Is ECFA the Solution to Taiwan's ASEAN Dilemma?

When ASEAN Plus China began to come into force in 2005, the Council for Economic Planning and Development (CEPD) conducted a survey to ask manufacturing firms what sort of impact they expected as a result of Taiwan's exclusion from the ASEAN Plus China and ASEAN Plus Three (China, Japan, South Korea) free trade zones on our six major exports-optoelectronics, electronics, petrochemicals, steel, textiles, and automobile parts.

The results indicated that Taiwan, China, Japan, Korea, and the five original members of ASEAN already enjoyed reciprocal free trade in large appliances and electronics through their participation in the World Trade Organization's Information Technology Agreement (ITA). As a result, slightly more than half of Taiwan's exports to ASEAN, China, Japan, and Korea are already tariff-free. Though ITA does not cover LCD panels and a small number of other electronics products, upwards of 80% of these components enjoy tariff rebates because they undergo further processing locally before being exported to a third nation. Consequently, they too have been largely unaffected by the ASEAN Plus China agreement, and are unlikely to be much affected if and when an ASEAN Plus Three agreement is concluded. That portion of the just under 50% of products that are not already traded freely but that undergo further processing before export are also unaffected. The study anticipated that the petrochemicals, steel, textiles, and machinery industries would be most affected by the agreements. Unfortunately, it forecast that the impact on these products, the principal exports of Taiwan's traditional manufacturers, would be significant.

A 2009 analysis of trade and tariff data by Ku Ying-hua, a research fellow with the Chung-Hua Institution for Economic Research (CIER), anticipates that the plastics industry will bear the brunt of the effects of the ASEAN Plus China free-trade zone when fully implemented in 2010. Upstream chemicals, plastics, and rubbers, including purified terephthalic acid (PTA), polystyrene (PS), polypropylene (PP), polyvinyl chloride (PVC), and acrylonitrile butadiene styrene (ABS) resin, are heavy, bulky, and extremely expensive to ship, making it more advantageous to export them to nearby nations than distant ones. Mainland China is still in an industrial development phase, and its demand for these products is high. Taiwan's proximity to the mainland enables it to benefit from this demand-we send about US$8.6 billion in petrochemical exports to the mainland every year, or about 60% of our total.

Singapore and Thailand, both ASEAN members, have been growing more competitive in the petrochemicals sector in recent years, and are gradually maturing into rivals to Taiwan. When the ASEAN Plus China free trade zone comes into full force, it will eliminate all tariffs on products traded between ASEAN and China. So, while Taiwanese petrochemicals makers will continue to pay tariffs averaging 6.5% on their China exports, ASEAN manufacturers will pay none. Facing such an uneven playing field, Taiwanese manufacturers will have an extremely difficult time remaining competitive.

Ku believes the impact on the textiles and machinery industries, where Taiwanese exports are very competitive, will be limited. For example, ASEAN's machine tools producers are as yet no match for those in Taiwan. Mainland Chinese businesses that currently use Taiwanese machinery are unlikely to roll the dice on imports from ASEAN members just to avoid a 3% tariff.

But will Chinese firms end up taking over the ASEAN market? Ku thinks not. China is still developing its own economy and can't produce enough petrochemicals and machinery to satisfy its own domestic needs. It has no surplus to export.

Steel products will be more affected. Like petrochemicals, steel products are bulky, heavy, and primarily exported to nearby nations. Since 2005, most Taiwanese steel exports have gone to mainland China, but steel production capacity in China has skyrocketed in recent years, generating a surplus available for export. As a result, Taiwanese steel exports have started going to Thailand and Indonesia. After the ASEAN Plus China free trade zone is established next year, Taiwanese products may maintain market share for a time thanks to their superior quality, but exports to ASEAN will inevitably suffer as Chinese steel makers improve quality, especially given the price advantages enjoyed by the latter.

Taiwan's steelmakers casting about for a response to the challenge have two main options at their disposal. One is to simply lower their prices and wait for things to get better. The other is to set up operations with ASEAN, as China Steel has begun doing in recent years.

Analysts believe that ASEAN Plus Three will have a greater impact on Taiwan than any of the other ASEAN Plus arrangements, largely because Korea's exports so closely resemble those of Taiwan. How will Taiwanese products compete when Korean products are able to ride the zero-tariff provisions into the 2-billion-person ASEAN Plus Three market?

