Economics

Taiwan: Cross-strait economic links: review and preview

DBS Group Research 12 January 2012

We attempt to assess the macro impact on Taiwan since the cross-strait economic ties strengthened in 2008, and anticipate the post-election outlook The positive impact of cross-strait economic liberalization has been most pronounced in the services industry There is lack of evidence that Taiwans overall trade competitiveness has improved during the first year of tariff reductions under the ECFA. But certain sectors have benefited The phenomenon of asymmetric investment flows between Taiwan and China remains unchanged The future development in cross-strait economic relations hinges on the outcomes of the upcoming elections on Jan 14 A KMT victory in both the presidential and parliamentary elections will allow the current policy to continue Under the scenario that the KMT controls the presidency and the DPP controls the parliament, the implementation of cross-strait policy will become complex If the DPP surprisingly wins the presidential election, the pace of crossstrait economic cooperation will inevitably slow due to political hurdles

The cross-strait economic links between Taiwan and China have strengthened ever since Taiwans pro-China party Kuomintang (KMT) came into power in 2008. Policy initiatives to expand the cross-strait economic links were initially concentrated in several sectors such as tourism, transport and financial services. A quasi-FTA pact, which is named the Economic Cooperation Framework Agreement (ECFA), was formally implemented in 2011 (Table 1). In this article we attempt to assess the macro impact on Taiwan since the cross-strait economic ties strengthened in 2008, and anticipate the post-election policy outlook.

Table 1: The development in cross-strait economic relations

2008/7 2008/12 2009/6 2010/1 2011/1 2011/3 2011/6 Direct flights, Chinese tourists allowed to visit Taiwan Direct cargo flights and direct shipping links were established Chinese investment (FDI) allowed to enter Taiwan The financial MOU between Taiwan and China took effect The Economic Cooperation Framework Agreement (ECFA) took effect More industries in Taiwan were opened to Chinese investment The individual visitor scheme for Chinese tourists was launched

Sources: DBS, various newswires

Ma Tieying (65) 6878 2408 matieying@dbs.com

TW: Cross-strait economic links: review and preview January 12, 2012

Chart 1: Taiwan's exports to China & Hong Kong

USD bn, sa, 3mma 11 10 9 8 7 6 5 4 Jan-05 Global financial crisis Jan-07 Jan-09 Jan-11 The Olympics boom China's tightening & slowdown

Chart 2: Major countries' market share in China

%
16 14 12 10 8 6 4 2 0 2005 2006 2007 2008 2009 2010 2011

TW KR US Latin America

JP ASEAN 5 EU Oceania

The boosting impact on goods exports is not yet apparent

We firstly look at Taiwans trade performance in the past one year after the Economic Cooperation Framework Agreement (ECFA) took effect. The two key indicators are 1) the growth of Taiwans exports to China, 2) Taiwans share in Chinas imports. Overall, Taiwans exports to China did not outperform the historical trend in 2011, and on the cross-country basis, Taiwanese exporters as a whole have even lost market share on the mainland (Chart 1-2). This could be partly explained by the shift in Chinas import structure. Chinas imports (in nominal terms) have oriented towards commodities in recent years, inflated by higher global commodity prices, and also driven by its strong investment demand. As such, non-commodity exporters such as Taiwan, Japan and Korea have been broadly squeezed out in the Chinese market by the commodity-exporting countries like Australia (also Chart 2). On a sectoral level, the positive impact of free trade with China still appears visible. As showed in Chart 3, Taiwans exports to China of vehicles & transport equipment, and raw materials like stone & cement registered above-trend growth in 2011. Taiwanese exporters of these items also gained market share in the mainland last year. Meanwhile, exports to China of electrical machinery & equipment, agricultural goods like vegetables and wood also marked strong growth in 2011,
Chart 3: Taiwan's exports to China & HK: growth and market share, by product
1.0

Growth of exports to China & HK, 0.5 % QoQ sa (2011 vs. 2005-10 avg)
0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5 -26 -21 -16 -11
Minerals

