago, Chinese workers made less than a tenth of what their U.S. counterparts did. Today it is about a quarter.

Worker benefits have also been expanding. China’s Social Insurance Law, enacted in 2011, for example, requires employers to contribute to five kinds of social insurance, notes Kao Koong-liang, a Soochow University Chair Professor and former Secretary General of the Straits Exchange Foundation, the organization tasked with Taiwan’s negotiations with China. Due to the increased direct and indirect production costs, Kao predicts a steady decrease in future in Taiwan’s economic dependency on China.

Further, technological advances in China are challenging the advantageous position Taiwan long enjoyed in international supply chains for more sophisticated products.

In what has been a common business model, Taiwan takes orders from branded Western ICT companies, performs design work and the production of key parts, then sends the components to China for final assembly and export. But as Chinese companies catch up technologically in various industries, this sort of cooperation is being replaced by a competitive relationship. Tan cites the rivalry playing out in Southeast Asia, where Chinese smartphone brands including Xiaomi and Oppo now have international reputations and are squaring off against Taiwan’s HTC.

China also is becoming more selective about the types of Taiwanese businesses it welcomes. In the past, virtually any Taiwanese company willing to set up shop in China would receive tax breaks and other preferential treatment in the interest of national development, Tan says. Now those inducements tend to be limited to companies possessing what China regards as needed technology.

Future impact

Although the political standstill has not yet had much effect on the economy, the economic pressures may heighten over time. China’s regional and global economic influence seems set to expand, especially after the U.S. pullout from the Trans-Pacific Partnership (TPP) free trade arrangement. With the TPP in limbo, the only other prospective regional free-trade group is the China-backed Regional Comprehensive Economic Partnership (RCEP), whose member economies cover about 70% of Taiwan’s trade.

Kristy Hsu, director of the Taiwan ASEAN Studies Center at the Chung-Hua Institution for Economic Research (CIER), says she expects the pact to be signed at the end of next year at the earliest. Because of the Tsai administration’s rejection of Beijing’s one-China principle, Taiwan is considered to have little chance of joining RCEP. Tan notes that exclusion from the pact could bring the risk of entire supply chains shifting out of Taiwan – for example, the loss of auto parts orders to Vietnam as certain buyers seek to take advantage of tariff breaks under RCEP. Without Beijing’s acquiescence, in addition, Taiwan undoubtedly will find it hard to enter into bilateral free trade agreements with other trading partners.

CROSS-STRAIT HIGH POINT — The cross Strait détente during Ma Ying-jeou’s administration made it possible for him to meet with his Chinese counterpart Xi Jinping in Singapore in November 2015. Photo: AP/Joseph Nair

Former President Ma Ying-jeou, Tsai’s predecessor, was able to sign over a score of cross-Strait agreements in a détente based on his acceptance of a formula known as the “1992 consensus,” which refers to an informal agreement the Kuomintang considers was reached between Taiwan and China in 1992 in which both sides recognize the existence of “One China” but may have their own interpretations of exactly what that entails.

The consensus made it possible for Taiwan and China to sign an Economic Cooperation Framework Agreement (ECFA) in 2010, and established the basis for the landmark meeting between Ma and Chinese President Xi Jinping in Singapore in November 2015.

Tsai’s current challenge is to find a new formula to replace the 1992 consensus, one that is acceptable to China but does not disappoint her supporters, including the hardline pro-independence faction in her Democratic Progressive Party (DPP). Tsai last month told the Asia-Pacific Security Dialogue that she hoped to work with China on a new model for interaction. Until some new understanding can be reached, it would seem impossible to make progress on any further cross-Strait negotiations, including an agreement to improve investment protection.

In any case, nothing is likely to happen before the Chinese Communist Party’s upcoming 19th Party Congress this fall that will determine the leadership line-up under President Xi Jinping for the next five years and influence the succession beyond that. During the internal jockeying for power before the Congress, concessions towards Taiwan could be interpreted as a sign of weakness. But some analysts suggest that Xi, who is expected to retain his status as a strongman, may have more room to maneuver with Taiwan afterwards, although the possibility of full resumption of cross-Strait talks is still thought to be remote as long as the “One China” issue remains unresolved.

Meanwhile, China has sought to pressure Taiwan politically by poaching diplomatic allies such as Panama and blocking Taiwan’s participation as an observer in international organizations such as the World Health Assembly. Economically, the punishment has chiefly focused on limiting the number of Chinese tourists and students coming to Taiwan. Yen Chen-shen, a scholar at National Chengchi University’s Institute of International Relations, notes that while the Chinese central government has not issued a clear directive to reduce such contacts, many Chinese local governments, along with universities and travel agencies, have been adjusting their practices to fit what they believe to be the government’s wishes.

Last year Taiwan managed to offset the Chinese tourism losses by increasing the number of travelers from Southeast Asia and elsewhere. While Chinese visitors were down 16%, inbound tourism overall rose by 2.4% to set a new record of nearly 10.7 million.

Lately, however, the situation has not looked so rosy. In the first six months of this year, there were 5.7% fewer visitors than a year earlier, with the number of Chinese visitors down by a massive 40.1%. But the CIER’s Liu notes that while some sectors of the local tourism industry, such as pineapple-cake manufacturers and night markets, may be suffering from the drop, the overall impact on the economy is still “very minor.”

TIER’s Tan adds that the declining number of Chinese university students is even less significant economically, although some private universities, already facing smaller domestic enrollments for demographic reasons, are feeling the pinch. The more prestigious public universities are hardly affected, she says.

