Saturday, September 20, 2014

Policy Alternatives to Sustain Long Term Economic Growth

Darson Chiu

        It has been two years, 2012 and 2013, which Taiwan's economic growths laid beneath the averaged world growth rates. Is this turning into an accepted incident? Actually, there's a sign showing that Taiwan's economy might be able to turn the tables on the distinct disadvantage, so we probably do not need to worry about that at least for the short term. What this island actually needs would be policy alternatives to sustain its long term growth.

        One of the optimistic signs would be that the U.S. housing and job markets have been recovering in recent times owing to several rounds of quantitative easing measures. Although said measures taper off, they do help the demand back to an expansion mode. As the U.S. market is the world's largest end products destination, supply value chains in the region of Asia- Pacific have started to be actively revived again. Since 1980s, Taiwan has been playing a key role in regional supply value chains; whereas more than 75% of Taiwan's present exports are categorized as intermediate goods. Therefore, the revitalization of supply chains in the region will certain help pick up Taiwan's exports of this year.

        Taiwan's degree of reliance on exports stood at 70% for the past decade, and the degree has been increasing in recent times. That means a strong exports growth can be considered as a big push for Taiwan's economic growth. The most recent forecasts of 2014 world economic growth rateconducted by global creditable agencies such as World Bank, IMF, OECD, and Global Insight Institute etc standing at 3.0% on average. By comparison, Taiwan's GDP of this year is predicted to grow by 3.28% by the Taiwan Institute of Economic Research. It means there's a chance that Taiwan may outgrow the world economy by a slim margin when the actual numbers are out.

        A potential challenge could be addressed in the short run or foreseeable near future; however, the long term issues hindering Taiwan's growth capacity in the long run still remain. First, Taiwan's status in regional supply value chains has been challenged by the downstream economies, and the challenge mainly coming from mainland China. Second, Taiwan has been continuously losing overseas market shares due to insufficient free trade agreement (FTA) coverage.

        Due to the labor cost hike, Taiwan has been outsourcing its downstream manufacturing and packaging processes mostly to mainland China since early 90s and some to Southeast Asia even earlier. Outsourcing is necessary to better allocate human and other resources among countries that are in economic and trade relations. Both sides of Taiwan Strait had been benefitted from such a business model until global financial crisis triggering the European troubles.

        Nevertheless, the economic and trade relationship between China and Taiwan has been changing from a cooperative to more of a competing mode. Because the demand of China's biggest exports destination-Europe has been shrinking ever since the outburst of European sovereign debt crisis, China has adopted a policy of import substitution or supply chains localization in response. Instead of purchasing intermediate goods from Taiwan, mainland China has been buying some less costly parts and components from local and other suppliers or making them on their own. The purpose of said Chinese policy would be to reduce production costs, and it has been hurting Taiwan's exports seriously.

        Besides China and Taiwan, East Asian countries including Japan, South Korea, Malaysia, Singapore, and Thailand and many more are all involved in the regional supply value chains. However, the Chinese policy seems to cause more harm on Taiwan's economy than others. The reasons behind would be a) economies such as Japan and South Korea have had sufficient technological advantage to stand firm on their positions and b) other economies especially Southeast Asian countries do not depend on the Chinese market as much as Taiwanese firms do.

        Why can't Taiwanese suppliers hold their positions in supply chains and overcome downstream challenges? If the intermediate goods designed and produced by Taiwanese firms are irreplaceable and critical, China's import substitution acts will pose no threat at all. South Korea's research and development (R&D) expenditures over GDP ratio is around 4.36%, which is the highest ratio among all OECD countries. Japan's R&D over GDP ratio stands at 3.35%. By comparison, Taiwan's R&D over GDP is about 3.06%. Being less dedicated in R&D has made Taiwan more vulnerable to challenges.

        Therefore, the first structural reform that Taiwan needs to secure its long term growth would be to pursue technological improvement through R&D. As over 90% of Taiwanese companies are small and medium sized, and they probably lack of funds to conduct their own R&D. And this is where the government could and should jump in to guide them and lend a helping hand. Japanese and Korean governments' policies to enhance corporate capacity building would be a good reference for the Taiwanese government to refer to.

        The reason why the Taiwan economy has been relying on China and losing market shares at the same time would result from Taiwan's lacking sufficient FTA coverage. Many have been stressed how crucial it is for Taiwan to join the Trans-Pacific Partnership (TPP) and Regional Comprehensive Economic Partnership (RCEP) so as to effectively enhance Taiwan's FTA coverage. The Ma administration has also issued a special order directing all ministries and government agencies to join forces and pursue both FTA processes simultaneously. It is understandable why Taiwan is in such a rush. The FTA coverage ratios of China, Japan, and South Korea stand at 29.79%, 18.93%, and 36.81% respectively, whereas Taiwan's coverage is only 9.69%. Since Taiwan is way behind the leading group, the government has been striving to pick up the pace and try to catch up. However, a FTA strategy is needed; otherwise the joint efforts will be futile.

        The second step that Taiwan ought to take to sustain its economic growth in the long run would be to prioritize the multilateral FTAs that provide Taiwanese companies most benefits and cause fewer impacts. It is hence suggested to aim for RCEP before TPP. First, RCEP members include Taiwan's number one and number two exports destinations, mainland China and Southeast Asia. TPP on the other hand is all about the US market. Although it's the world largest end products market, Taiwan is basically a supplier of intermediate goods but end products. Second, the averaged tariffs of RCEP are 7.7%, and overall tariffs of TPP are around 4.4%. That means TPP requires more market opening and less protection, which could cause more damages on Taiwan's defenseless industries. In other words, Taiwan needs more time to prepare itself for TPP. Join RCEP first and enhancing industrial resilience while applying for TPP membership would be a more feasible approach for Taiwan to address its long-standing constraints for growth.

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