ALTHOUGH MANY OF its best companies have gone from strength to strength, the Taiwanese economy has lost considerable momentum in the past 10 years. Economic growth has slowed this decade by roughly one percentage point compared with the average of the past two decades.
Foreign businesses have become less attracted to the country. Taiwanese companies have invested heavily abroad while largely shunning their own economy. Taiwanese wealth has also flowed out of the country to the tune of US$200 billion ($283 billion) to US$300 billion since 2000. We believe there is now a good chance that all this is set to change.
NO REASON TO BELIEVE TAIWAN IS HOLLOWING OUT
Many believe that a major reason for Taiwan’s lacklustre performance has been the rise of China. In this view, Taiwan’s economy has been hollowed out as China’s compelling economic strengths attracted Taiwanese companies to relocate to China. That meant that the action shifted away from Taiwan to China. We disagree.
Many countries — Singapore and Hong Kong for instance — have seen large chunks of their economy relocate to cheaper production areas and yet did not sink into economic under-performance. In these cases, low-value activities were replaced by higher-value ones, allowing both Singapore and Hong Kong to sustain dynamic economies.
Moreover, Taiwan’s manufacturing sector, which bore the brunt of the relocation, actually continued to enjoy output growth. So, even as low-end production shifted to China, production of other, higher-end products continued to expand in Taiwan. So, the hollowing-out theory does not really add up.
POLITICAL WEAKNESSESS THE MAIN REASON
The real problem was that as low value activities moved out, Taiwan did not see a rapid enough growth of higher-value activities. We would argue that there were two reasons for this. First and most importantly, the election of Chen Shui-bian as Taiwan’s president in 2000 ushered in a period of disastrously poor relations with mainland China.
Policy changes necessary for Taiwan to fully reap the economic benefits of China’s rise and its own growing technical prowess were not carried through. More than that, President Chen’s policies drew such unremitting hostility from China that many of Taiwan’s economic partners around the region hesitated to conclude economic-partnership agreements such as free-trade agreements with it. So, Taiwan was excluded from the growing web of regional and bilateral trade pacts in this part of the world and its companies lost out by remaining in Taiwan.
Another reason for Taiwan’s under- performance was the lack of policy reform. While the country has an extremely credible and respected central bank, its policy regime overall is marked by excessive caution and over-regulation. The World Bank’s Ease of Doing Business study saw Taiwan’s ranking slip from a relatively acceptable 35th in the world in 2006 to 61st in 2008. This was not so much because Taiwan went out of its way to get in the way of business as that it was not improving its regulations as quickly as many other countries.
Another example is Taiwan’s financial sector, which continues to be burdened by intense competition due to a fragmented banking sector. As a result, profitability in Taiwanese banks is extremely low. Elsewhere in the region, policymakers have successfully promoted consolidation in the banking sector but not in Taiwan. Taiwanese banks have also not been allowed to expand their overseas footprint and remain solely dependent on their over-banked home market.
UNDRAMATIC BUT POSITIVE POLITICAL CHANGES
The main reason for our optimism is the change in the political context. A new president, Ma Ying-jeou, was elected in May 2008 with a mandate to improve relations with China. Although the global economic crisis has distracted his government, progress is now beginning to accelerate. An agreement has allowed large numbers of Chinese tourists to visit Taiwan, opening up a new area of growth for Taiwan. More recently, Taiwan and China have re-established “the three links” (air links, sea links and postal communication) that were cut after the 1949 civil war ended with the defeated Nationalist forces retreating to Taiwan. Direct air connections have multiplied between the two countries as a result.
Now, two major economic agreements are under negotiation — a comprehensive Economic Cooperation Framework Agreement (ECFA) and a Memorandum of Understanding (MOU) on the financial sector. Although political obstacles remain and may delay the actual conclusion of negotiations over these two agreements, it is only a matter of time before these two landmark agreements usher in a new era of more rapid economic integration between China and Taiwan.
What about the policy regime — are we likely to see reforms? This remains an area of concern for us. President Ma’s Kuomintang (KMT) party enjoys a strong majority in the legislature but the KMT is notoriously factionalised and it has not been easy for him to push through reforms. Now, he appears to have realised the need for his policies to be implemented more effectively. The appointment last week of Wu Den-yih as prime minister gives President Ma a much increased capacity to govern effectively. Wu has good relations with different parliamentary factions and has extensive connections with the business sector. He is likely to give the Ma Administration a sharper focus and is more likely to be able to secure parliamentary approval for the critical ECFA and financial-sector MOU once they are finalised.
WHAT DIFFERENCE WILL IT MAKE?
We think the accelerating improvement in ties with China and a more effective administration will mark a key turning point in Taiwan. We think that once the global financial crisis is finally over, GDP growth could potentially accelerate to around 6% from the roughly 4% growth averaged in the recent decade:
- We see a decisive improvement in the investment climate, resulting in a rise in the investmentto- GDP ratio of two to three percentage points.
- There will also be less visible improvements, with profound effects. Over the past decade and a half, roughly one million Taiwanese are estimated to have moved to work in China. In any economy, the loss of about 5% of its population would have meant such a drain of productive talent that economic growth would clearly be hurt. In coming years, this negative is likely to be less pronounced as business opportunities improve in Taiwan itself.
- Taiwan is also now in a better position to conclude partnership agreements with its economic partners, opening up considerably more economic space for Taiwan- based businesses.
- We also see some portion of the massive outflow of savings returning to Taiwan. Much of that outflow was precipitated by the insecurity generated among savers by the bad relations between China and Taiwan. With the risks of a conflict between China and Taiwan receding decisively, Taiwanese savers will feel that they do not need to put so much of their wealth abroad. Some recent policy measures such as the liberalisation of the inheritance tax will help this process of repatriation of capital.
Of course, the path to this higher growth will not be easy. A large minority of Taiwanese remain deeply suspicious of China, giving the opposition a strong base to throw up obstacles to progress with China. But, China’s leaders realise this and have taken a far more nuanced and calibrated approach to Taiwan. So, there will be ups and downs on the way, but the bottom line will be that, over the next few years, we are likely to see a far more dynamic Taiwanese economy.