• The level of cross-strait business linkages is particularly significant in the computer electronics sector, with Taiwan manufacturers increasingly transferring production to the Mainland to remain competitive in the global supply chain. There is an ongoing debate within the Taiwan Government regarding whether to loosen existing restrictions on investment and technology transfers to the Mainland in its flagship semiconductor industry.

• Cross-strait economic linkages are likely to accelerate in the future now that both China and Taiwan are members of the WTO, and over time could help ameliorate political tensions between the two.

• The growing reliance of Taiwan firms on the Mainland as a manufacturing center raises concerns about Taiwan’s vulnerability to Chinese economic leverage, and correspondingly to U.S. dependence on items made in China for its computer electronics and other high- technology sectors.

• China far outpaced most of its Asian neighbors in terms of export growth over the past decade. Among Asian countries, China led the region in terms of export growth to the United States and now ranks second behind Japan as a source of U.S. imports.

• In addition to Taiwan, other developed countries in Asia, most notably Japan, are relocating significant manufacturing and research and development (R&D) capacity to China to take advantage of lower production costs.

• China’s enhanced economic standing in Asia has given it new political influence in the region as its trade with neighboring countries has increased rapidly in recent years.

• WTO accession may accelerate all of the above trends, enhancing China’s attractiveness as a destination for FDI, stimulating export production, and expanding intra-Asian trade.

China’s rise as a global economic power has significant implications for its neighbors in Asia and for U.S. interests in the region. The trends that have already begun in this regard appear likely to accelerate as a result of China’s accession to the WTO. The intra-Asia balance of power, and U.S.-Asia relations will be a focal point of U.S. economic and military strategic planning for the foreseeable future. Accordingly, it is essential that U.S. policymakers accurately assess how China’s emergence as a major player in the global economy will impact the region as a whole.

Subsumed in this topic, but in many regards a separate issue from a U.S. strategic planning perspective, is the developing nature of cross-strait economic relations. The China-Taiwan economic relationship is undergoing fundamental change. Economic linkages are proliferating despite the ongoing political and military tensions. Moreover, both entities are now members of the WTO, a development that introduces a new structure to their economic relationship. Given the United States’ direct stake in cross-strait relations, any new dynamic in the China-Taiwan relationship must be carefully monitored and planned for by U.S. strategic planners. The state of military frictions between the two sides, and the corresponding implications for U.S. national security, is the subject of Chapter 8.

Cross-strait economic linkages, in both investment and trade, have expanded dramatically over the past decade. Despite ebbs and flows in the political relations between the two sides over that time, their economic relationship has grown steadily.

China today stands as Taiwan’s third largest trading market, with total two-way trade valued at over $30 billion.¹ As reflected in Figure 5.1, Taiwan exports to China — which the Taiwan Government calculates as a composite of its direct exports to China plus 70 percent of its exports to Hong Kong — have increased from around $6 billion in 1990 to over $26 billion in 2000, while Taiwan’s imports from China have expanded from approximately $342 million in 1990 to $6.2 billion in 2000, resulting in significant trade surpluses for Taiwan.

Note: Export figures include direct exports to China plus 70 percent of exports to Hong Kong

Source: U.S.-Taiwan Business Council/Taiwan Board of Foreign Trade

On the investment side, there is a great disparity between official and unofficial estimates of Taiwan investment in the Mainland. The Taiwan Government places significant restrictions on such investment, but Taiwan businesses have proven adept at circumventing them by, for example, investing in the Mainland via Hong Kong, the Cayman Islands and other third-party countries. While official Taiwan Government figures place Taiwan firms’ investment in the Mainland at $17 billion at the end of 2000, Taiwan officials readily admit that actual investment could be as high as $60-70 billion, which would account for 40 percent of Taiwan’s outward investment.² Mainland investment in Taiwan is negligible as a result of Taiwan’s strict prohibitions on such investment.³

Source: U.S.-Taiwan Business Council/Taiwan Board of Foreign Trade

The most significant sector for cross-strait trade is computer electronics. Taiwan has been a dominant player in this industry for the past decade and its success has been one of the key drivers of its economic growth and development. More than half of Taiwan’s top ten manufacturing firms in 2000 were computer electronics manufacturing firms and Taiwan now supplies 60 percent of the world’s motherboards and is the world’s leading supplier of notebook computers, monitors, mice, keyboards, video cards, sound cards, on-off switches, LAN cards, graphic cards, scanners, and laser disk drives.⁴

