Taiwan’s Trade Potential:
Risks and Opportunities
in a Changing Global Trade Context
Peter C.Y. Chow, CityUniversity of New York
NationalTaiwanUniversity
Dan Ciuriak, Department of Foreign Affairs and International Trade, Government of Canada
Abstract
In recent years, global growth in trade in goods and services has been boosted by so-called “integrative trade” in which an increasing share of traded goods and services consists of inputs into production processes, as these are being fragmented with elements distributed world-wide (“off-shoring”). At the same time, in the context of stalled multilateral trade negotiations, major trading economies are seeking free trade agreements (FTAs) to secure their market access objectives, creating risk of trade diversion for third parties. This paper will use simulations with the GTAP computable general equilibrium model and the TradeSim gravity model of international trade, and, to examine Taiwan’s actual trade and trade potential by trade partner andby commodity, with particular attention risks posed by exclusion from East Asia’s emerging set of FTAs and the opportunities from concluding an FTA with the United States.
I.Introduction
In recent years, much of the impetus to global growth in trade in goods and services has come from so-called “integrative trade” in which an increasing share of traded goods and services consists of inputs into production processes, as these are being fragmented with elements distributed world-wide (“off-shoring”). There are several main drivers for this trend, including the ongoing reduction in the cost of information management and communication which permits the management of production on a geographically widely distributed basis; improved logistics for shipping components; and much remaining scope for wage arbitrage as large population developing economies increase their degree of integration into the global economy.
At the same time, in the context of stalled multilateral trade negotiations, major trading economies are seeking free trade agreements (FTAs) to secure their market access objectives.
The combination of these two trends creates both opportunities and risks for trading economies such as Taiwan—opportunities to take better advantage of domestic capabilities to acquire specialized tasks that are becoming newly contestable in the global division of labor; and risks of being bypassed in this process due to disadvantageous market access prospects because of exclusion from regional FTAs.
At first blush, the risk of serious erosion of Taiwan in international trade seems modest: since acceding to the World Trade Organization (WTO) at the beginning of 2002, Taiwan’s two-way trade in goods and services has risen much faster than GDP, such that two-way trade has increased from 95.4% of GDP (2001) to 134.3% (2006)[1]. However, in the process, Taiwan has become more dependent on Asia for export markets, with the share of merchandise exports going to Asian destination having increased from 53.2% in 2001 to 65.4% in 2006[2]. Moreover, East Asian regionalism is at an early stage as yet, at least in terms of implementation of free trade commitments.
This paper examines Taiwan’s actual trade and trade potential by trade partner andby commodity scetors, with particular attention to risks posed by exclusion from East Asia’semerging set of FTAs and the opportunities from concluding an FTA with the United States. Amongst the many possible scenarios, we focus on a comprehensive FTA involving the major East Asian economies, Taiwan’s major trading partners and competitors.
The paper is organized as follows. Section 2 estimates, using the Global Trade Analysis Project (GTAP) computable general equilibrium (CGE) model, the impact on Taiwan of full implementation of an East Asian FTA. Section 3 examines the sectoral implications of the trade diversion identified in Section 2 and considers the opportunities in third markets, based on simulations with the TradeSim gravity model of international trade. Section 4 considers the scope for offsetting any trade losses due to preferential trade agreements struck by Taiwan’s trading partners through an FTA of its own with the United States. Section 5 draws some conclusions for Taiwan’s trade policy.
II.The Impact of East Asian FTAs on Taiwan’s Trade
East Asia has become a hotbed for bilateral and regional trade negotiations. All the major economies in the region are in pursuit of preferential market access both with other regional partners and outside the region. Taiwan is no exception. It has signed individual deals with Panama, Guatemala and Nicaragua as well as a trilateral deal reached in May 2007 with El Salvador and Honduras[3], continues to pursue a deal with the United States and has put out feelers with the European Union[4]. However, given the political issues raised for Taiwan’s trading partners when it comes to FTAs, Taiwan is at a decided disadvantage in gaining access to such agreements, not only with its major regional trading partners but also with the major global economies.
Not surprisingly, this situation has led many observers to worry about Taiwan’s marginalization as a trading economy. How significant such concerns should be is an open question. On the one hand, FTAs have the potential to divert trade, imposing economic welfare costs on excluded parties. On the other hand, FTAs can also boost economic activity in the partner economies, generating additional demand, which could partly or fully offset the trade lost by third parties due to the trade diversion effect. In short, it is possible that the income effect could offset the price effect.
