Forecasts for Taiwan’s economic growth next year currently range between 2.18% and 2.5%.

The Taiwan economy is expected to undergo a moderate slowdown next year as overseas demand falters for its information technology and other high-tech products. But if that prospect is somewhat disappointing, the consolation is that Taiwan is likely to escape suffering harsh collateral damage from the U.S.-China trade war.

After a roaring start of over 3% growth in the first half of this year, the economy started to slacken in the third quarter, slowing to 2.27% year-on-year, the government said.

In November, the government projected that Taiwan’s GDP growth for the full year will come to 2.66%. It forecast growth of 2.41% next year, a drop from the earlier estimate of 2.55%.

Other views of next year’s economic prospects range from a high of 2.5% from Standard Chartered Bank down to 2.18% from the Chung-Hua Institute for Economic Research (CIER).

Economists generally agree that the global economy is softening, which will directly impact export-dependent Taiwan’s sales of its electronics, machinery, and other manufactured goods. The International Monetary Fund in October revised its forecast for global growth for this year and 2019, adjusting it downward to 3.7% from the 3.9% projected three months earlier. It was the first decrease in the IMF’s forecast since July 2016.

On the positive side, economists note that 2019 is expected to be a transition year for Taiwan’s high-tech industries. Among the new technologies nearing the take-off point for mass production are devices related to 5G mobile communications and the internet of things (IoT), as well as robotics and automotive electronics.

At the same time, however, demand is weakening for traditional consumer electronics. Liang Kuo-yuan, chairman of the Yuanta-Polaris Research Institute, notes that the market for smart handheld devices is almost saturated. Worldwide, iPhone sales have been falling since 2016. “This is undoubtedly weighing down the speed of export growth of Taiwan’s electronics components,” he says.

Given the importance of Taiwanese companies in the Apple supply chain, the domestic economy tends to benefit whenever Apple products are doing particularly well. Such Taiwanese suppliers as Catcher, which makes casings for iPhones, and Largan, which makes their lenses, are key pillars in Taiwan’s electronics sector.

This year the new products that Apple rolled out, such as the iPhone 8 and iPhone 8 plus launched in September, did not generate nearly as much excitement as in previous years. “If Apple isn’t going to come up with a killer product, what can Taiwanese companies rely on?” asks Angela Hsieh, vice president for research at Barclays, the investment bank.

Compared with previous years, in addition, the international environment is now fraught with downside risks due to the tariff skirmish under way between the United States and China. If heavy tariffs on Chinese-assembled products depress demand, it could cut deeply into the business of Taiwanese suppliers providing the components for those products.

The Trump administration in September announced tariff increases of 10% on US$200 billion worth of Chinese imports, threatening at the time to raise them to 25% by the end of the year. The September announcement was on top of previous tariffs on US$50 billion of Chinese imports imposed since July. Unlike earlier rounds, the September list targeted consumer goods, including luggage and furniture.

China hit back with tariffs on US$60 billion worth of American goods, triggering a further threat from President Trump to slap a 25% duty on the remaining US$267 billion worth of Chinese goods destined for the U.S. market. In an interview with the Wall Street Journal, Trump said this list could include laptops and Apple iPhones.

At the G20 summit in Buenos Aires at the beginning of December, Trump and Chinese President Xi Jinping reportedly agreed to a ceasefire in the tariff battle. According to a White House statement, the 10% tariffs on the US$200 billion worth of Chinese products would remain in place, but no additional tariffs would be imposed for 90 days while the two countries continued to negotiate.

The White House said the two sides also agreed to immediately start talks on structural changes in the Chinese economy to remedy problems such as forced technology transfers, intellectual property violations, cyber intrusions, and other matters. If no agreement is reached within the 90-day period, the United States would raise the tariffs to 25%.

Hoping for the best

In the absence of Chinese confirmation of the progress stated by the White House, analysts generally expect that the trade war is likely to be prolonged. But as long as no new U.S. tariffs are imposed on goods from China, economists such as Ma Tieying of Singapore-based bank DBS say the impact on the Taiwanese economy should be modest, as consumer electronics are largely excluded.

Standard Chartered economist Tony Phoo points out that the two combatants in the trade war – the United States and China – are both among Taiwan’s largest trading partners. The United States takes about 11.5% of Taiwan’s exports, while a massive 42.5 % goes to mainland China and Hong Kong.

But he also notes that the U.S. is much more important market for Taiwan than the direct trade ledger would indicate. Many of Taiwan’s shipments to China consist of components and materials for assembly into finished products destined for the American market.

