Can Taiwan decouple from the Chinese economy?

Written by Michael Reilly.

Image credit: DSCF2278 by Studio Incendo/Flickr, license CC BY 2.0

In mid-January 2020, prospects looked rosy for Taiwan’s economy and its main businesses. The Taiwanese economy had grown by over 3% in the last year, outperforming that of its traditional rival, South Korea and with growth accelerating towards year-end. President Tsai Ing-Wen had just been re-elected with an increased majority, and her Democratic Progressive Party (DPP) retained control of the Legislative Yuan (LY), assuring another four years of domestic political stability and predictability.

The impact of US President Donald Trump’s trade war with China had been much less damaging to Taiwan than at one time feared. Although Taiwanese exports to China fell as the impact of the new American tariffs started to bite, its exports to the USA increased by just over 17% in 2019, offsetting the decline in its exports to China. The biggest beneficiary was Vietnam, to where some multinational companies and their sub-contractors, including some Taiwanese companies, hastened to relocate production from China and which saw its exports to the USA surge as a result. Reflecting this, Vietnam’s imports from Taiwan jumped by almost 20% between the third quarter of 2018 and that of 2019, further helping to absorb the drop in Taiwan’s exports to China.

But the mood of euphoria in Taiwan at Tsai’s win had barely started to decline before the full severity of the new coronavirus outbreak in Wuhan became apparent. Together with Trump’s trade-war – suspended but not ended – and Xi Jinping’s ongoing threats to Taiwanese sovereignty, the coronavirus outbreak will, therefore, only strengthen the voices of those in Taiwan arguing to reduce Taiwan’s reliance on the Chinese economy. It is a vindication of Tsai’s New Southbound Policy, the aim of which is to do just that.

Nevertheless, regardless of how desirable this may be for Taiwanese, there are many practical reasons why it will not happen soon. First, the consequences of the coronavirus outbreak have highlighted the extent to which China is now an integral part of the global economy. Airlines have suspended flights to and from China as the flow of Chinese tourists have dried up, and motor manufacturers and others have warned of threats to production as the supply of components from China have ceased. In 2002, at the time of the SARS outbreak, China accounted for 8% of global gross domestic product. Today, that proportion is just under 20%.

But if the world economy is dependent on that of China, so China is currently reliant on the Taiwanese economy. In a reflection of this, and what the outbreak might mean in terms of impact on Taiwan, in the five trading days immediately after the Lunar New Year holiday, the Taipei stock market fell by 7%.

Just a few very different examples help to illustrate this and also give some idea of the difficulties of reducing the problem of inter-dependence. Consider first the case of Huawei, China’s biggest indigenous ICT player and an especial focus of Trump’s trade war. At least sixteen Taiwanese companies supply Huawei with key components. Two of these, maybe more – TSMC and ASE Tech Holding – receive around 10% of their total earnings from supplying Huawei. In this case, Trump’s trade war could be considered ‘personal’ in that his administration is taking steps over and above the broader tariffs applied on Chinese goods to limit the use of Huawei products both in the USA and by its allies. Even if Huawei were to switch production to a third country, it seems unlikely that this would change. And Huawei’s size in the global market means its Taiwanese suppliers cannot easily find an alternative customer of comparable standing to replace it.

Then look at the direct consequences of the coronavirus outbreak on Taiwanese companies, setting aside political aspects, such as the problems Taiwan faced in trying to repatriate its citizens from Wuhan. Around 20 Taiwanese companies have production facilities in Hubei province alone, the one at the epicentre of the outbreak and therefore most affected. These are not just in ICT but consumer goods (Uni-President) construction (Asia Cement) and other sectors. They include some giants, such as Honhai, which on its own employs around one million Chinese. For now, these facilities remain shuttered. Even when production restarts, it remains to be seen whether the migrant workers, on which so many of them have depended, will be willing to return to Hubei province. Yet Hubei province is far from being the only one in China with Taiwanese operations. It is not even the most important — most Taiwanese investment having gone historically to Guangdong, Fujian and Jiangsu provinces. Honhai has factories in more than ten other Chinese provinces in addition to Hubei, for example.

Consider too, the challenges in moving production to a third country such as Vietnam. Set aside, in doing so, the practical difficulties companies will face if they scale down operations in China (laying off staff, closing factories). Even after the increase in Taiwan’s exports to Vietnam last year and the drop in those to China, Taiwan’s exports to China were still more than eleven times its exports to Vietnam. The entire manufacturing workforce in Vietnam is about the same in numbers as that of Guangdong province alone in China, meaning foreign companies investing there are likely quickly to face labour and skill shortages. Even combined, the South East Asian economies are but a fraction of the size of China’s.

This last point is especially relevant in the case of companies considering relocating production back to Taiwan from China. There are simply not enough workers available in Taiwan for the labour intensive, low-skill assembly work that accounts for so much of China’s industrial output. Add to that regulatory and other constraints, such as the difficulty of acquiring land and the relevant permits needed for large scale facilities, or the red tape associated with exporting and importing, and the repatriation of production to Taiwan will be limited.

In the medium to long-term, the coronavirus outbreak may turn out to be the high-water mark of foreign investment in China. Even before this, foreign companies were growing increasingly frustrated as the government increased minimum wage levels in provinces such as Guangdong and Fujian, and they also became frustrated with a growing burden of regulations and a bias in favour of domestic companies. Worries about the risks of depending on extended global supply chains were already growing and have only been reinforced by the coronavirus. Expect to see China’s predominant role in supply chains reduce, but over time, not overnight.

But there is much that Taiwan’s policymakers can do to help reduce dependence on China rather than simply wait for it to happen. The government is likely to continue to emphasise the New Southbound Policy, but more can be achieved through domestic measures. For a start, it could reduce the regulatory burden on companies, making the process of importing and exporting quicker and easier. Second, it needs to persuade Taiwanese companies to move away from their traditional ultra-low-cost model of doing business, paring margins to the minimum and instead work with them to promote brand awareness and brand value. Through tax and other incentives, it should also encourage them to invest more in automation. And it needs to persuade Taiwanese companies to pay their staff more, skilled managerial staff especially, to encourage them to remain in Taiwan. The steady haemorrhage of Taiwan’s most highly skilled, highly motivated and ambitious young talent to China, represents both a gift to China and one of the biggest threats to the long-term health of the Taiwanese economy.

Michael Reilly is a Non-resident Senior Fellow in the Taiwan Studies Programme at the University of Nottingham. His research interest includes the EU’s relations with Taiwan, specifically prospects and opportunities for developing these against the continuing growth of China. His latest book, The Implications of Brexit for East Asia, co-edited with David W. F. Huang, was published in summer 2018.

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