In the face of the country’s economic stagnation, Taiwan’s newly elected president Tsai Ing-Wen has pledged to re-ignite Taiwan’s economic growth engine by promoting domestic industrial upgrading and diverting the country’s trade dependence away from China. On one hand, Ms. Tsai plans to set up a quasi-sovereign wealth fund to kick-start innovation-driven industrial development. On the other, she wishes to bring Taiwan into the US-led Trans-Pacific Partnership (TPP) and enhance economic cooperation with several countries beyond China. These economic structural adjustment policies may address Taiwan’s long term vulnerabilities, including its low profit margin manufacturing and its over-dependence on China’s market. However, they do not seem sufficient to effectively pull Taiwan out of its current lackluster economic state, which has been caused by the shortfall of external demand. Amid the sluggish export prospects, without a robust stimulus policy, a strong economic bounce is not likely anytime soon.
Taiwan’s Economic Slowdown
Taiwan’s economy has shown a declining trend since 2011. The economic growth rate plummeted even more sharply to 0.75 percent in 2015, the lowest since the global financial crisis in 2009 (-1.57 percent, see Figure 1). Net exports (total exports minus total imports of goods and services) contributed negatively (-0.67 percent) to economic growth for the first time while domestic consumption remained weak (with 1.41 percent of contribution to the economic growth in 2015).
Figure 1. Taiwan’s GDP Growth Rates by Expenditure 2007-2016 Q1 (Year on Year)
Source: Taiwan Directorate-General of Budget, Accounting and Statistics (DGBAS). (2016). Retrieved from http://www.dgbas.gov.tw/ct.asp?xItem=39213&ctNode=5624&mp=1
Note: The figure for the first quarter in 2016 is forecast.
Both merchandise exports and imports in the first two months of 2016 fell 12 percent (year on year) as shown in Figure 2. In addition to weak domestic demand, the fall in imports also suggests that manufacturers are not prepared to increase production for export. Export orders, an advanced indicator for exports, also dropped 12.4 percent in January 2016 according to the Ministry of Economic Affairs (MOEA, 2016), indicating further weaknesses ahead. Due to the sluggish export prospects, economic growth in the first quarter of 2016 remains depressed with -0.64 percent of growth forecast (see Figure 1).
Explaining Taiwan’s Export Slump
The export contraction began a few years ago. Supply chain linkages mean the export and import of goods tend to move together. After the post-crisis rebound in 2010, both Taiwan’s exports and imports shrank in 2012 (see Figure 2), resulting in a sharp slowdown of Taiwan’s economy to 2.06 percent, down from 3.8 percent the previous year (see Figure 1). Overall merchandise trade grew slightly in 2013 and 2014. In 2015, exports and imports dropped 16 percent and 11 percent respectively.
Figure 2. Taiwan’s Export and Import Growth Rate 2010-2016 (Jan & Feb)
Source: Taiwan Ministry of Finance. (2016). Retrieved from http://www.mof.gov.tw/Pages/Detail.aspx?nodeid=281&pid=69192
Taiwan’s economic growth has relied on supplying intermediate goods to developing countries (mainly China) for manufacturing, and exporting final products from these countries to the global market (the US in particular). As the US economy has gradually recovered [with annual economic growth rates of between 1.6 percent and 2.5 percent during 2010 to 2015, according to the US Bureau of Economic Analysis (2016)], Taiwan’s persistent export shrinkage implies that the traditional model of supporting Taiwan’s economy through the export of intermediate goods to China no longer works.
First, mainland-based Taiwanese firms’ change of procurement preferences from Taiwan to China explains why Taiwan has gradually lost its export strength. According to Taiwan’s MOEA, in 2002 only 19 percent of Taiwanese firms in China procured capital equipment in China but this percentage increased to 73 percent in 2013. During the same period, mainland-based Taiwanese firms’ procurement from Taiwan decreased from 54 percent to 19 percent.
Second, the shift towards local procurement in China also indicates that Chinese industry has been upgraded to a certain level. Due to Taiwan’s slow progress in industrial upgrading, the technology gap between Taiwan and China is narrowing. As such, there is less demand for the import of industrial goods from Taiwan. Taiwan’s long term reliance on original equipment manufacturing (OEM), which emphasises cost savings instead of innovation, is an important reason behind its inability to rapidly upgrade its industry. Indeed, Taiwan’s small economic size means that it has limited financial resources to devote to R&D. Although Taiwan’s R&D expenditure increased from USD 15.3 billion in 2005 to USD 39.7 billion in 2013, the amount in 2013 was only 9 percent of China’s, according to statistics from Taiwan’s Ministry of Science and Technology (2015).
Furthermore, China’s economic transformation towards a more consumption-based economy, and the hike in wages in recent years, all made the country no longer a low cost production site for Taiwanese manufacturers. As a large portion of Taiwan’s exports to China was investment-induced, the decreasing investment in China’s manufacturing sectors has led to a decline in the import of industrial goods from Taiwan. Data from Taiwan’s Investment Commission shows that, since 2012, Taiwan’s investment in China has been slowing down, even though China remains Taiwan’s largest outward investment destination. The investment growth in China in 2015 fell 17 percent compared to the previous year. In 2015, 57 percent of Taiwan’s investment was in services compared to 43 percent in the manufacturing sectors. This is a sharp contrast to the period when, up until few years ago, Taiwan’s investment in China was almost dominated by the manufacturing sectors.
