COVER STORY

Taiwan’s Economy: Back in the Race

After a dismal 2009, Taiwan bounced back vigorously this year to achieve what might even become its first double-digit GDP growth since 1989. Inevitably, the pace will need to slow next year, but most economists still expect healthy 2011 growth in the 4-5% range. Over the next several years, Taiwan is likely to do well in comparison with its fellow Asian Tigers. Although export growth may be modest, domestic consumption is seen as becoming a much more important contributor than it has in the past. Helping to boost that consumption is the increase in tourism, especially from the other side of the Strait.

The Gain So Far is Mainly in Tourism and Direct Flights

The Ma administration’s 15 ground-breaking agreements signed with China since it came into office in 2008 may have eased military tensions, returned Taiwan to the radar screens of multinational companies, and muzzled the opposition’s anti-China rhetoric – but aside from tourism and associated direct flights, none so far are generating revenues with a significant economic impact, economists say.
And there are already foreboding signs that political controversies are starting to stymie further cross-Strait economic integration.

A Chat with CEPD Minister Christina Liu

BY JANE RICKARDS

Taiwan’s Economy:
Back in the Race

Traditionally, Taiwan’s economic engine has been primarily fueled by exports such as computer products and other high-tech gadgets. But Taiwan’s heavy reliance on overseas consumer demand, especially from wealthy markets such as the United States, caused its economy to be ravaged by the global financial crisis before undergoing a remarkable V-shaped rebound throughout 2010.

Next year, although exports will continue to be important, most economists expect other forces such as domestic private investment and private consumption of goods and services to be the key contributors to economic growth – something that has not been seen here for a decade. “I think there is a structural shift under way here,” says Chen Miao, chief of the Macroeconomic Forecasting Center at the Taiwan Institute of Economic Research. “And the next growth engine will be felt more down at the grassroots level.”

In the wake of the financial crisis, Taiwan’s economic performance this year was stellar, though of course benefiting from the low base of 2009. The Directorate General of Budget, Accounting and Statistics (DGBAS) projected in late November that Taiwan’s GDP will grow by 9.98% this year, upping an earlier August forecast of 8.24%. Christine Liu, Minister of the Council for Economic Planning and Development (CEPD), says she expects the final figure to exceed 10%, giving Taiwan its first double-digit growth since the 10.28% of 1989. Compared with fellow Asian Tigers Hong Kong (with projected 6.6% growth this year) and Korea (with 6.1%), this was quite a good showing, although Singapore’s staggering 14.5% is expected to lead the pack.

The government is projecting economic growth next year of a less torrid but still robust 4.51%, while the average among forecasts by private-sector institutions is an equally respectable 4.1%. “The latest world economic forecast indicates that the growth of the world economy in 2011 will be at a modest pace,” the DGBAS said in a statement accompanying release of its forecast. Already there are signs of the impact of a global slowdown. Taiwan’s first quarter growth this year came to 13.59% and the second quarter growth was 12.86%, together forming Taiwan’s fastest expansion in 30 years. But third quarter growth slowed to 9.8%, while the forecast for the final quarter is only 4.7%.

Although most economists are estimating that economic growth for 2011 of between 4% and 5%, two of those interviewed for this report had other – and diverging – opinions. Bert Lim, president of the World Economics Society, a local think tank, expressing doubts that Taiwan will be able to significantly wean itself of export reliance anytime soon, says the domestic economy would be “lucky” to attain 4% growth next year. At the bullish end of the spectrum, Chen Tain-jy, a National Taiwan University economics professor and the first CEPD minister in the administration of President Ma Ying-jeou, predicts figures of 5% or even 6%. He believes that most forecasters are being too pessimistic about the likelihood of a sharp slowdown in export orders from Europe and other overseas markets, and notes that the government is likely to increase public investment ahead of the 2012 presidential election.

