CROSS-STRAIT AVIATION - THE GOLDEN LINK STILL OUT

C O N F I D E N T I A L SECTION 01 OF 04 TAIPEI 003850

SIPDIS

DEPT FOR EAP/TC AND EB/TRA/OTP
DEPT PLEASE PASS AIT/W

E.O. 12958: DECL: 12/03/2014
TAGS: EAIR ECON PREL ETRD EINV TW CH
SUBJECT: CROSS-STRAIT AVIATION - THE GOLDEN LINK STILL OUT
OF REACH

REF: A. AIT TAIPEI 2320


B. AIT TAIPEI 3406

Classified By: AIT Direct Douglas H. Paal, Reason 1.5 D

Summary
--------------


1. (C) Direct air transportation is the last area where the
"three-links" have not been realized in either name or
substance. Direct air links would cut passenger travel time
by up to an hour and a half; ticket prices by more than 25
percent; and airfreight costs by 20 percent or more.
Taiwan's high-tech industries would benefit from reduced air
transportation costs that would likely increase cross-Strait
trade. Less expensive cross-Strait air transportation could
also dampen the rate of increase in the flow of investment
from Taiwan to the PRC. Taiwan airlines have already
developed connection arrangements akin to code-shares with
PRC airlines in order to compete with Hong Kong and Macau
carriers across the Strait. However, Taiwan carriers are
also ready to compete with PRC firms on direct cross-Strait
routes. U.S. passenger airlines are not interested in
providing cross-Strait service, but some U.S. air cargo
firms, are concerned that if direct air links were to be
established, foreign firms would be excluded from the new
routes. Direct air links would contribute to growth on both
sides of the Strait, but politics continue to get in the way.
End Summary.


2. (U) When originally proposed in 1979, the "three-links" to
be established between Taiwan and the PRC consisted of direct
postal and telecommunications services, cross-Strait
commerce, and direct transportation. The first two links
have been effectively realized. Over one million pieces of
mail and about 50 million phone calls cross the Taiwan Strait
every month. The PRC accounted for 70 percent of Taiwan's
outward investment and 25 percent of its exports in the first
half of this year and has been Taiwan's largest trade partner
for two years. In transportation, various methods of
cross-Strait sea freight have emerged to keep costs low
despite the absence of full direct shipping (reported ref B).
The last and missing link is air transportation.

Passenger Aviation ) Inconvenient and Expensive
-------------- --


3. (U) Most cross-Strait air travelers pass through Hong Kong
and Macau, but airlines have also tapped other airports to
handle cross-Strait air traffic. Every week there are 444
scheduled flights between Taiwan and Hong Kong (counting both
outbound and inbound). There are 336 scheduled flights
between Taiwan and Macau. Some cross-Strait traffic also
passes through Okinawa, Japan, and Cheju, South Korea, with
28 and 7 scheduled weekly flights. According to Ministry of
Transportation and Communications (MOTC) statistics, more
than 617,000 passengers flew between Taiwan and Hong Kong in
September 2004, 195,000 between Taiwan and Macau. About
15,000 passengers flew between Taiwan and Okinawa. MOTC did
not release data for Cheju. Most passengers flying to Hong
Kong and Macau proceed on to airports in the PRC. Eva Air
(EVA) currently estimates that 60 percent of Hong Kong
passengers and 80 percent of Macau passengers continue onward
to airports in the PRC. The percentage of travelers to
Okinawa and Cheju who are ultimately bound for PRC airports
is probably even higher.


4. (C) Air travel on the popular route between Taipei and
Shanghai generally costs between NT$ 14,000 and NT$ 18,000
(USD 435 to USD 560) for a round trip ticket. Far Eastern
and China Eastern Airlines offers a much cheaper fare through
Cheju of about NT$ 10,000 (about USD 310),but that fare is
the exception. It is difficult to estimate precisely how
much cheaper the fares would be on direct flights. Joseph
Lee, Manager of the International Affairs Department at Eva
Air, told AIT/T that direct air links would probably cut NT$
5,000 to NT$ 7,000 (USD 155 to USD 215) from the total cost
of a Taipei-Shanghai round trip ticket, or somewhere between
25 and 50 percent of the total ticket price. Total travel
time is generally about five and a half hours. Airlines
agree that direct flights would cut about one and a half
hours off the total travel time.
Air Cargo ) Important Factor in Cross-Strait Trade
-------------- --------------

