TCS Daily

Time for a Taiwan Straits FTA

By Alan Oxley - September 8, 2004 12:00 AM

The absurdity of the idea of war in the Taiwan Straits only becomes clear when intolerability of the economic cost is considered. While there is talk aplenty of the prospect of war over Taiwan from hawks and political opportunists in Beijing, Taipei and Washington, we hear little from business or economic analysts who can demonstrate how talk of war is ridiculous and how economic integration across the Taiwan Strait will shape the future. It is time to push for a Free Trade Agreement between China and Taiwan.

When they turn their lights out at night in the Leadership compound in Beijing, what do China's leaders fear most? An independent Taiwan or social disorder in China? A study of the economic relationship between the US and China completed early this year by Bates Gill and Sue Ann Tay for the Centre for Strategic and International Studies in Washington[1] provides valuable insights to what is going on in the Chinese economy.

Most of the new wealth in China goes to the thirty percent of the population living in cities. The transfer of wealth is not a smooth process. Since 2001, 35 million workers, mostly in cities, have been laid off from state-owned enterprises. Of the 8.6 million who lost jobs in 2003, only 4.4 million got new ones. At the end of last year, the Ministry of Labor and Social reported that 24 million more jobs were needed in 2004 to absorb China's ever-growing work force.

China needs at least seven percent growth per year to generate these jobs. In recent years it has achieved this growth. But it is on a rocky base. China's four major state banks hold just over 60 percent of the country's loans. Official statistics show 23 percent of all loans are bad. Standard and Poor's consider the share could be easily double that. Western financiers rate all of China's banks as technically insolvent. Solving that problem could cost US $600 billion, 40 percent of China's GDP. Dr Ou Xingxiang Chief Economist of Taiwan's Bank of China, recently pointed out China's official reserves can cover the exposure of the banks. But the situation is highly unstable.

What about the rural areas where 70 percent of Chinese live? Today, urban dwellers residents earn on average three times as much as those in the countryside Gill and Tay find that rural income in China is stagnating, and the gap between rural and urban income is widening. China's leadership receives regular reports about social disturbances in rural and urban areas across China. The media doesn't report them but visitors are regaled by accounts them and often see incidents first hand.

No serious leader would casually aggravate such a delicate situation. Yet military action against Taiwan would certainly do so. It is obvious that any action would severely disrupt economic activity between China and Taiwan and between China and the US.

China depends on trade. It is equivalent to 56 percent of GDP. Twenty percent of China's exports go to the US and Taiwan and about eighteen percent of its imports come from the US and Taiwan.

Investment may be more important. While official Taiwanese statistics record approved investments in China at US $ 5 billion in 2003, the American Chamber of Commerce in Taiwan cites a figure more like US $ 70 billion in over 50,000 enterprises. Between a half and one million Taiwanese are resident in China. Amcham in Taiwan estimates Taiwanese investment is critical to 60 percent of production of China's IT exports. This is one of China's leading export sectors.

And before US legislators get too worked up about the trade deficit with China, they should note the analysis by Gill and Tay that US-owned companies earn more from sales of US subsidiaries in the US (a significant share of which is exported to the US) than from direct exports to China.

It is clear the economies of China and Taiwan would be severely damaged as a result of military action by China against Taiwan and the inevitable retaliation by Taiwan and the US, and that US economic interests would also be significantly damaged.

The question it begs is not how likely is military conflict, but who is talking it up? President Chen Shui-bian has kicked this off. He knows Taiwanese enjoy their new-found democratic freedom and prosperity and do not want to be part of China. So he publicly toyed with the idea of formal independence to win votes. But he also knows that Taiwanese want to retain their prosperity and that they would stop short of formal independence since that would antagonize China. He has backed away from supporting independence, but is continuing to play to Taiwanese sentiment to win votes.

China's leaders could be forgiven for not understanding the nuances of playing to public sentiment in democracies. But there may be something else to the sabre-rattling in Beijing. Recent reports suggest conflict between President Hu Jintao and former President (but now head of the powerful military commission) Jiang Zemin. Nothing can be guaranteed to muster support inside the Chinese Communist Party more than to call up the spectre of an independent Taiwan.

And what about in Washington? The spectre of a threat is always good for drawing support for military programs. Military strategists also by and large still think in military and political terms when assessing threats and often overlook the influence on decision-makers of the economic cost of military conflict or the strategic impact of economic self interest.

There is a new school of strategists who understand the impact of economic interdependence. Robert Zoellick is one. He talks about the strategic benefits of free trade and the common economic interests free market politics foster. Economic trends in Taiwan and China vividly demonstrate the power of free market economic activity and how once it is unleashed, governments can do little to stop it. First Beijing and then Taipei legislated to prevent trade and investment between China and Taiwan. Neither succeeded.

As the trade and investment across the Taiwan Straits inexorably increases, each rattle of saber sounds increasingly tinny. No one can see clearly how to resolve the political differences between Beijing and Taipei. But challenging both regimes to consider negotiating a free trade agreement will focus attention on the importance of the economic relationship and the opportunity it would provide to contribute to stability by giving certainty and predictability to the business sectors in each country.

It might also force some political leaders to reveal to their respective constituents that prosperity is not something in which they are primarily interested. There are few countries where that does not have an effect.

Alan Oxley is a former Chairman of the GATT (the predecessor of the WTO) and host of the Asia Pacific page of

[1] Gill and Tay, Partners and Competitors, Coming to terms with the US China Economic Relationship, CSIS 2004


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