Economists also differ on forecasts for 2012 and the years beyond. Tony Phoo of Standard Chartered Bank foresees a healthy 6% for Taiwan in 2012, while Standard and Poor’s, in a late October report, put the number at 3.5% for both 2012 and 2013. CEPD has paid particular attention to a recent International Monetary Fund report that shows Taiwan trailing Hong Kong, Korea, and Singapore in economic growth in 2011, but then exceeding the pace of the other three Asian Tigers from 2012 to 2015. For 2015, the IMF study shows growth rates of 5% for Taiwan, 4.28% for Hong Kong, 4.01% for Singapore, and 3.96% for Korea.

Tourism boom

Tony Phoo, Chen Miao of TIER, and Cheng Cheng-mount, the chief economist at Citibank, share the view that next year's domestic demand will play a more salient role than Taiwan has been accustomed to. Chen Miao notes that tourist spending has become a more important factor than before, with Taiwan this year exceeding the five-million visitor mark for the first time – in fact, that level was reached in the first 11 months – including at least 1.5 million Chinese tourists. He calculates that if each visitor on average spends US$250 a day over a five-day stay, tourism injected a total of US$6.3 billion into Taiwan’s economy. The influx of visitors has also provided more employment for blue-collar workers laid off when manufacturing businesses migrated to China over the past decade, he notes, and that also creates more consumption.

The increase in domestic consumption is shown by Ministry of Economic Affairs (MOEA) data. For example, sales in the food-services sector posted an increase of 12.03% year-on-year as of October, and retail trade grew by 7.11%. These effects are likely to increase further next year, based on China's recent offer to raise tourist arrivals from the mainland from the current 3,000 a day to 4,000. If regulations change sometime next year to permit solo Chinese travelers to make the trip, as is considered likely, the economic benefits will be spread even more widely, as individual Chinese tourists are expected to go to more far-flung locations, stay at cheaper hotels, and patronize smaller eateries.
With the boost from tourism, Chen Miao says he expects the service sector, which accounts for over two-thirds of Taiwan’s GDP, to grow by 10% this year – something not seen in the past decade. Citi’s Cheng, on the contrary, projects service-sector growth in the range of only 5%-6%, mainly because the over-regulated financial-services subsector is underperforming.

"We believe that a continuing revival in consumer spending, aided by rising tourist arrivals, will keep the economy on a recovery path, despite the anticipated slowdown in exports,” Standard Chartered’s Phoo wrote in a report issued in late November. He notes that private consumption has been steadily improving throughout 2010 and that the consumer confidence index published by National Central University rose to a six-and-a-half-year high in October. Perceptions of household finances gave the best performance in the history of the survey, adds Citi’s Cheng.

Cheng predicts that consumption will increase next year by 3.8%, “the best in a decade,” and then by another 3.8% in 2012. That is far better than the 2.2% average from 2000 to 2008, yet the 3.43% achieved in 2010 still lags behind neighboring Hong Kong with 5.2% and Korea with 4.2%.

The job market is expected to improve next year, along with household finances, after a long stretch in which the Taiwanese saw little increase in wages. “People will feel more confident in spending money,” says Cheng. He forecasts GDP per capita for 2010 of US$18,580, up from the US$16,442 in 2009, and notes that personal income rose 6% this year – 2% from salaries and 4% from bonuses. He sees GDP per capita rising again rise to US$20,477 in 2011.

In the past, the low wages in China caused Taiwanese salaries to stagnate, notes Cheng. But now with some parts of China experiencing wage increases of around 15% per year, some “Taiwanese companies want to cost down their manufacturing operations by moving back to Taiwan.” Further contributing to the domestic economy may be the increased expenditures in Taiwan by executives with operations in China; thanks to the convenience of the cross-Strait direct flights, they are now spending more of their time with their families on the island.

The export component

Exports still matter. Total exports in November, at US$24.37 billion, climbed 21.8% from the same month of last year, while imports – at US$23.96 billion – were up by 33.8%. The monthly trade balance was in surplus by US$410 million. Mainland China (together with Hong Kong) was the largest market for the exports, absorbing 40.3%, followed by the ASEAN nations with 14.5%, and then the United States and Europe, each at 12.1%.

Taiwan’s exports to China include many semi-finished parts and materials, which after processing on the mainland are re-exported to advanced economies. Once this effect is factored, the U.S. share of Taiwan’s exports is believed to accounts for 20%, says Cheng. That level was once an even higher 30%, he adds, but has declined as Asian economies improve while U.S. growth remains sluggish. In the process, notes Cheng, Taiwan’s export base has become less dependent on electronic and IT products, as demand increases from ASEAN and China for petrochemicals and steel.

