China's Economic Shift A Looming Threat
BMI View: In our review of the implications of China's 12 th Five Year plan on Taiwan's economy, we find that Taiwan's semiconductor and flat-panel sectors face the greatest risk from Chinese competition over the long term, due to a prolonged lack of progress in high-end manufacturing. In the medium-term, however, upside potential for Taiwan stems from a reinvigoration in Taiwanese homebound investment, a possible return of skilled labour, and a liberalisation in cross-strait banking. We argue that unless Taiwan makes material efforts to move up the value chain, China's imminent rise in the global tech sphere will eventually threaten the industrial model on which the island's economy is built on.
A Recap Of China's 12th Five Year Plan
In the twelfth edition of its five-year master plan that came into effect in 2011, Beijing acknowledged that the rapid pace of growth achieved over the preceding three decades was a feat that was unlikely to be repeated going forward. The central government was seeking a more sustainable, higher quality pace of growth and a reorientation away from the export and investment-driven structure of its economy. Beijing consequently outlined plans to develop the country's western regions, engage in industrial upgrading and improve energy use, among other things, as a means of achieving a more steady economic growth trajectory.
Seven industries were placed on a priority list: Biotechnology, IT Hardware, High-end Manufacturing, New Materials, New Energy, Clean Energy Vehicles and, Energy Saving and Environment Protection. These sectors were to be groomed to be global champions and to progressively take over the economic role of China's more traditional industries. The central government sought to increase their contribution of less than 2% of GDP then, to 8% and 15% of GDP by 2015 and 2020, respectively. By virtue of the size of its economy, as well as its growing trade links with the rest of the world, any structural shift in China's economy would have natural implications for not just the domestic economy, but also its trade partners, particularly within Asia. Taiwan is one such country and one in which the effects of China's structural economic shift will be more pronounced.
|Increasingly Leveraged To China|
|Taiwan - Trade With China|
Taiwan's Growing Dependence On China
Taiwan has become one of the most leveraged economies, regionally, to China over the past decade. Trade between the two countries has grown 11-fold from US$10.6bn in 2000 to more than US$121.6bn in 2012. The mainland's share of Taiwanese exports skyrocketed from 3% to 26% during the same time period. The cross-strait boom also saw a swell in investment activity, with Taiwanese investors pumping more than US$110bn between 1991 and 2012 into the mainland. This surge has been a result of a confluence of factors, fuelled by both economics and politics. From an economics viewpoint, China's industrial progress over the years has seen it progressively move up the technology value chain and in the process, become increasingly aligned with Taiwan's tech-oriented industrial structure. Taiwanese manufacturers, along with others from around the world, attracted by China's cheap labour costs and Beijing's increasing willingness to open up its economy, flocked over in droves. Political motivations were also at play, as China employed a change in tact and opted to use the prospect of greater economic linkages as an economic carrot with which to realise its goal of eventual reunification.
Sectoral Implications: Long-Term Risks To Semiconductors, Flat-Panel Manufacturers
Semiconductors - competitive advantage diminishing: While China's economic progress may have carved open many opportunities for Taiwanese investors, it is this same relentless advancement that now poses an increasing threat to Taiwan's growth prospects. At a time when Beijing is driving Chinese firms up the value chain, and successfully doing so, Taiwanese firms have stagnated (for more colour see 'Downgrading Structural Growth As Multiple Headwinds Build', November 27). China has transformed from semiconductor producer to semiconductor consumer and, increasingly, from low-margin back-end manufacturing to the lucrative design and licensing phase of semiconductor manufacturing, an important pillar of Taiwan's semiconductor industry.
China's closing of the technological gap with global players was evident in 2012 when it leapfrogged the US to become the fourth largest consumer of raw materials used in semiconductor manufacturing, lending credence to the central government's push towards high-tech manufacturing. China's forays into semiconductor manufacturing have consistently been impeded by US and Taiwanese national laws that prevented the export of advanced semiconductor manufacturing technology. This left mainland manufacturers generations behind in production capabilities. With the aid of public financing that has been ploughed into R&D, coupled with the licensing of processing technology from foreign sources and the diminishing need for sophisticated semiconductor technology, the mainland is slowly but surely playing catch up. With domestic chip companies reportedly supplying just 10% of China's semiconductor needs, it goes to show how much foreign chipmakers stand to lose if and when Chinese manufacturers eventually acquire the know-how to begin domestic production.
