NOW THE HARD PART
The China-Taiwan thaw: now for the hard part.
By Cesar Bacani

To get a sense of the euphoria wafting through Taiwan’s business community, listen to Richard Fan, Singapore-based co-founder of greater China hedge fund UG Investment. He has been in touch with business people in Taiwan after KMT party stalwart Ma Ying-jeou’s landslide victory in the island’s presidential elections in March. “Taiwan right now is very bullish,” he says. “The KMT has historically been pro-China and pro-business. Clearly there’s going to be a lot of pro-China policies that will be put in place, and that means more opportunities for companies in Taiwan.”

Ma won’t take office until May, but investors inside and outside Taiwan are already giddy. As of April 11, the Taiwan Stock Exchange was up 18 percent for the year, even as bourses elsewhere in Asia remained volatile—and underwater. More than US$1 billion in foreign money is estimated to have flowed into the Taipei market in anticipation of a rapid thaw in cross-strait relations.

People should probably settle down. While improved relations with the mainland are positive, Taiwan’s economic problems run deep. “What we’re seeing in Taiwan is a hollowing out, not just of the industrial base but also of the population,” argues Frederic Neumann, Asia-Pacific economist at HSBC in Hong Kong. “Younger people who are highly educated are leaving, depriving the economy of needed skills and explaining, in part, why spending and productivity growth are weak.”

The numbers tell the story. “Taiwan has been growing at 4.7 percent annually in the past six years, but it’s almost all due to exports,” notes Thomas Byrne, senior vice president and regional credit officer at Moody’s Investors Service. “Consumption has grown only a little bit more than 1 percent per annum.” Investment by local businesses has been weak as well, even as capital flows to China continue to surge. Taiwan is estimated to have put US$100 billion to work in China, making the island the mainland’s top investor.

The export sector’s success has not spilled into the broader economy. “Very little of the export earnings are repatriated to Taiwan, even though the island runs a large trade surplus,” says Neumann. “People do not see a profitable opportunity to deploy that capital in Taiwan.” The economy’s dependence on exports is worrying at a time when the United States appears to be in recession and a slowdown is likely in Europe. In the last U.S. recession in 2001, Taiwan’s economy contracted 2 percent after expanding almost 6 percent the year before.

Neumann says the long-term solution lies in making Taiwan a more attractive place for its most talented citizens to work, invest, and live. That means improving public infrastructure, which has fallen into disrepair because of wrangling between the presidency—which was controlled by the DPP party—and the KMT-dominated legislature; deregulating the financial sector and other industries; and offering incentives to spur investment in the services sector. Infrastructure spending may now move forward with the presidency and legislature both in the hands of the KMT.

Happier relations with the PRC could make a big difference. In the campaign, Ma Ying-jeou promised to lift restrictions on investments in China, let mainlanders buy stocks and residential properties in Taiwan, allow mainland-owned manufacturing businesses, increase the travel quota to 3,000 daily visitors from China, and establish direct air links with the mainland. Under the DPP, chartered flights to a limited number of cities in China were allowed only during the Lunar Chinese New Year and three other festivals.

“If business people and their families find it easier to travel home, they may make more trips and purchase homes, cars, and other big-ticket items in Taiwan,” says Kilbinder Dosanjh, an analyst with the Economist Intelligence Unit. But that would require more than the weekend chartered flights Ma has proposed. “To be really effective, it would have to be regular scheduled flights,” says Byrne of Moody’s. “That could then lead to the big stage, where they come to some kind of bilateral agreement that will greatly increase trade and investment.”

If that happens, Taiwan can become a true gateway to China, perhaps surpassing Hong Kong, given its bigger size and more extensive commercial ties with the mainland. But don’t expect immediate change. Ma has flatly ruled out a visit to China, and in a recent newspaper interview has said his government will move slowly on cross-strait economic deregulation. Hopefully, he’ll move faster on reforms at home.