Export orders, an indication of demand in the months to come, slowed somewhat in October, posting 12.26% growth, but accelerated again in November, rising 14.34% on stronger-than-expected demand for electronic items such as cell phones, with U.S. demand especially strong. This uptick caused MOEA to forecast record export orders for the full year of some US$405 billion, up more than 33%. Chen Miao of TIER predicts export growth of 6.4% for 2011 – not bad, considering this year’s high baseline.

Investment was also a predominant growth driver this year. CEPD has investment growing by 31% this year, but the figure for 2011 is projected to be -2.76%. Economists say that electronics companies this year increased their capital expenditures substantially, but that much of it was to make up for spending deferred during the crisis years of 2008 and 2009. “There is a capex cycle that won’t be repeated next year – won’t be repeated for another three years,” Chen Miao says.

Still perceptions linger that U.S. growth next year, which the International Monetary Fund forecasts at 2.9%, will be sluggish, with unemployment staying at 9.6% due to structural factors. That leads to worries that the current plentiful level of export orders may not be sustainable, with supply in the U.S. market soon outstripping demand. Europe, following debt crises this year in both Greece and Ireland, is also the source of some uneasiness among exporters. The world has recovered from the global financial crisis at “two speeds,” says Academia Sinica economist Hu Sheng-cheng, another former CEPD minister. “ASEAN and the nearly-developed countries are enjoying high growth rates while the advanced economies are not doing so well.”

In November the U.S. Federal Reserve conducted a second round of “quantitative easing,” expanding money supply by buying treasury bonds. The move has had ramifications in Asia, where investors disillusioned with the greenback have sought to buy up Asian currencies. China is considered to be at risk of inflation, as well as of property and other asset bubbles, but over-aggressive tightening could cause China’s demand for Taiwan products to slow. China’s consumer-price inflation hit a 28-month high of 5.1% in November, Reuters reported, but so far the impact hasn’t been felt on economic growth.

In the face of continuing concern over the influx of “hot money” as foreign investors speculate on the New Taiwan Dollar as well as other Asian currencies, the Central Bank is likely to maintain its tight money policy throughout 2011, economists say. In June this year, the Central Bank made its first interest-rate hike in two years. Before June, interest rates stood at a historic low of 1.25% after a series of cuts in reaction to the global financial crisis and subsequent recession.

Another rate hike in September has since brought the rate to 1.5%. Showing its shift in concern from sluggish global growth to Taiwan’s rising asset prices, including a housing bubble, the Central Bank in June also imposed mortgage restrictions, including a 70% cap on loans for second homes in the Taipei metropolitan area. It said it would further urge local banks to enhance risk controls associated with land acquisition financing, and remains concerned that if market liquidity is not reined in, further asset bubbles could arise.

Another issue for policy makers is inflation. Although officials say the level is not worrisome, and remains modest compared to many other countries, it is nevertheless increasing. At 1.53%, consumer prices in November rose at their fastest rate in a year, sparked by increases for food and transportation. DGBAS has the consumer price index increasing by 0.98% this year, and by 1.85% next year, while Standard Chartered’s Phoo predicts an even higher 2.2% for 2011. “We fear local firms and business, encouraged by continuing economic growth, will pass on higher input costs to consumers,” he says.

Phoo expects the Central Bank to respond with another interest-rate hike at the end of December, bringing the benchmark policy rate to 1.625% at year-end. A further series of rate hikes, he predicts, will raise the benchmark interest rate to 2.125% by the end of 2011.

The widening interest-rate gap between the United States and Taiwan is likely to cause more hot-money headaches for the Central Bank, leading to concerns among economists that the Central Bank may impose harsher capital control measures. At the same time, “if there is real demand for New Taiwan dollars, there is only so much [the Central Bank] can do,” notes Chen Miao. The government and the leading high-tech companies want to keep the value of the currency low to protect exports, though as Standard and Poor’s points out, the currency appears to many to be substantially discounted in real terms.

