Taiwan: In the shadow of China Asia Pacific Economic Outlook, Q2 2015

Taiwan’s economy faces contradictory influences: Lower oil prices are helping domestic demand, while the worsening condition of the Chinese economy is hurting Taiwan’s exporting prowess.

Taiwan’s economy faces contradictory influences. On the one hand, lower oil prices are having a positive impact on consumer purchasing power, thus boosting domestic demand. On the other hand, the worsening condition of the Chinese economy is hurting Taiwan’s exporting prowess—although improvements in the US and European economies have the potential to provide a positive offset.

Positive effect of oil prices

First, consider oil. It accounts for roughly 10 percent of Taiwan’s imports. The price of oil has fallen more than 50 percent in the past year, thus providing Taiwan with both lower inflation and increased purchasing power.1 As of February 2015, consumer prices in Taiwan were down 0.2 percent from a year earlier, mimicking the deflation that many developed economies are now experiencing due to declining energy prices. At the same time, wages have been rising due to a relatively tight labor market. The unemployment rate is now 3.8 percent. Thus the real purchasing power of households is expanding, boding well for a strong increase in consumer spending in the coming year.

Moreover, lower global oil prices are having a positive impact on purchasing power and economic growth in many of Taiwan’s trading partners, and Taiwan’s exports should benefit from lower oil prices as well. In addition, one side effect of lower oil prices is a higher-valued US dollar. The Taiwanese currency has depreciated about 5 percent against the US dollar since the summer of 2014, boosting the competitiveness of Taiwan’s exports in global markets. Thus the overall prospects for exports—especially to countries other than China—are good.

Negative impact of China’s slowdown

Next, consider the impact of China’s slowdown. China and Hong Kong purchase almost 40 percent of Taiwan’s exports. Meanwhile, the United States and European Union account for nearly 20 percent of Taiwan’s exports. The Chinese economy has slowed considerably and continues to decelerate. Growth this year is expected to be the lowest in a generation. This is likely to have a chilling effect on the volume of Taiwanese exports to China. Moreover, China remains at risk of financial instability, given its high level of private sector debt, much of the servicing of which depends on investments that are generating negative returns. This sets the stage for potential problems for debtors, and China is the largest external debtor of Taiwanese banks.

Prospects for trade with China

In recent years, the ruling Kuomintang Party (KMT) of Taiwan has worked closely with the mainland to further deepen economic relations. Yet there has lately been a backlash in Taiwan against closer relations with China due to several factors. First, the political events in Hong Kong last year gave pause to those in Taiwan thinking about closer political relations with China. Second, as Taiwanese companies invest in China, there is concern about the loss of high-paying manufacturing jobs in Taiwan. Finally, Taiwan and China signed the Trade in Services Agreement, which many Taiwanese see as increasing Taiwan’s dependence on the Chinese economy. One side effect of popular resentment was that the KMT suffered losses in last year’s local elections. It will next face the electorate in national elections in 2016. As such, it seems likely that further integration will be placed on hold at least until after the 2016 elections. Yet Taiwan is not in a position to deepen trade relationships with countries other than China because it lacks formal relations with many of the world’s largest economies. Consequently, it has not been included in the Trans-Pacific Partnership, a trade agreement being negotiated by the United States, Japan, and nine other Pacific Rim nations. Taiwan’s only hope for greater and substantial economic integration is with China.

Longer-term issues

The challenge that Taiwanese leaders face is to continue the shift toward a higher-value-added economy while not completely losing the ability to produce a wide range of goods for the domestic and non-Chinese markets. In a way, Taiwan has come to be for China what Silicon Valley is to the United States: the center of high technology. The country is moving up the value chain, shedding goods production, embracing higher-value-added services, and becoming an affluent society. As this process takes place, Taiwan will see slower but normal rates of economic growth. In 2014, the economy grew 3.7 percent. Going forward, this will likely be at the upper end of the range of growth possibilities. Taiwan is not only becoming a more normal affluent nation; it is also facing some of the demographic challenges common to affluent nations. The working-age population is starting to decline (although this is partly offset by a rise in labor force participation). The solution to demographic constraints is to boost productivity—mainly by investing in higher-value-added processes. Thus integration with China offers a solution, although it is also seen as creating risks.