2020 Taiwan Forecast: Thriving Despite Trade War Dislocations

Next year, Taiwan’s economy will benefit from a steady flow of capital repatriation as local manufacturers move capacity home from China.

Momentum from Taiwanese businesses returning from China should help Taiwan reach a GDP growth rate of 2.3% to 2.6% in 2020, compared to about 2.4% this year, economists say. In addition, growth in trade is expected to pick up next year on the back of strong global demand for the tech hardware products Taiwan excels in producing, including semiconductors, smartphones, internet of things devices, and 5G infrastructure.

Taiwan is among the main beneficiaries of the U.S.-China trade war. Amid the tit-for-tat tariff escalation, Taiwanese companies are repatriating billions of dollars in capital from China, helping to rejuvenate local manufacturing.

Supply chains have shifted from China to many countries across Asia since the first tranche of tariffs Washington slapped on Chinese goods in June 2018. Taiwan, however, has been in a unique situation. Although it has among the highest exposure of any country to Chinese-based supply chains, its manufacturers are also famously agile. When the U.S. tariffs began to batter their bottom lines, many Taiwanese manufacturers swiftly packed their bags.

Some headed to Vietnam and other countries. But for quite a few companies, it was time to go home.

The Taiwan government rolled out the red carpet for their return with a three-year (2019-2021) incentive program that provides support for productive investments, including assistance with land acquisition and recruitment of personnel, as well as tax breaks. Thus far, 154 returning businesses have pledged to invest NT$697.7 billion (about US$23 billion), of which NT$200 billion is expected by year-end, according to the Ministry of Economic Affairs.

Rising exports to the U.S. are driving economic growth, while declining sales to China are retarding it, says economist Liang Kuo-yuan, president of the Yuanta-Polaris Research Institute. “We can think of the Taiwan economy as a seesaw caught between those two opposing forces,” he says. “Growth remains fairly good as long as exports to the U.S. are growing more than those to China are falling.”

Illustrating this trend, Taiwan’s total exports fell by 2.4% year-on-year from January to October, weighed down by the 6.4% drop in orders from China. But the decline slowed as shipments to the U.S. picked up during the year. Exports to the U.S. constituted a record 19% of outbound shipments through August. For the first 10 months of the year, they were up 17.7% over the same period of 2018.

The Chung-Hwa Institute of Economic Research (CIER), a semi-governmental think tank, estimates export growth of 6% in the fourth quarter, resulting in a slight 0.3% decrease for the year.

If the pace of returning investment from China accelerates, the outlook for next year could be even better, says Liang of Yuanta-Polaris. Government surveys show that roughly 50% of Taiwanese companies in China plan to reduce their investment there or relocate. Of the total, 20% plan to shift production to Taiwan and 22% Southeast Asia.

More Taiwanese businesses may exit China if no trade deal is reached between the U.S. and Beijing. China has pressed for a phased rollback of all tariffs imposed since the trade war began, but President Trump has resisted.

Trump criticized Beijing’s approach to the recent trade talks during a November visit to an Apple production facility in Texas. “China would much rather make a trade deal than I would,” he told reporters. “I haven’t wanted to do it yet,” he added, “because I don’t think they’re stepping up to the level that I want.”

The possibility of new levies on Chinese goods remains on the table, should the two sides fail to reach an agreement. “If we don’t make a deal with China, I’ll just raise the tariffs even higher,” Trump said during a Cabinet meeting in November.

Barring unlikely concessions from China on intellectual property protection or its contentious industrial subsidies, most of the tariffs are likely to remain in place. Yuanta-Polaris therefore expects the level of Taiwan’s private investment to rise about 5% in 2020, compared to an earlier estimate of roughly 3.7%.

Braving rough seas 

Skeptics of President Trump’s tariff war have warned that protectionist trade policies could push the global economy into recession. A recession is “the risk posed by the decoupling of U.S.-China trade,” wrote Nouriel Roubini, an economics professor at New York University’s Stern School of Business, in an October column for Project Syndicate.  Roubini was one of the few who predicted the 2008-2009 global financial crisis.

A recession in the U.S. would hit Taiwan’s export-dependent economy hard, especially as Taiwan is relying on continued growth in that market to offset the fall in trade with China. Should the U.S. enter a downturn, Taiwan would almost certainly plunge into a period of economic contraction itself.

When the U.S. economy was last in recession, during the global financial crisis, Taiwan’s economic growth cratered. In the fourth quarter of 2008, Taiwan experienced a record quarterly economic contraction of 8.36%. For the full year of 2009, Taiwan’s GDP growth fell by 1.6%.

According to the Washington, DC-based National Association for Business Economists, there is a 38% chance of a U.S. recession in 2020 and a 34% chance of one in 2021. 

A more immediate risk for the Taiwan economy is heightened coercive pressure from Beijing. Chinese leader “Xi Jinping is taking a tougher approach to Taiwan now than earlier on,” says Wang Jiann-chyuan, vice president of CIER. “He’s going to do what he wants to show China’s dissatisfaction with cross-Strait relations, without regard for Taiwan’s feelings.”

Wang didn’t speculate about what further measures China might take, but he notes that Beijing has already banned its citizens from visiting Taiwan as individual tourists. That ban, which went into effect August 1, has put a dent in hotel occupancy and hurt retail businesses reliant on Chinese tourists.

Mainland Chinese tourists visit the National Palace Museum in Taipei. Photo: Wikimedia Commons

Despite the ban, tourist arrivals keep growing. In the third quarter, a surge in visitors from Japan, South Korea, the Philippines, and Thailand helped the number of tourist arrivals to expand by 6.5% from the year before. The government now expects visitor numbers for the year to reach 11.8 million, up 7% over 2018. 

