US embassy cable - 05TAIPEI4851

C O N F I D E N T I A L SECTION 01 OF 05 TAIPEI 004851 
 
SIPDIS 
 
DEPT FOR EAP/TC 
DEPT PASS AIT/W 
 
E.O. 12958: DECL: 12/09/2015 
TAGS: ECON, EINV, ETRD, EAIR, EWWT, EFIN, PGOV, PREL, CH, TW, Finance, Foreign Policy, Transportation, Trade, Cross Strait Economics, Domestic Politics, Cross Strait Politics 
SUBJECT: CROSS-STRAIT ECONOMIC LIBERALIZATION - THE WAY 
FORWARD FOR  TAIWAN 
 
REF: A. 04 TAIPEI 3406 
     B. 04 TAIPEI 3464 
     C. 04 TAIPEI 4005 
     D. TAIPEI 343 
     E. TAIPEI 2565 
     F. TAIPEI 2653 
     G. TAIPEI 2743 
     H. TAIPEI 2896 
     I. TAIPEI 3122 
     J. TAIPEI 3931 
     K. TAIPEI 4085 
     L. TAIPEI 4395 
     M. TAIPEI 4624 
     N. TAIPEI 4717 
     O. TAIPEI 4719 
     P. TAIPEI 4778 
 
Classified By: AIT Director Douglas H. Paal, Reason 1.5 b 
 
Summary 
------- 
 
1. (C) Over the past two decades, Taiwan has gradually 
lifted many restrictions on cross-Strait economic relations 
resulting in the PRC becoming Taiwan's largest trade 
partner and top investment destination.  However, many 
restrictions remain, and many liberalization proposals 
continue to languish.  AIT assesses that Taiwan should 
first implement measures that allow people to move more 
freely across the Strait.  Second, Taiwan should allow 
money to flow, then technology, and finally it should free 
the movement of goods into Taiwan from the Mainland.  These 
measures will benefit the economies of Taiwan and the PRC 
and will also contribute to U.S. economic and security 
interests.  Some important measures may be implemented soon 
including regular passenger and cargo charter flights and 
opening of tourism.  However, the apparent postponement of 
the Economic Development Advisory Conference (EDAC) 
following the ruling Democratic Progressive Party's (DPP) 
sound defeat in the December 3 local elections is a sign 
that the Chen administration is unlikely to speed the pace 
of cross-Strait economic liberalization.  Continued advice 
from U.S. officials to both sides of the Strait to take 
pragmatic steps will be essential to further progress on 
liberalization measures.  End summary. 
 
Lingering Restriction in the Face of Rapid Integration 
--------------------------------------------- --------- 
 
2. (U) Taiwan has gradually lifted many restrictions on 
economic relations with the PRC over the last two decades. 
Starting with permission to visit family members in the 
Mainland in 1987, liberalization of indirect 
telecommunications and postal services in 1989, and lifting 
the ban on investment in the PRC in 1990, economic ties 
with the PRC have grown dramatically.  Today the PRC is 
Taiwan's number one trade partner and the destination for 
nearly 70 percent of approved outward investment each year 
(plus more unapproved investment to boot).  Every month 
more than 350,000 Taiwan visitors travel to the Mainland. 
It is no exaggeration to say that cross-Strait economic 
relations affect everyone in Taiwan. 
 
3. (C) However, progress toward liberalization has come 
very slowly in recent years under the DPP administration. 
The Renminbi exchange pilot program in Kinmen and Matsu 
(ref K), for example, languished with all preliminary steps 
completed more than a year before final approval to 
proceed.  In a similar vein, we will soon see the third 
round of Lunar New Year charter flights since 2003 (ref N), 
which highlights the failure of the two sides to reach an 
agreement on regular air links.  Other reform proposals 
continue to suffer long delays in the approval process. 
 
Recommendations for Taiwan's Cross-Strait Economic Agenda 
--------------------------------------------- ------------ 
 
4. (C) With numerous restrictions remaining across a broad 
range of sectors, Taiwan has ample possibilities for cross- 
Strait economic liberalization.  Based on discussions with 
a wide variety of businesses, academics and government 
officials, both foreign and Taiwan, AIT offers the 
following priorities for Taiwan's liberalization agenda 
based on Taiwan's own economic interests: 
 
First, Let the People Move 
-------------------------- 
 
-- (C) Establish Direct Air Links - The single most 
important step Taiwan must take is to establish direct air 
links with the PRC.  Direct air links will facilitate every 
form of cross-Strait economic interaction.  The lack of 
direct links causes more unnecessary expense and difficulty 
than any other cross-Strait restriction. 
 