Vehicles, Transport Equip Electrical Animals Vegetables Machinery, Equip Prepared Food Wood Fats, Oils Chemicals Pulp of Wood Base Metals Footwear Plastics, Rubber Textiles Raw Hides, Leather

Stone, Cement, Glass

Optical, Photographic Instruments

Share in China's imports, % (2011 vs. 2010)

4 9 14

-6

-1

TW: Cross-strait economic links: review and preview January 12, 2012

and maintained a steady share in the Chinese market. However, Taiwans exports to China of some key products like plastics & rubber and optical instruments have significantly underperformed, both on the historical basis and cross-country basis.

Chart 4: Who eroded Taiwan's market share in China?

% 28 24 20 16 ASEAN 5: Plastics & Rubber ASEAN 5: Chemicals EU: Optical instruments EU: Textiles EU: Footwear

On a positive note, Taiwan chemical, textiles/footwear 12 exports expanded strongly in China. Even so, market share 8 in these sectors was eroded by major trade rivals, 4 noticeably from ASEAN and 2005 2006 2007 2008 2009 2010 2011 the EU (Chart 4). ASEAN products, in particular, were more competitive in terms of price. This could be due to the China-ASEAN Free Trade Agreement (CAFTA), which was not only established earlier than the ECFA, but has also entered the phase of tariff exemption since 2010. As for EU exports to China, Europe has a technological advantage in capturing Chinas demand for high-tech capital goods for industrial upgrading. On the retail front, demand has been strong on rising income, with Chinas consumers attracted to Europes strong branding, especially in luxury consumer goods. In summary, there is no strong evidence that Taiwans overall trade competitiveness has been boosted by the ECFA during the first year of tariff reductions. The regional competition for building the free trade network is intense. Boosting the core competitiveness of trade requires more efforts on technology advancement and productivity enhancement. However, certain sectors may have benefited. It is also reasonable to expect that the positive impact of the ECFA will become more prominent over time. The tariff rates for items under the early harvest program will be progressively reduced to zero by 2013. A larger number of free trade items would be added pending further negotiations. The challenges imposed by CAFTA could be mitigated as a result.

The services industry has benefited significantly

In terms of services trade, it was clear that services exports have surged since 2008 (Chart 5). The acceleration of services export growth was seen in subChart 5: Services exports surged
USD bn 12 11 10 9 8 7 6 5 4 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10

Chart 6: Services export growth, by sector

Personal, cultural & recreation Other business services Royalties & License fees Computer & Information Financial Insurance Construction Communications Travel Transport 2008-11 avg (%, QoQ sa) -2 2005-07 avg
8 18 28

TW: Cross-strait economic links: review and preview January 12, 2012

Chart 7: Services employment growth is strong

Persons, mn, 3mma 6.4 6.3 6.2 6.1 6.0 5.9

Chart 8: Taiwan's outward investment in China's services industry has surged

USD bn, 3mma
1.2

Manufacturing Services

0.9

0.6

0.3

5.8 5.7 Jan-05

0.0 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Jan-07

Jan-09

Jan-11

sectors including travel, communications, royalties & license fees, and personal, cultural & recreation (Chart 6). The increase in travel receipts was apparently due to Taiwans opening of tourism to Chinese visitors. Chinese tourist arrivals totaled 2.8mn persons during 2008-2011, which was estimated to have generated tourism revenues of USD 5bn, the equivalent of more than 1% of Taiwans annual GDP. Meanwhile, services employment growth has also been strong in recent years (Chart 7), helping to underpin domestic demand and to sustain the economic upcycle driven by services trade expansion. The potential of services trade has, in our view, not been fully realized. Services exports accounted for about 9% of Taiwanese GDP, which was not only much lower than the services-oriented Asian NIEs like Hong Kong (47%) and Singapore (50%), but also lower than some of the less developed Asian economies such as Malaysia (14%) and Thailand (11%). The contribution of services to employment in Taiwan (59%) is the lowest amongst Asian NIEs (69% in Singapore and Korea, 88% in Hong Kong). There is great scope for services to play a bigger role in driving output and employment growth in Taiwan. Expanding services trade with China provides a window of opportunity in this regard.

