Article

What Are the Implications of Taiwan-China Economic Liberalization?

Daniel H. Rosen November 7, 2011

Observers of cross-strait relations between Taiwan and mainland China are getting past their skepticism that a breakthrough in the pair’s economic relationship is afoot, and starting to examine the significance for the two and — directly and indirectly — for the United States. This is tricky analysis for a couple of reasons. First, both Taipei and Beijing have been publicly coy on the extent of the liberalization they are contemplating. Then, the economic consequences of not pursuing cross strait economic opening requires clarification in order to make clear the net value to all parties to an economic agreement.

It is reasonable to expect that a Taiwan-China economic undertaking, currently discussed under the term Economic Cooperation Framework Agreement, or ECFA, will take the shape of a comprehensive free trade agreement (FTA) such as the ASEAN+China agreement. That describes it in terms of endpoint, but not in terms of action to get there. Most economies undertaking an FTA start from normal trade relations. Taiwan’s relationship with China is not normal: it maintains a broad array of unilateral protectionist measures plainly in violation of WTO obligations. So an ECFA means committing both to normalization and liberalization, and hence more tumult than might be expected in moving to the same level of integration between two parties with a less complicated relationship.

While China professes little concern with the economic implications of such an undertaking, Taiwan President Ma Ying-jeou argues that ECFA is entirely about maximizing Taiwan’s economic position; that is, it has nothing to do with political integration. However, Taiwan did not undertake a considered economic analysis of ECFA until late in the game, in the spring of 2009, well after public debate was heating up. With research now under way, including a forthcoming study by a colleague and me for publication this fall, a clearer picture of the economic implications is emerging.[1] Our findings confirm that the economic impact for China will be minimal in the aggregate, though important for specific industries and key provinces closely involved with Taiwan trade and investment. If China opens further to Taiwan financial services providers, the scrappy banks from across the Strait can help patch the lack of capacity China’s state banking behemoths seem to have for servicing small and medium enterprise clients. Taiwan, on the other hand, sees very large aggregate gains from an ECFA. But these are misunderstood: they mostly arise from dynamic adjustment inside Taiwan due to dismantling barriers to China, not from increased market access in China — where Taiwanese goods already enjoy largely unfettered access.

The implications of Taiwan remaining aloof from liberalization with the mainland (and also the region, which has been wary of agreements with Taiwan due to Chinese pressure) are severe. Taiwan will suffer in terms of domestic investment, productivity growth, and national income. In contrast, by undertaking an ECFA agreement Taiwan will generate significant GDP and welfare gains through 2020, and likely re-establish its competitive momentum in the region, momentum which has eroded as obvious political risk considerations about Taiwan’s future were left unresolved. Once the policy impediments to Taiwan’s economic intercourse with China are removed, most of the disruption to Taiwan’s potential growth is likely to be remedied.

Taiwan would enjoy additional, though modest, gains in economic performance through 2020 if it could then proceed to conclude other FTAs in the region after cross-strait economic flows are opened. Economic deepening with the mainland generates the lion’s share of gains for Taiwan; but if Beijing impedes Taiwan’s progress toward a level economic playing field and does not allow it to join in the regional trade integration festival that China is helping inspire, it will be altering the situation significantly. The status quo in Asia is to keep the bicycle of trade integration rolling. For Taiwan to be forced to walk while others bike is to change that status quo.

For the United States, two questions about the economic implications of an ECFA stand out. First, are there economic side-effects for the United States? In the first instance there are likely some economic costs in terms of trade diversion, but these will be minor and in some cases just represent a switch from the sales from a US company’s domestic operations to their China facilities. Looking ahead, however, the dynamic implications are major. If even China and Taiwan are moving ahead with trade deepening, the U.S. failure to ratify FTAs, long since completed and now gathering dust, truly does represent abdication of Asia Pacific economic leadership. As Rupert Hammond-Chambers of the US-Taiwan Business Council recently observed, if the United States does not have a trade policy for Asia, then it does not have an Asia policy — period.

Second, what difference does ECFA make to America’s long-standing interest in Taiwan’s security? No doubt the opening of Taiwan to additional imports, investment, and human resources from China will elicit concerns about exposure to mainland influence. But the larger consideration is that Taiwan’s competitiveness and long term prosperity are the wellspring of its security. The business as usual outlook for Taiwan’s economy is not healthy. The evolution of comparative advantage and industrial value chains in the region is profound, and Taiwan will not maintain its place in key industries if it is not on equal ground with regional peer competitors. A Taiwan with robust domestic business investment, continuing preeminence in cutting edge technology clusters, and an economy that adjusts to the new reality of the Asian economy is vastly preferable from a US security commitments-perspective than a marginalized economy to which international investment is allergic. Whatever choices Taiwan’s people embrace in the future with regard to political and security relations with the mainland, they will be in a demonstrably stronger position to pursue those preferences if their economy is vital, growing and productive.