-- (C) Liberalize Entry Permits for PRC Workers - Taiwan 
needs to make it easier for firms to bring PRC employees to 
Taiwan for short-term activities and long-term employment. 
This was one of the highest priorities identified by the 
American Chamber of Commerce in Taipei in its 2005 White 
Paper (ref F).  This is especially important as firms 
complain of a shortage of skilled workers in Taiwan's high- 
tech industries (ref H).  Progress has been made in this 
area but more is needed (ref L).  When combined with direct 
air links, less restrictive entry permit regulations will 
also have a strong positive effect on Taiwan government 
efforts to encourage firms to set up their regional 
operations headquarters in Taiwan.  Taiwan entrepreneurs 
would be able to maintain headquarters and research and 
development operations in Taiwan even as they expand 
manufacturing and sales operations in the PRC.  Foreign 
firms could integrate Taiwan into their greater China 
operations and even maintain their regional headquarters on 
the island.  Without direct air links and more cross-Strait 
personnel mobility, Taiwan and foreign firms alike will 
increasingly abandon the island. 
 
-- (C) Open Tourism - More than any other measure, opening 
Taiwan to PRC tourists traveling direct from the Mainland 
will have an immediate positive impact on the domestic 
Taiwan economy.  Industry observers are confident that 
tourists will come and spend significant amounts of money 
to the benefit of Taiwan's underdeveloped tourist industry 
(ref E).  Many cite the example of Hong Kong and the 
important role PRC tourism has played in its recent 
economic success.  At about 3 million visitors per year, 
Taiwan is dwarfed by Hong Kong's more than 14 million and 
similar numbers elsewhere in the region. 
 
Second, Let the Money Move 
-------------------------- 
 
-- (C) Remove Investment Caps - Taiwan firms across all 
industries complain about restrictions on the total amount 
of capital they are permitted to invest in the PRC.  Taiwan 
has a graduated schedule of limits on investment in the PRC 
based on a firm's total capital.  Most firms are not 
permitted to invest more than 40 percent of their total 
capital.  The largest firms are limited to even lower 
percentages.  These restrictions are not effective in 
keeping investment in Taiwan.  They are effective in 
encouraging firms to use less transparent business 
practices to hide their investment, sometimes illegally, or 
to abandon Taiwan entirely (ref M).  They have also proved 
effective in keeping American firms from using Taiwan to 
operate in China. 
 
-- (C) Permit Renminbi Exchange - The ability to exchange 
Renminbi in Taiwan will be essential to realize the full 
potential of increased tourism from the PRC, once that is 
opened.  In addition, current restrictions unnecessarily 
inconvenience business travelers.  Although looser 
restrictions on Taiwan's offshore banking units facilitate 
business transactions, the current regulations still impose 
a needless burden without achieving any economic or 
security benefits for Taiwan. 
 
-- (C) Liberalize Banking Investment - The Taiwan 
government has embarked on an ambitious financial reform 
plan, whose aims include making Taiwan a regional financial 
center.  However, Taiwan banks are not permitted to provide 
banking services in the PRC, their most logical market for 
expansion.  Nearly 70 percent of Taiwan's approved outward 
investment goes to the PRC.  By prohibiting Taiwan banks 
from opening branches in the Mainland, the government 
excessively restrains Taiwan banks in the one foreign 
market where they might have a competitive advantage. 
Given that a key determinant of bank competitiveness is 
scale, restrictions add to Taiwan's challenges. 
 