Fortunately for Taiwan, the ASEAN Plus Three free trade zone remains an uncertain prospect. Proposed in 2001, the arrangement is still under study, the key hurdle right now being the difficult question of whether China or Japan will lead the talks. Few scholars see any agreement being signed in the foreseeable future.

In an effort to address the outbreak of the AH1N1 flu, the health departments of the 13 nations that comprise ASEAN Plus China, Japan, and Korea held a planning meeting in Bangkok this May. Billboards relating to the meeting towered over the streets and indicated just how rapidly Southeast Asian integration is progressing.

The failure of firms that have been operating in the export market for years would certainly be disheartening, but as far as both Taiwanese industry and academia are concerned the real problem is that such an integrated economy will divert investment away from Taiwan.

Tung Chen-yuan, an associate professor with the Graduate Institute of Development Studies at National Chengchi University, has over the last four years surveyed a total of more than 1,000 companies of five types: Taiwanese firms traded on the Taiwan Stock Exchange or the GreTai Stock Market, Taiwanese parent firms, Taiwanese firms in China, foreign firms operating in Taiwan, and international investment consultants. His results show that if Taiwan is unable to sign onto an East Asian economic integration agreement, 26-35% of respondents will cut their investments here, while 23-37% will increase them (See Table 1). Taiwan's ability to participate in such an agreement will thus affect the investment behavior of 49-72% of domestic and foreign firms.

The main reasons firms would reduce their investment in Taiwan would be out of concern that Taiwan, as an outsider, would be unable to take advantage of the growth opportunities, the resource integration, and the economies of scale associated with the larger integrated market. They fear local corporations would lose their competitive edge and be unable to compete with the firms of other nations.

"In fact, Taiwan lost over a billion US dollars worth of international investment capital between 2000 and 2007," says Tung. "And with it left talent, technology, and consumption power." A concerned Tung argues that this outflow has hindered Taiwan's ability to further develop its economy, and that this damage will accelerate and become more severe as the integration of the East Asian economies accelerates.

Industries making goods for daily use, which depend primarily on domestic sales, are likely to be hit especially hard by ECFA. The government should propose measures and transformation plans as quickly as possible to assuage the worries of businesses and the public. The photo shows a floor-and wall tile production line located in Yingge.

If we want to end Taiwan's orphan status, which nations should we sign economic integration agreements with? According to the survey, our first priorities should be China (which accounts for 20% of Taiwan's external trade) and the US (which accounts for 12%), and our second priorities should be Southeast Asia (13%) and Japan (13%). How would an economic integration agreement with China affect Taiwan's ability to attract foreign investment? As many as 30-41% of survey respondents said they would increase their investment in Taiwan.

Businesspeople are both very worried and exceedingly expectant. But China and Taiwan have an unusual relationship that raises questions about how we go about integrating the two economies. Is the ECFA the government has proposed signing with the mainland the only option? How should we go about estimating the costs and benefits of ECFA? Views on these questions vary widely, and there is no consensus in sight.

Analysts have had a difficult time estimating the effects of the draft of ECFA released by the Ministry of Economic Affairs because the various major "frameworks" (for trade in goods and services, investment guarantees, economic cooperation, and intellectual property rights) haven't really taken shape. Moreover, the government has no plans to release any concrete information on them because it is reluctant to lay too many of its cards on the table before talks begin. Supporters and opponents have both been left to read the tea leaves as best they can, making it very difficult for them to come together on anything.

Reason one for supporting ECFA: It will insulate Taiwan from damage from ASEAN Plus.

Ku's newest estimates show the 2010 establishment of the ASEAN Plus China free trade zone decreasing Taiwan's industrial output by US$2.46 billion per year-US$1.2 billion from plastics, US$1.0 billion from textiles, and US$300 million from petroleum and coal products-an amount equivalent to 16% of our present annual manufacturing output. Ku further projects that a continuing decline in Taiwanese manufacturing capacity could lead to the loss of more than 100,000 jobs. And if key links in some manufacturing chains (e.g. the textiles industry's dyeing sector) relocate overseas, it could lead to supply crunches that sharply weaken the manufacturing clusters that Taiwan is so proud of.

