The deal was reached by Taiwan and Mainland China on June 29, 2010, despite wrangling in the Legislative Yuan between representatives from the Nationalist party and those opposing the framework, the Democratic Progressive Party (DPP).
The agreement calls for Mainland China’s tariff cuts on 539 categories of Taiwanese exports to China over the next two years and Taiwan to reduce tariffs for 267 categories of Mainland’s exports. Benefits arising from reducing tariffs are well studied and understood. Apart from the efficiency gains from resource reallocation across industries through the specialisation in industries which have a comparative advantage, recent developments in trade theory suggest that trade liberalisation will increase industry productivity through resource reallocation from inefficient firms to more productive firms within an industry.
Recent estimates by the Peterson Institute on the impact of the ECFA on Taiwan suggest a 4.5 per cent gain in its 2020 GDP. Nonetheless, this is likely to be an underestimation as it only captures the former channel. Computational general equilibrium models, an economic modeling technique, have yet to incorporate the feature of firm heterogeneity which is a newly discovered channel that improves industry productivity. More importantly, the largest benefit of ECFA for Taiwan is that it incorporates Taiwan’s industry into the economic fabric of the increasingly integrated East Asian region.
An important feature of Asia’s trade pattern is its increasing intra-regional trade. According to the World Trade Organization (WTO), intra-regional merchandise trade in Asia accounts for almost half (49.7 per cent) of Asia’s total exports in 2007 while Asia’s exports to North America and Europe accounts for 19.9 per cent and 18.8 per cent respectively. Trade within Asia has experienced a significant shift from traditional inter-industry trade to intra-industry trade in finished goods, and more recently, to intra-industry trade in parts and components, in particular in ‘machinery and transport equipment’ industries where a large number of multi-layered vertical production processes are involved.
Mainland China’s trade patterns mirror that of Asia. Exports from Mainland China to Asia account for nearly half of Mainland China’s total exports. In contrast, Mainland China’s exports to the United States and Europe account for about 20 per cent of its total exports. Comparatively, mainland China’s imports from Asia represent about 65 per cent of total imports, suggesting Mainland China has engaged intensively in intra-industry trade in parts and components with economies in the Asian region while exporting finished goods to markets in developed Western economies.
These changing patterns of trade in Asia, and Mainland China in particular, reflect changes in the nature of international production from the traditional pattern of producing a good in one country to production fragmentation where the whole production process is carried out in a dispersed manner in different countries. The formation of a production fragmentation network within Asia has led to new international divisions of labor. East Asia economies are now integrating more tightly than ever and a trend of further trade liberalisation within the region is evident.
Against this backdrop of growing economic integration among Asian economies, restrictions on trade across the Taiwan Strait isolates Taiwan from participating in this newly developed economic architecture of Asia. At present, Taiwan still imposes import restrictions from Mainland China on 2,200 items of agricultural and manufactured goods. A simple comparison with its neighboring economy South Korea is illuminating. South Korea is both bigger economically in terms of GDP, and more populated than Taiwan by a factor of two. The value of their exports to Mainland China is comparable (about USD$ 100 billion in 2007). Yet, the volume of South Korea’s exports to Mainland China is almost three times that of Taiwan’s, thanks to trade restrictions with the Mainland.
A recent study by the author on potential volumes of trade suggest that given Taiwan’s size, its stage of economic development, its distance from other economies among other factors, and if Taiwan could import freely from Mainland China as other East Asian economies do, Taiwan’s imports from Mainland China should be more than double that of the current value.
A loosening up of trade restrictions with Mainland China will not just increase Taiwan’s trade with Mainland. More importantly, it will significantly reshape Taiwan’s industrial structure, allowing Taiwanese industries to participate actively in the new division of labor within the Asian production network. This efficiency gain through reallocating resources to the most productive industries and firms in Taiwan will be the key to the future of Taiwan’s economic fortune.
Of course, as with all free trade agreements, the devil is in the detail, in this case the complexities in the implementation of the ECFA.
The road to a more efficient economy will not be smooth, but this is a deal that Taiwan cannot afford to miss.
Xinpeng Xu is Associate Professor of Economics in the Faculty of Business at the Hong Kong Polytechnic University and Research Associate at the ANU.