Third, Let the Technology Move 
------------------------------ 
 
-- (C) Liberalize Semiconductor Investment - Even as some 
IT industries farther down the supply chain, such as laptop 
PC manufacturing, have moved almost all of their production 
to the PRC (ref O), Taiwan still prohibits certain forms of 
investment in high-tech industries, especially 
semiconductor manufacturing.  These regulations are 
ostensibly aimed at keeping sensitive technology out of the 
PRC and preserving Taiwan's manufacturing base in these 
industries.  However, many of the technologies that are 
restricted are already in use in the PRC by local as well 
as foreign companies (refs D and G).  Moreover, the 
restrictions prevent Taiwan's most successful firms from 
competing in the industry's fastest growing market; soon to 
be the world's largest consumer of semiconductors.  Taiwan 
should quickly remove investment restrictions on 
semiconductor packaging and testing and semiconductor 
manufacturing with feature size no finer than 0.18 microns 
(currently manufacturing investment is only permitted at 
the 0.25-micron level and above).  It should also consider 
further liberalization of semiconductor manufacturing and 
semiconductor design.  U.S. firms are already exporting 
these technologies to the PRC either through direct 
investment or equipment sales to PRC firms.  If Taiwan 
firms are not allowed to compete, PRC competitors will have 
the market protection that could allow them to dominate the 
industry's key market, costing Taiwan its currently 
considerable competitive edge. 
 
-- (C) Liberalize TFT-LCD panel manufacturing - The TFT-LCD 
industry faces a similar situation to semiconductors. 
Taiwan firms are among the world's most important players, 
but they are unable to build TFT-LCD panel manufacturing 
facilities in the PRC where most of the panels are 
assembled into consumer goods (ref B).  The current 
restrictions hold back what are arguably Taiwan's two most 
competitive and economically important industries. 
 
Fourth, Let the Goods Move 
-------------------------- 
 
-- (C) Establish Direct Maritime Links - Although shipping 
companies have found ways to comply with the letter of 
Taiwan regulations that prohibit direct shipping with only 
minimal increases in shipping costs, current restrictions 
still impose unnecessary burdens on shipping firms and 
their customers (ref A).  The regulations also reduce the 
attractiveness of Taiwan ports.  With the rapid growth of 
PRC ports, Kaohsiung's harbor has fallen from the world's 
third busiest container port to the sixth and stands to 
fall further.  In addition, Taiwan's free trade port 
initiative aimed at attracting more investment to Taiwan's 
harbors has had difficulty in attracting tenants to the new 
zones.  The lack of direct links is an important obstacle 
to Taiwan's goal of becoming a regional logistics center. 
Taiwan's major geographic advantage is it's proximity to 
the Chinese market.  Without direct links, that advantage 
is left languishing on the shelf. 
 
-- (C) Lift Import Prohibitions - Taiwan still maintains 
import prohibitions on numerous goods produced in the PRC. 
Many of the prohibitions violate WTO commitments.  The 
removal of prohibitions on automobiles and auto parts as 
well as certain food items, especially chocolate, has been 
a high priority for some U.S. & foreign firms.  They argue 
that these prohibitions prevent foreign firms from 
integrating Taiwan into their regional operations.  If 
forced to choose between the two markets or establish 
manufacturing facilities in both, many foreign firms are 
likely to choose to leave or bypass the Taiwan market. 
However, the U.S. must also be mindful of the impact of the 
removal of such restrictions.  In addition to local 
producers who could be negatively affected, removal of some 
restrictions, especially on certain agricultural products, 
will have a strong negative impact on U.S. exports to 
Taiwan. 
 
And Don't Forget Other Industries 
--------------------------------- 
 
-- (C) Liberalize Telecommunications Investment - Taiwan 
telecommunications firms have entered into numerous 
cooperative arrangements with Mainland firms to try to 
capitalize on the growing demand for cross-Strait services 
(ref C).  However, they are still prohibited by Taiwan from 
most forms of investment in the Mainland.  These 
regulations are counterproductive to Taiwan's goals for 
developing digital-content industries. 
 
-- (C) Allow Naptha Cracker Investment - Taiwan's 
petrochemical firms, especially Formosa Plastics Group 
(FPG), are eager to build naptha cracker facilities in the 
PRC that would allow them to expand their downstream 
petrochemicals production and further exploit their most 
important market (ref I). 
 
Benefits to U.S. Interests 
-------------------------- 
 
5. (C) All of these liberalization proposals will 
potentially benefit the economies of both Taiwan and the 
PRC.  They are also strongly in U.S. economic and security 
interests.  Many of these measures would have a direct 
impact on U.S. businesses in the region, most importantly 
by allowing them to better integrate Taiwan operations into 
their broader strategy for greater China.  In addition, 
many U.S. exporters and U.S. investors in the region will 
benefit from stronger growth in Taiwan. 
 
