CROSS-STRAIT ECONOMIC LIBERALIZATION - THE WAY

C O N F I D E N T I A L SECTION 01 OF 05 TAIPEI 004851

SIPDIS

DEPT FOR EAP/TC
DEPT PASS AIT/W

E.O. 12958: DECL: 12/09/2015
TAGS: ECON EINV ETRD EAIR EWWT EFIN PGOV PREL CH TW
SUBJECT: CROSS-STRAIT ECONOMIC LIBERALIZATION - THE WAY
FORWARD FOR TAIWAN

REF: A. 04 TAIPEI 3406

B. 04 TAIPEI 3464

C. 04 TAIPEI 4005

D. TAIPEI 343

E. TAIPEI 2565

F. TAIPEI 2653

G. TAIPEI 2743

H. TAIPEI 2896

I. TAIPEI 3122

J. TAIPEI 3931

K. TAIPEI 4085

L. TAIPEI 4395

M. TAIPEI 4624

N. TAIPEI 4717

O. TAIPEI 4719

P. TAIPEI 4778

Classified By: AIT Director Douglas H. Paal, Reason 1.5 b

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


1. (C) Over the past two decades, Taiwan has gradually
lifted many restrictions on cross-Strait economic relations
resulting in the PRC becoming Taiwan's largest trade
partner and top investment destination. However, many
restrictions remain, and many liberalization proposals
continue to languish. AIT assesses that Taiwan should
first implement measures that allow people to move more
freely across the Strait. Second, Taiwan should allow
money to flow, then technology, and finally it should free
the movement of goods into Taiwan from the Mainland. These
measures will benefit the economies of Taiwan and the PRC
and will also contribute to U.S. economic and security
interests. Some important measures may be implemented soon
including regular passenger and cargo charter flights and
opening of tourism. However, the apparent postponement of
the Economic Development Advisory Conference (EDAC)
following the ruling Democratic Progressive Party's (DPP)
sound defeat in the December 3 local elections is a sign
that the Chen administration is unlikely to speed the pace
of cross-Strait economic liberalization. Continued advice
from U.S. officials to both sides of the Strait to take
pragmatic steps will be essential to further progress on
liberalization measures. End summary.

Lingering Restriction in the Face of Rapid Integration
-------------- --------------


2. (U) Taiwan has gradually lifted many restrictions on
economic relations with the PRC over the last two decades.
Starting with permission to visit family members in the
Mainland in 1987, liberalization of indirect
telecommunications and postal services in 1989, and lifting
the ban on investment in the PRC in 1990, economic ties
with the PRC have grown dramatically. Today the PRC is
Taiwan's number one trade partner and the destination for
nearly 70 percent of approved outward investment each year
(plus more unapproved investment to boot). Every month
more than 350,000 Taiwan visitors travel to the Mainland.
It is no exaggeration to say that cross-Strait economic
relations affect everyone in Taiwan.


3. (C) However, progress toward liberalization has come
very slowly in recent years under the DPP administration.
The Renminbi exchange pilot program in Kinmen and Matsu
(ref K),for example, languished with all preliminary steps
completed more than a year before final approval to
proceed. In a similar vein, we will soon see the third
round of Lunar New Year charter flights since 2003 (ref N),
which highlights the failure of the two sides to reach an
agreement on regular air links. Other reform proposals
continue to suffer long delays in the approval process.

Recommendations for Taiwan's Cross-Strait Economic Agenda
-------------- --------------


4. (C) With numerous restrictions remaining across a broad
range of sectors, Taiwan has ample possibilities for cross-
Strait economic liberalization. Based on discussions with
a wide variety of businesses, academics and government
officials, both foreign and Taiwan, AIT offers the
following priorities for Taiwan's liberalization agenda
based on Taiwan's own economic interests:

First, Let the People Move
--------------

-- (C) Establish Direct Air Links - The single most
important step Taiwan must take is to establish direct air
links with the PRC. Direct air links will facilitate every
form of cross-Strait economic interaction. The lack of
direct links causes more unnecessary expense and difficulty
than any other cross-Strait restriction.