|China Playing Catch Up|
|Global - Semiconductor Materials Sales, US$bn (LHS) & % chg y-o-y|
Panels - Chinese capacity increasing, venturing into new technologies: Also, Taiwanese flat-panel manufacturers were unnerved recently amid speculation that Chinese buyers would be making their final procurement trip to the island this year. Their fears were temporarily ameliorated when it was revealed that Chinese domestic panel production was still insufficient to meet local demand. Local manufacturers are already feeling the heat from the rapid expansion of Chinese manufacturing capacity in the existing dominant Liquid Crystal Display (LCD) technology, with anecdotal evidence suggesting that Chinese panel manufacturers were recording higher profit margins than their Taiwanese counterparts. Additionally, there remains a looming threat of mainland manufacturers gaining a foothold into Organic Light-Emitting Diode (OLED) technology, which is poised to become the next generation of display technology. While it may be somewhat premature to make such a bold statement, given the embryonic stage of China's flat-panel industry, its evolving semiconductor sector as well as firm support from the central government will only serve as a catalyst in expediting the mainland's catch up with Taiwan.
Macro Picture: Medium-Term Upside Still Possible
From a macro perspective, China's endeavours to alter its industrial structure may actually provide some near- to medium-term benefit for Taiwan. An inevitable by-product of such a move has been a rapid rise in Chinese wages. Part of the objectives of the recent Five Year Plan was to raise the national minimum wage by an average of at least 13% annually in order to double salaries by the end of 2015. As a result of this, companies have faced pressures to either move inland, where infrastructure is not as developed, or even move production facilities out of China altogether.
|A Blessing In Disguise|
|China and Taiwan - Annual Wage Growth, % chg y-o-y|
Such is the case that Taiwanese businesses based in China have been reorienting their investments away from the mainland, shifting towards ASEAN and also back home. This could well be the jolt that Taiwan's economy needs. Alongside the one-sided cross-strait relationship that the island has had to endure over the past few years, the country has also witnessed a migration of skilled talent to the mainland, leaving the island with a dearth of skilled workers, which, has in turn impeded growth of the domestic tech industry. A resurgence in homebound investment will therefore bring about the investment that Taiwan has been sorely missing, as well as the return of skilled Taiwanese workers, an added advantage considering that the country has not been receptive towards engaging foreign workers.
|Homegrown Businesses Returning For Good?|
|Taiwan - Government-Approved Investment In China, US$bn|
Taiwan's services sector may also stand to benefit from China's rebalancing towards greater consumption. In particular, we highlight the banking sector as a likely beneficiary. In our opinion, the liberlisation of cross-strait banking stands to be a mutually beneficial relationship for both countries. China's banking sector, while vast, still remains underdeveloped and unstable and lacks the required expertise to expand at the pace it desires. Taiwan, on the other hand, has the expertise, but as a result of its excessive fragmentation and a small domestic market, has had to contend with razor-thin margins and limited growth opportunities. China's opening up to Taiwanese banks in recent years, and the designation of the island as an offshore yuan centre may consequently provide the Taiwanese banking industry with additionals avenue of growth, and serve as the catalyst for much needed consolidation within the industry.
China Still A Long Term Threat
We caution, however, that the potential for medium-term upside in Taiwan is founded on the premise of a continued warming in the cross-strait political relationship. The further liberalisation of cross-strait economic partnerships will largely revolve around the theme of reciprocity. Taipei will have to strike a balance between seeking greater economic growth and managing the political implications that may arise from greater Chinese involvement. Beijing may demand greater access to Taiwan's tech sector (i.e. raising the investment ceiling in Taiwanese companies), in return for further easing in cross-strait banking regulations. Also, while China may be able to provide the capital that Taiwanese banks need, Taiwanese regulators, cautious towards extending too much control of its financial sector to the mainland, may be apprehensive towards allowing greater investment.
The cost pressures in China may presently be compelling foreign businesses to look elsewhere, but this may not last if the central government manages to iron out its structural deficiencies and push through its five-year economic blueprint. The development of infrastructure and the promotion of industrial clustering, particularly away from Eastern China, will serve to alleviate the supply chain issues that have dogged businesses in China for years, bringing costs pressures down, among other factors and ultimately making its business environment more attractive. If Taiwan fails to progress up the value chain in the coming years, as it has done over the past few years, it will only be a matter of time before China leapfrogs the island and threaten the industrial model on which Taiwan's economy is built.