Is Taiwan Winning the U.S.-China Trade War?

Tech firms are repatriating from tariff-hit China, boosting the local economy. But can Taiwan secure a long-term position in global supply chains?

For years, it was a foregone conclusion that Taiwan’s tech hardware sector would concentrate production in China. Starting in the 1990s, local contract electronics manufacturers began moving capacity across the Taiwan Strait. They followed their American customers, who were lured by cheap labor, tax breaks, and later the efficiency gains reaped from China’s complete supply chains.

The efficiency factor ensured that many firms stayed put in China even as it became a costlier place to do business.

The trend seemed unstoppable – until the trade war broke out last year between China and the U.S. Fed up with Beijing’s stalled market reforms and theft of American intellectual property, Washington slapped punitive tariffs first of 10% and then 25% on hundreds of billions of dollars’ worth of Chinese goods. Many information technology and communications (ICT) devices manufactured by Taiwanese firms in China were affected. 

Suddenly, China no longer looked like an ideal production base. As Taiwanese manufacturers scrambled to avoid the tariffs, the Tsai Ing-wen administration unveiled a three-year (2019-2021) reshoring incentive program: the “Action Plan for Welcoming Overseas Taiwanese Businesses to Return to Invest in Taiwan.” Led by the InvesTaiwan office of the Ministry of Economic Affairs (MOEA), the program provides assistance and preferential conditions to returning Taiwanese manufacturers. By bringing these firms home, the government aims to revitalize local industry. 

The program covers land, power and water supplies, financing, labor and taxation. “Think of it as a one-stop shop to help manufacturers return home smoothly,” says Emile Chang, director-general of the Ministry’s Department of Investment Services and chief executive officer of InvesTaiwan.

A similar organization, the Invest Taipei Office established in 2016 by the Taipei City government’s Department of Economic Development, is specifically focused on attracting investment opportunities to the capital city. It stresses Taipei’s comprehensive infrastructure, safe and comfortable living environment, numerous universities, and such facilities as the Neihu Technology Park and Nangang Software Park.

For many Taiwanese firms, repatriating is feasible because labor costs in Taiwan are no longer significantly higher than in China’s developed coastal regions. At the same time, Taiwan offers strong supply chain fundamentals, a familiar environment, and rule of law.

Further, the government’s plan addresses Taiwan’s longstanding “five shortages” (referring to limitations in the supply of land, water, electricity, labor, and professional/managerial talent) – with special emphasis on land. According to government data, 435 hectares of industrial land are immediately available and supply will be increased to about 873 hectares before 2021.

As for water and electricity, the government maintains that it can ensure an adequate supply of both. With the most pressing of the five shortages under control, relocating from tariff-hit China looks like an increasingly attractive option. Tax breaks and swift access to financing are additional incentives.

As a result, business opportunities are growing here even as the trade war casts a shadow over the global economy. Through June, the MOEA had approved 84 applications from companies reshoring under the initiative. Their investments are valued at almost NT$435 billion (US$14 billion) and are expected to create more than 39,000 jobs, the Ministry says.

ICT firms make up the largest share of returnees, particularly makers of high-end network communication equipment, servers, and peripheral PC products. Manufacturers of machine tools, auto parts, and bicycles are also well represented.

“Returning onshore is an important option” for Taiwanese telecom manufacturers, says Remus Hsu, a senior network communications industry analyst at the semi-governmental Market Intelligence & Consulting Institute (MIC). These firms will need to rejuvenate local production lines that have been used mainly for prototyping, he notes. But once they do so, “they can support some production for export to the U.S, alleviating the overall impact of the tariffs.”

Taiwan’s exports to the U.S. rose 17.4% in the first half of the year to a record US$222 billion on the back of strong demand for electronics used in PCs, the Ministry of Finance reported in July. The American market now accounts for 13.9% of Taiwan’s electronics exports, a 13-year high, the Ministry said.

In contrast, China’s exports to the U.S. fell by about 15% annually in the January-March period, PriceWaterhouseCoopers (PwC) noted in its July Global Economy Watch report. If U.S. import substitution continues, “it is likely to contribute to faster economic growth in Vietnam, South Korea, and Taiwan, in particular,” PwC said.

Darson Chiu, an economist at the Taiwan Institute of Economic Research (TIER), estimates that the investment Taiwan is repatriating from China could help boost GDP growth by at least one percentage point this year, “with all other things being equal.”

The Tsai administration’s investment repatriation scheme is proving more effective than previous efforts because it targets raising economic productivity, he says. “Only companies who are involved with the 5+2 plan can benefit from the incentives,” he notes, referring to a state-led policy to upgrade Taiwan’s industrial base, focusing on seven sectors the government deems innovative. Those sectors are advanced technology, biomedicine, smart machinery, green energy, national defense, circular economy, and high-value agriculture.

Without strict guidelines on the returning investment, capital inflows chasing high returns could pour into the real-estate sector, overheating the market, Chiu observes. That’s exactly what happened when former President Ma Ying-jeou invited Taiwanese businesspeople to repatriate their offshore investments by lowering the gift and estate tax from 50% to 10% in 2008. Since most of the money went into the property market, the benefit for Taiwan’s real economy was negligible, Chiu says.