Several studies on the impacts of East Asian economic integration on Taiwan’s economy were based on various scenarios on the economic integration such as ASEAN plus China, ASEAN plus 3 ( China, Japan and Korea ). [5]Yet, the development of Close Economic Partnership Agreement between China and Hong Kong (CEPA-CHK) made it necessary to consider China and Hong Kong as an integrated economic unit. Moreover, Taiwan’s trade with China and Hong Kong has had an increasingtrend with 34.3% of its exports destined to CEPA-CHKin 2002-2003. Meanwhile, though ASEAN countries have 10 members, in terms of Taiwan’s trade with and investment in the region, the most significant components are its original 5 members plus Vietnam. The ASEAN-6 ,which include Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam accounted for 11.8% of Taiwan’s exports in the same period.
To shed some quantitative light on this issue, we examine the impact on Taiwan of a comprehensive FTA involving the major East Asian economies – Japan, China, South Korea, Hong Kong, and the ASEAN 6. Taiwan’s export to these 10 economies
In the region accounted for more than three quarters of its total exports in 2002-2003.
Technical background and caveats
To simulate the impact of an East Asian FTA which excludes Taiwan on the Taiwanese economy, we use the Global Trade Analysis Project (GTAP) computable general equilibrium (CGE) model, version 6.0.[6]This model integrates data on bilateral trade flows, trade protection and domestic support together with input-output tables that describe the internal economic linkages within each economy. This allows the model to generate estimates of the impact of preferential tariff elimination under FTAs on trade flows, economic output, employment and economic welfare.
The simulations are conducted with the global economy disaggregated into 26 regions (see Table 6 below for the full list). The base year for the GTAP 6.0 data is 2001; in other words, the model depicts the global economy as it was in 2001, including the size of trade flows, the level of protection and support for trade in the various economies, as well as the size and composition of GDP and other economic variables for each country/region. The protection data in the GTAP 6.0 database come from Market Access Map (MAcMap), which was produced and is maintained collaboratively by the Paris-based Centre d’Etudes Prospectives et d’Informations Internationales (CEPII) and the International Trade Centre (ITC) in Geneva. The tariff data are compiled at the Harmonized Tariff System 6-digit level and include the ad valorem equivalent of specific tariffs and the tariff equivalent of tariff rate quotas (TRQs). The GTAP 6.0 protection data are current only as of 2001; accordingly, we update these to take into account the full implementation of the Uruguay Round tariff cuts, China’s accession commitments to the WTO, and the expiry of the WTO Agreement on Textiles and Clothing (ATC)[7].The simulations reported below involve full elimination of trade protection as captured in the GTAP database, updated as described above, for all industrial and agricultural sectors.
We do not attempt to model services or investment liberalization for several related reasons:
(a)reliable information on the level of protection provided by the various domestic measures affecting services trade and foreign direct investment is lacking;
(b)estimates of the potential response of services trade and investment flows to changes in regulatory barriers are crude at best;
(c)liberalization of services trade and/or investment in FTAs tends to be specific to particular sectors and it is impossible to know ex ante which sectors in which economies might be subject to liberalization.
The simulations were conducted on a fully disaggregated sectoral basis (57 sectors, of which 43 are merchandise). The standard GTAP 6.0 parameter set was used; the key Armington parameters (the elasticities of substitution between products according to country of origin) have recently been updated based on new econometric research. These elasticities are on average lower than those used in some other models such as the World Bank’s Linkage model; the estimated trade and welfare impacts reported here are thus relatively conservative.[8] The definitions of the GTAP merchandise trade sectors are given in Table 1 below, along with the values of the Armington elasticities of substitution.
