Suggestions of Improving Taiwan’s Economic Relations with the US and China

Darson Chiu

     As the world’s largest economy, the size of US economy is at US$ 19.38 trillion or 24.4% of the world’s GDP. China is the second largest economy in the world, and its GDP will be standing at US$ 12.36 trillion or 15.5% of the world economy. The US provides the biggest market demand for end products, whereas China has been the largest exporting country since the year of 2010. As the US and China jointly represent around 40% of the global economy as well as the major demand side and major supply side, a potential economic conflict between these two giants will certainly cause tremendous impacts on the global economy and its supply value chains.

     The economy of Taiwan standing at nearly US$ 535.54 billion in 2017 has been an export oriented economy and deeply integrated into the global supply value chain. From such a perspective, the negative impact on Taiwan will be inevitable, if a potential trade war between the US and China takes place.

Secure Economic Relations with the US and China

     A trade deal between the US and China to boost the American exports to China was announced in May in wake of the Trump-Xi summit in April 2017. The trade war between the two giants seems unlikely; however, they will follow their agendas with respect to their own national interests. When the big powers are pursuing their national interests, small players such as Taiwan has been striving to cope with growth constraints. Sign a bilateral investment agreement (BIA) with the US and conclude the Economic Cooperation Framework Agreement (ECFA) with China would be the way for Taiwan to secure economic relations with these two big powers, whereas ensure good economic relations with the US and China can be a good strategy for an export oriented economy like Taiwan.[1]

    The US has been recognized as the world market, and it used to be a world factory. Currently, the world factory is on the quest to find or bring back the spirit of world factory. China has long been identified as the world factory, and it has undergone the third 5-year plan trying to transform itself to be a world market. When the world market and world factory are in attempt to switch their partial identities, paradigm-shift in world economic order is unavoidable, and Taiwan also needs to adapt its economic model.

US National Interests and Self-agenda

      The US President Donald Trump’s policies could be critical and the biggest uncertainties to the world’s economic outlook. At least, most economic forecasting agencies believed so after the election outcome in the year end of 2016. Trump pledged to promote GDP growth for the US and create more job opportunities for American citizens. During his campaign, Trump pledged to declare China as a currency manipulator, force China to uphold intellectual property laws, put an end to China’s export subsidies, and place a 45% tariff on Chinese exports to the US. It was predicted before the Trump-Xi summit that a trade war between US and China was probable to happen.

     Trump also issued an executive order to withdraw from the Trans-Pacific Partnership (TPP) in January 2017; he insisted to negotiate fair trade instead of free trade deals. In addition, Trump pledged to mandate a 15% tax on outsourcing jobs and cut corporate income tax from 35% to 15%. His purpose would be to move the manufacturing back to the US by using tax measure as a threat as well as an incentive. However, the fact is that the private consumption has long been the only economic engine function properly for the US economy. If Trump fulfills all of his promises, the imported inflation will take place and cause impacts on the US economic recovery.

China’s National Interests and Self-agenda

     President Xi Jingping of China has been conducting a supply side structural reform to fix the consequences resulted from China’s over investment during the most recent global financial crisis and to resolve the issue that the Chinese economy has been overly relying on the external demand. The reform of Xi is about to a) cutting excess capacity, b) destocking, c) deleveraging, d) lowering corporate costs, and e) improving weak links.

     In addition, Xi hopes to fulfill the goals of China’s 13^th 5-year plan: a) annual real GDP growth rate from 2016 to 2020 to reach 6.5% on average, and b) service sector accounting for 56% of GDP by 2020. Structural reform is in general targeted at the long-term outcome, and the reform may very likely to compromise cyclical growth or recovery. Therefore, a slowing down Chinese economy is almost certain. Nevertheless, with its economic performance in 2016 and forecast of growth in 2017, a hard landing for China in the near future seems hardly likely.[2]

Taiwan’s Economic Constraints and Agenda

     Taiwan is having troubles to regain its growth momentum due to two major structural constraints: a) its exports of ICT products have been facing difficulties in coping with “red supply chain” and b) its exports of traditional manufacturing goods have been dealing with tariff barriers because of insufficient free trade agreement (FTA) coverage.[3] Taiwan’s President Tsai Ing-Wen is heading the five plus two innovative industrial plan, which include a) green energy technology, b) the development of an Asian Silicon Valley, c) biomedicine, d) intelligent machinery, e) national defense and aerospace, plus f) the development of a new agricultural paradigm, and g) a circular economy.

     In addition, she is further heading the new southbound policy that calls for the development of comprehensive relations with ASEAN, South Asia, and Australia and New Zealand, while promoting regional exchanges and collaborations. The fact is that Taiwan needs to move up supply value chain, and Taiwan also needs to expand its FTA coverage. It is still uncertain that the five plus two innovative industrial plan can help Taiwan’s industries move up their relevant supply value chains. It is also questionable that the new southbound policy is the right cure for resolving the issue of Taiwan’s insufficient FTA coverage.

The State of US Economy and Policies

     The US economy is on the right track with full recovery by lowering its unemployment rate to the level before the most recent global financial crisis. Despite the fact that most forecasting agencies referred the US President Donald Trump as one of the biggest uncertainties that could hinder the economic recovery. After the election, signature agencies such as the IMF, Global Insight institute and OECD adjusted their forecasts for the US economic growth of 2017 upward.[4] The upward adjustment is not that those agencies have endorsed Trump’s leadership in leading the US economic recovery but increasing global demand due to the rebound of crude oil price. However, it can be concluded that the Trump uncertainties subside.

