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Taiwan's China fever (SCMP June 18)

China fever is raging in Taiwan. The Bush administration may have underwritten the US commitment to the island republic in less ambiguous terms than did Mr Clinton, and arms sales has boosted its confidence in medium term security. But never has Taiwan felt the gravitational pull of the mainland economy so strongly.

This translates into two political factors. Firstly, it suggests that the economic price of quasi-independence may be rising and that Taiwan may in the not too distant future have to temper its position towards Beijing if its prosperity is to be further enhanced. Secondly, it has partly re-opened the ethnic divide between Taiwanese who put a high priority on Taiwanese identity and those of mainland origin who find economic as well as emotional reasons for emphasising links with the mainland.

Of course, the situation is not cut and dried. Most people are of Taiwanese origin and most occupy the middle ground of politics wanting to preserve the political status quo, remaining very suspicious of an authoritarian Beijing but recognising the necessity of economic ties. But there are some real policy issues here, and they also reflect class as well as ethnic divides.

In very general terms central and southern parts of the island are not only more self-consciously Taiwanese and more likely to vote for the DPP, they also happen to be suffering most from the shift of labour or land intensive industries overseas, especially to the mainland. The mainland pull takes several forms. Mostly they are not new.

Similar fevers have been experienced in the past and been doused by events on the mainland ranging from economic downturn to murder of Taiwanese to the hidden costs of doing business there. So this may be yet another cycle. However it is one which is coinciding with Taiwan's weakest economic performance since the 1975 world oil crisis recession and the probable entry of China and Taiwan into the World Trade Organisation, a step which in overall economic terms is good for both but which has short term costs, and in political terms is a mixed blessing for Taiwan.

The debate in Taiwan focuses on whether the current restrictions on mainland links are economically detrimental to Taiwan, as the majority of business interests insist, or that Taiwan is already being damaged by a sheep-like rush by business to invest in the mainland. There are in fact several quite distinct issues to be considered. Firstly is the issue of direct air, sea and telecommunications links. These would undoubtedly cut costs and make life easier for Taiwanese businesses with mainland activities - just as they would damage all those HK businesses, such as Cathay Pacific which currently provide intermediation.

However, it is questionable whether it would make much difference to the level of Taiwan investment which has been driven by the hope of improved returns and for whom the additional time and costs of going via Hongkong or Macau are not decisive. Tourism might be another matter. Direct flights to Shanghai could entice the Taipei elite, many with mainland relatives, to hop across to the newly dynamic city across the strait just as many Hongkongers now shop in Shenzhen. But the impact shouldn't be exaggerated.

Though it has been easy and cheap for Taiwanese to visit the mainland for the past decade, with only the briefest touchdown in Macau, 75% of the population has yet to do so. Likewise it is doubtful whether mainland tourists would rush to Taiwan which is expensive and poorly provided with tourist facilities.

Restrictions on Taiwan investment in the mainland currently apply to high level technology, to very large projects and to infrastructure. They have been partly successful - such as in preventing Formosa Plastics from a huge mainland investment, delaying the move of wafer plants and laptop manufacture to China and probably slowing the process of investment.

However, most investment has gone ahead regardless and lower end wafers and laptops are now moving too. The fact is that investment is propelled either by the need for lower costs for export, or the prospects (more questionable) of a growing domestic market, or by Taiwanese parts manufacturers needing to be close to big name end-users who themselves have set up on the mainland. In reality most investment plans are approved, or routed via some offshore location.

This does not mean that the attractions of the mainland are not to some degree a threat or competition to Taiwan - merely that liberalisation of controls probably would not make much practical difference at least until the next China boom or next global TMT surge. There are signs that Taiwan are actually cutting back mainland investment either because export demand has softened or because they see gluts coming. The very same provincial governments who in the mid-90s were dangling carrots before all and sundry auto makers are now doing the same with semi-conductor industry.

Taiwan has of course been surprised by the speed of the development of the mainland electronics industry, especially in Shanghai and adjoining Jiangsu. It has been due to a combination of foreign and Taiwan capital, big local incentives (especially for Taiwanese) and the availability of engineers who have been easy to attract to this prospering part of China from less favoured regions. Tens of thousands of Taiwanese also now live in and around Shanghai too now, an important contributor to local high life and night life.

Taiwan naturally fears that its industries are being subjected to a "hollowing out", which is being encouraged by Beijing for political reasons. In one sense that is true - but it has been true since 1990. Easy access to cheap mainland labour has resulted in a shift in Taiwan's economy away from manufacturing, which now accounts for only 25% of GDP against 33% ten years ago. There has been both a shift to services and to high value manufacturing which, until this year, was sustaining per capita GDP growth at around 5% -- a much better performance than Hongkong over the same period.

Nor has the mainland been the only beneficiary. They may be less attractive now, but southeast Asia and Latin America have also attracted large amounts of Taiwan capital and manufacturing know-how. The current focus on China and the suggestion that Taiwan's salvation lies with the mainland is belied by the diversity of its investments and the fairly stable level of its trade with the mainland.

The percentage of exports to the mainland climbed rapildy in the early 1990s then flattened out at around 22%. It has risen again recently but is still only 24 % in 2000 despite the boom both in China's domestic demand and the surge in electronics exports by Taiwan owned mainland factories, which probably source at least a third of their components from Taiwan. However, there is also little doubt that the appeal of the mainland has for now overtaken the speed of upgrading in Taiwan itself. The mainland in some respects is now competitor as well as cheap labour source.

The problem for Taiwan is not acute as for SE Asia. Top of the technology chain manufacturers from Japan and the US continue to move high valued added activities to Taiwan where manufacturing skills are often second to none the movement outwards is at least as fast. But the ability of Taiwanese to move into design and product development, and to adapt to rapid market changes, is barely keeping up with losses of less sophisticated industries.

There is not much Taiwan can do about this other than maintain its own steep learing curve. At least much of the intellectual property is being retained by Taiwan firms. However, there are things that Taiwan can do to offset the negative impact. The first is to speed up the development of its service sector, hamstrung, a little like Japan, by all kinds of regulations and cartels.

Next is to use it financial resources to resolve banking sector problems as soon as possible. The third is to open up further to foreigners, and mainlanders so that the inflow of money and skills better balances the outflow. Those are not "stroke of the pen" changes which will resolve problems overnight. They would not provide the immediate investor confidence boost which major cross straits progress would give, and perhaps push the stock index, now 5,000, within striking distance of its record reached more than a decade ago.

But in this moment of mainland fever Taiwan does need to understand that in economic terms China is neither saviour nor nemesis. Like the US and Japan, the mainland is a major component in an economy which is a niche player in some leading edge global markets. Ends

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