The bilateral investment flows are still asymmetric

The cross border investment flows between Taiwan and China are still asymmetric. Taiwans outward direct investment to China has soared further in the past few years. These were largely driven by higher investment in the services industry particularly financial services. Taiwanese banks have been allowed to operate business on the mainland since 2010. In sharp contrast, Taiwans foreign direct investment (FDI) received from China has totaled USD 175mn, since Chinese corporates have been permitted to invest in Taiwan in 2009. This paltry sum was equivalent to a mere 0.5% of Taiwans outward investment on the mainland from 2009 to 2011, and no more than 2.0% of the total FDI Taiwan received during the same period. As we elaborated in the previous articles, Chinas outward investment primarily aims to acquire technology, brands and natural resources. However, Taiwans high-tech industries such as semiconductors and flat panels were under protection and opened to Chinese investors only in 2011 (with caps on the ownership ratios). Currently, Chinese residents business travel to Taiwan is still constrained by strict visa controls. Further deregulation is, in our view, still needed to substantially promote investment from China.

TW: Cross-strait economic links: review and preview January 12, 2012

A preview of the post-election policy outlook

The future development in cross-strait economic relations hinges on the outcomes of Taiwans upcoming presidential and parliamentary elections on January 14th. The ruling KMT party attains only a slim majority of public support against the opposition DPP according to various media polls. The benefits from the KMTs opening policy over the past 3-4 years have not been felt across sectors. On the other hand, there are public complaints against the side-effects of cross-strait opening speculations in the asset market and surge in housing prices. If the KMT retains control of both the presidency and parliament, the current cross-strait policy will continue. The KMT may attempt to further promote the trade and investment links with China under the ECFA framework. This would include broadening the free trade items covered by the ECFA, expanding the individual visitor scheme to allow more Chinese tourists to visit Taiwan, opening a larger number of sectors to FDI from China, and negotiating easier market access conditions for Taiwanese companies investing in the mainland (Table 2). Needless to say, a KMT presidency and a DPP-dominated parliament would complicate the implementation of cross-strait policy. Judging from the past experiences, the DPP would oppose the KMTs policy of promoting bilateral investment with China. One of the DPPs criticism is that increasing investment in China would lead to industrial hollowing-out and unemployment in Taiwan. The DPP also views attracting more investment from China as a threat to Taiwans sovereign security. The DPP may also oppose lowering tariffs for imports from China, in order to protect the low income class in Taiwans agricultural and low-end manufacturing sectors. On the other hand, the DPP could still support tariff reductions on Taiwanese exports to China and tourism links with China, as the benefits of these initiatives perceived by the common public are relatively direct. In the event that the DPP surprisingly wins the presidential election, the pace of cross-strait opening will inevitably slow in the next four years. Political hurdles will arise even if the DPP is willing to talk with China on economic cooperation. The DPP does not accept the One China principle defined by the 1992 consensus, which is however seen by Beijing as the paramount precondition for crossstrait dialogues. Without a political reconciliation, negotiations with Beijing on economic issues will be difficult and uncertain.
Table 2: Taiwan's cross-strait policy: the past and the future
Trade Exports to China Tariff The past reduction achievements (539 items) KMT's policy direction DPP's policy direction Imports from China Tariff reduction (267 items) X Services Services Services exports to imports from China China Direct transport Tourism Investment Investment in China Easier market access (11 services sectors). Relaxed controls on investment in high-end electronics X Investment from China Opened a total of 247 sectors to FDI from China X

Sources: MOEA, various newswires, DBS

Notes: All data from CEIC, Bloomberg, and DBS Research (forecasts and data transformations).

TW: Cross-strait economic links: review and preview January 12, 2012

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