     Although Trump pledged to promote growth and create jobs with whatever it took, what can be truly expected is that Trump is launching an expansionary fiscal stimulus policy, renew infrastructure and cut taxes with respect to budget constraint. In short, fiscal policy will replace monetary operations to help pick up the US growth from the year of 2017 on during Trump’s term. As for moving manufacturing back to the US, it was on the former President Barack Obama’s agenda as well. Trump would further push forward the agenda by providing tax incentives. As for protectionism, it will further list inflationary pressure on the US economy, Trump is likely only to take certain symbolic measures.[5] Inflation is not necessarily bad for economic growth; however, inflation as part of misery index is bad for public approval rate.

     On the subject of declaring China as a currency manipulator, Trump refrained himself after the Trump-Xi summit in April 2017. It is almost certain that there will be no trade war between the US and China. In addition, a trade deal between Washington and Beijing was announced one month after the summit, and the deal is believed to enormously boost the US exports to China.

China’s Economy and Economic Policies

     Dur to its structural reform, China has had slowing growth in recent years making it no longer the leading economy in terms of GDP growth among BRIC countries. However, the economic size of China is still out weighting the other 3 BRIC countries, Brazil, India, and Russia. Destocking and deleveraging have become two very important ingredients of China’s reform mainly because of its overinvestment during the most recent financial crisis. In the year of 2009, China’s annual export dropped by 5.3Fred% due to shrinking world demand. In response, China issued a tremendous amount of stimulus package making its fixed gross investment grow by as much as 24.1% in 2009. The outcome was rewarding; the Chinese GDP grew by 9.4% outperforming the rest of the world during the crisis. Nevertheless, the consequences are overstocking and overbanking.

     As China’s structural reform must be performed to cope with the consequences, its economic slowing down is inevitable. However, a planned economy is having many measures to avoid hard landing. The economic growth of China stood at 6.7% in 2016, and it has been predicted to be at 6.5-6.5% in 2017. Regarding China’s economic goals of 6.5% growth of GDP on 5-year average and service sector accounting for 56% of GDP by 2020, the EIU forecasts have showed that both goals would be very difficult to fulfill.

Taiwan’s Economy and Policies in Response

     Taiwan has long been an export oriented economy relying significantly on the external demand. As a result, most of its economic policies, long term or short term, have been designed and implemented to support Taiwan’s growth in exports. Because of the plunge of crude oil price since June 2014, all East Asian countries experienced continuous decline in exports roughly during the period from third quarter of 2015 to the first quarter of 2016. However, Taiwan was the only Asian country had 3-quarter consecutive economic recession during that period because of shrinking exports. That actually indicate that export has been Taiwan’s one and only growth engine. When the engine fails, the entire economic system stops functioning.

     The reason is also because that Taiwan has been deeply integrated into the global value chain, and the correlation coefficient between Taiwan’s and the world growth standing at 0.7811 from 2000 to 2016. Consequently, the uncertain, quivering or deteriorating global conditions can easily cause impacts on Taiwan’s economy. Taiwan experienced its very first negative GDP growth in 2001 due to the internet bubble burst and the second downturn in economic growth in 2009 because of the global crisis. In contrast, Taiwan’s economy used to be very resilient in coping with the oil crises in the 70s, 80s, and 90s when the correlation coefficient between Taiwan and the world was much lower.

     Taiwan’s exports of ICT goods (43% of total) have been facing difficulties in coping with “red supply chain” and Taiwan’s exports of traditional manufacturing goods (the other 57%) have been dealing with tariff barriers because of insufficient FTA coverage. Therefore, the potential solutions are clear: a) Taiwan needs to move up supply value chain, and b) Taiwan needs to expand its FTA coverage. The idealistic FTA partners for Taiwan would be: a) trading partner that has great market potential and b) trading partner that tend to impose higher barriers. From these perspectives, Taiwan might want to sign FTAs with the US and China, because both of them have significant market demands. In addition, Taiwan could sign a FTA with China, since this economy is by comparison highly protected.

Suggested possible Solutions

     Taiwan needs to adapt and adjust its policies with respect to an improving US-China relationship mirrored by the recent bilateral trade deal. As Trump has been demanding more manufacturing and jobs, Taiwan can consider to sign a BIA with the US, as signature Taiwanese companies like Foxconn and TSMC already announced their plans to invest in the US. A BIA is therefore needed to protect outbound investors’ investments and further the bilateral relationship. Furthermore, a BIA is less politically sensitive compared with a FTA.

     Despite that fact that Taiwan is coping with the red supply chain, Taiwan ought to realize a competition with China’s supply side does not mean that Taiwan has to ignore China’s demand side. Therefore, Taiwan may consider to conclude ECFA. After all, China is a big and still highly protected market. Furthermore, Taiwan may try to apply for the status of External Economic Partner (EEP) with a concluded ECFA, whereas an EEP is a required status to join the negotiation of Regional Comprehensive Economic Partnership (RCEP). In spite of everything, expanding Taiwan’s FTA coverage is indeed much needed.

(Darson Chiu is the Director General of CTPECC)

---

[1] The US is the economy that provides 28%, the biggest, of Taiwan’s annual export orders; around 40% of Taiwan’s annual export heading for China.

[2] The economy of Chins grew by 6.7% in 2016, and the Economist Intelligence Unit predicted a 6.6% GDP growth for China in 2017.

[3] The “red supply chain” has been widely referred as China’s import substitution policy that is instead of importing ICT parts and components from Taiwan, China’s downstream manufacturers have been producing the intermediate goods by their own due to technology advancement. 43% of Taiwan’s exports would be ICT goods, and the other 57% are traditional manufacturing goods.

[4] For the year of 2017, IMF forecast the US economy to grow by 2.3%, whereas the growth is predicted to reach 2.4% by both the Global Insight and OECD.

[5] According to the US Bureau of labor Statistics, the inflation rate of US in April 2017 was 2.2% that already exceeded the Federal Reserve’s target of 2%.