With that in mind, lawmakers passed a bill in July allowing Taiwanese entrepreneurs who bring home offshore assets to invest under preferential tax rates – but the money cannot be used to purchase property or securitized property products. The bill requires that at least 70% of repatriated funds be placed in productive investments, while 25% can be used for financial investments and 5% for other purposes.

According to the Finance Ministry, the law is expected to attract a total of NT$800 billion to NT$900 billion (US$25.7 billion-$28.9 billion) in investment.

Supply chain reorientation

In the short-term, the Tsai administration expects continued capital inflows attracted by the government’s three-year action plan, says InvesTaiwan’s Chang. Tech hardware makers, many with moderate or heavy exposure to the American tariffs on Chinese goods, will be among the main beneficiaries of the policy.

In June, MOEA announced that a number of hardware makers would increase their investments here under the government’s plan. They include Universal Microelectronics Co., a maker of consumer electronics components, which will invest more than NT$900 million to expand its factory in the Taichung Nantun Industrial Park; circuit protection components manufacturer Thinking Electronics Industrial Co., which will spend NT$1.58 billion to build a new automotive electronics and 5G plant in Kaohsiung’s Nantze Export Processing Zone; and mobile-phone camera-lens maker Zhong Yang Technology Co., which will spend NT$770 million to beef up local production capacity and develop new optical lens products.

The Ministry said several other key investments were being made by tech firms that declined to be named publicly. One of these, described as following a top client back to Taiwan, was said to be planning to spend NT$3 billion to upgrade its plant in the Southern Taiwan Science Park.

Another firm plans to build a new plant in the Hsinchu Science Park, adding advanced production capacity utilizing automated equipment for making its network communications products, the Ministry said.

Analysts say that makers of telecom equipment, given their heavy exposure to the trade war, are accelerating their departure from China. After the U.S. announced the first round of tariffs in mid-2018, most Taiwanese telecom manufacturers began to relocate portions of their production from China, while also holding out hope that Beijing and Washington would reach a detente, MIC’s Hsu says. Initially the Taiwanese firms avoided spending heavily to shift their manufacturing facilities, but have had to reconsider as the trade war dragged on.

When the tariffs were at the 10% level, U.S. buyers were largely willing to absorb the cost increase, but they also advised their Taiwanese partners to prepare to decamp from China, Hsu says. Pressure to make the move mounted after the tariffs climbed to 25%.

Given the rising tension in the Sino-U.S. relationship, “the migration of Taiwanese telecom manufacturers away from China looks set to become a long-term trend,” Hsu adds.

Research by MIC shows that if the U.S. government proceeds with plans, currently under study, to implement tariffs on an additional US$300 billion worth of Chinese goods, the most seriously affected sector would be mobile phones and related products, which make up 70% of the list. That would spell bad news for Taiwanese manufacturers, who would be heavily exposed to the levies through their role in Apple’s supply chain.

Should those further tariffs by implemented, Apple might pass on some of the additional costs to its Taiwanese partners, MIC says. At the same time, the tariffs would cause the volume of shipments to fall. Those factors’ one-two punch could put a sizable dent in the bottom lines of Taiwanese iPhone suppliers. 

Indeed, in many cases, China’s loss is not necessarily Taiwan’s gain. While some Taiwanese firms have returned home, others are moving capacity to emerging regional tech supply chains in Europe, North America, and Southeast Asia.

Supply-chain fragmentation is occurring because no single country can take China’s place. “There’s what we can call an ‘ABC’ (Anywhere But China) supply chain now, but there is not going to be another ‘world’s factory,’ says Jack C. Chang, deputy general director of the Industry, Science and Technology International Strategy Center (ISTI) at the Industrial Technology Research Institute ITRI).

To meet that challenge, Taiwanese manufacturers have adopted four principal strategies including reshoring, Chang notes. Those focused on the China market itself are redoubling efforts to boost sales to Chinese customers. Others are beefing up capacity in emerging markets, mainly Southeast Asia and India. Finally, a few are investing directly in the U.S. or building plants in Mexico to supply American customers.

Larger companies, who often already have extensive overseas operations, are in a better position to steadily shift capacity away from China. Small and medium-sized enterprises, hamstrung by capital constraints, are adopting more of a wait-and see approach, ITRI’s Chang says.

Regionally, one advantage for Taiwan as a manufacturing location is its developed country status. In contrast, countries like Vietnam, Indonesia, and India have inferior infrastructure, fragmented supply chains, in some cases a shortage of skilled labor, and poor internet connectivity relative to Taiwan. Further, given local operational risks (such as strikes), shifting production capacity to such countries “requires careful consideration,” says MIC’s Hsu.

Looking ahead, economists say that robust returning investment will be sufficient to offset export declines wrought by the trade war – at least for the remainder of 2019. DBS Bank forecasts that while Taiwan’s economy will expand by a modest 1.9% this year, domestic investment growth should hit a six-year high of 4.9%, fueled by the capital inflows from returning businesses.