“While U.S.-China trade relations are not likely to improve any time soon – and may get worse before they get better – we do not see a major impact on demand,” Phoo says. “No one expects a scenario whereby the economy slips into recession.”

He sees the 10% level of U.S. tariffs on Chinese goods as manageable, though conceding that 25% on a broader range of goods could be “a little tricky.”

In fact, in the worst-case scenario of the U.S. slapping 25% tariffs on all Chinese imports, he calculates that it would shave 1.8 percentage points off Taiwan’s economic growth. That would leave Taiwan’s 2019 growth at a mere 0.7%, as Standard Chartered forecasts a GDP growth rate of 2.5% next year.

(The situation could become even worse. DBS warns in a report that mishandling of the tariff war could plunge the entire global economy into recession.)

Phoo says his relatively optimistic view is based partly on the assumption that export-oriented Taiwanese manufacturers in China will be able to relocate to Southeast Asian nations or back to Taiwan without serious disruption in their operations.

“That will keep them relevant in the global supply chain and they will continue to service demand in the U.S. as well as China,” he says.

Phoo also notes that China and the U.S. are still continuing to grow at a relatively robust pace. The IMF puts China’s economic growth at 6.6% for this year and 6.2% for 2019, while the comparable figures for the U.S are 2.9% and 2.5%. Demand by consumers in both countries should continue to be strong, he says.

Barclays’ Hsieh also suggests that the “impact of the direct tariffs won’t be as big as everyone thinks.” She is paying more attention to the non-tariff issues in the U.S.-China trade dispute, such as the alleged rampant Chinese theft of American companies’ intellectual property.

In one recent case, a U.S. jury indicted United Microelectronics, Taiwan’s second-largest contract chipmaker, on charges of helping a Chinese company, Fujian Jinghua, steal trade secrets from American memory chip maker Micron. Shortly afterwards, UMC moved to dissociate itself from Fujian Jinghua, halting all joint R&D activities.

Many observers expect U.S. companies to bring further legal cases against Chinese competitors on IPR issues. If Taiwan is viewed as a safer location for protection of proprietary information, it could benefit by picking up orders that previously went to China. United Microelectronics’ involvement in the Micron case so far appears to have been viewed as an aberration and hasn’t impaired Taiwan’s overall reputation for safeguarding IPR.

The Taiwan government is setting out the welcome mat for technology-intensive companies – whether multinational or Taiwanese – who might seek refuge from the trade wars by shifting production from China to the other side of the Strait. Already a number of Taiwanese companies are reducing their output in China to avoid facing U.S. tariffs – and boosting production overseas, including Taiwan and Southeast Asia, says Liu Meng-chun, a CIER economist.

“A few companies have indicated they intend to come back to Taiwan, but this won’t happen overnight,” says Barclay’s Hsieh. She notes that rather than leave China altogether, large-scale Taiwanese companies are likely to reduce capacity in China and increase it at their existing facilities in Taiwan, especially for higher-value production. Smaller Taiwanese companies with bases only in China will lack that flexibility.

Rick Lo, chief economist and senior vice president at Fubon Financial Holding Co., refers to “market talk” that several major tech companies are in the process of boosting production capacity in Taiwan. The reports are unconfirmed, he says, since most companies in that position will keep their plans confidential so as not to upset China.

To attract Taiwanese businesses to return, the Executive Yuan in late November approved a three-year plan, reportedly to take effect on January 1. Under the plan, companies utilizing smart technology would enjoy relaxed regulations on the employment of foreign workers.

“The government has made it very clear that they only welcome high-end production processes,” Phoo says. “They will assist other producers to move to ASEAN in line with the New Southbound Policy.”

Looking south

For companies considering relocating to Southeast Asia, Vietnam appears to be the favored choice. Labor there is inexpensive, Taiwanese find it to be a culturally comfortable environment, and it has a warm trading relationship with the U.S. Another top choice for companies seeking to relocate or boost production outside China is the Philippines.

Citing Vietnamese media sources, Reuters reported that Taiwan’s Foxconn, the world’s biggest electronics manufacturer, is considering setting up a factory in Vietnam to mitigate any impact from the deterioration in U.S.-China trade relations.

Even before the trade war ignited, there was already a trend for Taiwanese companies, particularly low-end manufacturers, to move to Southeast Asia due to rising Chinese labor costs, including employers’ compulsory contributions to various kinds of social insurance. However, the shortage of skilled labor in Southeast Asia is an impediment that may slow the shift of supply chains out of China, says CIER’s Liu.

