The major areas of success in the past year have been the establishment of direct flights and the sharp expansion in tourism to Taiwan by mainland Chinese.

By Jane Rickards

Taiwan’s new direct flights to China are proving to be an advantage for Advance Auto Parts, a U.S.-based Fortune 500 company.

Kevin Dempsey, the company’s vice president of global sourcing, says the company recently chose Taipei as the location for its Asian headquarters, rather than Hong Kong or Shanghai. Key influences on this decision, he says, were the government’s new flight links to China, along with more business-friendly tax laws. Employees of the company need to travel frequently all over Asia, and now they can easily do this from Taipei. “It’s is a very livable city and is now a good base to cover Asia from,” Dempsey says.

The government hopes that more foreign and local companies will follow Advance’s lead. Since President Ma Ying-jeou’s inauguration last May, numerous policies governing economic relations with China have been liberalized. Although these policies may strengthen Taiwan’s economy in the medium to long term, their immediate impact has been limited because of the global financial crisis.

China is Taiwan’s biggest export market and investment destination, and over the past decade has received an outpouring of skilled manpower and capital from Taiwan. An estimated 100,000 Taiwan-invested businesses operate in China, and as many as one million Taiwanese are believed to be living and working there. Tung Chen-yuan, a National Chengchi University professor who specializes in cross-Strait economic relations, estimates that as of the end of 2007, Taiwanese companies employed some 24 million Chinese workers. Adding in upstream and downstream enterprises would bring the number to 40 million.

The officially registered figure for cumulative Taiwanese investment in China is around US$73 billion, says MAC Vice Minister Chao Chien-min. When investments through third countries such as the Cayman Islands are included, even the oft-quoted US$150 billion figure “might be on the conservative end,” he says.

Whatever the figure, new Taiwanese investment in China is now drying up dramatically. Ministry of Economic Affairs statistics show that it started to plunge in July and has since declined further. Of course, the global financial maelstrom has slowed the flow of foreign direct investment into China from all sources, not just from Taiwan, and investment levels should pick up again when the world economy starts to recover. But even before the current crisis, the level of Taiwanese business activity in China appeared to be on the decline. Taishang, the term for Taiwanese entrepreneurs in China, have been discouraged by higher taxation and by a new labor law, introduced in mid-2007, which makes it harder to fire workers while boosting social security and severance payouts.

The labor law has caused many Taiwanese companies to close, says Peter Kurz, Taiwan country head for Citi Investment Research – not only due to the direct cost of compliance, but also because “their suppliers, which tend to be smaller companies, were shutting down, causing the cost of materials to grow.” Cheng Cheng-ping, associate professor of economics at Taipei’s Soochow University, estimates that these policies have driven around a quarter to a third of Taishang to move to Southeast Asia or to China’s hinterland, while a further 10% have quietly returned to Taiwan.

Exports are also plummeting. Last year, two-way trade with China came to around US$130 billion, with Taiwan enjoying a trade surplus of around US$35.5 billion. But Taiwan’s cross-Strait exports started to shrink late last year. Some 60% of Taiwan’s China-bound exports are eventually re-exported after assembly (components for notebook computers are a prime example). As Westerners tightened their belts and stopped buying so many consumer electronics products, Taiwan’s exports to China fell by a record 58.6% year-on-year in January. They did slightly better, but still decreased heavily, in February (-25.2%) and March (-37.5%). Cheng says exports recently were boosted a bit by China’s economic-stimulus policy of subsidizing purchases of consumer electronics in rural areas.

Areas of success

The Ma government’s biggest successes in cross-Strait affairs prior to the just-completed latest round of Taipei-Beijing negotiations have clearly been the establishment of direct flights and the sharp expansion in Chinese tourism. In June last year, Taipei and Beijing agreed to allow 36 charter flights each weekend; though nonstop, political sensitivities meant they still had to pass through Hong Kong airspace. In mid-December, the frequency became daily, with a total of 108 flights a week, and a more northerly flight path was adopted, eliminating the detour over Hong Kong and reducing travel time between Taoyuan and Shanghai from 144 to 82 minutes. “Fuel costs were reduced by 40% to 50%,” says Lin Shinn-der, deputy director of the Civil Aeronautics Administration.

The number of destinations on the mainland was also expanded from 5 to 21. Still, most China-bound travelers continue to go through Hong Kong, and the direct flights carry only one-fifth of the total passenger volume. As a result, demand for the Taiwan-China flights is high and load factors have recently been 75% or more. The figure hit 88.6% in the second week of March, an especially remarkable feat at a time when most airlines worldwide are suffering.