Curbing speculation

Throughout the year, the Central Bank has frequently intervened to manage “hot money” by privately talking to dealers, and in early November the Financial Supervisory Commission banned foreign funds from investing more than 30% of their portfolios in government bonds with a maturity of a year or less. Reports have surfaced that the government is mulling further measures. For example, Phoo points to reports that the Ministry of Finance is considering imposing a 20% tax on forex gains made using hot money. “This is expected to receive strong support from lawmakers, as it does not require amending the current tax law,” Phoo says.

But Hu of Academia Sinica cautions that the Central Bank’s ability to control hot money is limited because much of the phenomenon is actually home-grown. “Taiwan has excess savings this year,” he notes, adding that “we might stop hot money from coming in, but the hot money [already here] will not go out because of increasing uncertainty outside Taiwan.” Economists doubt that the regulators will take drastic action for fear of triggering massive equity outflows.

In the long-run, the exchange rate will be therefore be determined by the market, and Cheng points out that a stronger currency would reflect the anticipated transformation in Taiwan’s economic structure to focus on growth from domestic demand as well as exports. In mid-December, the Taiwan dollar rose to a 13-year intraday high of NT$29.85, breaking the NT$30 psychological barrier. While TIER is forecasting that the exchange rate next year will be NT$30.9 to the U.S. dollar, Cheng’s forecast is NT$29.6 for a year from now and NT$29 for the year after.

Among the standout industrial performers this year were such famed high-tech companies as chip-foundry Taiwan Semiconductor Manufacturing (TSMC) and handset maker HTC Corp. The rebound in their exports contributed strongly to Taiwan’s growth this year, whereas D-RAM chip makers and LCD flat panel makers did not do so well because of substantial profit erosion from falling prices.

Standard and Poor’s also cautioned that Taiwan’s weak and fragmented banking system is a handbrake on growth. Over-competition is causing banks to engage in inadequate risk pricing in their bid to win over customers, the ratings agency says, while the high degree of state ownership in the sector impairs efficiency. In a severe downturn, it estimates, up to 30% of the banking sector’s credit to the private sector and to non-financial public enterprises could become problem loans.

When asked which economic problems need to be addressed most urgently by the government, interviewees most frequently cited the rapidly widening gap between the rich and poor. Although salaries are likely to improve overall in the next few years, there are signs the gap may not lessen soon. "In 2005 to 2009, household disposable income grew at an average rate that was only half the corresponding average for GDP growth, reflecting a distribution of household income towards higher income groups,” Standard and Poor’s says.

Chen Miao attributed the flat income levels in part to the Central Bank’s policy of keeping the New Taiwan dollar low to protect exports.

A related problem cited by Hu is that the reduction in the estate and gift tax appears to have encouraged many China-based Taiwanese executives to return here to buy luxury housing, pushing up property prices. The average price of an apartment is currently at least 10 times that of average annual household income.

Structural unemployment may be exacerbating the problem. According to DGBAS data, the unemployment rate dropped .013 percentage points to 4.92% in October, and the seasonally-adjusted unemployment rate also dropped by 0.12 percentage points to 4.96%, enabling both numbers to hit the government target of under 5%. But labor activists complain of widespread hidden unemployment or underemployment. Television commentator Yang Sen-hong told a recent seminar that an estimated one million people are in insecure temporary positions. In addition, points out Lim, unemployment for the 20-to-24-year-old age group is closer to 8%, causing a brain drain as many young people leave Taiwan to seek other opportunities, particularly in China.

Citi’s Cheng urges President Ma to make the income-disparity issue a priority for the remainder of his term. In his first two years in office, “Ma’s logic was because we have just pulled out of the financial tsunami, the first priority is to stabilize economic growth,” he says. “But after four years, if you have not made income more equalized, then I would say your policy is not successful.” Cheng says the education system also needs scrutiny, as the oversupply of colleges is bringing economic inefficiencies. According to unofficial statistics, he notes, at least one-third of college students have taken out loans, something that previously rarely occurred in Taiwan. These indebted students, he adds, may not necessarily obtain improved employment opportunities upon graduation.