To maintain its competitive position in the computer electronics industry, Taiwan has increasingly looked to the Mainland as a low-cost manufacturing center. The degree of cross-strait integration in this sector is striking. As Meritt Todd Cooke of the American Institute in Taiwan testified:

Another significant element of cross-strait economic linkages is the growing number of Taiwan businessman residing and traveling to the Mainland. During its trip to China this past November, the Commission visited Kunshan, a city near Shanghai that has become an enclave of Taiwan-invested businesses, including high-tech manufacturers producing circuit boards, computers, and telecommunications equipment. The Commission members were told that 32 of the top 100 Taiwan firms had invested in Kunshan, which has attracted around $11 billion in foreign investment in the three pillar industries of precision machinery, chemicals, and information technology. During the Commission’s visit to Taiwan in January, we were informed that some 400,000 to 700,000 Taiwan nationals live and work on the Mainland (representing 7-10 percent of Taiwan’s entire labor force), concentrated in the high technology and high economic growth areas of Shanghai and Shenzhen.

Taiwan followed China into the WTO by officially becoming a member of the organization on January 1, 2002, three weeks after China’s formal admission. Although Taiwan’s accession negotiations generally had been concluded ahead of China’s, Taiwan’s formal admission was delayed until after China formally joined due to political considerations within the WTO. The Chinese Government ultimately did not contest Taiwan’s separate WTO membership on the grounds that this membership only recognized Taiwan as a separate trading entity, like Hong Kong, rather than a separate sovereign entity. Taiwan officially joined the WTO under the designation of the "Separate Customs Territory of Taiwan, Penghu, Kinmen and Matsu," also referred to as "Chinese Taipei".

During these early days of China’s and Taiwan’s membership in the WTO, there is a sense of optimism that it will improve cross-strait relations by increasing economic linkages and providing a forum for dialogue. This hopeful outlook was recently articulated by Dr. Ing-wen Tsai, Chairwoman of the Mainland Affairs Council of the Executive Yuan of the Republic of China (Taiwan):

At the same time, however, WTO membership creates new possibilities for bilateral tensions. As noted, China’s acceptance of Taiwan’s membership did not signal a new position by the Mainland on the political status of Taiwan. For example, if China refuses to recognize a formal trade dispute initiated by Taiwan or to otherwise accord Taiwan’s representatives to the WTO equal treatment with other members, this could become a new source of conflict.

The WTO membership of China and Taiwan in the WTO will likely accelerate the growing levels of Taiwan investment into China. While increasing economic linkages between the two could help ameliorate political tensions, it also has the potential to increase Taiwan’s economic dependence on China, and the security implications that go along with that dependence.

To counter concerns about Taiwan’s growing economic integration with China, the Taiwan Government in 1996 instituted a "no haste, be patient" policy regarding investment in the Mainland, which, among other things, restricted investment in certain industries, including high-tech and infrastructure projects, and required special approval for individual investments greater than $50 million. The goal was to limit investment in the Mainland and thereby minimize Beijing’s ability to exert economic leverage. However, this policy did not effectively stem the flow of investment as Taiwan businesses found numerous ways to circumvent the restrictions.

In August 2001, the Economic Development Advisory Conference (EDAC), an influential group of Taiwan business, academic, and government leaders convened by the Taiwan Government, recommended relaxing the "no haste, be patient" policy in favor of one characterized as "vigorous liberalization and effective management" (also referred to as "active opening, effective management"), which would allow greater flexibility for investments in the Mainland. The EDAC further recommended opening up the "three links" across the Strait — trade, transportation, and communications.⁸ Taiwan President Chen Shui-bian promptly endorsed the Conference’s recommendations.⁹ The main drivers of this shifting approach to cross-strait economic relations appear to be pressure from Taiwan’s business community and the need to address the island’s current economic slowdown. Taiwan businesses, particularly in the information technology sector, see expansion of their operations in China as vital to remaining competitive in international markets. This is compounded by Taiwan’s current economic downturn, its worst in decades.

