The Great Deflation
Taiwan: Escaping the China Trap
Amid concerns that China's attempts to boost slowing economic growth and stem capital outflows could cause a global recession, Taiwan's dependence on the Chinese export market is coming back to haunt it.
Taiwan: Escaping the China TrapBy Peihua Lu
From CommonWealth Magazine (vol. 581 )
"Quite a few Chinese investors ask us ‘Can't we buy up Taiwanese listed companies?',” says Jonathan Chen, executive vice president of Deloitte Taiwan's tax division. The threat from the "red” Chinese supply chain becomes greater day by day. After poaching Taiwanese talent with high salaries, China is now putting out feelers for Taiwan's electronics industry.
On the Back of a Giant
For the past decade, China has been by far Taiwan's largest export market, with a 40 percent share of total exports. Taiwan exports twice as much to China than to its second-largest export market, the six core members of the Association of Southeast Asian Nations (ASEAN). (Table 1)
The lion's share, 40 percent, of the goods that Taiwan produces for export are electronic products. Half of these ITC goods are shipped to China. (Table 2)
Taiwan's central bank notes in a recent report that Singapore, South Korea and Taiwan all mainly export ITC products. South Korea, however, also exports transportation equipment, while Singapore counts mining products and chemical products among its exports. As a result, Taiwan has a higher commodity concentration coefficient, which measures the degree of commodity concentration in a nation's exports, than Singapore or South Korea.
Commodity concentration (in electronics) and geographical concentration (on China) put Taiwan right in the eye of the storm now that China's growth machine is stalling. "In the past we developed by riding on China's back," remarks Chen Tain-jy, professor at the Department of Economics of National Taiwan University.
Since 2008, China has overinvested in manufacturing, creating production overcapacities, and the world market was not able to absorb its output. On the other hand, Chinese wages kept moving upward.
Taiwanese businesses, in order to cut costs, began to source materials and parts in China instead of Taiwan, thus stimulating the growth of the local "red" supply chain. Today, China-based Taiwanese manufacturers no longer procure upstream products in Taiwan, and Taiwanese exports have declined as a result.
The Industrial and Economic Knowledge Center (IEK) under the Industrial Technology Research Institute (ITRI) concludes in an analysis that Taiwan's only internationally competitive export industry is semiconductors. In all other export segments such as petrochemicals, handsets, machine tools, displays and LEDs, Taiwan relies heavily on the Chinese market. However, in China, these industries have seen the emergence of strong Chinese brands, leading to malicious price competition across the Taiwan Strait.
Chen of Deloitte Taiwan points out that numerous Taiwanese parts manufacturers based in southern China liquidated their businesses and withdrew from China as the global market contracted over the past three years and Chinese-funded businesses grabbed international orders.
Relocating to Southeast Asia
Taiwanese exports to the ASEAN region have now posted negative growth for nine successive months, flashing a new alarm light with regard to the island's export dynamics.
A look at Taiwan's export figures shows that the value of the island's exports to the ASEAN region continued to increase between 2004 and 2011, with only the exception of 2009 when the financial tsunami hit. Exports to ASEAN grew 20 percent annually on average. However, the annual growth rate declined to 9.8 percent in 2012 and continued its downturn thereafter to post negative growth from the second half of last year.
Kristy Hsu, associate research fellow at the Taiwan ASEAN Studies Center of the Chung-Hua Institution for Economic Research (CIER), notes that developing countries, not just China, are incubating their own supply chains. The ASEAN countries are also developing their own industries. Thailand, for instance, has an auto parts industry, while Malaysia aggressively develops its petrochemicals industry. Some countries rely on foreign investors, some on government support, to grow their domestic supply chains. As these supply chains take shape, reliance on Taiwanese imports naturally declines.
Moreover, ASEAN has been actively working toward regional economic integration, which has far-reaching consequences for Taiwan due to its magnet effect, which uproots Taiwanese upstream manufacturers. This phenomenon is most obvious in Vietnam.
Vietnam concluded free trade agreements with South Korea, the Eurasian Economic Union (Editor's Note: members include Armenia, Belarus, Kazakhstan, Kyrgyzstan and Russia) and the European Union this year. Vietnam is also a member of the Trans-Pacific Partnership (TPP) multinational trade agreement. In order to prevent products from a country outside a trade agreement to "jump on the bandwagon" to exploit the agreement's benefits, newer free trade agreements have introduced the rule of origin. The TPP, for example, stipulates the "yarn forward rule of origin," which means that, starting with the yarn, all products in a garment must be made in one of the member nations.
"The old business model under which Taiwanese businesses imported yarn, fabric and other raw materials and then re-exported them after locally merely sewing on a button, is not feasible anymore," Hsu points out.
This means that if Taiwan's textile industry wants to take advantage of Vietnam's large export market, the upstream textile manufacturers that originally produced in Taiwan will be forced to relocate production to Vietnam. As the exodus of domestic manufacturers abroad gains pace, the two engines of Taiwan's economic growth – exports and investment – will lose steam.