Another area singled out for improvement was government efficiency. Cheng points to the most recent Global Competitiveness report compiled by the World Economic Forum, in which Taiwan ranks 13th overall but only 35th in terms of institutions. Chen Tain-jy urges the speedy implementation of government reorganization to reduce the number of ministries and agencies, eliminating overlapping responsibilities. And Chen Miao points to incidences of the government shifting plans for developing industries midstream, sometimes for political reasons after a change in administration. “We have limited resources. If we’re really trying to develop industries for the future, there needs to be continuity – knowledge needs to be accumulated.”

Longer term challenges include managing Taiwan’s aging population. By 2060, a CEPD draft report says, a staggering 41.6% of the population will be aged 65 and over if current trends continue, whereas those aged 21 and under would be 14.2%. Standard and Poor’s warns that government debt could escalate drastically with the burden of caring for a rapidly aging society.

Both to balance the age distribution and to spur economic growth, Cheng suggests that Taiwan in the next five years will need to change its policy on immigration, especially to allow white-collar talent to move here. Five to ten years after that liberalization, he says, the economy will become more service-driven, while the level of manufacturing sophistication can be upgraded. “If we’re able to do that, we might be able to maintain 5% growth” for the long-term, he says.

Hu predicts that in the coming several years, Taiwan’s IT industries will increasingly make a contribution to the development of future growth areas such as cloud computing, automotive electronics, medical devices, and green energy. “Taiwanese businesses are nimble, flexible,” he concludes. “I am quite optimistic.”

The Gain So Far is Mainly in Tourism and Direct Flights

Despite the signing of the Economic Cooperation Framework Agreement (ECFA) with China in late June, the joint steering committee to oversee implementation of the pact had still not been formed as of press time. The tariff reductions for over 500 Taiwanese goods covered in the ECFA “Early Harvest” kick in from January 2011, and the tariffs on those items will be phased out over two years. “The impact on export-boosting will be quite marginal,” says Cheng Cheng-mount, Citibank’s chief economist, although the provisions may help Taiwan defend its market share in China against competition from Korea and Japan. Next-stage talks under ECFA for further tariff reductions and the liberalization of trade in services have not yet been scheduled.

The removal of barriers to Chinese investment in 204 industrial sectors in Taiwan has also so far brought very limited results, economists say. They also say there are few signs so far that Taiwan businesses based in China are shifting investments back to Taiwan to a significant degree. In addition, the various procurement missions China has sent to Taiwan have turned out to be mainly publicity exercises, with pledges of large volumes of purchases but little actual follow-up.

The sheer technicalities of dismantling 60 years of Cold War restrictions on cross-Strait relations are also proving to be problematic. At talks between Taipei and Beijing at the end of last year, the plan to negotiate an agreement to end double-taxation was shelved at the last minute. And just this month, the two sides failed to reach accord on the terms of a long-awaited investment protection agreement, which was scrapped from the agenda shortly before the holding of a cross-Strait negotiating session. Officials cited technical difficulties but the sticking point was understood to be the location of arbitration in case of investment disputes. Taiwan wants to designate a third territory – probably Singapore – but China is unwilling to internationalize its dealings with Taiwan, which it believes should be a domestic matter.

"The easier parts [of cross-Strait integration] have already been concluded and we will see more difficulties ahead of us,” says George Tsai, a professor of politics at Taipei’s Chinese Culture University, who is a frequent visitor to Beijing. More fundamentally, China appears to hope that the many economic sweeteners it has offered Taiwan will lead to political or military talks, an idea that still seems too politically sensitive in Taiwan for President Ma to accept.

— By Jane Rickards

A Chat with CEPD Minister Christina Liu

Before taking her current post in May this year, Minister Liu was chief economist of the Chinatrust Financial Holding Co. She was previously a two-term member of the Legislative Yuan, economic advisor to various government organizations and private businesses, and a professor of economic and finance in the United States, Taiwan, and China. She earned an M.S. in business administration and a Ph.D. in economics from the University of Chicago. Below are excerpts from a recent interview with Taiwan Business TOPICS’ Don Shapiro and Jane Rickards.

