Whales Fight, Shrimps Get Hurt – What Trump’s Trade War with China May Mean for Taiwan

Whales Fight, Shrimps Get Hurt – What Trump’s Trade War with China May Mean for Taiwan

Whales Fight, Shrimps Get Hurt – What Trump’s Trade War with China May Mean for Taiwan

On August 7, the Financial Times drew attention to the impact any further round of US tariffs on imports from China would have on America’s own tech industry. The proposed next list of extra tariffs, the latest stage in President Trump’s escalating trade war with China, features US$200 billion of additional levies. For the first time, these would hit the tech industry directly, as tariffs would be raised on almost the full range of the industry’s infrastructure, from motherboards and memory modules to switches and servers. Industry insiders were quoted as complaining that the new tariffs would do little to influence Chinese policies, but would hit companies that imported components from China, ironically making it harder for them to compete with Chinese companies.

Much of this is a direct reflection of the complex nature of global supply chains. In the ICT sector especially, notwithstanding the recent rise of companies such as Huawei and ZTE, most Chinese production is little more than the final assembly of components imported from elsewhere, ironically including the United States itself. China has been an attractive venue for this, at least until recent years, because of the ample availability of low cost labor needed for the semi-skilled and repetitive final assembly operations.

Taiwanese companies have long been major investors in the Chinese electronics and ICT sector, and the impact of the proposed new tariffs could hit them especially hard. The fact of the matter is that outside Taiwan itself little is known about just how much the Chinese industry owes to Taiwanese companies for its success. Most final assembly operations of companies such as Honhai Precision (Foxconn) and Quanta, global leaders in contract manufacturing, are carried out in China where Honhai alone has more than one million employees, equivalent to almost ten percent of the entire Taiwanese labor force.

And while Honhai might be well known, more usually as Foxconn, through its role in supplying Apple, the Quanta name, like others in the sector, is almost unknown outside Taiwan. Although most of the components for the finished product are shipped into China from elsewhere (again, often Taiwan), because of the way export statistics are calculated, no account is taken in the recorded export price of the cost of these imports. The iPhone X may be an extreme example in that as little as 3 percent of the final sale price is attributable to manufacturing costs in China, but the general pattern is much the same. Similarly, US tariffs are levied on the cost of the finished goods when they leave China, even if most of the components were originally imported from elsewhere, including the United States.

So it is not difficult to see how increased American tariffs on Chinese exports may hurt Taiwanese electronics producers. The output of Honhai’s, or Quanta’s, or any other Taiwanese company’s factories in China will be subject to the higher tariffs, making them less competitive than comparable products made, say, in South Korea and the logical response of American buyers will be to try to move final assembly away from China to avoid the tariffs.

Yet, this is only part of the story since Taiwanese companies are also major suppliers of the essential components that go into the finished product, especially the critical integrated circuits and chips. The full significance of Taiwanese investment in the sector becomes apparent when one looks at the role of the country in industry supply chains. According to the WTO , in 2016 China’s top four exports by value were all in the electronics and ICT sectors – sectors targeted by the latest proposed US tariff increases—and totalled some US$412 billion. But China’s top import in the same year was in the same sector—integrated circuits (IC). At US$228 billion, ICs represented around 15 percent of all China’s imports and were equivalent in value to more than half that of the country’s four main exports combined.

Although Taiwan’s exports to China have been growing more slowly than those of the world as a whole since the Economic Co-operation Framework Agreement (ECFA) was signed in 2010, the electronics sector has been an exception. Here, Taiwan has successfully increased its market share of Chinese imports, mainly on the back of rapid growth in its export of electronics and ICT products, which now account for more than 45 percent of all Taiwan’s exports to China and around one-fifth of all China’s imports of ICs . Given that most are ultimately destined for export from China in a finished product, they are at risk from the tariff increases envisaged by President Trump.

Taiwan therefore faces a double hit: its principal export market is China and its dominant export industry is electronics and IT, both the target of the latest proposed tariff increases. So, tariffs intended to force China to take action to reduce its trade surplus with the United States are in practice likely to affect Taiwanese industry most. In the careful bureaucratic phrasing of the WTO:  “The statistical bias created by attributing the full commercial value to the last country of origin can pervert the political debate on the origin of the imbalances and lead to misguided, and hence counter-productive, decisions.”

However, could the trade war be a blessing in disguise? Could this offer an opportunity for Taiwan? The Tsai Ing-wen government has long been concerned about the country’s dependence on the Chinese market. The likely impact of higher US tariffs will provide a graphic demonstration of one consequence of such dependence, albeit not likely one envisaged when the New Southbound Policy was announced. The logical response of Taiwanese producers should be to try to help repatriate some of the final assembly in China back to Taiwan, or move it to a third country such as Malaysia or Vietnam, where it would be free from higher tariffs. There are signs that some companies are moving southbound to minimize the impact of the trade war.

This will not happen overnight, certainly not on any large scale: Intel calculates that moving a chip packaging plant out of China would cost between US$650 million and US$875 million and most manufacturers are likely to prefer to avoid such a commitment, hoping instead that the tariff increases will not be implemented, or would be quickly reversed by a future US administration. Furthermore, the Taiwanese labour market is probably too small to meet the large-scale needs of the big contract manufacturers, certainly without major accompanying structural adjustment in other sectors. But shifting modest amounts of final assembly back to Taiwan should certainly be possible, especially as labour costs in Taiwan are competitive with those of the mainland and more of the final assembly operations are being mechanised.  

If the tariffs are implemented and not quickly removed, the attraction in the longer term of moving more final assembly back to Taiwan should certainly grow. But if this is to happen, the Taiwanese government needs to do much more than simply exhort manufacturers to ‘re-shore’ or to avoid putting all their eggs in the China basket. It should take a hard look at some of the many impediments to domestic investment, in particular its own regulations and requirements.

In the latest edition of the World Bank’s Doing Business report, Taiwan ranks an impressive 15th overall of 190 countries worldwide. But its export processing procedures remain unnecessarily burdensome, placing it a lowly 55th place for ease of international trade—below countries such as Armenia or Kosovo, and even the West Bank. Manufacturers are unlikely to shift assembly back to Taiwan to avoid higher tariffs if they simply end up paying high export administration costs instead. Taiwan’s lowest ranking of all in the report is for access to credit, perhaps the biggest concern of all for small businesses operating in a sector known for its wafer-thin profit margins. A pro-active government approach to help China based electronics companies find land in Taiwan for new factories and provision of credit to help with the cost of relocation could make a big difference.  

The main point: Increased US tariffs on Chinese electrical exports are likely to hit Taiwanese producers hard. But this offers a long-term opportunity for Taiwan to repatriate final production and reduce dependence on the Chinese market.  For this to happen, however, the government must make it easy for the electronics companies to relocate.