It is presently unclear how these new policies will be implemented in practice and what impact they ultimately will have on cross-strait investment. Taiwan’s political leaders likely will try to strike a balance between their country’s need for China as a production and export market and the security concerns raised by this economic integration. This is reflected in statements from Taiwan officials, such as Mainland Affairs Council Chairwoman Ing-wen Tsai:

As Taiwan Government officials wrestle with the challenges of cross-strait economic ties, new business relationships are developing apace. In the past year, numerous new ventures were announced, including several in the strategically important energy and semiconductor sectors. The following are some of the most significant:

• Chinese Petroleum Corp. (Taiwan) — China National Offshore Oil Corp. (China) - These two state-owned firms controlled by their respective governments signed an agreement in May 2002 to set up a $25 million joint venture to conduct oil and gas exploration in the Taiwan Strait. Executives of the two companies have expressed an interest in expanding the venture to conduct joint oil and gas development in the future.¹¹

• China Airlines (Taiwan) — China Eastern Airlines (China) - China Airlines, Taiwan’s flagship carrier, negotiated to buy a 25-percent stake in China Eastern Airlines’ cargo subsidiary (China Cargo). China Eastern is one of the Mainland’s largest domestic passenger carriers.¹²

• Sampo Group (Taiwan) — Haier Group (China) - The biggest consumer appliance makers in Taiwan and China have formed an alliance to sell each other’s products. Sampo will sell Haier-made refrigerators, television sets and washing machines under its own brand name in Taiwan, while Haier will sell Sampo DVD machines and flat-screen TV sets in China. Sampo may eventually manufacture products for Haier on a contract basis in its mainland factory.¹³

• Taiwan Power Co. - Taipower signed one-year contracts for the purchase of 1.2 million tons of mainland coal — roughly 10 percent of the company’s total demand. Taipower has also been in touch with mainland authorities on storing low-level waste from Taiwan’s three nuclear power plants.¹⁴

• Taiwan Semiconductor Manufacturing Co. and United Microelectronics Corp. - Taiwan’s two largest semiconductor manufacturers have both indicated intent to build plants on the Mainland to produce eight-inch wafers if the Taiwan Government loosens current cross-strait investment restrictions in this sector (see discussion below).¹⁵ Former United Microelectronics Corp. executives have reportedly been involved in the establishment of a semiconductor plant that broke ground on the Mainland earlier this year.¹⁶

The semiconductor industry has been the pride of Taiwan’s high-technology sector and Taipei’s deliberations over how to address mainland investment in this industry illustrate the conflicting pressures facing Taiwan in its ongoing efforts to manage cross-strait economic relations. Taiwan semiconductor manufacturers are pushing for a loosening of constraints on their ability to set up manufacturing facilities on the Mainland, while there are conflicting concerns that this would lead to a "hollowing out" of Taiwan’s manufacturing capabilities in this industry and would give the Chinese access to cutting-edge technology that could pose a security risk. During the Commission’s trip to Taiwan this past January, Morris Chang, President of Taiwan Semiconductor Manufacturing Company (TSMC), told the delegation that his interest was to produce only older generation 8-inch wafers on the Mainland, and not any of the advanced 12-inch wafers.

On March 29, 2002, Taiwan Premier Yu Shyi-kun announced a new policy regarding investment by Taiwan firms in semiconductor manufacturing facilities on the Mainland. The new policy would allow up to three Taiwan firms to set up 8-inch wafer plants on the Mainland by 2005 provided they transfer only second-hand equipment to these plants and only if they have constructed more advanced 12-inch wafer foundries in Taiwan that have reached "stable levels of basic production."¹⁸ This policy has not been finalized and reportedly is still being hotly debated within the Taiwan Government.¹⁹

The expansion of cross-strait economic linkages is a dynamic that may operate to minimize the prospects for hostilities by developing commercial relationships that give both sides a vested interest in peaceful relations and by opening new channels for dialogue. But this dynamic raises corresponding concerns about economic dependence and the possible leverage this may give China over Taiwan. The future direction of cross-strait economic relations is of enormous significance to U.S. national security given that the state of cross-strait relations is a potential flashpoint in the U.S.-China relationship. Moreover, given the growing integration between China and Taiwan in the global supply chain for high-technology goods, the state of their relations has a direct impact on an industry key to U.S. economic health.

The following are key indicators the Commission will continue to examine to assess the impact of cross-strait economic integration on U.S. national security:

By all accounts, Taiwan sees trade and investment with the Mainland as a key to its future economic growth, particularly with regard to high-technology goods. China offers Taiwan a low-cost production center for manufactured goods, an increasingly essential need in order for Taiwan companies to stay internationally competitive in this sector, as well as an enormous potential market for these goods.

