CROSS-STRAIT TRADE AND INVESTMENT TRENDS GIVE PRC

C O N F I D E N T I A L SECTION 01 OF 04 TAIPEI 001690 SIPDIS DEPT FOR EAP/TC DEPT PLEASE PASS AIT/W E.O. 12958: DECL: 04/06/2015 TAGS: ECON ETRD EINV ETTC TW CH SUBJECT: CROSS-STRAIT TRADE AND INVESTMENT TRENDS GIVE PRC A GROWING ADVANTAGE REF: A. 04 TAIPEI 3464 ¶B. TAIPEI 136 ¶C. TAIPEI 539 ¶D. TAIPEI 1191 ¶E. TAIPEI 1216 ¶F. TAIPEI 1376 ¶G. TAIPEI 1402 ¶H. TAIPEI 1438 ¶I. TAIPEI 1511 ¶J. TAIPEI 1594 Classified By: Acting AIT Director David J. Keegan, Reason 1.5 b Summary -------------- ¶1. (C) In recent reporting, AIT/T has identified three important trends in cross-Strait trade and investment. First, even as the PRC becomes an ever more important trading partner for Taiwan, Taiwan's relative importance as a trading partner and source of investment for the PRC is diminishing. Second, Taiwan investment in the Mainland increasingly relies on demand within the PRC and on inputs produced in the PRC. Finally, increasingly advanced technology continues migrating from Taiwan to the PRC. These three trends have the common effect of making it easier for the PRC to use economic policy effectively to apply pressure on Taiwan. Their effects may already be apparent in the PRC's offer to open up its markets to Taiwan agricultural imports, and pressure on high profile businessmen who have been supporters of the ruling DPP. Cross-Strait liberalization is increasingly an economic necessity for Taiwan leaving it little room to maneuver. End summary. ¶2. (C) Rapidly growing levels of cross-Strait trade and investment are increasing economic ties between the PRC and Taiwan. However, there are several less obvious trends in trade and investment patterns that are also having an important impact on the nature of cross-Strait economic relations. The common feature among these trends is that they all have the potential to increase the ability and willingness of the PRC to use economic policy to apply pressure to Taiwan for political ends and at the same time make Taiwan more susceptible to that pressure. AIT/T has identified three such trends in various reports over the last several months. This report highlights them together and assesses their combined impact. Taiwan's Shrinking Share of PRC Trade and Investment -------------- -------------- ¶3. (U) Even as the PRC becomes an ever more important trading partner for Taiwan, Taiwan's relative importance as a trading partner for the PRC is diminishing. As reported ref J, the PRC accounted for 25.8 percent of Taiwan's exports in 2004, up from just 17.9 percent in 2001. The PRC also provided 9.9 percent of Taiwan's total imports, compared to 5.5 percent in ¶2001. However, even as the dollar value of cross-Strait trade rose, Taiwan's share of the PRC's total trade has fallen a peak of 8.2 percent in 1996 to just 5.3 percent in ¶2004. While Taiwan has consumed a slowly increasing portion of PRC exports -- up to 2.8 percent in 2004 -- Taiwan exports account for a steadily decreasing share of PRC imports. In 1997, a record 15.8 percent of the PRC imports came from Taiwan. By 2004, Taiwan's share had fallen by almost half to 8.0 percent. ¶4. (U) The same is true of investment. Taiwan continued to pour large amounts of investment into the PRC in 2004 as reported ref D. According to PRC data, the contracted value of Taiwan's investment in the Mainland rose by 8.7 percent in 2004 and investment in the PRC made up two-thirds of Taiwan's total outward investment. Nevertheless, investment from other locations grew even more quickly. As the table below shows, Taiwan's share of total contracted foreign investment in the PRC has fallen while South Korea's has risen steadily. Percent of Total Contracted Foreign Investment in the PRC -- 2001 2002 2003 2004 Taiwan 10.0 8.1 7.4 6.1 South Korea 5.0 6.4 8.0 8.8 A Taiwan Board of Foreign Trade official told AIT/T March 23 that he believes South Korea has improved its competitive position because of its closer trade and investment ties with China. Taiwan Investment Focused on PRC Domestic Market -------------- --- ¶5. (C) Taiwan investment in the PRC is increasingly aimed at sales to the PRC domestic market and uses PRC-based sources for inputs. As reported ref E, Taiwan enterprises in the PRC that responded to a Ministry of Economic Affairs (MOEA) survey indicated that PRC buyers accounted for 55 percent of their sales. This survey did not capture what portion of sales eventually ended up in the hands of PRC consumers. Most experts assess that a substantial portion of that 55 percent of total sales went to other firms manufacturing exports in the PRC that were eventually shipped to the U.S., Japan, Europe and elsewhere. This is the result of the gradual transfer of entire supply chains in export-oriented industries from Taiwan to the PRC. However, there is anecdotal evidence to indicate that a significant and growing portion of sales to PRC buyers is destined for PRC consumers. For example, Taiwan's cement industry (reported ref B) has seen growing investment in the Mainland with most of its PRC output used locally. Other Taiwan firms have indicated that they see the PRC domestic market as an increasingly important target for sales. PC brand Acer recently announced that it aims to double its revenue from domestic sales in China this year. Consumer electronics brand BenQ reported that 40 percent of its laptop PC sales were shipped to Mainland China in 2004. ¶6. (C) Regardless of how much is ultimately destined for PRC consumers versus export manufacturers; both kinds of investment are more closely tied to the PRC economy than those enterprises that sell their products directly overseas. Any buyer based in the PRC is subject to fluctuations in the PRC economy, including labor pressure, exchange rate changes, and shortages of key inputs such as power. Therefore, domestic economic conditions in the PRC will have a strong effect on demand from those buyers. ¶7. (U) The MOEA survey also indicated that PRC sources supplied Taiwan enterprises in the Mainland with much of their industrial inputs and finance. Survey respondents indicated that they purchased 50 percent of their raw materials, components and equipment from Mainland sources, compared to only 39 percent from Taiwan. They also received 34 percent of operational financing from PRC institutions compared to only 3 percent from financial institutions in Taiwan. Migration of Advanced Technology to PRC -------------- ¶8. (C) Taiwan