US-CHINA TRADE IMBALANCE (C-AL5-00044)

C O N F I D E N T I A L SECTION 01 OF 03 TAIPEI 000385

SIPDIS

DEPT FOR INR/I, EAP/TC
DEPT PLEASE PASS AIT/W

E.O. 12958: DECL: 01/31/2015
TAGS: PINR ECON ETRD EINV CH TW
SUBJECT: US-CHINA TRADE IMBALANCE (C-AL5-00044)

REF: A. STATE 11139

B. 04 TAIPEI 3930

Classified By: AIT Director Douglas H. Paal, Reason 1.5 (d)

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


1. (U) Taiwan export manufacturing firms have made massive
investments in the PRC, with especially strong 50 percent
growth in investment during 2004. In the key industries of
electronics and information technology products
manufacturing, a pattern of triangular trade has emerged.
Taiwan firms export high-tech components to Taiwan-owned
factories in the PRC. Then Taiwan firms fill U.S., European
and Japanese export orders for finished consumer goods from
their PRC assembly plants. As a result, Taiwan's exports to
the U.S. have fallen overall the last few years. Notebook PC
manufacturers have invested heavily and rapidly in the PRC.
Nearly 100 percent of laptop PC's produced by Taiwan firms
will be assembled in the PRC in 2005. The industry saw a
particularly strong fourth quarter with fierce competition
cutting costs and driving up demand. Taiwan's investment in
the PRC in the telecommunications equipment industry has not
been as strong. The PRC factories account for just 28
percent of cell phones manufactured by Taiwan firms. (End
summary.)

Triangular Trade Pattern
--------------


2. (U) Although not an action addressee on ref A, AIT would
like to provide input on the questions raised about the rapid
increase in China's exports to the United States. Investment
by Taiwan firms in the Mainland has been massive. Taiwan
figures, based on applications for investment approved by the
government, put total investment since 1991 at over USD 41
billion. This does not include substantial investment
funneled through third territories, which is widely thought
to exceed officially approved investment by a factor of 2, 3
or even 4. After two years of strong growth, Taiwan's
investment in the PRC surged in 2004. Taiwan government
statistics show that investment in the PRC rose by 38.6
percent in 2002 and 19.1 percent in 2003 over the previous
years, but then increased again by a remarkable 51.2 percent
to USD 6.94 billion in 2004. Growth in the first half of
2004 was even more striking at 68 percent compared to the
same period in 2004. Most of Taiwan's investment in the PRC
has involved the transfer of manufacturing and assembly
operations to the Mainland and then exporting the output to
the U.S., Europe and Japan.


3. (U) Electronics and information technology (IT) have
played an increasingly important role in cross-Strait trade
and investment (ref B). Taiwan firms now dominate the PRC's
IT export industries. The Market Intelligence Center (MIC),
an industry research firm, estimates that Taiwan firms
accounted for 79 percent of total PRC IT output (excluding
software) in 2004. In these industries a pattern of
triangular trade has emerged. While moving less advanced
assembly operations to the PRC, Taiwan has maintained a base
on the island for manufacturing high-tech components,
including semiconductors and flat-panel display components.
These kinds of components and other manufacturing inputs
account for 80 percent of Taiwan's exports to China. After
export to the PRC, the components are mostly re-exported in
finished consumer goods to the U.S., Europe and Japan. Given
this trade pattern, it is not surprising that the PRC's trade
surplus with the United States -- USD 71.5 billion in the
first 11 months of 2004 -- mirrors the PRC's combined deficit
with Taiwan and South Korea -- USD 78.6 billion during the
same period.


4. (U) With increasing investment in the PRC, Taiwan's
exports to the U.S. have generally fallen as trade is routed
through production bases in the Mainland. Although last year
saw Taiwan's exports to the U.S. rise 8.4 percent to USD 28.1
billion, this increase followed three years of decline.
Total 2004 exports to the U.S. still fell almost 20 percent
below the 2000 figure. The gap between U.S. purchase orders
for Taiwan firms and Taiwan exports to the U.S. illustrates
the nature of triangular trade between the U.S., Taiwan and
the PRC. In December 2004, Taiwan export shipments to the
U.S. totaled USD 2.5 billion, only 42.5 percent of the USD
5.8 billion in purchase orders Taiwan firms received from the
U.S. during the month. Most of the difference is filled with
products assembled in the Mainland. Strong growth in U.S.
orders to Taiwan firms in the fourth quarter of 2004, which
were 32 percent higher than the previous year, may translate
into more strong PRC export growth in the first or second
quarter of 2005, depending on when the orders are shipped.
Notebook PCs ) Rising PRC Investment and Export Demand
-------------- --------------


