Thursday, February 16, 2006

China's economic analysis is flawed

By Hwan C. Lin, Taipei Times, Feb 11, 2006

[Remark: The Hanji version of this op-ed was publishd earlier in Liberty Times (自由時報), Feb 7, 2006. Taipie Times translated it into an English version.]

The spokesperson for the Taiwan Affairs Office of China's State Council, Li Weiyi (李維一), made a couple of comments regarding President Chen Shui-bian's (陳水扁) "active management, effective opening" policy at a press conference on Jan. 24.

First, he said that Taiwan enjoyed a trade surplus of US$58 billion with China last year and an accumulated trade surplus of US$330 billion. He went on to say that this amounts to more than the total of Taiwan's current foreign exchange reserves, and that if it had not been for this huge trade surplus with China, Taiwan would have experienced a trade deficit.

Second, he said that this huge trade surplus has directly stimulated the Taiwanese economy, eliminated a great deal of unemployment and led to increased incomes for many people.

At first glance, Li's comments seem to make sense, but they do not stand up to strict and logical economic analysis.

Simply put, as long as a trade deficit is maintained at a sustainable level it will not have an adverse effect on the economy of the country experiencing the deficit. And if the deficit is the result of active domestic investment activity, it will instead be beneficial to the country's economic growth in the long term.

In the same way, a trade surplus by itself will not necessarily be beneficial to the economy of a country. Furthermore, if the surplus is the result of slow domestic investment activity, leading to excessive savings rates and capital outflows, it will instead hurt the country's economic growth in the long term.

In the 1990s, for example, the Japanese economy stagnated even though Japan enjoyed a long period of healthy trade surpluses, while the overall production power of the US economy saw vigorous growth despite a long period of trade deficits. This shows that there is no absolute causal relationship between a trade surplus -- or deficit -- and overall economic performance.

Li is half right: deduct Taiwan's US$58 billion trade surplus with China -- according to official Chinese figures -- and Taiwan will have experienced a deficit in its trade with partners other than China. His logic is, however, flawed.

Li has fallen into a mercantilist trap, mistakenly believing that a trade surplus must be beneficial to the party experiencing the surplus. He is thus using biased figures to reach his conclusion when he says that Taiwan's enormous trade surplus with China has stimulated Taiwan's economy, eliminated much of its unemployment and led to increased incomes for many people.

The fact is that systematic attempts to achieve long term international trade surpluses in order to stimulate economic growth is an anachronistic mercantilist attempt at a "beggar-thy-neighbor" policy -- an international trade policy of competitive devaluations and increased protective barriers that one country institutes to gain at the expense of its trading partners.

Experience shows that this can easily lead to international trade disputes. Both surpluses and deficits must be kept within reasonable levels to prevent the overall economy from becoming seriously unbalanced, leading to structural economic problems.

The fact is that Taiwan's trade surplus with China is mainly a reflection of changes in the global industrial supply chain. There is no question that the Taiwan-China-US supply chain meets manufacturer demands for cost effectiveness, but if we consider the overall economic interests of the people of Taiwan, we must ask if Taiwan has already invested too much in China in order to develop this supply chain. This is a policy issue to which the Taiwanese government must give serious consideration.

Hwan C. Lin is a research fellow at the Taiwan Public Policy Council, a US think tank, and associate professor of economics at the University of North Carolina at Charlotte.

Translated by Perry Svensson

Thursday, January 26, 2006

Taiwan has potential to become an FPE winner

By Hwan C. Lin, Taipei Times, Jan 09, 2006

[Remark: The Hanji version of this op-ed was publishd earlier in Liberty Times, Jan 3, 2006. Upon the author's permission, Taipie Times translated it into an English version.]

Given global trade liberalization and competition and the spread of production technologies, such things as wages, land rent, capital interests and profits will necessarily move toward global equilibrium.

From a factor price equalization (FPE) perspective, China's economy has been rapidly integrating with the international economic system since the 1990s while also causing an increase in international competition.

There is much foreign direct investment flowing toward China, resulting in much of the spread of global production technologies going to China -- a low-wage developing country with an abundance of labor. This in turn has meant that China is catching up technologically with Taiwan and other newly developed economies. Against this backdrop, FPE theory gains practical use by explaining the falling average wage level for global labor and the creation of unemployment. The far-reaching integration of trade investments in Taiwan and China can of course not avoid the impact of this equalization.

Taiwan must have a complete and visionary set of economic policies to lessen the impact of this trend. The following describes what these policies should focus on.

First, Taiwan must accumulate the ability to innovate so that it can climb the technological ladder to give its industry a comparative advantage and distance itself from China and other low-wage economies, while also increasing the overlap with high-wage economies such as the US. If Taiwan were able to do so, the impact of the phenomenon described by FPE theory would be gradually lessened. At the same time, industries with a comparative advantage would close in on the advanced nations, for example by equalizing the production factor price in Taiwan and the US, which would have the effect of raising wage levels in Taiwan.

Second, Taiwan must make an effort to raise the quality of its work force so that it can close in on the high-quality workers in industries with comparative advantages in advanced nations. The proportion of such high-quality workers should not only be large in terms of production factors internationally, but it must also be an absolute majority in Taiwan's population structure. If this could be achieved, the downward impact of low wages in developing countries would be restricted to a minority and would not affect the formation of a high-wage employment environment.

Third, Taiwan must provide effective protection of intellectual property rights while at the same time applying technological management and government subsidies to stimulate "vertical innovation." This is needed to maintain a balance between the inflow of advanced technologies and the outflow of low technologies and increase the technological distance to low-wage developing countries. Although "horizontal innovation" facilitates the spread of technology locally in Taiwan, it may also lead to a "me too" phenomenon with other countries being able to produce the same products as Taiwan. That would create a vicious circle of price competition which would mean deteriorating trade conditions for Taiwan, which would be bad for income growth.

Taiwan has the potential to become an FPE winner. If Finland, Sweden, Switzerland and other small, high-wage countries can, why shouldn't Taiwan be able to do it, too?

Hwan C. Lin is a research fellow at the Taiwan Public Policy Council, a US think tank, and an associate professor of economics at the University of North Carolina at Charlotte.

Translated by Perry Svensson