Caught in the Middle of a Trade War

U.S. President Donald Trump has been adamant in pursuing a tariff war designed to force China to change its trade practices.  Photo: CNA

It’s still hard to assess the prospective impact on Taiwan of the U.S.-China tariff battle.

As the U.S.-China tariff war unfolds, observers in Taiwan have been searching for clues as to what the impact on the Taiwan economy will be. Heavily trade-dependent Taiwan, after all, is in a precarious position in the middle. It regards itself as a close friend of the United States, which is a major trading partner and the chief supporter of Taiwan’s security. At the same time, Taiwanese companies have huge investments in manufacturing plants in China, and about 40% of Taiwan’s exports go across the Taiwan Strait to China and Hong Kong.

When these two giant economies go head to head, it seems virtually certain that Taiwan will be hit by collateral damage – and the longer the fight goes on, the greater the impact is likely to be. But just how much damage is difficult to say at this point. It is still early days, with many analysts assuming that neither Donald Trump nor Xi Jinping will readily back down. When the dust settles, whenever that may be, the landscape for Taiwanese business, both at home and abroad, could look quite different.

The major reason why the impact on Taiwan companies has yet to be fully felt is that the U.S. tariffs on China-made goods – including goods made by Taiwan-owned companies operating in China – are being imposed in stages (and only partially affect China’s export sector), notes Ross Darrell Feingold, a Taipei-based consultant who advises multinational corporate clients on political risk in Asia, including US-China relations.

“The staged implementation of U.S. tariffs has allowed Taiwan companies to process orders placed earlier in the sales cycle, or orders placed in the first half of 2018 for which the buyer had no other option and was unable to locate a cheaper replacement source for the product,” Feingold says. “Taiwan companies might benefit from this even going into the sales cycle for Christmas season orders. The export data reported for July showed positive growth.”

Roy Chun Lee, deputy executive director at the Taiwan WTO and RTA Center at the Chung-Hua Institution for Economic Research (CIER), offers another reason why the real impact of the trade war has yet to be felt. Since the volume of U.S.-China trade was increasing before the first round of tariffs took effect in July, “it will take some time for firms to digest their warehouse stocks,” Lee says. “The actual effects of the trade war may not be apparent until late September or early October.”

In late August, the United States imposed 25% tariffs on 279 Chinese products, including motorcycles and chemicals, with an export value of US$16 billion. China fired back with a 25% tax on the same value in American goods.

The two countries have so far slapped tariffs on US$50 billion in goods from the other side, and Trump has threatened to escalate with a further set of 25% tariffs on US$200 billion more in Chinese goods. As a result, China’s stock market has been slumping and its currency has been weakening against the dollar.

“The value of the yuan is declining, which should help China, but it’s also making investors more wary of putting money into China,” said former American Institute in Taiwan director William Stanton at an August discussion on the US-China-Taiwan triangular relationship at the Legislative Yuan. “The overall effect on global trade could be negative, and if it’s negative on global trade, it’ll affect Taiwan, which is very much an international trader, since 64.8% of its GDP is the export of goods and services, according to 2017 statistics.”

Speaking at the same event, Kuomintang legislator Jason Hsu said that Taiwanese companies producing steel and a few other items were being impacted by the tariffs, but that the real threat to Taiwan’s economic health lay in the proposed US$200 billion in additional tariffs.

Legislator Jason Hsu speaks at a forum at which he and former American Institute in Taiwan Director William Stanton, far left, commented on the current trade war being waged between the United States and China. Photo: Courtesy of Legislator Hsu, Yu Jen Congressional Office

“If [the trade war] moves full-scale into high-tech items, Taiwanese high-tech companies might be heavily affected,” Hsu said. Many Taiwanese in the ICT sector have moved their final assembly and packing operations to China, from which point the products are exported onward to the United States. Since they are shipped from China, on the trade ledger they are considered Chinese goods.

“If President Trump continues to put heavy tariffs on high-tech products,” Hsu said at the forum, “I think Taiwan’s tech supply chain will be affected.”

The odds of that happening increased in late August, when a mid-level meeting between Chinese and American officials in Washington failed to yield any results, as had largely been expected. The Chinese delegation reportedly said it would be the last talks before the U.S. midterm elections in November.

Initial rumblings

“So far, so good” is probably the best way to describe the situation for most Taiwanese businesses with regard to the trade war. But the third round of tariffs looms large on the horizon, with significant potential short-term and long-term implications – some of which may even turn out to be positive.

Mike Wong, general manager of Kraton Formosa Polymer Co., a 50-50 joint venture between U.S.-based Kraton and Formosa Plastics, says that the US$60 billion in proposed counter tariffs by China – in response to the pending US$200 billion in U.S. tariffs – would affect many of the products that Kraton exports to China from the United States.

The Taiwan operation produces polymers and rubber items for Kraton that end up in construction materials, medical products, and other goods, many of them made in China. The proposed Chinese tariffs would probably make it more competitive to ship the intermediate materials from Taiwan rather than the United States, Wong says.

When Kraton established its joint venture with Formosa Plastics, it intended to eventually shift production of certain products from Ohio to Taiwan’s Number 6 Naphtha Cracker at the Mailiao petrochemical complex in Yunlin County. The trade war will likely cause that process to be accelerated, Wong says.

But considerable analysis will be necessary before any decisions are made about shifting production, he added, since other Asian countries such as India, Thailand, and Vietnam will also see their competitiveness vis-à-vis the United States increase due to the tariff war. “The question becomes how competitive my plant is in Taiwan versus our competitors in other parts of Asia – that’s the big unknown,” Wong says.

