When discussing the so-called economic cooperation framework agreement (ECFA) between Taiwan and China, local academics often cite studies that link Taiwan’s absence from the ASEAN Plus groups and the decline of the nation’s GDP because of falling international trade. This, however, is not the primary cause of Taiwan’s GDP decline. What affects it more is the problem of “investment diversion.”
To be specific, this means that it is more profitable for companies to make and sell their products in an economically integrated region, with the result that investment and production will increase in the countries participating in regional groups. By the same token, companies in countries that are not part of the group will see profits fall and investment in these countries will thus decrease. This investment diversion effect has been proven by surveys on local and foreign businesses in Taiwan.
However, one should also note that even if overall investment increases in an integrated region, this increase will not be evenly spread. According to the core-periphery model of Nobel Laureate Paul Krugman, when trade costs between two areas decrease, the greater market or region with a larger population benefits and becomes the economic core for investment and production, while the smaller market or region is deindustrialized and relegated to the periphery of development. Later research by many other academics showed that when member states of a customs union lower tariffs, the smaller countries may suffer rather than benefit from the union and their losses may even exceed those of non-member states.
Companies now only see the benefits of regional integration — e.g., their production and export costs would drop — and therefore say they would be willing to invest in Taiwan if it were a union member. The factor that will really determine whether they will choose Taiwan for their manufacturing base, however, is whether costs in Taiwan are lower than those in China. This is an aspect that most companies have not yet considered.
As an example, look at the opening of cross-strait direct flights, which has lowered the cost for for Taiwanese airlines. However, it has also lowered the cost for Chinese airlines. Given the massive scale of the Chinese market, economies of scale mean that the costs of Chinese airlines are still lower than those of Taiwanese airlines. This means that the competitiveness of China-based companies will increase, while the competitiveness of companies based in Taiwan will drop. The same reasoning applies to other sectors.
In other words, lower cross-strait trade costs or duties will benefit China-based firms rather than those in Taiwan. This may result in yet another wave of businesses moving to China, thus making Taiwan the loser in the economic integration. Since such a major policy involves the long-term interests of the public as a whole, the government should not overstep its duties by making the decision on its own. The only democratic way to deal with this issue is to hold a referendum on the signing of an ECFA.
Lu Zhen-ru has a doctorate in economics.
TRANSLATED BY EDDY CHANG
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