But this economic strategy comes with risk, as it links Taiwan’s economic well-being to the shifting currents of cross-strait relations. Deterioration in these relations could lead China to exercise economic leverage over Taiwan by threatening to restrict or cut off Taiwan’s trade and investment with the Mainland. China might even take (or threaten to take) the provocative step of seizing Taiwan assets located on the Mainland. It is more likely, however, that China will seek to exercise its economic leverage in indirect ways, including attempting to influence the Taiwan business community (which wields substantial political clout in Taipei). To this end, the Commission has learned of instances where China has exerted pressure on Taiwan businessmen operating, or seeking to operate, on the Mainland to support pro-Beijing policies.²⁰

The presence of hundreds of thousands of Taiwan businessmen resident on the Mainland presents another security risk for Taiwan as these individuals might be at risk in the event cross-strait relations took a turn for the worse. Further, if the community of Taiwan businessmen on the Mainland was forced by the Chinese Government (or otherwise felt compelled) to return home, Taiwan could face a significant employment crisis.

China reaps substantial economic benefits from its trade and investment relationship with Taiwan. As noted above, Taiwan’s cumulative investment into China is estimated to be around $70 billion and it is increasingly focused on the production of high-technology goods. The Commission again notes the testimony it received that 70 percent of China’s $25.5 billion in information technology production value in 2000 was attributable to Taiwan-invested firms. Further, Taiwan officials estimate that Taiwan investment on the Mainland has contributed to the creation of at least 3 million jobs.²¹ It seems clear that an increasing number of Chinese businesses are becoming vested in the cross-strait economic relationship, creating a growing force within China for moderating tensions with Taiwan. The extent to which these economic benefits factor into China’s posture toward Taiwan may be modest at present, but may become an increasingly important component of Beijing’s political calculations should the economic relationship continue to grow.

The integration between Taiwan and China in the high-technology goods supply chain creates a triangular relationship with the United States that presents both economic benefits as well as strategic challenges. In terms of economic efficiency, this triangular relationship allows the three parties to maximize the efficient use of their resources: U.S. research and development, Taiwan manufacturing, management and marketing know-how, and Chinese low-cost labor and production. High-technology goods and services have been a key driver of the U.S. economy over the past decade or more, with the United States leading the way in the innovation and development of these items. During this same time period, Taiwan established itself as a preeminent manufacturer of semiconductors and other high-technology products. The latest development has been the outsourcing of production by Taiwan businesses of these products to the Mainland.

Through this triangular relationship, the U.S. high-technology industry is becoming increasingly reliant on mainland production, heightening the economic stakes of any cross-strait hostilities. Any disruption in this supply chain could reverberate through the U.S. economy via a slump in the technology sector. To illustrate this point, Merritt Cooke of the AIT told the Commission that when a severe earthquake hit Taiwan in September 1999, the tech markets in New York dropped more in percentage terms than in Taipei.²² Tellingly, news reports indicate that representatives of Dell Computer, a U.S. firm that is the largest buyer of laptop computers from Taiwan companies, have been pressuring Taiwan officials to establish direct trade and transportation ties with the Mainland.²³ This may be indicative of a larger trend of U.S. businesses joining many in the Taiwan business community in pressuring Taiwan’s leaders toward more economic integration with the Mainland.

The WTO accession of China and Taiwan and the expected expansion of economic linkages between the two might well make the U.S. economy even more vested in peaceful cross-strait relations. Rupert Hammond-Chambers, President of the U.S.-Taiwan Business Council, testified:

The entry of both China and Taiwan into the WTO provides a new forum for dialogue as well as disputes between these parties. At the outset, there have been some positive indications about how the two may interact within the organization. As discussed above, the GATT/WTO made a decision to allow China to formally enter the organization ahead of Taiwan, regardless of the status of their respective accession negotiations. Some observers feared that China would use this sequential accession to block or otherwise hold up Taiwan’s accession. In the end, China took no such action and Taiwan formally joined the WTO three weeks after China. Another positive sign was that neither side chose to invoke WTO Article XIII, a provision allowing a member to opt out of the WTO agreement with regard to another member. Nonetheless, China and Taiwan are likely to have an uneasy coexistence in the organization, particularly during the early years of their membership.