investment trends have seen more and more advanced technologies transferred to the Mainland. Technology transfer issues in the semiconductor industry have attracted the most attention. Recent developments in the controversial United Microelectronics Co. (UMC) case (reported refs C and G) have confirmed long-standing rumors that UMC, Taiwan's second largest semiconductor manufacturer, provided substantial assistance to PRC IC foundry He Jian, which can now produce semiconductors with features at least as fine 0.15 microns. TSMC has an operational 8-inch wafer fab using 0.25-micron technology and has been actively pressing the Taiwan government to further liberalize and permit 0.18-micron technology investment. In addition, other foreign firms have established advanced semiconductor facilities in the Mainland and competitive PRC-based firms such as Semiconductor Manufacturing International Corporations (SMIC) and Grace Semiconductor Manufacturing Corporation (GSMC) have emerged. ¶9. (C) The TFT-LCD manufacturing industry, another high-tech cornerstone in Taiwan's economy, has also seen growing pressure to move technologically-advanced, capital-intensive manufacturing processes to the Mainland (reported ref A). Module assembly functions are already performed mainly in the PRC. Some firms have expressed an interest in moving panel and array manufacturing operations to the PRC as well. The Mainland Affairs Council (MAC) has indicated (ref F) that it is close to approving investment in the PRC in small-size screen TFT-LCD panel manufacturing. ¶10. (U) The information technology (IT) industry as a whole has seen a dramatic shift in manufacturing from Taiwan to the PRC over the last decade. By 2004, approximately 73 percent of IT products manufactured by Taiwan firms were produced in the PRC. For some critical items, the rate was significantly higher. Taiwan firms have the highest global market share for motherboards, but 84 percent are produced in the Mainland. The shift in notebook PC manufacturing has been particularly stark. Taiwan investment in notebook PC assembly in the PRC was illegal until November 2001, but by the end of this year the Market Intelligence Center, an industry research firm, predicts that nearly 100 percent of notebook PCs produced by Taiwan firms will be assembled in the Mainland. Comment ) Bigger Sticks and Sweeter Carrots -------------- ¶11. (C) These three trends have the common effect of making it easier for the PRC to use economic policy effectively to put pressure on Taiwan. With cross-Strait trade and investment increasingly dominating the Taiwan economy but accounting for a smaller and smaller portion of the PRC's total trade and investment, any policy that restricts these flows would have more potential for negative impact on Taiwan but less potential for disruption of the PRC economy. The deepening integration of Taiwan investment with the domestic Mainland economy has a similar effect. Taiwan investment has often been generalized as export assembly operations using PRC labor and Taiwan materials. If the PRC or Taiwan government were to implement more restrictive economic policies, investors using this kind of export assembly model can much more easily transfer their operations to other locations such as Vietnam or back to Taiwan. However, if whole supply chains have moved to the Mainland and Taiwan firms increasingly target local PRC demand, investors are left with few options. The transfer of more advanced technology has had at least two important effects. First, the PRC is not so heavily reliant on Taiwan investment to bring new technologies to the PRC economy and increase its high value-added manufacturing. Second, the successful emergence of technology clusters and mature supply chains in the PRC has increased the need for Taiwan high-tech firms to have a substantial presence there in order to stay competitive. The common result of these three trends is to strengthen the PRC's ability to use the restriction of or interference with Taiwan trade and investment for political ends. At the same time, the Taiwan government will feel increasing pressure for more cross-Strait economic liberalization from various circles in Taiwan and will have less ability to resist PRC manipulation. ¶12. (C) These trends are already having a significant impact on the dynamic in cross-Strait relations. The PRC seems bent on using its growing economic cross-Strait muscle, Taiwan's increasing reliance on exports to the Mainland, and Taiwan's falling market share in the PRC's total trade to advance its broader political cross-Strait agenda. For example, the PRC recently offered to open up to Taiwan's agricultural exports unilaterally. This positive incentive is aimed at agricultural interests based mainly in Taiwan's south, the center of DPP and pro-independence support. Taiwan officials have complained that private-sector interest in the initiative could undercut the Chen administration's more cautious cross-Strait policy. The PRC has also used negative incentives, as evidenced by the publication of Chi-Mei founder Hsu Wen-lung's letter (reported refs H and I) in support of the "one China" policy. It was a remarkable display of the PRC's ability to use its economic clout to force a drastic turnaround in the public rhetoric of one of Taiwan's most pro-Green businessmen with key economic interests in the Mainland. Acer founder Stan Shih's announcement that he would not serve another term as one of Chen Shui-bian's Presidential Advisors because he wants to emphasize his political neutrality again showed the PRC's increasing influence among Taiwan businessmen. Some officials have claimed that this kind of pressure on Taiwan businesses already constitutes the "non-peaceful means" threatened in the Anti-Secession Law. ¶13. (C) In the coming weeks, the Taiwan government will attempt to deal with the KMT-CCP agreement with its various economic initiatives, resolve the issues surrounding the UMC case, and respond to other cross-Strait economic issues. The Chen administration will have to operate within the context of the PRC's increasing economic influence over Taiwan and its growing willingness to exercise that influence. On several recent occasions, the Taiwan government has reaffirmed its commitment to economic opening. Further liberalization is increasingly a matter of economic necessity, and Taiwan's room to maneuver economically is only going to shrink. End comment. KEEGAN