Table 1: GTAP sectors and Armington elasticities of substitution
Manufacturing Sectors / Armington ElasticitiesFull GTAP description / Domestic vs. Imports / Between alternative sources of imports
Paddy rice / 5.1 / 10.1
Wheat / 4.4 / 8.9
Cereal grains nec / 1.3 / 2.6
Vegetables, fruit, nuts / 1.9 / 3.7
Oil seeds / 2.5 / 4.9
Sugar cane & sugar beet / 2.7 / 5.4
Plant-based fibres / 2.5 / 5.0
Crops nec / 3.3 / 6.5
Cattle, sheep, goats ,horses / 2.0 / 4.0
Animal products nec / 1.3 / 2.6
Wool, silk-worm cocoons / 6.4 / 12.9
Forestry / 2.5 / 5.0
Fishing / 1.3 / 2.5
Coal / 3.0 / 6.1
Oil / 5.2 / 10.4
Gas / 17.2 / 34.4
Minerals nec / 0.9 / 1.8
Meat: cattle, sheep, goats, horse / 3.8 / 7.7
Meat products nec / 4.4 / 8.8
Vegetable oils & fats / 3.3 / 6.6
Dairy products / 3.7 / 7.3
Processed rice / 2.6 / 5.2
Sugar / 2.7 / 5.4
Food products nec / 2.0 / 4.0
Beverages & tobacco products / 1.1 / 2.3
Textiles / 3.8 / 7.5
Wearing apparel / 3.7 / 7.4
Leather products / 4.1 / 8.1
Wood products / 3.4 / 6.8
Paper products & publishing / 3.0 / 5.9
Petroleum & coal products / 2.1 / 4.2
Chemical, rubber, plastic products / 3.3 / 6.6
Mineral products nec / 2.9 / 5.8
Ferrous metals / 3.0 / 5.9
Metals nec / 4.2 / 8.4
Metal products / 3.8 / 7.5
Motor vehicles & parts / 2.8 / 5.6
Transport equipment nec / 4.3 / 8.6
Electronic equipment / 4.4 / 8.8
Machinery & equipment nec / 4.1 / 8.1
Other manufacturing products / 3.8 / 7.5
Source: GTAP
GTAP results are heavily influenced by the choice of microeconomic and macroeconomic “closure” rules[9]. Under the GTAP model’s default microeconomic closure, the factor endowments (i.e. the total supply of labour, both skilled and unskilled, as well as of capital and land) are fixed; factor prices (i.e. wages and return to capital and land) adjust to restore full employment of the factors of production in the post-shock equilibrium.[10] Under alternative microeconomic closures that are sometimes used, the return to capital or to labour can be fixed and the supply of capital and/or labour then adjusts to restore equilibrium.[11] Each of these closure rules makes an extreme assumption about the supply of labour and/or capital: it is either perfectly elastic or perfectly inelastic. The reality is likely to be somewhere in between, meaning there is likely to be some impact on factor endowments stemming from an FTA. The economic literature supports positive but low long-run labour supply elasticity; the default closure rule is likely to be a reasonably good approximation, although the welfare impacts are likely to be somewhat understated due to missed endowment effects.With regard to the long-run supply of capital, given the high degree of globalization of capital markets, small open economies that have good access to capital are likely to face a relatively elastic capital supply, even if there is a low domestic savings response to changes in rates of return. The closure rule under which rates of return are fixed and the supply of capital adjusts may be the better approximation, although the endowment effects are likely to be somewhat overstated.
Given these considerations, we use two alternative microeconomic closure rules: the default closure (no endowment effects) and a closure rule under which the rates of return to capital are fixed for the FTA partners and for Taiwan but the labour supply is fixed (capital flexible). The second closure rule introduces a quasi-dynamic effect into the simulations. The expectation is that East Asian the members of the regional FTA would experience greater positive benefits while the impact on Taiwan would be equivocal, depending on whether Taiwan’s export gains driven by the additional GDP gains in the FTA member economies outweigh any losses due to reduce levels of investment, on top of the losses due to trade diversion.
The second aspect of closure is macroeconomic closure. Two approaches are available here: the standard approach with the GTAP model, which is used in the present simulations, is to allow the current account to adjust to the trade shock, with passive accommodation by international investment flows. The change in the current account implies a change in domestic investment. In the GTAP model, the change in investment is reflected in the profile of final demand, which in turn affects the profile of production and trade but does not feed through into the productive capacity of industries/regions. The alternative macroeconomic closure is to fix the current account, implicitly assuming no international capital mobility; this is a much less realistic assumption; this option is accordingly eschewed.[12]
The simulations are subject to a number of general caveats. CGE simulations do not take into account the impact of many elements of modern FTAs which typically address a wide range of issues over and above tariffs on merchandise trade, such as cross-border trade in services, specific financial services measures, temporary entry of businesspersons, investment, government procurement, competition, intellectual property, e-commerce, dispute settlement and institutional provisions. As well, FTAs often address non-tariff issues that affect goods trade, includingnon-tariff measures (such as standards), customs procedures, trade facilitation and so forth. Given complementarities between investment and services trade on the one hand and goods trade on the other, services and investment liberalization could induce a stronger response of goods trade to an FTA than tariff elimination alone would predict. Moreover, in the context of sunk costs of market entry, the political commitment and the non-tariff facilitative aspects of an FTA can provide extra inducement to business to commit the resources to take advantage of the new market opportunities. These various considerations suggest that the estimated increase in merchandise trade generated in CGE simulations amongst FTA partners is likely to underestimate the actual increase that would take place given a high quality FTA.