5. (C) A high volume of air cargo crosses the Taiwan Strait,
playing an important role in cross-Strait economic trade. In
addition to cargo carried on passenger flights, Taiwan, Hong
Kong, and Macau airlines conduct a total of 86 weekly all
cargo flights between Taiwan and Hong Kong or Macau. In
2003, Taiwan exported 94,000 MT of goods to Mainland China by
air via Hong Kong and Macau. During the same period it
imported 66,000 MT from the Mainland by air. EVA estimates
that 35 percent of air cargo shipped to Hong Kong and 30
percent of cargo shipped to Macau is ultimately bound for the
PRC.


6. (C) The impact direct flights would have on the cost of
cross-Strait air cargo varies by the type of service.
Door-to-door express delivery services offered by firms like
Federal Express, DHL and UPS differ in cost structure from
services offered by freight forwarding firms or smaller
courier services. Nick Chen, Director of Operations for DHL
Taiwan, estimated that direct flights would cut the cost of
DHL's cross-Strait express delivery service by approximately
20 percent. The savings on air cargo arranged by freight
forwarders that do not generally provide door-to-door service
would be higher.

Impact ) More Trade, Possibly Less Investment
-------------- ---


7. (U) Lower air transportation costs from direct aviation
links would stimulate cross-Strait trade, particularly for
Taiwan's high-tech industries. MOTC statistics show that
Taiwan's electronic goods manufacturers rely heavily on air
transportation. According to the most recent data,
approximately 15 percent by weight of Taiwan's electronics
exports to Mainland China are shipped by air. Electronics
goods accounted for almost 58 percent by weight of Taiwan
exports shipped to Mainland China by air and about 44 percent
of imports.


8. (C) Less expensive, more efficient cross-Strait
transportation might also mitigate the rate at which Taiwan
investment in the PRC is increasing. If it's cheaper and
easier to move goods from Taiwan to China, there may be less
economic pressure to move manufacturing operations to the
Mainland. Jason Chen, Deputy Spokesman for Taiwan laptop
computer manufacturer Quanta, told AIT/T that Quanta could
assemble its laptops in either Taiwan or the Mainland, but
felt forced to move its manufacturing facilities to the PRC
because most of its suppliers had already moved. Inexpensive
and reliable air cargo transportation would increase the
incentive for Taiwan firms to maintain the manufacture of
capital and technology-intensive components in Taiwan,
regardless of the location of input manufacturers or final
assembly facilities. Overall, Taiwan firms will continue
investing heavily in the Mainland regardless of the status of
aviation links. However, the flow may be slightly slower
with direct air transportation.


9. (U) Reduced air transportation costs would also benefit
Taiwan firms that already have invested in the Mainland.
Lower airfares would cut costs for managers that live in
Taiwan and fly to the Mainland regularly to oversee
investments. Some managers, who currently reside in the
Mainland due to the inconvenience and high cost of air
transportation, might even decide to return to Taiwan as
their base of operations. Similarly, multinational firms
considering abandoning Taiwan as their headquarters for
greater China or East Asia would be more inclined to continue
managing regional operations from Taiwan.

Impact ) Airline Industry Competition and Exclusion
-------------- --------------


10. (U) Taiwan airlines have already taken measures to help
them compete with Hong Kong and Macau airlines, which can
offer service across the Strait and onward connections to PRC
destinations. China Airlines (CAL),EVA, Far Eastern Air
Transport (FAT) and Trans Asia all have representative
offices in Shanghai and Beijing. EVA also has offices in
Guangzhou and Xiamen. Many carriers also have cooperative
agreements with PRC airlines that function like code-shares
in everything but name. CAL flights into Okinawa connect to
China Eastern Airlines flights to Shanghai. FAT has a
similar arrangement with China Eastern for its flights into
Cheju. EVA partners with Shanghai Airlines. Taiwan airlines
are able to sell tickets on the PRC legs of these connections
to their customers in Taiwan and their PRC partners sell
tickets on flights into Taiwan to Mainland customers.
However, Taiwan law prohibits Taiwan airlines from entering
into code-share agreements with PRC airlines, so these
arrangements are not identified as code shares.