Chinese tourism got off to a slow start, but is now also flourishing. Immediately after his March 2008 election victory, Ma forecast that Taiwan would soon see 3,000 mainland tourists per day, which officials said would bring in revenue of US$2 billion annually. But from July to December last year, the island could only attract a disappointing average of 296 Chinese tourists per day (not many more than the 224 per day in 2007).

Taipei late last year appealed for help to Beijing, which had been imposing various restrictions on tourism to Taiwan. “The Chinese worry about letting too many tourists come to an advanced democratic Taiwan too fast,” says Vice Minister Chao. They may also simply have wished to be cautious about the speed of opening up an entirely new destination.

After no major tourist mishaps occurred last year, Taipei and Beijing acted to facilitate more travel. Taipei cut the minimum size of a tour group from 10 to five and lengthened the maximum stay from 10 days to 15. Beijing changed its rules to allow visitors to Taiwan from more provinces and municipalities (21 instead of the previous 13) and expanded the number of Chinese travel agencies allowed to offer Taiwan tour packages (from 33 to 146).

In an apparent attempt to stimulate tourism to Taiwan, Premier Wen Jiabao said publicly in mid-March that he himself was keen to make the trip. “Although I am 67 years old, I would like to go to Taiwan if possible,” he said. “I would like to go, even if I can’t walk and I have to crawl.”

As a result, daily tourist arrivals from China recently have swelled above 3,500. The MAC even said in a statement on its website that it would temporarily raise the daily ceiling on Chinese tourist arrivals from 3,000 to 5,000 from April 16 to May 1 in order to accommodate demand during the Labor Day holiday period.

Around 1,600 employees of Amway (China) came to Taiwan on an incentive trip in March, the first of nine such groups scheduled to visit. Local media estimated that the Amway visitors will generate NT$620 million (about US$18 million) in business.

With regard to direct sea and air cargo links, progress has been mixed. Regular air-cargo charter flights began operating in mid-December with 60 round trips per month between Taoyuan or Kaohsiung and Shanghai or Guangzhou. By early April, the load factor was 59.2%, but the link between Taipei and Guangzhou was recently cancelled as companies prefer to go through Hong Kong.

For sea transport, China opened up 63 ports and Taipei 11, so that vessels no longer have to detour via Ishigaki in Japan or Hong Kong. Reducing the time of a voyage to Shanghai from 27 to 16 hours enables shipping costs to be cut by 15% to 30%.

Last July, the government also revised the rules on visits by mainland professionals; applications can now be submitted one month before the trip instead of two. But Western multinational companies say it is still too inconvenient for their Chinese employees to enter Taiwan. Part of the problem is the long time needed for processing on the Chinese side. But they also criticize the short length of stay permitted by the Taiwan authorities – two weeks or three months, depending on the type of visit – which they say does not meet their real needs. In addition, Taiwan regulations may require locally based executives to take personal responsibility as the Chinese visitor’s guarantor.

New rules on investment

In addition, the government in August reduced the ceiling on Taiwanese investment in China and simplified investment review procedures. Now individuals can invest up to US$5 million a year, up from NT$ 80 million. Enterprises can invest up to 60% of their net worth in China, up from previous caps ranging from 20% to 40% according to company’s size. Further, the 60% cap is waived for companies certified to have their headquarters in Taiwan. But owing to the economic downturn and other factors, there has been virtually no impact so far.

One of those other factors, says Chuang Chao-jung, an economist with the Taiwan Institute of Economic Research, is that Taishang prefer to keep using the unofficial investment channels they are accustomed to. “Taishang invest through the Virgin Islands or Hong Kong not just because of government restrictions, but also for risk diversification,” he says. “They can also avoid paying tax and keep their finances secret.”

Over the past five years, more than 60 Taiwanese companies listed on the Hong Kong stock exchange to avoid being hampered by the investment restrictions imposed by the DPP administration. It is considered unlikely that many of them will re-list in Taiwan soon, but some movement in that direction does seem to be taking place.

Want Want China Holdings, which is listed in Hong Kong, already has made a second listing on the Taiwan Stock Exchange. The company converted 210 million ordinary shares of the company to 210 million Taiwan Depositary Receipts, giving the offering a value of up to nearly US$100 million. Trading in the TDRs was due to begin in late April, the first time for an overseas-listed Taiwanese company to make a second listing in its home market since Ma took office.

