Taiwan & China

While Taipei's politicians defend independence, business leaders want to fully unite the economies

Not so long ago, Microtek International Inc. was an icon of Taiwan corporate excellence. Its high-quality, affordable scanners were hot sellers around the world, and it consistently turned in handsome profits. Like many Taiwanese companies, Microtek's success involved moving much of its manufacturing to the mainland. As such, it was part of an exodus of industry, from textiles to tech, that over two decades has capitalized on lower labor costs across the Taiwan Strait. In recent years, however, Microtek has stumbled. Last year, it eked out a small profit, but the global slowdown has since walloped its operations.

Now, keen to reverse its fortunes, Microtek is starting to view the mainland in a whole new light. No longer does it see the People's Republic as merely a manufacturing base. With global demand withering, Microtek now sees China as a market for its products. Moreover, as stock markets at home plumb record lows, the company is eager to tap China's booming bourses. It plans to be among the first Taiwan companies to list in the mainland. "We have to concentrate on China more and more," says Microtek Vice-President Luke Liou. So much so, he says, that the China operations could soon be "bigger than the parent company."

Microtek's flight from Taiwan underscores a seismic shift now under way in the economic relationship between Taiwan and China. The global slump and Taiwan's ailing economy are prompting a dramatic reevaluation in the island's boardrooms. With the U.S. sputtering and no other engines of growth in sight, Taiwan execs increasingly see China as their only salvation. Taiwan Inc. wants a major migration to the mainland, free of restrictions from Taipei. The reasons are many: to be close to multinational customers in China, to sell to the booming mainland market, and to tap the cheaply priced brainpower of China's top academies. And the Taiwanese know that with both sides gearing up to join the World Trade Organization this year or next, trade and investment flows between the archrivals are certain to soar in the years ahead.

TIGHT SPOT. The new economic thinking in Taiwan seems quite at odds with the political situation. After all, tensions are rising across the strait, owing in large part to the Bush Administration's tilt toward Taiwan and away from China. Beijing is furious that the U.S. has agreed to sell the Taiwanese its largest arms package in more than a decade. And Taiwan President Chen Shui-bian's mid-May stopover in the U.S., en route to Latin America, only exacerbated tensions.

Yet never before has the economic relationship with China loomed so large in Taiwan's calculus. No longer can Taipei credibly tell execs to look elsewhere for business opportunities. "All of our future growth depends on the mainland," declares C.Y. Kao, CEO of Taiwanese conglomerate Uni-President Group, which has invested $1.5 billion in China and is hoping to list some of its subsidiaries on Chinese bourses. Kao is calling on Chen to scrap the long-standing "go slow, be patient" policy that caps mainland investments at $50 million apiece and bans anything the government deems too high-tech.

To remove these restrictions and open direct trade, transportation, and communications would be a reversal of epochal proportions, not to mention a political risk for a President who once led Taiwan's pro-independence forces. The clamor to tear down all barriers is putting Chen in a tight spot: He must more tightly mesh the two economies without losing control of Taiwan's destiny. He must also be mindful of relations with the Bush Administration. Some in Taiwan think the U.S. may discourage improved ties with the mainland just to push forward its own more aggressive policy toward China.

Still, Chen is under enormous pressure at home. Exports have plunged, falling 10% in April alone, and gross domestic product growth fell to 1% during the first quarter, the slowest pace in almost 30 years. To be sure, Chen's policymaking ability is being sabotaged by a legislature dominated by the opposition Kuomintang. But executives say Chen must shoulder the blame. "If Taiwan is like a big company, then Chen is not so good as the CEO," says Way-zen Chen, who is chairman of software maker Ulead Systems Inc. (and no relation to the President): "The goals aren't clear, and the management team isn't experienced."

The criticism seems to be getting through. Breaking with Democratic Progressive Party stalwarts, Chen is starting to acknowledge that a shift in the relationship with China is essential. "Cross-strait economic policies," the President said recently, "must be constantly reevaluated and adjusted." In January, Chen called for greater economic integration. He even suggested eventual political integration, angering his independence-minded allies. On May 28, Chen's government announced it was liberalizing rules limiting how much money companies can raise overseas and invest in China. "There's no other way," says Wang Heh-song, chief economist at the state-owned International Commercial Bank of China (ICBC) in Taipei. "Everyone knows where they must go. They have no choice."