Reason two for supporting ECFA: It will increase the size of Taiwan's economy.

Johnny C. Chiang, director of the Division of International Affairs at the Taiwan Institute of Economic Research, says that China, the world's third largest economy with a 2008 GDP of roughly US$4.3 trillion (about 7.7% of the global economy), has tremendous potential to grow its market. It also happens to be the single largest consumer of Taiwanese exports, accounting for about 40% of our exports. We, in turn, are the mainland's fifth largest supplier of imports. Signing the ECFA and pursuing deep economic integration would likely make Taiwanese products more competitive in the mainland market. The 1.3-billion-person mainland market would, in turn, increase Taiwan's economic scale.

Reason three for supporting ECFA: It will make domestic firms more competitive against our greatest trade rival-Korea.

Chiang says that the 90% similarity between Taiwan's and Korea's export structures used to mean that every devaluation of the Korean Won increased the relative cost of Taiwanese exports and caused our export orders to fall. However, if the Taiwanese and mainland economies were to integrate, dropping tariffs to zero and making shipping more convenient, the cost of shuttling Taiwanese goods across the strait would decline, guaranteeing them a price advantage over Korean goods. That would enable Taiwanese firms to better resist Korean efforts to use a cheap Won policy to gain a price advantage.

Reason four for supporting ECFA: It would facilitate the signing of free-trade agreements with other nations.

In recent years, Taiwan has aggressively pursued regional integration and worked through numerous channels in the hope of securing a free-trade agreement (FTA) with one or more of its major trading partners. Unfortunately, progress has been hindered by the cross-strait impasse and the many other roadblocks mainland China has put in our way. A number of scholars have suggested that signing the ECFA with China would effectively announce the normalization of cross-strait trade relations. They also note that Taiwan has always had close trade relations with its neighbors (Taiwan is the 10th largest investor in ASEAN and the seventh largest importer of ASEAN goods). Were these roadblocks to come down, nearby nations would likely hurry to establish reciprocal relations with Taiwan.

Setting aside the political objections to ECFA-that it represents a "cozying up to China" and "economic unification with China"-what are the bases for opposition to the agreement?

Reason one for opposing ECFA: It benefits only the major exporters of petrochemicals, textiles, and steel, but opening both markets equally would do serious harm to local small- and medium-sized enterprises (SMEs) that sell to the domestic market.

These SMEs-makers of shoes, furniture, ceramics, bedding, garments, and food-repeatedly voiced their opposition to ECFA at a press conference held early this year. They asserted that cheap bedding and food from China have taken over Taiwan's department stores and warehouse retailers, and argued that these low-end products have driven higher quality Taiwanese products off the shelves, costing Taiwanese manufacturers valuable market share. They also noted that manufacturers of a number of goods for which imports have not yet been liberalized (e.g. ceramic tiles) are already struggling as a result of rampant smuggling. If imports were liberalized even on a conditional basis, they'd suffer still more. Ceramics makers observe that as many as half of Taiwanese domestic manufacturers would shut down. At 15 meetings held by the Chinese National Federation of Industries to familiarize local firms with ECFA, it came to light that, in addition to the five types of goods mentioned above, traditional manufacturing industries are very concerned that ECFA will also seriously affect a wide range of products made for the domestic market, including woven fabrics, towels, household appliances, electrical machinery, pharmaceuticals, steel, frozen seafood, paper products, cardboard, and bags & luggage.

The Ministry of Economic Affairs says that the ECFA resembles neither the Closer Economic Partnership Arrangement (CEPA) China has with Hong Kong and Macao, nor a free trade agreement (FTA), but is instead an "economic cooperation agreement that reflects the special character of cross-strait relations." But what does it actually consist of? The government has yet to say.

Instead, the government keeps emphasizing its ECFA negotiating principles: no mainland workers in Taiwan, no further liberalization of agricultural imports beyond the 1,400-plus items already permitted, and the active protection of fragile traditional manufacturers through either high tariffs or an extended adjustment period. Demanding much while offering nothing in return violates the reciprocal spirit of an FTA, and is reminiscent of China's 2003 CEPAs with Hong Kong and Macao. In those, the trade and investment perks China granted the two territories had a strong air of a "sugar daddy" bestowing favors. Is this what Taiwan wants?

