US embassy cable - 05TAIPEI385

C O N F I D E N T I A L SECTION 01 OF 03 TAIPEI 000385 
 
SIPDIS 
 
DEPT FOR INR/I, EAP/TC 
DEPT PLEASE PASS AIT/W 
 
E.O. 12958: DECL: 01/31/2015 
TAGS: PINR, ECON, ETRD, EINV, CH, TW, Cross Strait Economics 
SUBJECT: US-CHINA TRADE IMBALANCE (C-AL5-00044) 
 
REF: A. STATE 11139 
     B. 04 TAIPEI 3930 
 
Classified By: AIT Director Douglas H. Paal, Reason 1.5 (d) 
 
Summary 
------- 
 
1. (U) Taiwan export manufacturing firms have made massive 
investments in the PRC, with especially strong 50 percent 
growth in investment during 2004.  In the key industries of 
electronics and information technology products 
manufacturing, a pattern of triangular trade has emerged. 
Taiwan firms export high-tech components to Taiwan-owned 
factories in the PRC.   Then Taiwan firms fill U.S., European 
and Japanese export orders for finished consumer goods from 
their PRC assembly plants.  As a result, Taiwan's exports to 
the U.S. have fallen overall the last few years.  Notebook PC 
manufacturers have invested heavily and rapidly in the PRC. 
Nearly 100 percent of laptop PC's produced by Taiwan firms 
will be assembled in the PRC in 2005.  The industry saw a 
particularly strong fourth quarter with fierce competition 
cutting costs and driving up demand.  Taiwan's investment in 
the PRC in the telecommunications equipment industry has not 
been as strong.  The PRC factories account for just 28 
percent of cell phones manufactured by Taiwan firms.  (End 
summary.) 
 
Triangular Trade Pattern 
------------------------ 
 
2. (U) Although not an action addressee on ref A, AIT would 
like to provide input on the questions raised about the rapid 
increase in China's exports to the United States.  Investment 
by Taiwan firms in the Mainland has been massive.  Taiwan 
figures, based on applications for investment approved by the 
government, put total investment since 1991 at over USD 41 
billion.  This does not include substantial investment 
funneled through third territories, which is widely thought 
to exceed officially approved investment by a factor of 2, 3 
or even 4.  After two years of strong growth, Taiwan's 
investment in the PRC surged in 2004.  Taiwan government 
statistics show that investment in the PRC rose by 38.6 
percent in 2002 and 19.1 percent in 2003 over the previous 
years, but then increased again by a remarkable 51.2 percent 
to USD 6.94 billion in 2004.  Growth in the first half of 
2004 was even more striking at 68 percent compared to the 
same period in 2004.  Most of Taiwan's investment in the PRC 
has involved the transfer of manufacturing and assembly 
operations to the Mainland and then exporting the output to 
the U.S., Europe and Japan. 
 
3. (U) Electronics and information technology (IT) have 
played an increasingly important role in cross-Strait trade 
and investment (ref B).  Taiwan firms now dominate the PRC's 
IT export industries.  The Market Intelligence Center (MIC), 
an industry research firm, estimates that Taiwan firms 
accounted for 79 percent of total PRC IT output (excluding 
software) in 2004.  In these industries a pattern of 
triangular trade has emerged.  While moving less advanced 
assembly operations to the PRC, Taiwan has maintained a base 
on the island for manufacturing high-tech components, 
including semiconductors and flat-panel display components. 
These kinds of components and other manufacturing inputs 
account for 80 percent of Taiwan's exports to China.  After 
export to the PRC, the components are mostly re-exported in 
finished consumer goods to the U.S., Europe and Japan.  Given 
this trade pattern, it is not surprising that the PRC's trade 
surplus with the United States -- USD 71.5 billion in the 
first 11 months of 2004 -- mirrors the PRC's combined deficit 
with Taiwan and South Korea -- USD 78.6 billion during the 
same period. 
 
4. (U) With increasing investment in the PRC, Taiwan's 
exports to the U.S. have generally fallen as trade is routed 
through production bases in the Mainland.  Although last year 
saw Taiwan's exports to the U.S. rise 8.4 percent to USD 28.1 
billion, this increase followed three years of decline. 
Total 2004 exports to the U.S. still fell almost 20 percent 
below the 2000 figure.  The gap between U.S. purchase orders 
for Taiwan firms and Taiwan exports to the U.S. illustrates 
the nature of triangular trade between the U.S., Taiwan and 
the PRC.  In December 2004, Taiwan export shipments to the 
U.S. totaled USD 2.5 billion, only 42.5 percent of the USD 
5.8 billion in purchase orders Taiwan firms received from the 
U.S. during the month.  Most of the difference is filled with 
products assembled in the Mainland.  Strong growth in U.S. 
orders to Taiwan firms in the fourth quarter of 2004, which 
were 32 percent higher than the previous year, may translate 
into more strong PRC export growth in the first or second 
quarter of 2005, depending on when the orders are shipped. 
Notebook PCs ) Rising PRC Investment and Export Demand 
--------------------------------------------- --------- 
 
