SCENESETTER FOR CONGRESSMAN KENNEDY

UNCLAS SECTION 01 OF 03 TAIPEI 002420

SIPDIS

SENSITIVE

DEPT FOR EAP/ TC

DEPT PLEASE PASS TO AIT/W

PLEASE PASS TO PETER SU IN THE BUREAU OF LEGISLATIVE
AFFAIRS (H)

E.O. 12958: N/A
TAGS: OREP AMGT ASEC AFIN OTRA TW
SUBJECT: SCENESETTER FOR CONGRESSMAN KENNEDY

REF: STATE 90490

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


1. (U) The United States has maintained unofficial relations
with Taiwan under the Taiwan Relations Act (TRA) of 1979.
The TRA commits the United States to offer defensive weapons
to Taiwan, now the second largest purchaser of U.S. weapons
systems in the world. Taiwan is governed by a multi-party
democracy. In 2000, the independence leaning opposition
party, the Democratic Peoples Party (DPP) won the presidency
from the Nationalist Party (KMT),which had ruled since it
moved to Taiwan from the Mainland in 1947. Since 2000,
Taiwan has suffered from gridlock with the DPP controlling
the presidency and the KMT controlling the legislature. One
result of that gridlock has been an inability to approve a
USD 18 billion appropriation for the purchase of defensive
equipment approved by the United States in 2001. Taiwan's
economy, long one of the most successful in Asia, hit its
first recession in 2001; and growth has been slow with 2005
GDP growth expected to be below 4 percent. Outstanding
trade issues between the U.S. and Taiwan include
intellectual property rights, market access for
pharmaceuticals, telecommunications, and rice. Despite
cross-Strait tensions, the economy increasingly depends on
exports to Taiwan's PRC-based manufacturing. (End summary.)

U.S.-Taiwan Relations - Security and Trade
--------------


2. (U) On January 1, 1979, the United States changed
diplomatic recognition from Taipei to Beijing. In the U.S.-
P.R.C. Joint Communique announcing the change, the United
States recognized the Government of the People's Republic of
China as the sole legal government of China and acknowledged
the Chinese position that there is but one China. The Joint
Communique also stated that within this context the people
of the United States would maintain cultural, commercial,
and other unofficial relations with the people of Taiwan.
In April 1979, Congress passed the Taiwan Relations Act
(TRA) creating the legal authority for the establishment of
the American Institute in Taiwan (AIT),a private nonprofit
corporation.


3. (U) Under the TRA, the United States is committed to
offer defensive military weapons to Taiwan. A USD 18
billion Special Defense bill to purchase diesel submarines,
P-3C anti-submarine patrol aircraft, and PAC-III anti-
missile batteries has been under consideration by the LY for
a full year. Political bickering and the resulting
legislative gridlock have thus far kept the bill bottled up
in the procedural committee.


4. (SBU) Market access and trade issues are the main
concerns in U.S.-Taiwan economic relations. Taiwan joined
the WTO in 2002 and committed to reduce barriers to trade in
several areas, including telecommunications and government
procurement. Many of these commitments remain incomplete.
For several years, intellectual property rights have also
been a key point of contention. Taiwan has been a center
for piracy of optical media and has seen an influx of
counterfeit products, including pharmaceuticals and branded
goods, from China.


5. (SBU) However, in the last year, Taiwan has improved
enforcement of its intellectual property laws, passed an
amended Copyright Law, and proposed legislation to create a
data-protection regime for pharmaceuticals. These
improvements led the U.S. Trade Representatives office to
recognize progress by shifting Taiwan from the Special 301
Priority Watch List to the Watch List in an out-of-cycle
review in early 2005. The U.S. still has concerns about
market access for pharmaceuticals and telecommunications
service providers. In a major step forward on trade
relations, on April 16, 2005 Taiwan lifted its ban on
imports of U.S. beef. Taiwan health authorities led the way
for Asian economies by following a careful and credible
review of procedures following the detection of BSE in the
U.S. We also continue discussions with Taiwan on its tariff
and quota regime for rice imports. On November 29, the U.S.
and Taiwan resumed talks under the Trade and Investment
Framework Agreement to further progress toward resolving
outstanding issues.
Politics: Divided Government, Legislative Gridlock
-------------- --------------

6. (U) Chen Shui-bian's election as President of Taiwan in
2000 marked the first transfer of political power between
parties in Taiwan since World War II and the consolidation
of multi-party democracy in Taiwan in the 1990s. Over the
past five years, Chen's independence-leaning Democratic
Progressive Party (DPP) has asserted increasing control over
the executive branch bureaucracy, which had been dominated
for decades by the Kuomintang (KMT). In March 2004, Chen
was narrowly reelected with less than 50.1 percent of the
popular vote. A controversial shooting incident the day
before the election, in which Chen and Vice President
Annette Lu were mildly injured, and the KMT's refusal to
accept the results of the 2004 election created a bitter
partisan environment in the run up to the December 2004
Legislative Yuan (LY) election.


