The global economic climate has started to change much more rapidly than before, not so different than global climate change causing a shift in weather patterns around the world. For example, there were only two seasons this year in Taiwan, with regard to the economy — spring and winter.
The economic climate looked promising in the first quarter, with foreign and local institutions forecasting annual GDP growth of 4 percent.
However, the weather soon turned cold, due to exports declining for eight consecutive months and suffering double-digit losses from April to September, except in June. The government’s latest forecast for GDP growth is only 1.56 percent, down 2.3 percentage points from February’s forecast.
According to government officials and academics, there are three reasons that caused the heavy decline in the nation’s exports.
The first reason is the falling oil and commodity prices, which hurt the export of minerals, petrochemicals and steel. That is because oil and steel are low-demand products, which means that falling prices do not necessarily translate into an increase in trade volume, but instead cause a decline in revenues.
The second reason is an innovation bottleneck in high-tech products, as seen in the weak improvements in Apple Inc’s latest iPhones.
The last reason is the “red supply chain,” which describes import substitutions in China.
Brazil and Russia, as well as Middle Eastern and Central Asian nations supply raw materials, constituting the upstream of the production process. The US, the EU and Japan manufacture equipment, refined rare earth minerals and petrochemicals, and sell them to Taiwan and South Korea to be used in the production of intermediate goods, such as integrated circuits (IC) and other components.
The final stage takes place in China or ASEAN, where the products are assembled and exported.
For example, to make iPhones, steel, petrochemical products and rare earth minerals are imported from upstream nations. Japan makes components like DRAM, while Taiwan and South Korea manufacture semiconductors and other components.
Chinese factories perform the final assembly and export the product.
According to a 2010 cost structure analysis, Apple gets one-third of the revenue, manufacturers in Taiwan, Japan and South Korea get another one-third, while the remaining one-third is spent on as assembly, shipping and labor.
Average labor cost in China is only 2 percent of an iPhone’s retail price, so the Chinese are not satisfied with the small piece of the pie they are getting and want to get more value-added assignments by extending the supply chain upstream.
The red supply chain is not news for traditional industries. As China’s economic power has grown in recent years, the nation’s industries have become dissatisfied with performing only subcontractor work and expressed their desire to become import substitutes to upstream nations like Taiwan and South Korea.
They want to boost their capabilities to manufacture value-added products in different ways: through Chinese government policy, via foreign direct investment or by hiring skilled professionals.
Between the 10th and the 12th five-year plans, Beijing spent huge resources to boost the development of strategic industries and to encourage industrial equipment manufacturers to increase the share of local products they use in the manufacturing process. Chinese companies investing abroad have acquired brands and technologies by merging with foreign businesses. Today, they want to expand their IC manufacturing capabilities by hiring skilled professionals, such as Taiwanese managers.
The efforts are aimed at developing China’s local industries so that the nation would not have to rely on imported goods; and the measures have begun showing their effects.
According to a survey by the Ministry of Economic Affairs and data from Beijing, China’s imports for subcontracting work decreased 14 percentage points from 41 percent in 2006 to 27 percent last year, while the rate of local equipment purchases increased 18 percentage points from 55 percent in 2008 to 73 percent in 2013, while the rate of local raw material purchases went up from 58 percent to 66 percent during the same time. In the steel industry, the local manufacturing rate grew from 90.3 percent in 2001 to 98.7 percent in 2013, while imports from Taiwan, Japan and South Korea decreased.
Similar patterns can be seen in petrochemical and panel industries. China’s imports of ethylene products from Taiwan, Japan and South Korea went down from 13.5 percent, 18.5 percent and 14.7 percent respectively in 2008 to 10.2 percent, 17.9 percent and 10.9 percent respectively last year. The import of panel products also decreased from US$15.7 billion in 2012 to an estimated US$12 billion this year.
In Taiwan, information technology and IC industries’ combined contribution to the GDP corresponds to one-third of that of the manufacturing industry. They also face challenges from China.
In 2011, only six Chinese companies had the “Made for iPhone” license from Apple; by this year, the number has increased to 20. Some of them are likely to replace Taiwanese companies’ role in the Apple’s supply chain. This has already begun to happen. China’s Goretek replaced Taiwan’s Merry Electronics, which made acoustic components for Apple; Desay Battery replaced Simplo Technology in batteries and Luxshare Precision won a share of the cable order that originally went to Wanshih Electronic and Acon.
If the steel industry is the perfect tense, and petrochemicals and panel industries are the progressive tense, then the IC industry would be the future tense that China’s government and businesses want to import substitute.
In Taiwan, the IC’s industry’s production value is NT$1.2 trillion (US$36.5 billion), while the Chinese IC industry’s — of which 60 percent is controlled by foreign companies — production value is NT$355 billion. Taiwan still ranks higher than China in this regard.
The IC design production value is NT$576 billion in Taiwan and NT$524 billion in China — almost equal. However, in the IC packaging and testing industry, China’s production value is NT$628 billion, higher than NT$454 billion in Taiwan.
To expand their IC manufacturing capabilities quickly, Chinese firms have shown interest in investing in US semiconductor companies. They also want to acquire Taiwan’s experienced personnel to boost their capabilities.
To attract managers and engineers, they offer high salaries, give stocks or stock options and open branch offices in Taiwan so that workers do not need to leave home to work for a Chinese company.
To cope with the challenges presented by the red supply chain, Taiwanese firms employ measures such as utilizing horizontal integration and investing directly in China. To keep their personnel, semiconductor companies offer to delay taxes on stocks, while optical precision companies invest in Taiwan to keep key jobs here.
Horizontal integrations are happening more often than before, such as the the world’s largest IC packaging and testing company Advanced Semiconductor Engineering acquiring Siliconware Precision Industries Co.
The government and most companies see the red supply chain as a threat, but some companies see it as an opportunity.
Their thinking is: “If I cannot fight China’s big companies, why not join them?”
Over the past 20 years, Taiwanese companies were subcontractors for large US companies. In the near future, Chinese manufacturers like Xiaomi, Huawei, and Lenova are expected to become the world’s largest IC and IT producers.
If Taiwanese companies can join them, they would not only avoid competition, but also find a chance to enter the Chinese market.
Probably the most important issue affecting the future of the economy is evaluating the threats and opportunities posed by the red supply chain and making the right decisions.
Gordon Sun is director of Macroeconomic Forecasting Center at the Taiwan Institute of Economic Research.
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