Taking the analysis a step further, if the ECFA is structured like an FTA, what will Taiwan have to give up? In the case of the petrochemicals industry, the Petrochemicals Industry Association of Taiwan estimates that an agreement from the mainland to lift the 6.5% tariff on Taiwanese imports would cost the mainland RMB20 billion per year. Since the mainland's own petrochemicals industry can't produce enough to meet its own domestic demand, the mainland has none to export and therefore would not benefit from a reciprocal elimination of Taiwanese tariffs. From the mainland's standpoint, those foregone tariffs are a dead loss. What industries will it attempt to claw them back from? And how should Taiwan respond to such efforts?

Reason three for opposing ECFA: The government has overestimated the extent to which ASEAN integration will squeeze out Taiwan.

Tung Chen-yuan says that firms that wish to take advantage of preferential tariff rates available under all the current East Asian economic integration agreements must produce complex and expensive certificates of origin, the cost of which typically amounts to 10-25% of a product's price. As a result, few firms utilize them. In the ASEAN free trade zone, for example, only about 10% of companies take advantage of the preferential tax rates. These agreements have therefore had less of an effect than expected on outside firms. It is therefore unclear just how much of an effect the ASEAN Plus China free trade zone will have on Taiwan's petrochemicals, textiles, and machine tools industries, which currently face tariffs that average 6.5%.

Tung also says that the computable general equilibria produced by research institutions all show varying degrees of negative impact on Taiwanese GDP if Taiwan is unable to join ASEAN Plus. But the forecasts produced by the models must be verified after the fact by comparison to the actual data if they are to be granted much credence. When he tested the models from the various institutions, Tung discovered that East Asian economic integration agreements have had only negligible negative impact on non-member nations such as Taiwan or no impact at all. "It's really farfetched to claim that Taiwan's economy has already been marginalized," argues Tung.

Reason four for opposing ECFA: Taiwan should bear in mind the harm CEPA has caused Hong Kong.

Chiou Jiunn-Rong, vice dean of National Central University's School of Management, says that when the Hong Kong government announced the signing of the CEPA, analysts thought that the zero-tariff regime would create job opportunities by providing Chinese manufacturers with an incentive to build factories in Hong Kong. In fact, manufacturing employment in Hong Kong fell from 170,000 in 2003 to 140,000 in 2007, and Hong Kong's exports fell 1.1% in 2006 and 19.1% in 2007. Rather than reviving Hong Kong's manufacturing sector, CEPA drew capital and personnel from Hong Kong and sent it northward into China, hollowing out the local manufacturing and service sectors. All that's left are poorly paid low-end jobs. Though businesses are doing well, workers are in more dire straits than before and the wealth gap has grown.

Although the large numbers of mainland tourists have brought prosperity to Hong Kong, those benefits have accrued to just a few, not to the economy as a whole. Worse, CEPA's guarantees have made it easier for conglomerates to borrow money to invest in Hong Kong stocks and real estate, creating bubbles in both.

Those in the know suggest that the government should work on forging the competing views on ECFA into a consensus as quickly as possible. But what options does the government have if taking time to reach a consensus impedes progress on the agreement?

"Rather than letting people's concerns about what the ECFA will contain balloon into political and economic conflicts," says Tung, "I recommend that we break the cross-strait economic integration discussions into pieces and move forward on multiple tracks, as provided for by the WTO enabling clause." He suggests that the two sides could first discuss liberalizing designated industries to resolve pressing problems arising out of ASEAN Plus China. Tung notes that in just the last 12 months, the two sides have concluded nine major economic agreements, including accords on tourism, transportation, and financial cooperation, and that discussions on four other issues, including cooperation on fishing industry labor and agricultural product inspections, are slated for later this year. To Tung, these agreements make plain that we can further cross-strait economic cooperation and gradually normalize cross-strait economic relations even without the ECFA. Discussions about an FTA or similar agreement will move ahead more easily once the government has properly prepared and developed measures to transform local industries.

To be sure, Taiwan cannot just stand on the sidelines while Asia's other nations rush to tighten their ties. Given the complex nature of cross-strait relations, all sides need to put aside their differences and work together to determine which course of action will most benefit our nation.

Table 1: Effects of East Asian Economic Integration Agreements on International Investment in Taiwan1

TaTable 2: Domestic Industries Likely to be Affected by ECFA