Chief Executive on Taiwan's Economy

The Chief Executive had an article last month on the challenges China offers Taiwan. The piece is a good summary of the issues. The article opens by discussing the prodigious explansion of Taiwanese investment in China:

For the government, its preferred solution has been to try to block the manufacturing move to China. Fearing an unemployment surge, Taipei outlawed the manufacturing of high-end semiconductors by Taiwan companies on the mainland as of 2001, saying it would review applications on a case-by-case basis. So far, only a few companies, such as Taiwan Semiconductor Manufacturing (TSMC), have received exemptions, and only for previous-generation and not next-generation production. Taipei officials fined the chairman of chip foundry UMC, Robert Tsao, $96,000 this spring for allegedly sneaking around government laws to set up a factory in China. (UMC denies any wrongdoing.)

But investing via companies set up in the British Virgin Islands is a key way that Taiwan companies get around the laws. Partly as a result, the BVI is ranked as the fourth-largest foreign direct investor in China. About 90 percent of that money can be traced back to Taiwan, according to Tung Chen-yuan, professor at National Chengchi University and head of the China Economic Analysis project of the Cross-Strait Interflow Prospect Foundation. "You can control money, but you cannot control people," he says. He expects the continuing restrictions on manufacturing's move to China to go the way of the dodo before long--once Taipei realizes that it is killing the competitiveness of its own companies and Cross-Strait trade continues to rise. From $32 billion in 2000, it nearly doubled to $62 billion in 2004.

Back in 2001, nearly half of Taiwan's $42 billion IT output was manufactured on the island. But by the end of 2003, the proportion had fallen to roughly one-third--a reaction to huge customer side cost pressure at the end of the tech boom: "The only escape was to very rapidly shift over to mainland China. Literally, there was a giant sucking sound that started in 2001 and ended in 2003," explains Martin Hirt, the Taipei-based head of McKinsey & Company's technology practice for Greater China.

Now, Taiwan companies account for about two-thirds of hardware output from mainland China. Around one million Taiwanese, including investors, factory managers and their families, have relocated to China. But without direct air links, currently prohibited by Cross-Strait tension, they must take long and costly detours to China via a third location, such as Hong Kong.

....and government policy:

The squeeze is on nearly everywhere. From 1998 to 2003, the average profit margin of Taiwan's IT companies, excluding semiconductors, fell by nearly half, to 4.8 percent, according to government figures. Margins on manufacturing notebook computers fell to between 4 percent and 8 percent from 15 percent a few years before--one reason that Acer's Shih had the foresight to get out of manufacturing altogether and instead contract out the assembly while focusing on design and innovation.

The reason semiconductor companies have fared better is innovation. Taiwan's big chip companies moved from being two generations behind to being highly innovation-driven world leaders, with net margins of 20-30 percent. Assemblers of licensed products continued to squeeze out 5 percent margins. Taiwan likes to brag that it is now No. 4 in the world in the issuing of U.S. patents: It earned 5,298 in 2003. That beat out South Korea's 3,944, but the U.S. was still leading at 87,901.

So President Chen Shui-bian has made R & D--and keeping it in Taiwan--a continuing government priority. He has increased the number of "Science Parks" such as Hsinchu to 10, although most appear to be little more than real estate plays so far. The few that have attracted big name companies include Taichung Science Park on the west central coast, and Tainan Science Park on the southwest part of the island. The desire is to turn the entire west coast of Taiwan, the side of the island that faces China, into a big high-tech corridor, and the whole place into a "Green Silicon Island." Chen also has called for an increase in R & D spending from 2.45 percent of GDP to 3 percent, particularly in the areas of biomedical research and energy and environmental technology.

Sadly, the editor, discussing the same article elsewhere in the magazine, falls into the economics-will-save us trap that trips up so many commentators:

What this suggests is that a military conflict between China and Taiwan is virtually inconceivable, particularly in the run-up to the Olympic Games in Beijing in 2008. Politicians on both sides will vent and their propaganda machines will crank out hostile statements. But the reality on the ground is that China and Taiwan have interwoven their economies in a way that was unimaginable in the early days of China's economic emergence. Neither side wants to risk military conflict because it would destroy their ability to create wealth.

A conflict is "virtually inconceivable!" On the contrary, look for further economic integration to create even more political problems -- and create new tensions as costs in China rise and companies shift to Vietnam and India.



[Taiwan] [China] [Trade]