5. (C) The transfer of manufacturing from Taiwan to the 
Mainland in the notebook computer industry has been dramatic. 
 A recent MIC study estimates that nearly 100 percent of 
laptops produced by Taiwan firms in 2005 will be assembled in 
the PRC.  Taiwan firms produce most of the world's laptop 
PCs.  Quanta Computer Inc. alone accounted for 25 percent of 
the global market in 2004 and has announced that it is aiming 
for 30 percent in 2005.  Its top two Taiwan rivals Compal and 
Wistron together accounted for almost 25 percent in 2004. 
Quanta's transfer of production to the Mainland has been 
astonishingly rapid.  Early in the first Chen Shui-bian 
administration, Quanta's founder and CEO Barry Lim had been 
vocal about keeping manufacturing in Taiwan.  However, price 
pressures and the migration of its suppliers to the Mainland 
forced Quanta to begin manufacturing operations in the PRC in 
2001.  Deputy Group Spokesman Jason Lin told AIT that 85 to 
90 percent of Quanta's 2004 third quarter notebook production 
was based in the Mainland.  That figure increased to 95 
percent in the fourth quarter and is predicted to approach 
100 percent in 2005. 
 
6. (SBU) In addition, the notebook computer industry saw 
unexpectedly high demand in the fourth quarter of 2004. 
Quanta shipped 3.7 million notebook PCs in the fourth 
quarter, up 32 percent from the previous quarter.  Low prices 
due to fierce competition among manufacturers were a major 
contributing factor to high demand.  The current average 
gross margin for the industry is just 5 percent and expected 
to fall below 4 percent according to MIC.  Executives of 
Quanta and Compal have called publicly for an end to the 
price war, which is driving down stock prices.  About 
one-third of the laptops produced by Taiwan firms in the 
fourth quarter was shipped to the U.S.  Another third was 
shipped to Europe, and one quarter of shipments went to Asia, 
excluding the PRC. 
 
7. (U) Nevertheless, the MIC study predicts that laptop 
shipments will drop by 14.7 percent in the first quarter of 
2005 to a total of 10.4 million units.  This is due in part 
to a shortage of key components, including Intel's Celeron 
central processing unit.  Quanta Chief Operations Officer 
Michael Wang suggested to AIT/T earlier this month that we 
urge Intel to sell them more components. 
 
Cell Phones ) Smaller but Significant PRC Investment 
--------------------------------------------- ------- 
 
8. (U) Taiwan manufacturers of telecommunications equipment, 
and cell phone handsets in particular, have not invested as 
heavily in the Mainland as some other electronics industries. 
 According to research by Taiwan's semi-official Industrial 
Technology Research Institute (ITRI), 61 percent of cell 
phone manufacturing by Taiwan firms takes place in Taiwan. 
This may in part be driven by continuing restrictions on the 
import of cell phones into Taiwan from the PRC, even as other 
categories of electronics have been liberalized. 
Nevertheless, with 28 percent of production in the PRC, 
cross-Strait investment has been substantial.  Furthermore, 
this figure does not capture some Taiwan investment that 
takes place through third territories. 
 
9. (SBU) BenQ is Taiwan's number one cell phone brand, a 
leading contract manufacturer for other brands, and the 
largest cell phone manufacturer both in Taiwan and the PRC. 
David Huang, BenQ's Financial Planning Department Senior 
Manager, told AIT/T that his firm has been transferring 
manufacturing operations to the PRC for over ten years. 
According to Huang, neither BenQ nor its major Taiwan 
competitors opened new factories in the PRC during the last 
half of 2004.  However, he notes that production capacities 
at their manufacturing plants in China are scaleable, 
allowing BenQ and other manufacturers to quickly expand 
production without large-scale capital investment. 
 
10. (C) Huang also said BenQ products manufactured in the PRC 
are exported in nearly equal amounts to the United States, 
Europe and Asia (excluding China), each accounting for about 
30 percent of sales.  The remaining 10-13 percent is produced 
for the China market.  For all Taiwan cell phone 
manufacturers, North America accounted for 26.1 percent of 
2004 sales, according to ITRI.  Europe and Japan accounted 
for 30.4 percent and 7.5 percent respectively.  Huang noted 
that as in laptop manufacturing, competition in the cell 
phone market has been fierce pushing down prices and cutting 
margins.  He said that BenQ might consider investment in 
other low-cost locations such as India or Southeast Asia if a 
revaluation of the Renminbi increases costs in the PRC. 
PAAL