5. (C) The transfer of manufacturing from Taiwan to the
Mainland in the notebook computer industry has been dramatic.
A recent MIC study estimates that nearly 100 percent of
laptops produced by Taiwan firms in 2005 will be assembled in
the PRC. Taiwan firms produce most of the world's laptop
PCs. Quanta Computer Inc. alone accounted for 25 percent of
the global market in 2004 and has announced that it is aiming
for 30 percent in 2005. Its top two Taiwan rivals Compal and
Wistron together accounted for almost 25 percent in 2004.
Quanta's transfer of production to the Mainland has been
astonishingly rapid. Early in the first Chen Shui-bian
administration, Quanta's founder and CEO Barry Lim had been
vocal about keeping manufacturing in Taiwan. However, price
pressures and the migration of its suppliers to the Mainland
forced Quanta to begin manufacturing operations in the PRC in

2001. Deputy Group Spokesman Jason Lin told AIT that 85 to
90 percent of Quanta's 2004 third quarter notebook production
was based in the Mainland. That figure increased to 95
percent in the fourth quarter and is predicted to approach
100 percent in 2005.


6. (SBU) In addition, the notebook computer industry saw
unexpectedly high demand in the fourth quarter of 2004.
Quanta shipped 3.7 million notebook PCs in the fourth
quarter, up 32 percent from the previous quarter. Low prices
due to fierce competition among manufacturers were a major
contributing factor to high demand. The current average
gross margin for the industry is just 5 percent and expected
to fall below 4 percent according to MIC. Executives of
Quanta and Compal have called publicly for an end to the
price war, which is driving down stock prices. About
one-third of the laptops produced by Taiwan firms in the
fourth quarter was shipped to the U.S. Another third was
shipped to Europe, and one quarter of shipments went to Asia,
excluding the PRC.


7. (U) Nevertheless, the MIC study predicts that laptop
shipments will drop by 14.7 percent in the first quarter of
2005 to a total of 10.4 million units. This is due in part
to a shortage of key components, including Intel's Celeron
central processing unit. Quanta Chief Operations Officer
Michael Wang suggested to AIT/T earlier this month that we
urge Intel to sell them more components.

Cell Phones ) Smaller but Significant PRC Investment
-------------- --------------


8. (U) Taiwan manufacturers of telecommunications equipment,
and cell phone handsets in particular, have not invested as
heavily in the Mainland as some other electronics industries.
According to research by Taiwan's semi-official Industrial
Technology Research Institute (ITRI),61 percent of cell
phone manufacturing by Taiwan firms takes place in Taiwan.
This may in part be driven by continuing restrictions on the
import of cell phones into Taiwan from the PRC, even as other
categories of electronics have been liberalized.
Nevertheless, with 28 percent of production in the PRC,
cross-Strait investment has been substantial. Furthermore,
this figure does not capture some Taiwan investment that
takes place through third territories.


9. (SBU) BenQ is Taiwan's number one cell phone brand, a
leading contract manufacturer for other brands, and the
largest cell phone manufacturer both in Taiwan and the PRC.
David Huang, BenQ's Financial Planning Department Senior
Manager, told AIT/T that his firm has been transferring
manufacturing operations to the PRC for over ten years.
According to Huang, neither BenQ nor its major Taiwan
competitors opened new factories in the PRC during the last
half of 2004. However, he notes that production capacities
at their manufacturing plants in China are scaleable,
allowing BenQ and other manufacturers to quickly expand
production without large-scale capital investment.


10. (C) Huang also said BenQ products manufactured in the PRC
are exported in nearly equal amounts to the United States,
Europe and Asia (excluding China),each accounting for about
30 percent of sales. The remaining 10-13 percent is produced
for the China market. For all Taiwan cell phone
manufacturers, North America accounted for 26.1 percent of
2004 sales, according to ITRI. Europe and Japan accounted
for 30.4 percent and 7.5 percent respectively. Huang noted
that as in laptop manufacturing, competition in the cell
phone market has been fierce pushing down prices and cutting
margins. He said that BenQ might consider investment in
other low-cost locations such as India or Southeast Asia if a
revaluation of the Renminbi increases costs in the PRC.
PAAL