HOW STRONG IS TAIWAN'S ECONOMY?

C O N F I D E N T I A L SECTION 01 OF 04 TAIPEI 002545

SIPDIS

SIPDIS

STATE PASS USTR, STATE FOR EAP/TC,USTR FOR STRATFORD AND
KATZ, TREASURY FOR OASIA/TTYANG, COMMERCE FOR
4431/ITA/MAC/AP/OPB/TAIWAN

E.O. 12958: DECL: 11/29/2017
TAGS: ECON EFIN ETRD PREL PGOV TW
SUBJECT: HOW STRONG IS TAIWAN'S ECONOMY?

REF: A. TAIPEI 2505

B. TAIPEI 2193

C. TAIPEI 2283

D. TAIPEI 2295

E. TAIPEI 2336

F. TAIPEI 2444

G. TAIPEI 2525

H. TAIPEI 2471

I. TAIPEI 2531

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Classified By: Stephen M. Young, AIT Director, for reasons 1.4 (b) and
(d).


1. (C) SUMMARY. Reflecting popular concern about the economy,
both presidential candidates are raising economic issues as
Taiwan heads into the 2008 legislative and presidential
elections. The DPP boasts about Taiwan's solid growth even
as the KMT pledges to reverse a purported economic decline.
Taiwan's ambiguous performance lends itself to multiple
interpretations: 2007 GDP growth has been revised upward to
a respectable 5.46 percent, unemployment is under 4 percent,
exports are booming, foreign direct investment is streaming
in (ref a) and the stock market is up by six percent thus far
this year. These positive figures, however, mask widely-held
concerns about stagnating living standards and eroding
international competitiveness. Taiwan's vibrant technology
sector accounts for most export growth, but an uncompetitive
service sector isn't always compensating for manufacturing
job loss to the PRC and other low-cost countries. Although
Taiwan remains an enormously successful economy, large
portions of the public and the business community see its
recent performance as unable to sustain a broad rise in
living standards while allowing Taiwan to keep pace with
regional competitors. There are important implications for
the U.S.: An emphasis on competitiveness will accelerate
cross-Strait integration and regulatory reform, likely
improving the investment climate for U.S. firms. At the same
time, ongoing concern about economic performance will fuel
Taiwan's continued interest in a bilateral FTA and other
tangible signs of U.S. commitment to Taiwan's continued
economic viability. END SUMMARY.

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IT'S NOT JUST ABOUT CROSS-STRAIT ECONOMIC TIES
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2. (C) Despite differences in emphasis, presidential
candidates Ma Ying-jeou and Frank Hsieh share a relatively
pragmatic approach to cross-Strait integration, and both have
declared their intentions to establish direct transportation
links while liberalizing investment and tourism (refs b-e).
This relative KMT-DPP convergence on cross-Strait economic
policy is based in part on a growing consensus that Taiwan is
not positioning itself to take full advantage of China's
ongoing economic boom. With both sides of the political
aisle acknowledging the link between a more pragmatic
cross-Strait economic policy and Taiwan's economic strength,
therefore, the cross-Strait issue is merely one manifestation
of an underlying concern with overall economic
competitiveness.

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AN ECONOMY IN TRANSITION
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3. (SBU) Based on stronger-than-expected growth in exports,
as well as a tentative rebound in private consumption,
Taiwan's official 2007 GDP growth projection was recently
revised upward by about a full percentage point, to 5.46
percent. David Hong, President of the private Taiwan
Institute of Economic Research (TIER) think tank, told us
that Taiwan's recent and projected annual growth rates in the
4-5 percent range are significantly lower than the economy's
50-year average of 8.2 percent after 1949, but are reasonable
given Taiwan's level of development. Citing a joint analysis
prepared by TIER and four other think tanks, Hong estimated
Taiwan's potential annual growth rate at 5 percent. Although
5.46 percent GDP growth compares favorably with 2007

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projections for Singapore, South Korea, and Hong Kong - the
other three East Asian "tiger" economies - Taiwan's overall
performance has been relatively weak in recent years. Since
2000, Taiwan's annual GDP growth has averaged 4.5 percent,
versus 4.9 percent in Singapore, 5.2 percent in South Korea,
and 5.5 percent in Hong Kong. Hong believes Taiwan is in the
midst of an "industrial structuring transition" as the
economy shifts from reliance on original equipment
manufacturing (OEM) to an emphasis on original design
manufacturing (ODM). In his view, Taiwan must adopt a new
business model that includes more attention to branding,
distribution, financing, and an increased focus on higher
value-added manufacturing.