Meanwhile, amid the frosty cross-Strait relationship, the future of Taiwanese firms in Chinese tech hardware supply chains remains a big question mark. Taiwanese firms typically enjoy a technological edge and are price-competitive. That has allowed them to sell a lot of components to Chinese smartphone makers like Huawei, Xiaomi, and Oppo, as well as American customers like Apple.

For now, Taiwan continues to do big business with Huawei, the world’s largest maker of telecommunications equipment and a target of crippling U.S. sanctions for more than a year. Washington alleges that Huawei violated U.S. sanctions on Iran and North Korea and could be deployed by China to assist in espionage campaigns. The U.S. has lobbied its allies to prohibit Huawei from building their 5G infrastructure. Japan and Australia have sided with Washington, while European countries are still mostly undecided.

Taiwan won’t allow Huawei to build its 5G network because of the company’s suspected links to the Chinese Communist Party. But business ties between Taiwan and Huawei are robust overall. In November, Nikkei Asian Review reported that a group of Huawei executives recently visited Taiwan to ensure that one of its top integrated-circuit suppliers, Taiwan Semiconductor Manufacturing Co. (TSMC), the world’s largest contract chipmaker, could continue to provide the Chinese firm with industry-leading chips.

“Observing the interaction between Taiwan, the United States, and China, selling components between countries is a matter of the laws and regulations of individual countries,” says Pan Chien-kuang, a senior industry analyst at the Taipei-based Market Intelligence & Consulting Institute (MIC). “Nevertheless, the decisions of Taiwanese suppliers selling components should not violate U.S. export and sanction laws.”

The PRC remains Taiwan’s top trade partner, with China plus Hong Kong accounting for nearly 40% of the export value.

Upgrading industry

The U.S.-China trade war has been a mixed blessing for Taiwan. By forcing Taiwanese manufacturers to reduce their China exposure, it has helped mitigate a growing risk for the nation’s economy. Excessive concentration of resources across the Taiwan Strait was a crisis waiting to happen, whether as the result of political tensions with Beijing or a steep slowdown in the Chinese economy.

Thus far, however, the homecoming of Taiwanese businesses has not made a noticeable impact on industrial transformation efforts. At the same time, the initiative offers more potential benefits for the real economy than cuts to the estate and inheritance taxes made by the Ma Ying-jeou administration (2008-2016) to encourage capital repatriation. The primary outcome of that policy was rampant speculation in the property market.

Still, questions remain about what lies ahead for Taiwan’s economy once the reshoring plan runs its course. The policy looks more like a short-term stimulus than a piece of a long-term restructuring plan. And without some fundamental changes, Taiwan’s economy will remain highly vulnerable to external shocks that shake export demand.

“Without the return of the Taishang [Taiwanese businesspeople], the economy would not be doing so well,” says Yuanta-Polaris’s Liang. He notes that Taiwan’s GDP growth this year will outstrip that of the other former Asian tiger economies (Hong Kong, Singapore, and South Korea), a rare occurrence.

A challenge for Taiwan will be to accelerate its plans to develop the digital economy, going beyond the production of hardware components. Manufacturing is just one part of the digital economy, and not necessarily where the most value is added. In ascendant sectors like fintech and artificial intelligence, software and services are often more important than hardware.

With limited natural resources and space, Taiwan is already under strain to meet the energy and land demands of manufacturers. There are also perennial environmental issues. Ratcheting up manufacturing activity could increase air pollution, which is already a serious problem in central and southern Taiwan.

At a November press conference, Minister Without Portfolio Kung Ming-hsin said that the government planned to use artificial intelligence and smart machinery (part of the 5+2 Innovative Industries plan) to help Taiwan deliver “a total solution” and not just rely on the production of components.

To tap the momentum from returning investment, Kung said that the Tsai Ing-wen administration will launch a plan to make Taiwan “a high-end research, development and manufacturing hub.” The government will provide underused or unused land in central and southern Taiwan as a base for this project, he said.

Addressing environmental concerns, Kung said that Taiwan should establish green supply chains and will do its best to achieve the target of having renewables account for 20% of the energy mix by 2025. Analysts say that deregulation of the energy market is likely necessary to reach that goal, entailing the introduction of new business models for electricity generated from renewables. 

Another question is how well demand for Taiwan’s exports will hold up, especially from China. Although some Taiwanese manufacturers will retain large Chinese clients, Taiwan’s exposure to China will likely continue to fall.  “The Chinese market is actively replacing imports with China-made products and some products will start to replace U.S.-made components with homegrown one,” says Eddie Han, a senior industry analyst at MIC. “This will also reduce China’s reliance on Taiwan supply chains.”

The challenges posed by changing supply chains highlight the need to cultivate new industries. Taiwan is the only one of the four erstwhile Asian tigers without a billion-dollar startup or “unicorn.” None of the unicorns established in Singapore, South Korea, or Hong Kong is a hardware manufacturer. Singapore’s Grab, valued at US$14 billion, began as a ride-hailing app and is now moving into digital banking. South Korea’s Toss, valued at US$1.2 billion, is a payment services app. Hong Kong’s Klook, valued at roughly US$1 billion, is a travel services and activities booking platform.

In February 2018, the Tsai Ing-wen administration announced its intention to create a Taiwanese unicorn within two years and six unicorns within three years. The first goal may be out of reach, while the second will not be easy.

When that objective was announced, then-Premier William Lai concluded: “Taiwan failed to grasp the business opportunities offered by the Internet and mobile applications, because of its focus on personal computer development at the time. It cannot afford to fall behind the latest trends in artificial intelligence, Internet of Things, financial technology and autonomous vehicles this time.”

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