Stagnation since ECFA

The “early harvest” provisions of ECFA introduced tariff concessions for 539 categories of Taiwanese goods and 267 items of Chinese products. But the real meat of the pact was expected to come from separate preferential agreements on trade in services and goods to be negotiated later under the ECFA framework. The Cross-Strait Agreement on Trade in Services was signed in Shanghai in 2013, but immediately ran into domestic opposition on the grounds that it had been negotiated in secret and would harm certain Taiwanese industries.

In what became known as the Sunflower Movement, protesters consisting of students and civic groups occupied the main chamber of the Legislative Yuan for over three weeks to prevent ratification of the agreement, ultimately leaving the deal in limbo. At the time, the Ma administration was close to finalizing a second deal for liberalization of merchandise trade, but negotiations were discontinued when the services agreement was stalled.

Completion of these or similar deals will be impossible as long as China refrains from formal contact with the Tsai government. But there is also another hurdle. In response to the Sunflower Movement protesters’ demand for greater transparency in cross-Strait negotiations, the government promised that a law giving monitoring authority to the legislature would be enacted before any new talks with China begin or any pending agreements ratified.

STALLED TRADE AGREEMENTS — The Sunflower Movement demonstrations in 2014 blocked ratification of the cross-Strait trade in services pact and caused negotiations on a merchandise trade pact to be suspended. Photo: AP / Wally Santana

No such legislation has yet been passed. The topic is highly controversial, as seen in squabbles among legislators earlier this year about proposed wording for the bill, when New Power Party lawmakers objected to a pragmatic DPP draft that referred to Taiwan as the “Taiwan area” rather than a nation. In addition, the legislative agenda is flooded with other high-priority bills relating to economic development, adding to uncertainties about the bill’s future.

Until the monitoring bill is passed, another pact favored by the Taishang, the Cross-Strait Agreement on Double Taxation and Enhancement of Tax Cooperation signed in 2015, is not expected to take effect.

Cheng Cheng-mount, a leading economist currently serving as vice chairman of the Financial Supervisory Commission, says that of the various pending cross-Strait deals, the agreement on trade in services is the one most desired by the business community because it would enable Taiwan’s financial institutions to expand in China, for example allowing banks to open sub-branches in Fujian.

But CIER’s Liu says that resumption of the cross-Strait dialogue appears to be much less of a priority for the Taishang than it was last year, largely because the economy is performing better than expected.

Two other prominent Chinese initiatives, the Belt and Road project and the Asian Infrastructure Investment Bank (AIIB), are not expected to have much impact on Taiwan, economists say. The Belt and Road initiative is China’s US$1 trillion plan for infrastructure projects and trade deals connecting Africa, Asia, and Europe. China has pledged to spend hundreds of billion of dollars building ports, railways, airports, and power plants, providing business for Chinese construction companies and opening economic opportunities for China in regions where labor costs are cheaper.

Chinese officials have said that Taiwan is welcome to participate, and they are encouraging investment from the Taishang. The initiative would allow Taiwanese companies to take part in projects in Southeast Asia and elsewhere that have been negotiated between foreign governments and China. But the FSC’s Cheng notes that Taiwan’s is a free economy, and despite politics, there are no restrictions preventing Taiwanese businesses from seeking opportunities overseas. They already have a strong presence in Southeast Asia.

Tan adds that the Belt and Road initiative is led by Chinese state-run enterprises, so in the early stages it will probably be of most benefit to Taiwanese companies that already have a presence in China and connections with these companies. But it is also unclear how successful this initiative will be, given suggestions of risky credit practices by Chinese banks.

Taiwan was unsuccessful in its bid to be a founding member of the China-backed AIIB that came into being last year, and the current political freeze means it is unlikely to be admitted as a regular member. The bank was established to finance major infrastructure projects across Asia, including Belt and Road projects, and is regarded by some analysts as a potential rival to institutions such as the International Monetary Fund (IMF) and the Asian Development Bank (ADB). Nevertheless, Cheng views the impact on Taiwan is “quite minimal,” as Taiwan is already a member of the ADB and can access its services and expertise.

In terms of inward foreign direct investment in Taiwan, China is not a major player, with a total last year of just US$247.6 million, a small increase of 1.5% over the previous year. Taiwan opened the doors to Chinese investment in 2009 on a limited basis, but more than two-thirds of industrial categories are now available for Chinese investors.

Chinese nationals are still prohibited from serving as a chief executive officer in a Taiwanese company, and investments in the media or advanced technology sectors are blocked for national security reasons. Most notably, restrictions are in place in the prized semiconductor sector with an eye to protecting trade secrets and other intellectual property, and there is an outright ban on Chinese takeovers of Taiwanese integrated circuit design companies. Three large deals in which Chinese state-backed giant Tsinghua Unigroup sought a controlling interest in Taiwanese chip packaging and testing firms ChipMOS Technologies, Siliconware Precision Industries, and Powertech Technology all fell through after President Tsai took office.

Another recent Chinese policy that worries the government on national security grounds is Beijing’s attempt to attract young Taiwanese, frustrated with low wages, to go to the mainland to create innovative startups.

The future of China-Taiwan business links will depend on the future direction and performance of the Chinese economy, says TIER’s Tan, including how successful China is in managing industrial restructuring and overheated investments and hidden debts in the system. Another key factor will be the degree of success of new policies such as the Belt and Road initiative, and whether they will offer Taiwan companies new opportunities.

Most Taiwanese companies still prefer to do business in China owing to a common language and culture. As long as the economic opportunities are evident, interest in cross-Strait business ties will be strong, Tan says.

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