WTO accession likely will accelerate cross-strait economic linkages as trade barriers between the two sides are reduced. Trade disputes inevitably will arise that will test their relationship within the organization. If China engages Taiwan in a formal dispute, thereby recognizing Taiwan as an independent member of the organization, China would be demonstrating a willingness to separate its political conflict with Taiwan from its economic relationship. However, China may refuse to formally recognize disputes initiated by Taiwan or work to prevent such disputes from reaching formal dispute settlement in order to avoid such engagement.

The WTO offers China and Taiwan a forum for dialogue outside of the formal government-to-government arena. Under the umbrella of a discussion between two "trading partners" rather than two governments, the two sides may be able to make positive progress on both trade and, potentially, non-trade matters.

Based on discussions the Commission had in Geneva with WTO officials and representatives of various member country delegations, the Commission understands that there have been some initial tensions between China and Taiwan in the early months of their WTO membership. China has apparently admonished WTO officials for inadvertently referring to Taiwan’s representative to the organization as "ambassador" and is protesting Taiwan’s use of the term "ministries" to reference its governmental entities in documents it submitted to join the WTO’s Government Procurement Agreement.

The United States has a national security interest in a stable cross-strait relationship. The growing economic linkages between China and Taiwan may help to achieve this goal. Nonetheless, if China attempts to exercise its considerable economic leverage over Taiwan in an aggressive manner, the result will likely be a heightening of tensions between the two. The Commission will continue to closely monitor the nature and status of cross-strait economic integration and to assess its implications on broader cross-strait relations.

For decades, Hong Kong played the role of gateway to the mainland market, a role many believed might expand following its transfer to mainland control in 1997 as a Special Administrative Region. The past few years, however, have seen the rise of Shanghai as an important business center and with that concerns about Hong Kong’s long-term role. The Commission believes it is important to monitor the economic future of Hong Kong as a barometer of the Mainland’s development as a sophisticated business and financial center and as an indicator of the success or failure of the "one country, two systems" policy governing its integration into the Mainland.

Hong Kong remains an important flow-through point for mainland trade and investment. According to Hong Kong data, nearly 90 percent of Hong Kong’s exports to China during the past few years (1998-2000) were "re-exports" (i.e., goods that were imported by Hong Kong and then exported to the Mainland, often after receiving some additional processing in Hong Kong).²⁵ More significantly, while specific data is unavailable, it is believed that the vast majority of China’s exports to Hong Kong are "re-exported" by Hong Kong to other countries after packaging or further processing since the bulk of these imports are electrical and other machinery, toys, sporting equipment, apparel, and footwear.²⁶

Hong Kong’s inward FDI flows increased dramatically in 1999 and 2000, surpassing the amount going into China by more than $20 billion in 2000.²⁷ Chinese statistics indicate that over the past several years around 40 percent of China’s inward FDI came from Hong Kong, suggesting that a significant portion of that FDI likely was destined for the Mainland from the outset.²⁸ This mechanism is used by Taiwan businesses to circumvent Taiwan’s mainland investment restrictions, by Chinese investors "round tripping" their money to obtain the favorable treatment available on the Mainland for foreign investment, and by investors in other countries who may be seeking to conceal that the Mainland is their actual investment destination.

Many observers see the expansion of direct trade and investment flows to the mainland market, with no bypass through Hong Kong, as a sign that its role as a gateway may be diminishing. Moreover, the Chinese leadership has made it a priority to develop Shanghai into a preeminent Asian business and financial center, as witnessed by the development of the Pudong financial district. China’s leaders have made no secret of their desire to see Shanghai overtake Hong Kong as the key financial hub for Greater China. In fact, Premier Zhu Rongji told reporters in 1999 that he saw Shanghai as China’s New York and Hong Kong as its Toronto.²⁹

Hong Kong’s status as a Special Administrative Region of China and the dynamic of the "one country, two systems" structure has allowed the city to remain for the most part an independent economic entity that is still ranked by some as the world’s "freest economy."³⁰ Nonetheless, as Hong Kong’s economy stagnates in the wake of the Asian financial crisis and the current global economic slowdown, it has been seeking greater integration with the Mainland, including preferential treatment for its firms over other "foreign" competitors, through the establishment of a free-trade arrangement with the Mainland — the so-called Closer Economic Partnership Agreement (CEPA).³¹

The future role Hong Kong will play in a Greater China and in Asia is still uncertain. The Commission will continue to monitor economic developments in Hong Kong and assess the implications for U.S.-China trade relations and for the region as a whole.