-- (C) Liberalize Entry Permits for PRC Workers - Taiwan
needs to make it easier for firms to bring PRC employees to
Taiwan for short-term activities and long-term employment.
This was one of the highest priorities identified by the
American Chamber of Commerce in Taipei in its 2005 White
Paper (ref F). This is especially important as firms
complain of a shortage of skilled workers in Taiwan's high-
tech industries (ref H). Progress has been made in this
area but more is needed (ref L). When combined with direct
air links, less restrictive entry permit regulations will
also have a strong positive effect on Taiwan government
efforts to encourage firms to set up their regional
operations headquarters in Taiwan. Taiwan entrepreneurs
would be able to maintain headquarters and research and
development operations in Taiwan even as they expand
manufacturing and sales operations in the PRC. Foreign
firms could integrate Taiwan into their greater China
operations and even maintain their regional headquarters on
the island. Without direct air links and more cross-Strait
personnel mobility, Taiwan and foreign firms alike will
increasingly abandon the island.

-- (C) Open Tourism - More than any other measure, opening
Taiwan to PRC tourists traveling direct from the Mainland
will have an immediate positive impact on the domestic
Taiwan economy. Industry observers are confident that
tourists will come and spend significant amounts of money
to the benefit of Taiwan's underdeveloped tourist industry
(ref E). Many cite the example of Hong Kong and the
important role PRC tourism has played in its recent
economic success. At about 3 million visitors per year,
Taiwan is dwarfed by Hong Kong's more than 14 million and
similar numbers elsewhere in the region.

Second, Let the Money Move
--------------

-- (C) Remove Investment Caps - Taiwan firms across all
industries complain about restrictions on the total amount
of capital they are permitted to invest in the PRC. Taiwan
has a graduated schedule of limits on investment in the PRC
based on a firm's total capital. Most firms are not
permitted to invest more than 40 percent of their total
capital. The largest firms are limited to even lower
percentages. These restrictions are not effective in
keeping investment in Taiwan. They are effective in
encouraging firms to use less transparent business
practices to hide their investment, sometimes illegally, or
to abandon Taiwan entirely (ref M). They have also proved
effective in keeping American firms from using Taiwan to
operate in China.

-- (C) Permit Renminbi Exchange - The ability to exchange
Renminbi in Taiwan will be essential to realize the full
potential of increased tourism from the PRC, once that is
opened. In addition, current restrictions unnecessarily
inconvenience business travelers. Although looser
restrictions on Taiwan's offshore banking units facilitate
business transactions, the current regulations still impose
a needless burden without achieving any economic or
security benefits for Taiwan.

-- (C) Liberalize Banking Investment - The Taiwan
government has embarked on an ambitious financial reform
plan, whose aims include making Taiwan a regional financial
center. However, Taiwan banks are not permitted to provide
banking services in the PRC, their most logical market for
expansion. Nearly 70 percent of Taiwan's approved outward
investment goes to the PRC. By prohibiting Taiwan banks
from opening branches in the Mainland, the government
excessively restrains Taiwan banks in the one foreign
market where they might have a competitive advantage.
Given that a key determinant of bank competitiveness is
scale, restrictions add to Taiwan's challenges.

Third, Let the Technology Move
--------------

-- (C) Liberalize Semiconductor Investment - Even as some
IT industries farther down the supply chain, such as laptop
PC manufacturing, have moved almost all of their production
to the PRC (ref O),Taiwan still prohibits certain forms of
investment in high-tech industries, especially
semiconductor manufacturing. These regulations are
ostensibly aimed at keeping sensitive technology out of the
PRC and preserving Taiwan's manufacturing base in these
industries. However, many of the technologies that are
restricted are already in use in the PRC by local as well
as foreign companies (refs D and G). Moreover, the
restrictions prevent Taiwan's most successful firms from
competing in the industry's fastest growing market; soon to
be the world's largest consumer of semiconductors. Taiwan
should quickly remove investment restrictions on
semiconductor packaging and testing and semiconductor
manufacturing with feature size no finer than 0.18 microns
(currently manufacturing investment is only permitted at
the 0.25-micron level and above). It should also consider
further liberalization of semiconductor manufacturing and
semiconductor design. U.S. firms are already exporting
these technologies to the PRC either through direct
investment or equipment sales to PRC firms. If Taiwan
firms are not allowed to compete, PRC competitors will have
the market protection that could allow them to dominate the
industry's key market, costing Taiwan its currently
considerable competitive edge.

