After China’s expected entry to the World Trade Organization (WTO) in the first half of 2001, Taiwan will likely follow. Despite some expected gains, entry to the WTO will inflict short-term economic pains in Taiwan, because the island will have to speed up structural adjustments. An investment hollow out from Taiwan to China will follow, as Taiwanese firms struggle to survive. This will lead to growth leakage and hurt employment in Taiwan in the short-term.
However, WTO will serve as an external lever for the weak minority DPP government to kick-start Taiwan’s much needed, but long ignored, structural reforms. Creative destruction under the WTO will strengthen the fundamentals for Taiwan’s high-tech economy and provide a structural underpinning for her asset market and currency in the long-term. But negative short-term cyclical and structural forces and bad politics will inflict more damages in the local markets before they stabilize.
Expected gains
As a WTO member, Taiwan will enjoy protection from unilateral trade sanctions and anti-dumping actions through the WTO dispute resolution process. This is important because most of Taiwan’s foreign trade is done with countries that she has no diplomatic relationship, and that makes Taiwanese exports susceptible to unilateral trade sanctions.
Taiwan will also recoup most of her indirect China trade business, which has been done mainly through middleman Hong Kong due to Taipei’s ban on the “three direct links” – transportation, communications and trade – with China. The bans have limited cross-strait trade to a one-way flow, mainly from Taiwan to China, reduced efficiency and raised transaction costs. WTO accession will oblige Taiwan to lift most, if not all, of the bans eventually.
According to Hong Kong’s trade data, this Taiwan-China indirect trade business amounts to over $10 billion a year, up from just $4 billion in 1990. That is equivalent to almost 10% of Taiwan’s annual exports or 3.8% of GDP (in US-dollar terms). The impact of direct trade with China should thus be positive for Taiwan’s growth.
Potential pains…
However, trade liberalization will inflict some short-term economic pains due to increased competition, including that from China. The bans on direct links have shielded the local agricultural sector, the auto industry and many low- to medium-end manufacturers from Chinese competition.
Scrapping the bans will force a shakeout of the sunset industries in Taiwan. Even the textile industry, which has been downsizing steadily, may have to face further retrenchment. This is because textile’s restructuring so far has mainly involved shifting downstream industries to the mainland. The remaining local production remains protected. With China’s product quality catching up and excess capacity in her upstream industries, freer trade under the WTO will likely lead to further retrenchment of Taiwan’s textile sector.
The potential industrial shakeout will also force more local companies, including those in the strong electronics sector, to relocate to China for survival. China is becoming the investment hub for the electronics industry, attracting significant investment from foreign giants like IBM, Intel, Motorola and NEC. Recently, President Jiang Zemin’s son has also teamed up with the son of one of Taiwan’s richest tycoon to set up a $1.6 billion chip plant near Shanghai. This “silicon rush” into China will likely speed up Taiwan’s investment migration to the Mainland after WTO entry.
The local financial sector will not escape foreign competition either. WTO could likely trigger significant consolidation to create larger and more efficient local institutions to compete with foreign firms. Currently, the domestic banking and securities industries are highly segmented, with 53 commercial banks, some 360 credit co-ops, and numerous small investment brokers.
…are costs to becoming efficient
Industrial shakeout and an investment hollow-out after WTO entry will hurt Taiwan’s economy and cost more jobs in the short-term. The official Council for Economic Planning and Development estimated that even a smooth WTO accession would flip Taiwan’s trade surplus into a deficit of US$5.3bn within a year and cost 20,000 jobs. However, these are the short-term pains for becoming more efficient in the long term. Taiwan’s trade sector (making up over 80% of GDP) could easily double in size under the WTO’s freer-trade regime.
To sustain long-term growth, Taiwan will need to implement structural reforms, switching investment expenditure from labour-intensive industries to high value-added industries. Taiwanese consumers will gain from cheaper imports, greater competition and hence, more choices under WTO. All this will result in sharp efficiency gains for the economy.
Kick-starting reform
WTO liberalization requirements will act as an external discipline for kick-starting structural reform, especially in the financial sector. The biggest structural flaw in Taiwan’s system is political interference. Most banks, credit co-ops and business concerns are either majority-owned or controlled by powerful politicians, especially those from the Nationalist Party.
This political-ownership structure of the financial system has created a serious conflict of interest problem because the Government is both the regulator and the regulated. Hence, there has never been a strong will to retrench.
The weak minority Taipei Government can use the WTO as a lever to push through reforms. WTO rules require governments to cede power, upwards to a rule-based, supranational body and downward to the private sector to make commercial decisions. Restructuring under the WTO will increase Taipei’s credibility as a reforming government and raise investor confidence in Taiwan long-term prospects.
Cost worth paying
The long-term efficiency gains from WTO accession are worth the short-term economic costs. Creative destruction under the WTO will strengthen the fundamentals for Taiwan’s high-tech economy by reducing political meddling, improving corporate governance and raising efficiency. All these will allow it to capture the massive opportunities from the global I.T. evolution. Direct trade linkages between Taiwan and the mainland will also increase trade volume, expanding the external sector and helping to relieve some of the short-term economic pains. All this should provide a structural underpinning for the New Taiwan dollar and local stock market in the longer-term, though short-term economic and political turbulence would keep them weak before stabilizing.
Chi Lo, regional head of research & senior economist (NE Asia), Standard Chartered Global Markets, Hong Kong