Terry Guo, head of the giant Hon Hai electronics company, also listed in Hong Kong, has said his company will list – possibly as a secondary listing – on Taiwan’s stock exchange. Steve Lin, a National Chengchi University economist, says around 20 Taiwanese companies in China have grown to a size where they need to go public, and that the government is trying to lure them to list in Taiwan, with incentives such as cheap land.

In the meantime, the combination of a global financial crisis, rising costs in China, and the government’s new cross-Strait reforms are already stimulating Taiwan’s economy in new ways. Kurz of Citi Investment Research, a 20-year-resident of the island, cites what he calls “the single most important event” to take place during his career in Taiwan – the first net inflows of equity capital.

Taiwanese started repatriating their capital into Taiwan on a net basis in the third quarter of last year. “We’re talking about portfolio flows as opposed to FDI flows,” he says. Overall, he says, it last year amounted to around US$20 billion of the estimated US$240 billion held overseas by Taiwanese.

Global turmoil has caused domestic insurers to repatriate capital and reduce overseas exposure. It also caused panicked Taiwanese to bring their money home where they feel it is safer – or at least where they can keep an eye on it, Kurz says. In addition, he says, markets here are becoming more open institutionally and attracting more foreign participation. The Taishang are also less worried about cross-Strait tensions and are encouraged by proposals for tax cuts, such as lowering the inheritance tax to 10% from as high as 50%. Kurz notes that the tax environment is shifting, with increases in China happening at the same time as the trend in Taiwan is in the opposite direction.

Other cost differences between Taiwan and China are narrowing as well. From an investor’s point of view, Kurz says, there are now cheap valuations here, something that has not been seen for 20 years.

Kurz and Dempsey both note that it is starting to be cheaper to employ Taiwanese, especially those with skills. Pay for highly skilled Chinese executives is rising sharply, whereas wage levels in Taiwan have been virtually flat or have even dropped. “There is a large pool of very qualified people available here,” says Dempsey.

Kurz notes that FDI and capital spending often follows portfolio spending, saying: “Money is the life blood of the economy. The more money that comes in, the more activity there will be around it.”

[INTERVIEW] “We’ve Been Doing the Things that are Needed the Most”

Mainland Affairs Council Vice Minister Chao Chien-min, a Ph.D. in political science from Southern Illinois University, has taught at the George Washington University and the University of Wisconsin-Madison. Prior to his 2008 appointment to MAC, he was a scholar at Academia Sinica. Chao was interviewed for TOPICS by Jane Rickards.

Will there be any major changes in China policy or is the government basically happy with the way things are going?

The pace is basically what we have had in mind. We’ve been doing the things that are needed the most, like direct transportation. There’s no way we can wait. Taiwan’s competitiveness has already been hampered.

Right now, of course, the issue of ECFA is in the news. Some people have great reservations and wonder if it’s a good time to bring up the issue. We understand that it might not be a good time in that some people may not share our convictions and understanding of the process.

But it is a good time in the sense that it is something we must do as ASEAN Plus One will take effect in eight months’ time. Referring to ASEAN Plus One, it was signed in 2002, eight years before it takes full effect. If we start talking to the Chinese side now, there’s no telling how much time we need, and even if it’s inked, there’s no telling how much time it would take before it could go into effect. We have to do it now – it’s already urgent.

What would you say to the opposition to reassure them about ECFA? How can you be sure that Taiwan’s sovereignty won’t be compromised?

Right now, there are around 240 free trade agreements in the world, mostly passed in the last two decades. In other words, we’ve entered an era where FTAs have become a necessity, not a luxury. If we can’t be included, it’ll be disastrous. We need to tell the opposition that this is not an agreement where [the question of] political sovereignty might be included.

Would Taiwan be described as part of China in the wording of the agreement?

That will never happen. If you look at the six agreements between the two sides signed last year, not even the terms “Taiwan” and “mainland China” were included. It was signed by two semiofficial organizations, SEF and ARATS.

There’s no way we would agree to terms that describe Taiwan as part of China in order to sign an agreement. That’s not acceptable. Some people worry that this economic agreement with China might pave the way for political unification. For us, that’s ridiculous because we’re talking about economic cooperation only.

Would ECFA benefit U.S. business? Has the U.S. talked to you about the wording of the agreement?

There is no wording yet. We’re just in the process of studying the issue and hearing what people have to say.

As for how it may help AmCham members and U.S. interests, more direct relations and a more liberalized economy and trade will benefit all businesses in Taiwan. For multinational corporations operating in Taiwan, a freer cross-Strait trade and economic environment means their goods could go to China and get the same benefits as local companies.