On top of that, the political uncertainties in the China-Taiwan relationship mean that it cannot be taken for granted that China won’t attempt to punish Taiwan as part of the trade war, he adds.

Taiwanese companies and multinationals with Taiwan operations now are having to think about their strategies for coping with the trade war, which could last for years. CIER’s Lee takes the view that this situation will resemble the U.S.-Japan trade war launched in the 1980s during Ronald Reagan’s presidency.

“The historical example of the U.S.-Japan economic conflict suggests that the U.S.-China trade war could last at least 10 years,” Lee says, although he also sees the possibility that the two sides could come to some agreement at an earlier stage that would allow both to claim victory and save face.

Companies in Taiwan are now considering how to stay out of the line of fire, and some will have tough choices to make. “The easiest option for Taiwan companies to minimize exposure is to seek more customers in other geographies such as China, ASEAN, and India with or without moving manufacturing from existing locations,” says Feingold.

The more difficult option is to move export-oriented manufacturing to locations that are not within the scope of higher U.S. tariffs. This alternative has created a guessing game for corporate leaders.

“In the tech sector there is greater interest to expand manufacturing in India, South America, and Europe, where Taiwan tech companies already have experience,” Feingold says. As an example he cites Foxconn’s renewed interest in recent months in a project in India’s Maharashtra State for which a memorandum of understanding was signed with state authorities in 2015.

“I’ve also received a number of inquiries from Taiwan companies considering expansion or a first facility in the United States,” he says. “However, the lead time to implement such a project is lengthy, and the smaller the company, the more challenging it is to determine whether or not such projects are worthwhile.”

Relocation is, of course, a costly proposition, regardless of a company’s size. In early August, president Tsai Ing-wen spoke about the risks faced by Taiwanese companies due to the escalating trade war. Taiwanese businesses face big challenges in terms of global deployment strategies and trade relations with China, which requires a comprehensive industrial upgrade to improve competitiveness, Tsai said.

The president asked the National Security Council to work with the executive branch, preparing if necessary to assist Taiwan businesspeople who choose to relocate their China operations to Taiwan or to countries that fall under the New Southbound Policy umbrella. In theory, this shift would not only mitigate the impact of the trade war on Taiwanese companies, but would also reduce Taiwan’s economic reliance on China to counter the political risk from Chinese leader Xi Jinping’s ambitions to absorb Taiwan into the People’s Republic.

Tsai said that if needed, the government should set up a fund to help companies respond to the fallout from the trade war. CIER’s Lee praised the idea of a special fund, saying “it would be beneficial for Taishang (Taiwanese businesspeople in China) to move back to Taiwan in terms of job creation and tax revenue.” The fund, which would be sector-neutral, “is a smart move, because at this moment we can’t tell which sectors will suffer most,” he noted.

The China operations of Taiwan’s information communication technology (ICT) sector is seen by many as being particularly vulnerable to American tariffs, but how much so is still difficult to assess, Lee said. There is no reliable data on how much of the output of Taiwanese-invested operations in China is exported to the United States, and how much is consumed within China. Firms who primarily produce for China’s domestic market are less likely to relocate, as they’ll be less affected by tariffs.

It is only natural for the Tsai administration to help Taiwanese businesses weather the coming storm, but it should also ensure that they play by the rules, even though those rules are changing, said Feingold.

“Unfortunately, we have seen examples of companies throughout Asia trying to engage in tariff-avoidance activities that include transshipment, relabeling, deceptive documentation, and other such actions,” he said.

“Taiwan companies who manufacture in China might engage in this behavior, and Taiwan logistics companies with their expertise in China-Taiwan-US trade are sometimes the facilitators,” he added. “Hopefully the Taiwan government will have a zero-tolerance approach to this, because it will have a detrimental impact on bilateral trade negotiations with the United States.”

A question of resolve

Few people at this point seem to think that either China or the United States will give way quickly, which means pain is likely to be felt on both sides, and in other countries including Taiwan, for some time. The United States imports more from China than it exports there, but the Xi government doesn’t have to worry about elections, as Trump does with the upcoming midterms in November.

Therefore, even though the Trump administration may slap an additional US$200 billion in tariffs on Chinese goods while China can retaliate with only US$60 billion, Beijing has carefully selected regions and industry sectors in the United States to target for its tariffs so as to maximize the pain felt by the Republican party base.

So if the Democrats win big in November and take control of the House of Representatives or even both houses of Congress, would the U.S. government’s trade policy change? Lee expressed doubt that that would be the case, noting the shared bipartisan sense in Washington that the old engagement model espoused by previous administrations had been proven wrong, and that “it’s time to get tough with China.”

Trump’s stated rationale for launching the trade war with Beijing includes unfair market barriers for U.S. companies in China, as well as intellectual property theft. For their part, however, the upper echelon of Chinese leaders, which just concluded its annual summit at Beidaihe, seems to have concluded that the U.S. government is seeking to thwart China’s rise in general.

With no end in sight, “Taiwan companies need to be prepared for an extended period of higher U.S. tariffs” in China, Feingold says. “Even if not at the highest rates threatened or already imposed by the Trump Administration, any negotiated settlement between the United States and China might maintain higher tariffs on some goods, and the Trump Administration might extend this principle to goods manufactured elsewhere – including in Taiwan.”

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