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A BIFURCATED ECONOMY?
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4. (SBU) Some private analysts have expressed concern that
Taiwan is becoming a bifurcated economy, divided between a
world class technology industry and a lackluster service
sector. Based on 2006 data, Taiwan's technology sector
dominated global production in a variety of key fields,
including 66.7 percent of semiconductor OEM, 91.4 percent of
Mask ROM production, 75.2 percent of TN/STN LCD panel
production, and 60.3 percent of IC testing. Between 1986 and
2006, the technology sector's share of GDP rose from 9
percent to 13.3 percent, and technology's share of overall
manufacturing production rose from 24 percent to 59 percent
over the same period. As of last year, the technology sector
accounted for half of manufacturing employment and 71.2
percent of total exports. Taiwan's economy, therefore, is
inextricably linked to the island's successful technology
sector.


5. (SBU) Is the technology sector alone, however, enough to
sustain the overall economy? Chen Tai-jy, a National Taiwan
University (NTU) economist who informally advises KMT vice
presidential candidate Vincent Siew (ref f),also believes
that Taiwan is in the midst of an economic transition, with
significant disparities in how different sectors of the
economy are adapting. Technology-intensive manufacturing is
holding up quite well, he said, even as labor-intensive
manufacturing continues to decline. Since the start of the
1990s, Taiwan has shed 431,000 manufacturing jobs, largely in
labor-intensive industries such as apparel, footwear, toys,
and sporting goods. Service sector jobs, however, have not
always offset job losses for less-skilled workers. In Chen's
view, the service sector has not been an official priority
and is "underperforming." Taiwan's service sector, he noted,
traditionally only focused on serving the island's
manufacturing industry, and has developed little
international competitiveness.


6. (C) In fact, significant portions of Taiwan's service
sector have not reached their full potential, and have yet to
make their full contribution to economic growth. According
to TIER's Hong, the service sector, despite accounting for 73
percent of GDP, has "almost no international
competitiveness." The financial sector, for example (ref g),
suffers from slow regulatory reform, a glut of banks, and
persistent low profitability. NTU's Chen singled out tourism
as a particular problem, with a performance he described as
"ridiculous" when compared with other economies in the
region. In 2006, Taiwan's 3.5 million overseas visitors
generated $5.14 billion in revenue, or 1.4 percent of GDP.
Corresponding figures for Singapore and Hong Kong are 6.1
percent and 5.5 percent, respectively, although Taiwan does
outperform South Korea, where tourism comprised only 0.6
percent of GDP in 2006. Even so, it is far behind other
regional tourism powerhouses such as Thailand (6 percent of
GDP) and Malaysia (7 percent of GDP).

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SOCIAL INEQUALITY
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7. (SBU) "M-shaped" has emerged as one of Taiwan's leading

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economic, social - and even political (ref h) - buzzwords to
describe a widespread perception that the island's vaunted
social homogeneity is unraveling in the face of economic
globalization. In fact, Taiwan's Gini coefficient has risen
only slightly in recent years, from 0.326 in 2000 to 0.34 in

2006. By comparison, similar figures for Hong Kong, Japan,
and South Korea are 0.533, 0.308, and 0.310, respectively
(NOTE: Japan's figure is from 2004, and South Korea's, which
is based only on urban households, is from 2005.) In
contrast, the U.S. Gini coefficient was 0.469 in 2006, and
China's was 0.47 in 2005. According to TIER's Hong, although
per capita GDP is still rising, social inequalities are
widening as some groups benefit more quickly than others.


8. (SBU) Lackluster wage growth (septel) is dampening
consumer confidence and contributing to weak consumption
growth. Average annual real per capita income growth
declined from 6.9 percent in the 1980s to 5.4 percent in the
1990s and only 2 percent in 2000-2006. Consumer confidence
is low, contributing to growth in private consumption of 3
percent in 2006, versus an average of 7.2 percent in the
1990s and 8.4 percent in the 1980s. While these figures may
be seen as consistent with Taiwan's progression from a
high-growth developing phase to a more mature developed
economy, they represent a shock to many Taiwan residents
conditioned to decades of rapidly rising living standards.

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REGIONAL IMBALANCES
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9. (SBU) According to official Taiwan household income and
expenditure data, income gaps between northern, central,
southern, and eastern Taiwan widened from 1996 through 2001,
but have since largely narrowed due to expansion of the
Tainan and Taichung high-technology industrial parks and the
2004 inauguration of Taiwan's second freeway. In central
Taiwan, average per capita incomes were 17.3 percent below
the northern benchmark in 1996, 21.9 percent below in 2001,
and 19.4 percent below in 2006. Corresponding figures for the
south are 14.9 percent, 25.2 percent, and 23.7 percent,
respectively. Contrary to widespread perceptions of a
deteriorating north-south income gap, Taiwan's real economic
laggard appears to be the relatively isolated and
sparsely-populated eastern part of the island, where per
capita incomes were 23.5 percent less than the northern level
in 1996, with the gap widening to 31.4 percent by 2006.
Hualien, the largest city in the east, has seen average per
capita incomes drop by 7.58 percent between 2001 and 2006.