The U.S.-China tariff spat has been reflected in Taiwan’s recent trade performance, economists say. In a frontloading effect, exports have increased in recent months as companies rushed to fulfill orders from China for components and intermediate materials ahead of anticipated higher U.S. tariffs. Imports correspondingly increased for equipment and raw materials to process those exports.

Exports in October rose 7.3% year-on-year to reach US$29.57 billion. From January to October the growth was 8%. At US$26.21 billion, imports grew in October by a whopping 17.6%, with year-to-date growth of 12.5%.

Because of the frontloading, “the increase in exports this year is a ‘pseudo effect,’” cautions Liu. He says that exports early next year will consequently show unusually low growth – one reason why economic growth is expected to slow somewhat in 2019.

Export orders – which in October stood at US$48.99 billion, up 5.1% over the same month last year – recently have showed slowing momentum, reports Barclay’s Hsieh, even though Western consumers will soon start their Christmas shopping.

“This is extremely unusual,” she says. “Usually the second half of the year is the peak season for the tech cycle.”

Another factor affecting Taiwan’s competitiveness in the international trade arena is its virtual exclusion from the world’s network of bilateral and multilateral free trade agreements. Given recent news of progress toward concluding the China-backed Regional Comprehensive Economic Partnership (RCEP), the issue is taking on increased relevance.

Reportedly, the 10 Southeast Asian states involved in the pact are determined to conclude RCEP by 2019, although hitches could arise since India is said to be less enthusiastic. After the United States backed out of the Trans-Pacific Partnership in early 2017, RCEP gained added significance within the region.

For Taiwan to be included in RCEP, say experts in cross-Strait affairs, it undoubtedly would have to go even further toward accepting the notion of “one China” than did the “1992 consensus” endorsed by former President Ma Ying-jeou.

Also noteworthy, says Charles Finny, a former New Zealand representative in Taipei and an experienced trade negotiator, is that the World Trade Organization’s Appellate Body, which serves as the organization’s supreme court, is close to breakdown. Amid President Trump’s railing against the WTO as a “disaster,” the U.S. government said earlier this year that it would block the reappointment of one of the four remaining judges at the WTO.

Finny says that a non-functioning Appellate Body would make it much harder for Taiwan to settle trade disputes compared with other nations that can utilize the dispute resolution mechanisms embodied in their free trade agreements.

“If I were a Taiwan policymaker, I would be very disconcerted,” Finny recently told a business group in Taipei, since Taiwan “is more dependent on the WTO to be the arbiter of trade disputes.”

Domestic conditions

On the home front, weaker-than-expected private consumption in the third quarter was a key reason behind the recent decision by the government’s Directorate General of Budget, Accounting and Statistics (DGBAS) to lower the GDP forecast for the year to 2.66% from the 2.69% announced in August.

DGBAS says that private consumption grew by 1.8% year-on-year, moderating from 2.29% in the second quarter. Similarly Barclay’s Hsieh says the drop in private consumption in the third quarter caused her to lower her GDP forecast this year from 2.8% to 2.6%.

In particular, DGBAS cited a decrease in car sales and sluggish growth in travel and financial services in the third quarter. Another explanation offered by some economists attributes the decreased consumption to a drop in consumer confidence due to a decline in the stock market.

After remaining above 10,000 points for most of this year, the Taiex index fell below that mark in October, influenced by credit-tightening measures from the U.S. Federal Reserve. Some US$4.7 billion flowed out of the Taiwan stock market in October alone, according to Singapore’s DBS.

Losses in stock trading may have made many Taiwanese consumers feel more cautious about spending. The psychological effect could persist for some time, said the economists interviewed for this report, as the Fed is likely to continue with its tightening policies.

Also having a significant impact in depressing private consumption, some economists suggest, have been the government’s pension reforms that went into effect in July this year. The Tsai administration defends the cuts to the generous retirement packages of nearly 500,000 teachers, civil servants, and military personnel as necessary to forestall bankruptcy in the pension system.

But the impact on consumption may have been felt by more than the almost half a million people directly affected, as many of these government personnel are also supporting family members such as aged parents.

Describing the drop in private consumption in the third quarter as a “shock,” Barclay’s Hsieh says “we didn’t know private consumption could be that weak.” CIER forecasts private consumption growth of 1.81% next year, down from 2.31% this year.