At the same time, FTAs typically include restrictive provisions for “sensitive” sectors which weaken the impact of FTAs. It is unlikely, for example, that significant agricultural sector liberalization (either with regard to tariff protection or reduction of producer support) would be included in any bilateral or regional trade agreement. Similarly, in sensitive areas of manufacturing such as textiles and apparel, rules of origin might restrict entry of products that do not meet minimum levels of domestic value-added.
Taken together, the simulations should be taken as indicative of the order of magnitude of the potential impacts of an East Asian regional FTA on the FTA members and on those excluded and not as an attempt to provide precise predictions of the impact of such a regional FTA.
Results: Fixed Endowments Scenario
Table 2 sets out the changes in Taiwan’s merchandise exports to the world as a result of an East Asian FTA from which it is excluded. As can be seen, the simulations suggest that Taiwan’s exports would be impacted negatively by trade diversion, with particularly large impacts in the textiles (-9.5%), leather (-5.3%), chemicals (-5.3%), motor vehicles/parts (-5.1%). At the same time, some sectors where trade protection is fairly low (e.g., electronic equipment) would benefit from the income gains in East Asia that such an FTA would generate. On balance, Taiwan’s exports would be cut by 1.1%.
Table 2: Impact of an East Asian FTA on Taiwan’s Merchandise Exports, Fixed Endowments Scenario
Pre-FTA2001 USD millions / Post-FTA,
2001 USD millions / Change in
2001 USD millions / % Change
Rice / 0.0 / 0.0 / 0.0 / 0.0
Wheat / 0.8 / 0.8 / 0.0 / 1.2
Cereal grains / 0.7 / 0.7 / 0.0 / 1.4
Vegetables & fruit / 75.3 / 68.4 / -6.9 / -9.1
Oil seeds / 3.0 / 3.0 / 0.0 / -1.0
Sugar / 0.0 / 0.0 / 0.0 / -
Plant-based fibres / 7.6 / 7.7 / 0.1 / 1.7
Crops / 145.6 / 133.0 / -12.7 / -8.7
Live animals / 0.1 / 0.1 / 0.0 / 16.7
Animal products / 144.6 / 146.9 / 2.3 / 1.6
Wool / 21.5 / 23.2 / 1.7 / 7.9
Forestry / 4.6 / 4.7 / 0.1 / 2.4
Fishing / 163.6 / 169.7 / 6.1 / 3.7
Coal / 0.0 / 0.0 / 0.0 / -
Oil / 0.0 / 0.0 / 0.0 / 0.0
Gas / 0.0 / 0.0 / 0.0 / -
Minerals / 29.4 / 29.4 / 0.0 / 0.1
Bovine meat / 14.3 / 14.4 / 0.2 / 1.1
Meat products / 46.4 / 39.6 / -6.8 / -14.7
Vegetable oils / 11.1 / 10.7 / -0.4 / -3.9
Dairy products / 8.2 / 8.3 / 0.1 / 1.1
Processed rice / 23.3 / 20.4 / -2.9 / -12.5
Processed Sugar / 8.2 / 8.1 / -0.1 / -1.7
Food products / 1,381.0 / 1,291.8 / -89.2 / -6.5
Beverages & tobacco / 60.3 / 59.0 / -1.3 / -2.2
Textiles / 11,426.8 / 10,342.5 / -1,084.3 / -9.5
Apparel / 1,848.7 / 1,868.6 / 19.9 / 1.1
Leather products / 1,537.2 / 1,456.3 / -80.9 / -5.3
Wood products / 1,981.9 / 2,012.7 / 30.8 / 1.6
Paper & publishing / 942.7 / 936.9 / -5.8 / -0.6
Petroleum & coal / 653.4 / 633.6 / -19.8 / -3.0
Chemical products / 14,253.0 / 13,503.3 / -749.7 / -5.3
Mineral products / 1,591.7 / 1,530.9 / -60.8 / -3.8
Ferrous metals / 2,861.4 / 2,776.3 / -85.1 / -3.0
Metals / 968.4 / 952.5 / -15.9 / -1.6
Metal products / 5,582.1 / 5,631.2 / 49.1 / 0.9
Motor vehicles & parts / 2,058.2 / 1,952.6 / -105.6 / -5.1
Transport equipment / 2,684.0 / 2,694.9 / 11.0 / 0.4
Electronic equipment / 51,416.3 / 52,277.5 / 861.2 / 1.7
Machinery & equipment / 20,095.7 / 19,976.6 / -119.1 / -0.6
Other mfg products / 3,514.4 / 3,563.4 / 49.1 / 1.4
Total / 125,565.0 / 124,149.5 / -1,415.5 / -1.1
Source: Authors’ estimates