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