As it is drawn further into the mainland orbit, Taiwan's economy will be dramatically transformed. Most technocrats expect the island to become more like Hong Kong. It is a useful comparison. After losing its manufacturing to Guangdong province in the 1980s, Hong Kong became stronger than ever by morphing into the service hub for the Pearl River Delta. Now Taiwan has the chance to play a similar role for the Yangtze River Delta and elsewhere in China, providing banking, logistics, marketing, and research and development for local companies that do most of their manufacturing in China. "Many American and other multinational companies view Taiwan as a preferred location for launching their business on the mainland," says Peter Banko, president of the American Chamber of Commerce in Taipei and Taiwan country manager of Bank of America.

Not that a closer economic relationship is risk-free. Taiwan could become beholden to China. "The more Taiwan invests in the mainland, the more restrained its actions will be," says Shen Dingli, a security analyst at Shanghai's Fudan University. The shift of factories to China will throw thousands of Taiwanese out of work. Unemployment is already at a two-decade high of 4%, but may be as high as 6% because of under-reporting. And even now, mainland competition is hurting the cement, shipbuilding, and petrochemical industries. Suppliers to the electronics industry are feeling the pain, too.

Nonetheless, the process is probably too far along to reverse now. Even as the Chen government steps gingerly, Taiwanese executives are deepening their business dealings on the mainland. They have been doing so for years, of course, shrewdly navigating the political shoals. Because much of the investment flows through Hong Kong or tax havens like the British Virgin Islands, no one knows just how much money has crossed the strait in the past decade. According to Beijing, Taiwan companies have pledged more than $48 billion in the mainland over the past 10 years; Taiwan officials reckon the figure is closer to $70 billion.

During the early 1990s, much of the money went into such labor-intensive industries as textiles and toys. Higher-end industries weren't allowed to set up on the mainland, though some companies found loopholes and eventually forced Taipei's technocrats to loosen the rules. In fact, market conditions forced them to: By the late 1990s, with computer makers facing shrinking margins for desktop PCs, the industry's survival depended on getting the government nod to shift operations to China. Pretty soon, the exodus was on. Today, according to Wang Jianming of Beijing's Chinese Academy of Social Sciences (CASS), 40% of Taiwan's hardware production--computers, parts, and peripherals--is manufactured on the mainland.

WINK, WINK. Now, despite legal restrictions on capital-intensive investment, chipmakers and designers are making the leap, too. As before, they are bending the rules to do so. Winston Wong, son of the founder of Formosa Plastics, is building a chip-fabrication plant in Shanghai, though he insists his Taiwanese company has not directly invested in the project. For their part, chip-design companies insist their China engineers are engaged in customer service--which Taipei allows. In fact, some will be designing chips. Such developments are doubtless vexing executives at Taiwan Semiconductor Manufacturing Co. (TSM ) and United Microelectronics Co. (UMC ), the giants of the island's information-technology industry. Neither company can so blithely flout the government's rules--they're simply too high-profile.

It's no wonder Taiwan's chipmakers are impatient to move operations to the mainland. Apart from meeting the challenges from Wong and others like him, they need to be closer to their multinational customers. Ditto for smaller companies such as chip designer Sunplus Technology Co. More than 80% of its customers, among them toymakers Hasbro Inc. (HAS ) and Mattel Inc. (MAT ), operate plants in China. Yet because of the restrictions, Sunplus risks losing business to other Asian rivals. Moreover, faced with a shortage of skilled labor at home, Taiwanese companies covet mainland engineers, who work for one-third of what their Taiwanese counterparts earn. Taiwan banks, too, bridle against restrictions that bar them from opening offices on the mainland. The ban means it's hard for them to assess the operations of their Taiwan clients in China. By the time they know clients are in trouble, says ICBC's Wang, "they're bankrupt." Recently, he sent a team of bankers to monitor clients in China. With a limited amount of time and a large number of companies to visit, they could do nothing more than a superficial inspection, he concedes. "We really need a representative office in China," says Wang. "That way we can compete with foreign banks."