6. (C) More importantly, closer economic ties between 
Taiwan and the Mainland will help reduce tensions and 
encourage both sides to move forward on negotiating 
solution to the issue of Taiwan's status, eliminating one 
of the most dangerous threats to regional stability.  In 
addition, stronger economic links could enhance Taiwan's 
influence on Mainland society, increasing exposure to 
Taiwan's stronger rule of law and democracy. 
 
Prospects Glacial 
----------------- 
 
7. (C) The months following the Lunar New Year holiday on 
January 28 could offer the most favorable environment for 
cross-Strait economic liberalization in years.  Some of the 
most important priorities, direct air links and opening 
tourism, are currently the subject of unofficial cross- 
Strait discussions.  The announcement on November 16 of 
Lunar New Year charter flights in January and February 2006 
was a positive step.  Reports from officials and industry 
associations of progress on cross-Strait weekend passenger 
charters and cargo charters are an indication that the 
administration is serious about moving forward on these 
initiatives. 
 
8. (C) The December 3 local elections sent a strong message 
of support for the KMT, which has successfully portrayed 
itself as the party that can work with the PRC and will 
implement cross-Strait economic liberalization measures. 
Although allegations of corruption in the ruling Democratic 
Progressive Party (DPP) had more impact on the election 
results than cross-Strait issues, it is increasingly clear 
that a majority of Taiwan voters support more open economic 
relations with the PRC.  In addition, the current opening 
in the political calendar is fairly large with the Taipei 
and Kaohsiung mayoral elections up next in December 2006 
and the legislative and presidential elections scheduled 
for December 2007 and March 2008 respectively.  The 
administration has some breathing space that could allow 
the DPP to implement measures that its pro-independence 
base does not support. 
 
9. (C) Progress might come after the planned second 
Economic Development Advisory Conference (EDAC).  For the 
second time, President Chen will convene an EDAC of 
business leaders, scholars, and other experts to make 
economic recommendations on a comprehensive range of 
economic issues.  Cross-Strait economic issues will be high 
on the EDAC's agenda.  This blue ribbon panel could give 
Chen the political cover he needs to implement some of 
these longstanding proposals.  The dates for the conference 
are unclear at this time, but it will probably take place 
sometime after the Lunar New Year holiday in late January, 
and could benefit from a likely rise in cross-Strait 
goodwill that holiday charter flights will generate.  If 
the PRC takes no provocative measures in the interim, this 
confluence of events could give the DPP administration the 
opportunity to implement liberalization measures that some 
in the government have been waiting for. 
 
10. (C) However, there are also signs that the Chen 
administration will do nothing to speed up the pace of 
cross-Strait economic liberalization.  The administration's 
original plans call for the EDAC to take place January 19- 
21, but the day after the ruling DPP's sound defeat in the 
December 3 local elections an Executive Yuan official 
indicated that it might be postponed, suggesting that 
President Chen may ensure that his pre-election prediction 
that a Pan-Blue victory would "tighten" cross-Strait 
relations becomes a reality (ref P).  Another bad sign is 
the continuing delay on the applications made by 
semiconductor manufacturers Powerchip and ProMos to build 
factories in the PRC.  The two firms applied almost a year 
ago.  Taiwan Semiconductor Manufacturing Company's (TSMC) 
investment in the PRC was approved nearly three years ago 
on February 26, 2003.  Approval for the Powerchip and 
ProMos projects would not represent any kind of 
breakthrough in cross-Strait economic policy, and yet the 
applications continue to languish in the approval process. 
 
11. (C) The Chen administration has already had several 
chances to live up to the "active opening" portion of its 
"active opening, effective management" cross-Strait 
economic policy.  To date, changes have come rarely and 
often only after the political opposition has forced the 
administration's hand.  There may be some important steps 
forward next year.  Most importantly, there may finally be 
some sort of regular direct aviation links.  However, there 
is little reason to suspect that this government will 
change the glacial pace of cross-Strait liberalization or 
its attitude about economic relations with the PRC. 
 
Recommendation - Continued Pressure 
----------------------------------- 
 
12. (C) U.S. advice to both sides of the Strait to take 
pragmatic action has helped keep these important economic 
liberalization proposals on the Chen administration's 
agenda, despite tendencies to govern from the DPP's pro- 
independence base.  Continued efforts will be essential if 
the current administration is to make further progress 
toward implementation.  U.S. officials at all levels should 
continue to urge Taiwan to execute policies that will 
further enhance the strong economic ties between the PRC 
and Taiwan. 
PAAL