7. (SBU) The December 2004 LY election constituted a setback
for President Chen and his DPP's hopes for winning a
majority of LY seats. The DPP and its "Pan-Green" coalition
partner, the pro-independence Taiwan Solidarity Union (TSU),
had hoped to take control of the legislature for the first
time. Instead, the "Pan-Blue" coalition, consisting of the
former ruling Kuomintang (KMT) and the People First Party
(PFP),won a razor-thin majority of LY seats, but promptly
split, leaving no workable majority in the LY. As a result,
the first LY session (February-May 2005) was characterized
by gridlock, with few pieces of legislation enacted.
Efforts to form ad-hoc legislative alliances to pass
specific legislation have been episodic and only
occasionally fruitful.


8. (SBU) The DPP's December election setback also showed the
limits of Taiwan voter support for the radical pro-
independence DPP campaign platform. Since then, President
Chen has followed a more moderate course, trying to appeal
to the majority of voters who support continuation of the
status quo rather than immediate unification or
independence.

Economy - Slowing Growth
--------------


9. (U) Taiwan is the 17th largest economy in the world. For
nearly 50 years before 2001, Taiwan experienced rapid
economic expansion, low unemployment, and low inflation --
often called "Taiwan's Economic Miracle." In 2001, the
economy contracted for the first time since 1952, largely
due to fallout from the global high technology industry
downturn that reduced demand for exports in the key markets
of the U.S., Europe and Japan. After two more years of
disappointing growth in 2002 and 2003, double-digit export
growth propelled the economy to nearly 6 percent real GDP
growth in 2004. Export growth has fallen, and economists
now predict that Taiwan's economy will slow significantly in
2005 with growth below 4 percent. This is low historically
for Taiwan and disappointing compared to the performance of
its neighbors and competitors.


10. (U) Exports of information technology and other high-
tech goods continue to be one of the main drivers of
Taiwan's economy, even as many firms move manufacturing
operations to China or Southeast Asia. In 2004, Taiwan's
exports grew more than 20 percent over the previous year.
Semiconductors have been an especially important component
of Taiwan's economic success. According to some estimates
the integrated circuit industry by itself accounts for 3
percent of Taiwan's GDP, excluding the suppliers and
customers who rely on the industry. Today, flat panel
displays are also playing an increasing role. Taiwan's
manufacturers of thin film resistor liquid crystal display
(TFT-LCD),the most widely used type of flat panel display,
control more than 40 percent of the TFT-LCD global market.
Taiwan's government has plans to continue to stimulate the
growth of these high-tech sectors, as well as to develop new
technologies such as biotechnology and nanotechnology.
Taiwan's government also hopes to diversify Taiwan's economy
beyond manufacturing into digital content, logistics,
finance and other services.


11. (U) Taiwan's macroeconomic policy has sought to maintain
stable exchange rates, low inflation and low interest rates.
Taiwan, after China and Japan, has the third largest stock
of foreign exchange reserves in the world. It has made
progress in strengthening a banking system that was in
serious trouble in 2001 and 2002 and improving the
supervision of financial institutions. However, the Taiwan
government has yet to fully deal with a number of insolvent
institutions. Taiwan's eroding tax base, a "no new taxes"
pledge (which it broke last week),and growing social
welfare costs have left the Chen administration with a large
budget deficit and limited options to pursue new spending on
key economic and defense objectives. In the context of the
continuing legislative gridlock, the budget crunch will
continue unless Taiwan manages to choose between the
politically difficult options of raising taxes, cutting
popular social programs, or running historically high
deficits.

Cross-Strait Tension and Economic Integration
--------------


12. (SBU) While strained political relations with Beijing
dominate both Taiwan's domestic politics and national
security issues, investment in the Mainland and trade across
the Strait are increasingly the driving forces in Taiwan's
economy. The recent visits to Mainland China by "Blue"
opposition party leaders Lien Chan (KMT) and James Soong
(PFP) have been hailed as an opportunity to improve cross-
Strait relations and have raised expectations in Taiwan.
The U.S. Government praised the visits and urged Beijing to
start direct contacts with the elected representatives of
Taiwan. However, PRC authorities and the Chen
administration have not been able to find a mutually
acceptable basis for direct contacts.


13. (U) In 2003, China replaced the U.S. as Taiwan's number
one trading partner. Exports to the PRC and Hong Kong make
up 35 percent of Taiwan's total exports. Many of these
exports are inputs destined for Taiwan-owned manufacturing
facilities in the Mainland. The PRC accounted for more than
67 percent of Taiwan's outward foreign investment in 2004.
Much of Taiwan's labor-intensive manufacturing has moved to
the Mainland, especially in industries like textiles, shoes,
toys, furniture, etc. In information technology and other
high-tech industries, the manufacture of the most advanced
and capital-intensive components has in large measure stayed
in Taiwan, while downstream assembly of final products has
moved to Mainland China. However, increasingly Taiwan
investors are moving the manufacture of upstream high-tech
components to the PRC as well. Currently, about 70 percent
of information technology products produced by Taiwan firms
are assembled in the PRC. The Taiwan government continues
to restrict investment in the Mainland for certain
categories of high-tech manufacturing. However, Taiwan
firms have been strongly urging the government to liberalize
investment in more advanced semiconductor manufacturing
technologies, semiconductor packaging and testing, and small-
size TFT-LCD panels. Most of the electronics consumer goods
manufactured by Taiwan firms in the PRC are still exported
to the U.S., Japan, or Europe. However, Taiwan economic
dependence on PRC domestic markets is growing across a range
of industries.

PAAL