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On the need to invest and innovate

Economic opening and competition are two sides of the same coin: the greater the degree of opening, the greater the degree of competition.

It is a good thing for nations or corporations to face international economic competition. Taiwan’s economy has always prospered from the constant challenges of international competition and an open economic policy. The decision by president-elect Ma Ying-jeou (馬英九) and vice president-elect Vincent Siew (蕭萬長) of the Chinese Nationalist Party (KMT) to abandon a previously conservative attitude represents the first time a Taiwanese government has opted for an open economic policy toward China since the war.

Yet behind the policy awaits competition of unprecedented proportions. The government must respond cautiously.

The essence of a policy of economic opening lies not in the openness itself, but in how competition can be dealt with and how economic conditions can be improved to reap real benefits. Judging from the new international and domestic political environment, opening up is easy. However, there are many other things the government needs to accomplish.

These tasks can be summed up by the expression “improving the environment for investment and innovation.” The benefits from opening the economy to international trade depend on the strengths and weaknesses of Taiwan’s policies for improving the domestic environment for investment and innovation.

The best result would be if this environment combined with an open economy. Under such circumstances, economic opening would generate an inflow of capital and human resources and assist in the competitive development of the international market.

The next best result would come from a healthy investment and innovation environment amid a more protectionist policy regime. This option has strong shades of mercantilism. Protective measures would include restricting imports and foreign investment in Taiwan. Meanwhile, encouraging exports and a good investment and innovation environment would maintain a competitive edge for domestic corporations. The development of Japan and South Korea are examples of this scenario.

The third-best result would be an imperfect investment and innovation environment in an open economy. If the domestic environment for investment and innovation is poor, opening the economy will accelerate the moving of domestic capital, human resources and businesses offshore, as well as result in the failure of domestic enterprises.

Detroit, which was once an advanced stronghold for the automobile industry, provides a good example of this.

From the 1960s, the deterioration of its investment and innovation environment combined with an open economy, which meant that Detroit could not match competition from other areas, leading to a three-decade recession. During this time, large car manufacturers relocated, the number of residents fell by half and unemployment reached as high as 14 percent

Even so, adopting an open policy can stimulate government and enterprises to seek improvement — a motivation that protectionist policies lack. Hence, an imperfect environment combined with a protectionist policy would be the worst possible combination of choices.

A simple analysis of the impact of cross-strait trade on Taiwan shows that after deregulation, a certain amount of investment capital would flow from Taiwan to China.

At the same time, a certain amount of Chinese capital would enter Taiwan, mainly through the stock market and real estate. Certain Taiwanese and foreign businesses would also increase investment in Taiwan because direct links would eliminate geographical barriers.

If China takes the next step and removes domestic barriers, Taiwan could compete against other regions in China for the status of operations headquarters. Certain high-level manufacturing and technological service industries would not even have to be located in China. This reflects Taiwan’s geographical advantage.

If Taiwan can take further advantage of low-cost Chinese labor, the only remaining areas of cross-strait competition would be basic infrastructure and human resources. In this situation, Taiwan’s chances of success are quite high.

Technological development centers could also be located in Taiwan because of convenient communication and the ease of coordinating with the Chinese market.

If all barriers to cross-strait trade were removed, the negative impact on Taiwan would be more significant. Currently, Taiwan’s barriers on imports of Chinese goods are higher than Chinese barriers on Taiwanese imports.

Once cross-strait free trade is established, the number of Chinese imports is almost certain to be larger than Taiwanese exports.

This would have an impact on domestic industry as well as the GDP.

Yet cross-strait free trade would also have a positive impact on Taiwan. For instance, once direct links are established, some Taiwanese businesses will replace China-bound investments with exports.

The optimistic forecasts listed here rest on one assumption: that Taiwan has a healthy investment and innovation environment. Only then can Taiwanese businesses be persuaded to remain in Taiwan after the economy opens its doors.

Taiwan can only face the competition that comes with economic opening if it is equipped with such an environment.

Cross-strait trade is not necessarily a panacea; the real issue is how all the prerequisites can be realized.

Chao Wen-heng is an associate research fellow at the Taiwan Institute of Economic Research.

Translated by Angela Hong
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