"Our past success is now becoming a fatal flaw. If our current economic growth model does not change, we will have an even tougher job ahead of us in the future,” remarks Cheng Cheng-mount, president of the Agricultural Bank of Taiwan.
Exclusive Interview with the Premier
Mao Chi-kuo: Cracking the ASEAN Market
Taiwanese exports declined 14.8 percent year-on-year in August, the Ministry of Finance said in announcing the latest export figures last week. Not only did exports shrink at a double-digit rate for the third month in a row, but the August figures also represented the steepest decline since the global financial tsunami in 2009.
The gloomy export figures could make the engine behind Taiwan's export-driven economy stall.
Despite all of this, the Cabinet, which has only 10 months left before its term of office ends, continues to place the focus of its work on medium- and long-term economic restructuring measures, which has been provoking a storm of criticism and doubts.
In late August, Premier Mao Chi-kuo granted CommonWealth Magazine an exclusive interview. He pointed out that on top of short term cyclical issues, Taiwan's economy faces greater structural challenges than other countries. The following are excerpts from the interview:
Q: What can be done to solve the geographical concentration and sectoral concentration of Taiwan's exports?
A: As soon as I took over as premier, I spent my greatest effort on innovation and entrepreneurship. Our generation did not think about launching their own business before they were in their thirties or forties. The young people today want to start their own company right from the beginning. However, Taiwan's innovation environment is not friendly enough. I spent half a year solving [problems], such as adding a special section on closed corporations to the Company Act.
Closed corporation means a company that is not publicly listed. The company can decide for itself what rights and obligations its shareholders have. Even though the government encourages startups, the Company Act was so rigid in the past that it took a long time from the founding of a new company to its actual opening, so that it was often not able to survive at all.
After the legal amendment was passed, many young people were finally able to return to Taiwan [to start a business].
Our venture capital firms also complicated the situation. They want the startups to do an IPO (initial public offering) within the first few years, but where is the money going to come from to successfully run a startup so that you can take it public? Therefore the National Development Fund set up an Angel Investor Program to fill that gap. In the short while since it has raised about NT$15 billion.
[What we call] "Productivity 4.0” is internationally known instead as "industry 4.0”, but I don't think this is used only in the manufacturing industry. Industry uses the Internet of Things to transform it into an Internet of machines. The agricultural industry can use it to monitor soil and crops and make intelligent decisions by using big data analysis. In commercial applications, handsets serve as [data] terminal equipment for the Internet of Things so that supermarkets can do an even more thorough job.
[Our] ETC (electronic toll collection on highways) is "productivity 3.9.” The system has the characteristics of the Internet of Things; it has hardware, a system, operations and management. We now have 20 million datasets per day. We are not far away from Industry 4.0.
As for the export problem, I am analyzing this from the globalization angle. The United States is also affected by globalization, but U.S.-based Apple Inc. is placing orders for production overseas. Taiwan accepts these orders and produces overseas. What makes the difference is brands and distribution channels. Since we have neither brands nor channels, we lose jobs and GDP.
The best solution to the export problem is to manufacture in Taiwan. If production is to be relocated overseas, the focus must be on brands and distribution channels. When enterprises go to the ASEAN region for production, they tout that labor is cheap in these places. I tell them that if you regard them as the world's factory, producing there and selling the products back to the industrialized nations, [you need to take into account] that after several years, those emerging countries will be able to advance themselves, and the ASEAN manufacturers will also rise.
You shouldn't regard a place simply as the world's factory, you should pay attention to its domestic market. ASEAN has a population of more than 600 million people. Go team up with local distributors and develop products that are sellable there.
In order to transform exports, our commercial and business models need to change as well. Lite-On [Technology Corporation], for instance, has teamed up with Everlight [Electronics Co. Ltd.], Unity Opto Technology Ltd. and Delta Electronics Inc. Originally they were only able to make home lighting, but the future is going to be lighting for the intelligent home. The added value is completely different. There are many real-world examples in Taiwan for the horizontal integration of such value chains.
These are all tech-related. The technology budget for next year has increased, I guess I am the first premier to allow the technology budget to break through the NT$100 billion mark.
Q: Do you already have a budget for the plans that you mentioned today?
A: I will not move forward on the whole front at the same time; I will choose the most mature, most urgent [projects] with the highest willingness to put those on the right track that ought to happen.
Q: Next year there might be a cabinet reshuffle. Will it then be possible to continue to implement those plans?
A: No matter who takes the helm, these are the directions we must take. Do you think Taiwan can stay away from productivity 4.0? We need an environment conducive to innovation to make many things happen. Can we afford not to have such a [business] ecosystem and environment? Again, can Taiwan avoid the structural transformation of its exports? Taiwan cannot wait; this must be done.
(Interview by Ying-chun Wu and Monique Hou. Compiled by Pei-hua Lu)
Translated from the Chinese by Susanne Ganz