-- (C) Liberalize TFT-LCD panel manufacturing - The TFT-LCD
industry faces a similar situation to semiconductors.
Taiwan firms are among the world's most important players,
but they are unable to build TFT-LCD panel manufacturing
facilities in the PRC where most of the panels are
assembled into consumer goods (ref B). The current
restrictions hold back what are arguably Taiwan's two most
competitive and economically important industries.

Fourth, Let the Goods Move
--------------

-- (C) Establish Direct Maritime Links - Although shipping
companies have found ways to comply with the letter of
Taiwan regulations that prohibit direct shipping with only
minimal increases in shipping costs, current restrictions
still impose unnecessary burdens on shipping firms and
their customers (ref A). The regulations also reduce the
attractiveness of Taiwan ports. With the rapid growth of
PRC ports, Kaohsiung's harbor has fallen from the world's
third busiest container port to the sixth and stands to
fall further. In addition, Taiwan's free trade port
initiative aimed at attracting more investment to Taiwan's
harbors has had difficulty in attracting tenants to the new
zones. The lack of direct links is an important obstacle
to Taiwan's goal of becoming a regional logistics center.
Taiwan's major geographic advantage is it's proximity to
the Chinese market. Without direct links, that advantage
is left languishing on the shelf.

-- (C) Lift Import Prohibitions - Taiwan still maintains
import prohibitions on numerous goods produced in the PRC.
Many of the prohibitions violate WTO commitments. The
removal of prohibitions on automobiles and auto parts as
well as certain food items, especially chocolate, has been
a high priority for some U.S. & foreign firms. They argue
that these prohibitions prevent foreign firms from
integrating Taiwan into their regional operations. If
forced to choose between the two markets or establish
manufacturing facilities in both, many foreign firms are
likely to choose to leave or bypass the Taiwan market.
However, the U.S. must also be mindful of the impact of the
removal of such restrictions. In addition to local
producers who could be negatively affected, removal of some
restrictions, especially on certain agricultural products,
will have a strong negative impact on U.S. exports to
Taiwan.

And Don't Forget Other Industries
--------------

-- (C) Liberalize Telecommunications Investment - Taiwan
telecommunications firms have entered into numerous
cooperative arrangements with Mainland firms to try to
capitalize on the growing demand for cross-Strait services
(ref C). However, they are still prohibited by Taiwan from
most forms of investment in the Mainland. These
regulations are counterproductive to Taiwan's goals for
developing digital-content industries.

-- (C) Allow Naptha Cracker Investment - Taiwan's
petrochemical firms, especially Formosa Plastics Group
(FPG),are eager to build naptha cracker facilities in the
PRC that would allow them to expand their downstream
petrochemicals production and further exploit their most
important market (ref I).

Benefits to U.S. Interests
--------------


5. (C) All of these liberalization proposals will
potentially benefit the economies of both Taiwan and the
PRC. They are also strongly in U.S. economic and security
interests. Many of these measures would have a direct
impact on U.S. businesses in the region, most importantly
by allowing them to better integrate Taiwan operations into
their broader strategy for greater China. In addition,
many U.S. exporters and U.S. investors in the region will
benefit from stronger growth in Taiwan.


6. (C) More importantly, closer economic ties between
Taiwan and the Mainland will help reduce tensions and
encourage both sides to move forward on negotiating
solution to the issue of Taiwan's status, eliminating one
of the most dangerous threats to regional stability. In
addition, stronger economic links could enhance Taiwan's
influence on Mainland society, increasing exposure to
Taiwan's stronger rule of law and democracy.

