Oct 25, 2006

Taiwan: Time Right for a US FTA

The US is Taiwan's second-largest trading partner. However, despite the continuing tension, the Taiwan-China connection has emerged as the strongest economic tie among Taiwan's international relations.

With the collapse of the multilateral WTO Doha Round of trade negotiations, the US has vowed to pursue alternative means of trade liberalization through bilateral free trade agreements (FTAs) with willing partners -- particularly with economies in the emerging economic powerhouse in East Asia.

This shift will bring into stark relief a major dilemma for US trade and diplomatic policy: the increasing political and economic isolation of Taiwan within the region. Heightening the US dilemma is the reality that the current wave of discriminatory intra-East Asian FTAs is already diverting trade and investment away from Taiwan's economy.

In determining whether the time has come for a US-Taiwan FTA, it is important to establish a clear picture of the positions and interests of the three parties directly affected: the two potential partners -- the US and Taiwan -- and, of course, the elephant in the room, China.

With total two-way trade amounting to just under US$57 billion last year, Taiwan is the US' eighth-largest trading part-ner, ranking ahead of France and Italy and just behind South Korea. The US is in turn Taiwan's second-largest trading partner.

Ironically, however, it is the Taiwan-China trade and investment connection that has emerged as the strongest economic tie among all of Taiwan's international relations -- despite the continuing tension over sovereignty issues.

Using China's statistical count (which more accurately includes much of Taiwan's exports to Hong Kong as ultimately bound for China), bilateral trade in 2004 amounted to US$78 billion, with Taiwan enjoying a trade surplus of US$51 billion.

This surplus stems in part from the fact that the Taiwanese government has many trade restrictions on imports from China. Electronics and related equipment constitute a significant portion of Taiwan's exports to China.

The underpinning of this burgeoning electronics trade with China is based upon huge investments that Taiwanese companies have made over the past decade. Though official estimates place the total investment at US$40 billion, more accurate unofficial estimates (which include money routed through Hong Kong and various Caribbean havens) run from US$70 billion to US$100 billion.

Turning to the political and strategic background to the proposal for a US-Taiwan FTA, it should first be acknowledged that according to the economic and political criteria set forth by the administration of US President George W. Bush itself to prioritize the choice of FTA partners, Taiwan should rank near the top of the list.

Among the key tests that Taiwan meets are the following: It is a democracy; it already has a significant economic relationship with the US; it is willing to negotiate a comprehensive agreement that goes beyond WTO liberalization; it is a stalwart diplomatic and security ally of the US; and finally, an agreement would enjoy bipartisan support in the US Congress.

On the downside, Beijing adamantly and forcefully opposes nations signing FTAs with Taiwan, arguing that this will in effect give Taiwan the status of an independent nation and violate what it considers the international rule of "one China." In pursuit of the goal of isolating Taiwan diplomatically, Beijing has directly threatened nations that have considered FTAs with Taiwan, warning them that they "would bring political trouble to themselves " if they proceeded with such an action.

Over the past decade, both the Clinton and the Bush administrations have cultivated a policy of "engagement" with China; and currently, the Bush administration has a number of diplomatic irons in the fire that depend upon Beijing's help and support -- with the difficult and dangerous situations in North Korea and Iran heading the list. Thus, the US must carefully balance support for a democratic Taiwan with equally important goals and relations with China.

In fashioning a response and a policy for future US-Taiwan trade relations, the following economic realities should be considered regarding potential Taiwan FTAs.

One, the economic benefits of a US-Taiwan FTA are real but small; two, the cumulative negative economic effects of East Asian bilateral trade agreements that exclude Taiwan are becoming quite sizable because of trade diversion -- and would reach truly damaging proportions for Taiwan's economy if a large East Asian FTA (ASEAN countries plus Japan, South Korea and China) were negotiated; and three, given its strong position within highly integrated East Asian production networks, Taiwan would reap the greatest benefit from entering into FTAs with its important regional partners, such as Japan, South Korea, Singapore and Thailand -- leveling the playing field now tilted against Taiwan by existing and planned FTAs.

How to proceed? First, the US should base its future course firmly upon Taiwan's status under international law and practice.

Thus, the US should point out to Beijing's leadership that their argument that the FTAs would violate the "one China" policy is fundamentally flawed. China has accepted Taiwan's membership into the WTO, where it is treated and defined under international law as a "customs territory."

By extension, bilateral FTAs are merely another manifestation of that legal status -- and indeed, the basis upon which China has become Taiwan's most important trade and investment partner.

As it moves to implement a regional trade policy in East Asia, the US should quietly, but firmly, present China with the following options. First, ask the Chinese to back off and allow Taiwan to negotiate FTAs with other nations, particularly its regional neighbors.

In turn, the US would strongly reiterate its commitment to the "one China" policy and affirm that Taiwan's status remained the same as in the WTO -- a customs territory. In addition, the US would step up pressure on Taiwan to remove direct transportation restrictions on the movement of goods to and from China and allow in more Chinese imports.

Second, if China refuses, and the US cannot get other Asian nations to conclude FTAs with Taiwan because of Chinese threats, the US should inform Chinese leaders that it will proceed itself to conclude a bilateral FTA with the island.

While China may react with anger at finally being called to account, there is both legal precedent and economic common sense behind these proposals.