10. (SBU) Expansion of Taiwan's freeway network appears to
have helped mitigate a widening north-south income gap,
suggesting that the year-old High Speed Rail (HSR) network
linking Taipei with major central and southern cities will
also help redress regional imbalances (ref i). Based on TIER
analysis, Hong said Taipei and the rest of northern Taiwan
would benefit most from the HSR, followed by Kaohsiung and
Tainan in the south. Machine tools and some other industrial
sectors in Taichung will get a boost from the HSR, he
projected, but overall impact on the city will be limited.
The HSR will actually have a negative economic impact on
other areas of central Taiwan, he added.

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CAN TAIWAN MAINTAIN ITS EDGE?
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11. (SBU) Although challenged by growing competition from
China and other developing economies, many Taiwan technology
executives appear confident they can maintain their
competitive advantage. The CFO of a leading integrated
circuit (IC) design firm, for example, recently predicted
that Chinese IC design companies will reach technical parity
with Taiwan design houses in about five years, but
anticipates that Taiwan firms will already have advanced to
the next generation of IC technology and continue to expand
their market share. This example is a microcosm of Taiwan's
larger competitive challenge: constantly develop new

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technologies and move up the value-added chain, or risk being
overtaken by lower-cost competitors. Although not as
advanced as regional competitors Singapore and South Korea,
Taiwan authorities are now focused on developing its nascent
biotechnology sector (septel) as a future engine for economic
growth. With U.S. $4.7 billion in annual biotech value,
however, Taiwan is far behind its regional competitors
Singapore ($15.9 billion in 2006) and South Korea ($7.5
billion in 2005) Currently, Taiwan's biotechnology sector
accounts for only 0.6 percent of the global market and
amounted to only one percent of the island's total exports in
2006, suggesting Taiwan still has a substantial way to go
before the sector plays a significant economic role.


12. (SBU) Regardless of concerns about the higher education
system, Taiwan remains a potent force in global research and
innovation. As a percentage of GDP, Taiwan's research and
development (R&D) spending has climbed steadily in recent
years, from 1.91 percent in 1998 to 2.52 percent in 2005.
Taiwan's R&D spending does not, however, match that of its
regional competitors. For example, the corresponding figure
for Japan rose from 2.95 percent in 1998 to 3.13 percent in
2004, and in South Korea went from 2.34 percent to 2.85
percent during the same period. Even so, Taiwan's innovation
performance has been solid. In 2006, for example, Taiwan
ranked fourth in terms of U.S. patents issued, behind the
U.S., Japan, and Germany.

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WHAT DOES IT MEAN FOR THE U.S.?
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13. (SBU) With little in the way of natural resources, Taiwan
has built a remarkably successful economy. Taiwan's
trajectory has been remarkably fast: from a poor,
agricultural economy in 1949 to today's high-technology
powerhouse with an annual per capita GDP of over U.S.
$16,000. Perhaps precisely because of the economy's
remarkable performance from 1950 until about 2000, Taiwan
residents now show a marked impatience and unease with the
relative stagnation of recent years. The economy's
impressive strengths are mixed with an array of
vulnerabilities, as outlined above. At this point, however,
perception may be more important than reality for the average
Taiwan voter. Both presidential candidates are keenly aware
of popular fears that Taiwan's vaunted economic prowess is
eroding, and are gauging their campaign platforms
accordingly.


14. (C) The U.S. economy receives tangible benefits from a
vibrant Taiwan, and domestic concerns about economic
competitiveness are only likely to underpin concrete reforms
beneficial to U.S. interests. The prospect of greater
cross-Strait economic integration is the most obvious result,
increasing Taiwan's attractiveness as both an investment
destination and market for U.S. businesses. In addition,
Taiwan's preoccupation with economic performance should drive
legal and regulatory reforms beneficial to U.S. interests.
The emphasis on economic growth is also likely to maintain
Taiwan's rhetorical push for a bilateral FTA as a concrete
symbol of U.S. confidence in the Taiwan economy. While an
FTA may not be on the table in the immediate future, the U.S.
should concentrate on Taiwan's interest in boosting economic
growth as leverage for achieving market-opening progress,
especially under the Trade and Investment Framework Agreement
(TIFA). In particular, there is strong interest among
American companies in Taiwan's financial, technology, and
other service sectors. Taiwan's increasing focus on
attracting foreign investment should also generate greater
efforts in further improving IPR protection.





YOUNG