BLURRED LINE. For companies that have already moved to the mainland, the distinction between local and Taiwan operations is increasingly hard to see. Uni-President has 180 Taiwanese managers working in China now, says Ted T.C. Tu, executive vice-president at Uni-President's international investment subsidiary. That's equal to 40% of the conglomerate's senior management team. But says Tu, "local people have become more capable." As a result, "starting from this year, localization is one of our important policies." So the distinctions between Taiwanese and Chinese in Tu's executive team should fade.

The drive by Taiwan companies to list on the mainland should push the localization process even further. Bicycle maker Giant Manufacturing Co. reckons its planned listing will boost brand awareness among mainland consumers and investors. It will encourage people "to identify Giant with their own country, not as a company from Taiwan," says Chief Financial Officer Bonnie Tu. It is not clear when Taiwan companies will be allowed to list, because Chinese regulators must devise the rules. But in recent months, Beijing has said it wanted Hong Kong and foreign public companies to do so.

Even as Taiwan's economic links with China solidify, the attendant risks are giving the Chen Administration pause. As high-end electronics manufacturing and R&D moves to the mainland, Taipei will be hard-pressed to replace them. While Taiwan still retains a big edge in industries like semiconductor manufacturing, such businesses are capital intensive and don't create enough jobs to compensate for the layoffs in more labor-intensive parts of the electronics business. Nor will next-generation industries such as biotech and chip design provide many jobs for laid-off factory workers. That means Taiwan will become a more mature economy, with a sizable number of jobless people on government assistance.

Becoming more dependent on China also raises the probability that Beijing will use Taiwanese investors to wrest political concessions from Taipei. Already, companies and executives close to Chen say they've been subjected to local harassment. Last year, mainland officials pounced on the Jiangsu operations of plastics and electronics maker Chi Mei Industry while they investigated the company for violations of mainland law. In the end, the officials came up empty-handed but made clear the probe was retribution for the company's support for President Chen. "China uses one hand to attract investment, the other to threaten," says Wu Rong-I, president of the Taiwan Institute of Economic Research. "China is using this lever to influence Taiwan policy."

Yet closer economic ties seem the only way forward for Taiwan. The problem is how to achieve them. To be sure, setting up postal, trade, and transport links would likely boost growth as Taiwanese and foreign companies rushed to take advantage of new opportunities. But to date, Chen's attempts to jump-start the process by establishing so-called minilinks between Taiwan's offshore islands and the mainland ports of Xiamen and Mawei have been met with Beijing's silence. While Chinese leaders favor direct links, they are prepared to wait until Chen swears allegiance to the notion of one China.

Still, mainland leaders may be ready to negotiate in coming months. With China trying to reform its economy and develop its lagging western region, the last thing it needs is more conflict with Taiwan that could scare off foreign investment. Indeed, the several billion dollars that Taiwanese are pumping each year into China's export economy provide key jobs as China reforms. "Taiwan investment," says Wang, the CASS scholar, "is key to solving the mainland's unemployment problem." At the same time, Beijing is eager to tap Taiwanese technological skill, management, and capital to help it meet its ambitious technological aspirations, including plans to develop world-class semiconductor and biotech industries.

Political considerations also may moderate Beijing's behavior. China's hopes to host the Olympics in 2008--not to mention its first Asia-Pacific Economic Cooperation summit meeting in Shanghai this fall--mean its leaders don't want cross-strait rhetoric to deteriorate. Already, there are positive signs. Among them: Beijing's offer to allow Taipei to cohost the Olympics. And while Beijing so far has rejected Chen's offer to visit Shanghai in October for the ministerial meeting of APEC, China is not opposed to the attendance of lower-level Taiwan officials. "If we have a message, we can pass it to them," says Tsai Ying-wen, spokesperson of the Mainland Affairs Commission, Taiwan's top policymaking body on China.

For President Chen, one year into a four-year term, a breakthrough can't come soon enough. His increasingly unpopular party faces legislative elections in December. They are expected to end with him attempting to forge a coalition government with the opposition, which favors a greater economic opening to the mainland. "Voter resentment is high," says Tim Ting, chief consultant to Gallup Taiwan. "Chen has to play the mainland card." If he doesn't, Taiwan's restless executives will.

By Dexter Roberts and Bruce Einhorn in Taipei, with Alysha Webb in Shanghai

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