Weak Services Sector Not Able to Bolster Taiwan’s Economic Growth
Taiwan’s services are not able to take up the slack when manufacturers face weak external demand. The service sectors in Taiwan have been characterized by low profit margins, low value-added, and they are dominated by small and medium sized enterprises.
Since the 1990s, Taiwan’s economy has undergone a structural change from manufacturing to services. In 2015, services accounted for 63 percent of GDP while industry and agriculture accounted for 35 percent and 2 percent respectively (see Figure 3). Nonetheless, the greater shares of services in GDP reflect a weakening of manufacturing rather than a strengthening of services. Over the last decade, the smaller share of industry in GDP was accompanied by a slower economic growth rate. Taiwan has lost its engine of economic growth as manufacturing has relocated to other countries, but services have not been able to sustain growth at home.
Despite the smooth expansion of service trade surplus, Taiwan’s economy still largely relies on exports of goods. The domestic market orientation of service firms explains their relatively insignificant contribution to economic growth. Services will only be able to compensate for the decline of manufacturing if their degree of value-added rises, which would require larger, more advanced, and internationally competitive service companies.
Source: Taiwan Statistical Data Book 2012, 2015; DGBAS. (2016). Retrieved from http://www.dgbas.gov.tw/ct.asp?xItem=39213&ctNode=5624&mp=1
Assessing Tsai’s New Economic Initiatives: Challenges Ahead
1. Diversifying Taiwan’s international trade: Different from President Ma’s rapprochement with China, Tsai Ing-Wen has put a higher priority on diversifying Taiwan’s economic diplomacy. In her policy speech before the election, she has stated her intention to pursue economic cooperation with Europe, South-east Asian countries, Japan, India and the United States. However, she did not mention China. Nonetheless, China remains Taiwan’s largest investment destination and trading partner and these will hardly be changed in a short period of time. The continued effort in finalizing free trade in goods and services agreements with China is no less important.
Both Tsai and the US government want Taiwan to join the TPP. Nevertheless, whether the TPP is an effective remedy to Taiwan’s worsening economy is still uncertain. First, the TPP puts more emphasis on intellectual property rights (IPR) though it also covers trade and investment liberalization. TPP’s focus on IPR implies that it could make Taiwan become more dependent on importing technology and products with IPR from advanced countries. Moreover, some domestic interest groups may protest against Taiwan’s further economic liberalization. The greater economic opening up to other countries could probably make less competitive small businesses suffer. The potential boycott in protection of domestic firms’ interests could make the domestic ratification for joining the TPP a long term process.
2. Re-industrialize Taiwan: Unlike Ma’s administration, which selected a wide range of service sectors for development, the incoming President Tsai plans to focus on a narrower set of sectors reckoned to reflect Taiwan’s strengths in manufacturing and technology, namely: precision machinery, biotechnology, green technology, the “internet of things,” and defense.
Both abundant financial resources and close connections with developed countries remain critical for the success of the new industrial development plan based on technology and innovation. More importantly, the successful re-industrialization plan will need the government’s long term commitment. The possible political party alternation after four or eight years means that the plan could be altered or be abolished few years later.
Tsai also plans to set up a quasi-sovereign wealth fund to finance the industrial development plan and has called on local entrepreneurs to invest in the fund. However, it is still not certain how many private companies will be interested to invest in the fund. Given the more visible opportunities for commercial profits in the short run, some Taiwanese companies may choose to cooperate with their Chinese counterparts in order to grasp a larger market share in China.
Need of Stimulus Policy to Address Short Term Downward Pressure
During the years of economic downturn, the government made insignificant spending to stimulate economic growth. In 2015, government consumption even contributed negatively to economic growth, according to the Directorate-General of Budget, Accounting and Statistics (DGBAS). The economic structural adjustment policies mentioned above are less likely to immediately rejuvenate the economy. The fiscal stimulus policy is needed to alleviate the current economic downward pressure. Taiwan’s government debt to GDP ratio is 36.5 percent in 2014, approaching the 40.6 percent ceiling set under legislation. However, it is still far below the average ratio in emerging market economies’ 44 percent and advanced economies’ 110 percent, as shown by data from the Bank for International Settlements (2015). Ma’s government had considered increasing the debt to GDP ceiling but it was not realized eventually. The incoming administration will have to revise the old rules to meet with the current economic reality. With strengthening financial muscle, the government will be better able to sustain the economy during the time when the economic transformation towards more innovation and high value-added is in process.
Bank for International Settlements. (September 2015). BIS Quarterly Review, p. 84.
Taiwan Department of Statistics, Ministry of Economic Affairs. (2016). Retrieved from https://www.moea.gov.tw/Mns/dos/bulletin/Bulletin.aspx?kind=5&html=1&menu_id=6724&bull_id=2360
Taiwan Ministry of Science and Technology. (2015). Retrieved from https://ap0512.most.gov.tw/WAS2/technology/AsTechnologyDataIndex.aspx
United States Bureau of Economic Analysis. (2016). Retrieved from http://www.bea.gov/itable/index.cfm