On investor interest in Taiwan and the impact of ECFA.

We have received a great deal of interest recently from all over the world. In fact, a lot of multinational firms have scheduled time in December, January or February to come and talk to us. And we’re also doing a series of road shows, which are generating a lot of interest. On our recent trip to Singapore, where we visited 20 companies, we had a group of 85, including 10 different ministries, three local governments, and 40-something industry people. Next we’ll go to India in February, the U.S. in March, Japan in April, and then Europe in May and June.

There are many reasons for the investment interest, but ECFA is a prerequisite. Without it, those other factors would be in vain. Because of ECFA, people in other countries are reopening their eyes to see Taiwan after having more or less forgotten about us. When they were choosing partners internationally, they were just not paying attention to Taiwan. But now once they look at Taiwan, they are finding some very impressive developments. For instance, some of the people we talked to in Singapore did not realize how far Taiwan has come in IPR protection – they thought we were still pretty much the same as China.

Those in the tourism field were amazed at how fast the cross-Strait connections have grown. They knew we had direct flights now, but were very surprised to learn that there are already 360 flights a week – and each of them is fully booked. Also surprising was that tourism from China, which two years ago was zero, now comprises 30% of the visitors for a total of 1.5 million tourists this year. And we haven’t even opened the market yet to individual travelers, only groups.

They can begin to imagine the potential for growth when Hong Kong, which is so small, is getting 10 million Chinese visitors a year. And the duration of stay for Chinese visitors is seven days in Taiwan, compared with only three days in Hong Kong.

ECFA is why they invited us to go there, but afterward they became aware of a lot of other aspects.

On Taiwan’s comparative strengths and weaknesses.

If we compare ourselves with Hong Kong, our industrial base is more diverse and more complete because they are focused mostly on finance and property development. Singapore is more diverse than Hong Kong, but the scale of its manufacturing sector is much smaller than Taiwan’s, but we have better connections and better knowledge in the China market.

That’s why Taiwan is now very popular as a place for strategic alliances for many multinational firms, especially from Japan. They have had a lot of cooperation with Taiwanese firms over the long-term, so if they are aiming at the China market, naturally we become a very good partner.

Our weak point is because for quite some we were rather isolated. We do a lot of business with China, and we have had a close long-time relationship with the United States, but Taiwan seems to have much less connection with other areas of the world. In terms of many of our institutions and regulations, we really need to catch up as quickly as possible – to get back to international standards. Since the year 2000 the world has been changing a lot. Many other Asian economies have already adopted international standards and regulations, but Taiwan is lagging behind. This is something that we should take very, very seriously.

On how to elevate Taiwan’s investment climate from good to great, as suggested in AmCham’s 2010 White Paper.

It’s not easy and will probably take some time. Recently I was saddened to see some figures comparing the decade of 1990-2000 and that of 2001-2008, excluding the 2009 crisis. In the 90s, Taiwan ranked number one among the Asian Tigers in the percentage of increase in consumption and investment. That was really the Golden Decade. No wonder people at that time were very satisfied with the economic performance. But then we dropped from that number one status all the way to the bottom of the Four Tigers.

Most younger people now don’t know what happened in the 1990s, when they were not yet in the workforce. Their memory is of the time when we were at the bottom of the Four Tigers, and so in general people in Taiwan have felt humbled. This year, even though the growth rate is 10%, people aren’t used to that anymore. If we tell them to aspire to something really great, I don’t think they are ready. They are satisfied with just doing okay.

So it will take time. If we sustain this momentum and continue to lead the Four Tigers for two or three more years, then people will regain more confidence and more ambition. We first have to prove to our people that we really have our own unique niche and can do much, much, much better than we have been recently.

On the reasons for the slip after the 90s.

Both economic and political factors were responsible. I think everyone, blue and green, wasted too much time discussing politics. If everybody’s talking about politics, who’s minding the economy? When I was teaching in Beijing, I noticed that everyone – whether taxi drivers, college students, professors, or policymakers – was talking about business and how to make money. All the attention was on economics.

In Taiwan, for so many years, all the energy was on politics. But fortunately, it’s not any longer. Finally we have come back to talking about economic issues.