Prospects Glacial
--------------


7. (C) The months following the Lunar New Year holiday on
January 28 could offer the most favorable environment for
cross-Strait economic liberalization in years. Some of the
most important priorities, direct air links and opening
tourism, are currently the subject of unofficial cross-
Strait discussions. The announcement on November 16 of
Lunar New Year charter flights in January and February 2006
was a positive step. Reports from officials and industry
associations of progress on cross-Strait weekend passenger
charters and cargo charters are an indication that the
administration is serious about moving forward on these
initiatives.


8. (C) The December 3 local elections sent a strong message
of support for the KMT, which has successfully portrayed
itself as the party that can work with the PRC and will
implement cross-Strait economic liberalization measures.
Although allegations of corruption in the ruling Democratic
Progressive Party (DPP) had more impact on the election
results than cross-Strait issues, it is increasingly clear
that a majority of Taiwan voters support more open economic
relations with the PRC. In addition, the current opening
in the political calendar is fairly large with the Taipei
and Kaohsiung mayoral elections up next in December 2006
and the legislative and presidential elections scheduled
for December 2007 and March 2008 respectively. The
administration has some breathing space that could allow
the DPP to implement measures that its pro-independence
base does not support.


9. (C) Progress might come after the planned second
Economic Development Advisory Conference (EDAC). For the
second time, President Chen will convene an EDAC of
business leaders, scholars, and other experts to make
economic recommendations on a comprehensive range of
economic issues. Cross-Strait economic issues will be high
on the EDAC's agenda. This blue ribbon panel could give
Chen the political cover he needs to implement some of
these longstanding proposals. The dates for the conference
are unclear at this time, but it will probably take place
sometime after the Lunar New Year holiday in late January,
and could benefit from a likely rise in cross-Strait
goodwill that holiday charter flights will generate. If
the PRC takes no provocative measures in the interim, this
confluence of events could give the DPP administration the
opportunity to implement liberalization measures that some
in the government have been waiting for.


10. (C) However, there are also signs that the Chen
administration will do nothing to speed up the pace of
cross-Strait economic liberalization. The administration's
original plans call for the EDAC to take place January 19-
21, but the day after the ruling DPP's sound defeat in the
December 3 local elections an Executive Yuan official
indicated that it might be postponed, suggesting that
President Chen may ensure that his pre-election prediction
that a Pan-Blue victory would "tighten" cross-Strait
relations becomes a reality (ref P). Another bad sign is
the continuing delay on the applications made by
semiconductor manufacturers Powerchip and ProMos to build
factories in the PRC. The two firms applied almost a year
ago. Taiwan Semiconductor Manufacturing Company's (TSMC)
investment in the PRC was approved nearly three years ago
on February 26, 2003. Approval for the Powerchip and
ProMos projects would not represent any kind of
breakthrough in cross-Strait economic policy, and yet the
applications continue to languish in the approval process.


11. (C) The Chen administration has already had several
chances to live up to the "active opening" portion of its
"active opening, effective management" cross-Strait
economic policy. To date, changes have come rarely and
often only after the political opposition has forced the
administration's hand. There may be some important steps
forward next year. Most importantly, there may finally be
some sort of regular direct aviation links. However, there
is little reason to suspect that this government will
change the glacial pace of cross-Strait liberalization or
its attitude about economic relations with the PRC.

Recommendation - Continued Pressure
--------------


12. (C) U.S. advice to both sides of the Strait to take
pragmatic action has helped keep these important economic
liberalization proposals on the Chen administration's
agenda, despite tendencies to govern from the DPP's pro-
independence base. Continued efforts will be essential if
the current administration is to make further progress
toward implementation. U.S. officials at all levels should
continue to urge Taiwan to execute policies that will
further enhance the strong economic ties between the PRC
and Taiwan.
PAAL