The drop in private consumption was considered particularly surprising in that wages have increased more rapidly under President Tsai than during the previous KMT administration. Standard Chartered estimates that monthly income grew 4.1% in the first nine months of the year, on track for the fastest growth since 2010. (This improvement did not seem to make an impression with voters, who gave the ruling Democratic Progressive Party a drubbing in recent municipal elections.)

A rise in wages is usually attributable to rosy economic performance, prompting more hiring. But the dominant factor in Taiwan this year may have been the tightening of the labor market as Taiwan’s society ages, leaving fewer working-age people in the employment pool. Seasonally adjusted unemployment – at 3.69% – was at a two-decade low in August, Standard Chartered says, before inching up to 3.7% in October.

Before seasonal adjustment, October’s unemployment figures stood at 3.75%, according to the DGBAS. Phoo says the tighter labor market should boost household incomes in the short term. In the longer term, economists say, Taiwan will need to attract skilled migrants.

Two China-related trends have also been denting consumption over the last few years – and are likely to continue until at least 2020. The first is the relatively low salary levels in Taiwan compared with many other industrialized countries. Including bonuses, non-agricultural workers currently earn an average of only NT$50,635 (US$1,640), according to CIER. The result has been a severe brain drain, as talented professionals flock to other nations, particularly China, in search of higher pay. It also means that many of the biggest potential consumers are offshore.

The second factor relates to tourism. Although the government has managed to marginally increase the overall number of international travelers by attracting visitors from Southeast Asia and elsewhere to make up for a sharp drop in Chinese tourists that began with the election of President Tsai, these visitors tend to spend considerably less than Chinese tourists.

Barclay’s Hsieh estimates that Taiwan’s tourist revenues last year fell 7.8% year-on-year due to the reduction in Chinese tourist “big spenders.”

Additional initiatives

Government efforts to boost private consumption next year should benefit from several new initiatives. One is the adoption of a new category of income tax deduction covering certain family expenses. The change is expected to benefit 1.49 million taxpayers, reports Standard Chartered.

In addition, from January the hourly minimum wage will be raised from NT$140 to NT$150, an increase of over 7%, while the minimum monthly wage will increase from NT$22,000 to NT$23,100, a 5% increase.

Despite the increase in the minimum wage, inflation is not expected to be an issue, especially since there is no sign that international commodity prices will be rising steeply. With global economic momentum decelerating, oil prices are falling. DBS predicts that oil prices will remain stable in 2019.

For the first 10 months of this year, the Consumer Price Index rose by a mild 1.6% year-on-year. The Central Bank projects CPI growth for this year to be 1.5%, before flattening to 1.05% next year. Given slowing growth and the lack of inflationary pressures, the Central Bank is expected to keep the discount rate unchanged at 1.375% next year.

Government policies aimed at attracting businesses to return to Taiwan should have a positive effect on the economy, says Standard Chartered’s Phoo. He cites the central government’s goal of adding more than 500 hectares of land for industrial use by the end of 2020. According to media reports, this plan will include making use of idle land in existing industrial parks, as well as building new such parks in cooperation with local governments.

“Land supply is one of several factors – along with manpower, water, and electricity supply – that have deterred Taiwanese investors from relocating back to Taiwan,” Standard Chartered said in a statement.

Electricity supply is now likely to be less of a concern for business after voters agreed in a November referendum to scrap a clause in Taiwan’s Electricity Act dictating that all nuclear power generation must cease by 2025. The Executive Yuan has already amended the act and sent it for review to the legislature, where it is expected to pass.

The government may also seek to shore up the economy next year through fiscal stimulus. DBS notes in a report that government debt has fallen from a peak of 39% of GDP in 2012 to 36% in 2017, well below the legal ceiling of 50%. The report also calls attention to the fact that public spending in Taiwan tends to increase before presidential elections as the ruling party seeks to broaden support. The next presidential election will be in March, 2020.

DGBAS estimates that fixed capital formation will increase by 5.4% next year, driven by continuing investments by the semiconductor industry and the government’s promotion of its Forward-looking Infrastructure investment program. The program is currently in the first of two four-year stages, each with a budget of NT$420 billion (US$13.8 billion).

Economists say there hasn’t yet been substantial contribution to the economy from the government’s “5+2 Innovative Industries” program covering seven industries and projects: smart machinery, Asia Silicon Valley, green energy, biomedicine, national defense and aerospace, new agriculture, and the circular economy. Of the seven, only smart machinery is currently generating substantial revenues.