11. (C) If direct air links are implemented, Taiwan carriers
will have to compete with PRC airlines on the lucrative new
cross-Strait routes. Taiwan and PRC authorities will tightly
control the routes. EVA's Lee speculated that the Taiwan and
PRC would initially open only four PRC airports for Taiwan
flights -) Beijing, Guangzhou, Shanghai and Xiamen. The
number of airlines permitted to fly each route would also be
strictly limited. PRC airlines may benefit from lower labor
costs for most operations, but as CAL's General Manager for
Strategic Planning Frank Mao pointed out to AIT/T, many of
the costs that airlines face )- fuel, equipment, and landing
fees )- are the same for all airlines. EVA's Lee told AIT
that although cross-Strait routes might reduce the airline's
profit margins, they would substantially increase the revenue
base. Both CAL and EVA are confident of their ability to
compete with PRC airlines on cross-Strait routes. They
expect to benefit from Taiwan investors in the PRC who would
prefer to fly Taiwan carriers for better service or due to
brand loyalty.


12. (U) The establishment of direct aviation links will
require negotiation and compromise on the classification of
cross-Strait routes that will impact non-PRC and non-Taiwan
carriers. The PRC government will insist that cross-Strait
routes are domestic ones, while Taiwan will seek to have them
classified as international routes. The most likely outcome
is a special "cross-Strait" classification or no
classification at all. The Hong Kong-Taiwan Aviation
Agreement (as reported ref A) does not identify Hong
Kong-Taiwan routes as either domestic, international, or
otherwise. However, only Taiwan and Hong Kong carriers are
permitted to conduct flights. A similar structure for
Taiwan-PRC direct air links would exclude U.S. and other
foreign carriers.


13. (C) U.S. passenger airlines are not particularly
interested in offering cross-Strait service. U.S. airlines
service to Taiwan has generally declined over the years.
Delta stopped service to Taiwan nine years ago. Northwest
eliminated Taipei-Tokyo service on November 1 and now only
offers Taipei-Osaka flights. United Airlines Taiwan General
Manager Andrea Wu told AIT/T that United would not be
interested in conducting PRC-Taiwan flights, but would be
interested in taking advantage of direct flights on other
carriers to offer better service for United passengers on a
"triangular route." She explained that a significant number
of United U.S. passengers traveling to Taiwan want to stop in
the PRC on the same trip. The typical pattern is a San
Francisco-Shanghai-Taipei-San Francisco trip for business
travelers from Silicon Valley visiting greater China's
technology centers.


14. (C) U.S. cargo carriers would be more concerned about
exclusion from cross-Strait routes. A firm like DHL that
primarily transports cargo on planes owned by other firms
would not be disadvantaged by a cross-Strait direct air link
agreement that excludes foreign carriers. However, FedEx,
which maintains its own fleet of aircraft, would be
negatively affected. Scott Williams, Taiwan Managing
Director for FedEx Express, told AIT/T that the impact of
such an agreement on FedEx's Taiwan operations would be
"huge." FedEx would be forced to use other carriers for
cross-Strait traffic in order to compete, a strategy FedEx
generally only employs when its own capacity is inadequate to
meet demand.

Comment ) Politics in the Way of Growth
--------------


15. (C) Taiwan and the PRC have gradually liberalized
cross-Strait economic relations in recent years, increasing
their economic integration. Establishing direct air links is
the single most important step that the two sides could take
to facilitate further cross-Strait commerce. More trade and
more efficient investment due to direct air transportation
would contribute to growth in both the Mainland and Taiwan.
However, domestic politics in Taiwan and the PRC still stand
in the way. The political environment after Taiwan's
December 11 Legislative Yuan elections on both sides of the
Strait will determine the potential for progress toward
direct air links. End comment.
PAAL