Asia is a region of vital importance to U.S. national security as it is home to key U.S. allies and trading partners. One of the stated U.S. goals for supporting China’s WTO accession was that it would enhance regional economic prosperity and foster peaceful intra-Asia relations. The Commission intends to test this assumption, as there have been some indications that China’s growing economic dominance in the region could have negative implications for neighboring economies.

Several key questions must be examined to assess China’s economic impact on its neighbors. First, to what degree is China attracting needed capital and export markets away from other Asian economies and how have U.S. investment and import patterns in Asia changed over the last decade? Second, will China grow to the point where it becomes a major investor and trade partner for its neighbors? In other words, the Commission will examine whether the growth of China as an economic power represents a zero sum game for other Asian nations in terms of their own economic growth or an economic engine that adds to the region’s economic prosperity. If China becomes a more significant trade and investment partner with the Association of Southeast Asian Nations (ASEAN) and other Asian nations, the dominant role the United States and Japan have played in this regard may diminish, which may lessen their political influence in the region as well.

In beginning to examine these questions, it is helpful to look at some of the basic trends that have emerged over the past decade. Figure 5.3 below indicates that China received nearly 40 percent of total FDI inflows into Asia ($245.1 billion out of $643.3 billion) from 1995-2000. China and Hong Kong together received nearly 60 percent of total FDI inflows into Asia during that period. China’s significant levels of inward foreign investment have in part been driven by investment from Hong Kong, which, as discussed above, accounts for around 40 percent of China’s annual inward FDI (thereby making any summing of China’s and Hong Kong’s inward FDI levels involve a certain measure of double-counting). FDI inflows into China increased to $46.8 billion in 2001, and are expected to grow significantly in future years in the wake of its accession to the WTO.

Source: World Investment Reports, UNCTAD, 2001

As shown in Figure 5.4, cumulative U.S. FDI flows into China of $6.8 billion for the period from 1995 through 2000 exceed U.S. FDI flows into other Asian markets, with the exception of Japan, Hong Kong, and Singapore. Combined U.S. FDI into China and Hong Kong exceeded U.S. FDI into any of China’s neighbors, with the exception of Japan. Notably, these figures suggest that U.S. investment in China remained fairly steady through the Asian financial crisis in 1997-98, while it dropped off in those years to some of the ASEAN nations, particularly Indonesia, Malaysia, and Thailand.

China’s growth in merchandise exports over the past decade far exceeded most of its neighbors, with the exception of the Philippines and Vietnam (whose export values were only a fraction of China’s total). Changes in export value and growth rates for the Asian economies are shown in Figure 5.5

Source: WTO 2001, Table A-5

As indicated in Figure 5.6, China led the Asian region in terms of growth in merchandise exports to the U.S. market over the past decade, with such exports growing more than six-fold (Vietnam grew by a higher percentage, but is not yet a significant trading partner of the United States). Japan began and ended the time period as the leading Asian source of U.S. merchandise imports; however China’s rapid growth in exports to the United States during that period allowed it to significantly close the gap.

Source: USITC Dataweb

The implications of China’s emergence as a regional trade and investment powerhouse are well understood by its neighbors. In a recent speech, Singapore Trade and Industry Minister George Yeo explained that "[i]n 1990, China accounted for less than 20% of total foreign investments in developing Asia, while Southeast Asia took 60%. Today, the numbers are reversed."³² Jin Nyum, South Korea’s Economic and Finance Minister, remarked that China is becoming a "juggernaut in the global economy, turning itself into the world’s manufacturing plant, which will suck all manufacturing facilities into it like a black hole."³³ South Korea’s Trade Minister, Hwang Doo-yun, noted that "[w]e are losing competitiveness (to China) in areas of light manufacturing industries that are at the lower end of the market, and they (China) are also very rapidly coming up in areas that are technology-intensive. That is a serious problem."³⁴

In addition to seemingly drawing investment dollars and export markets away from its Asian neighbors, China is drawing jobs as well. Taiwan’s transfers of manufacturing facilities to the Mainland were discussed above. Japan is also shifting segments of its manufacturing industry to China to take advantage of China’s lower production costs and market potential. Japanese electronics manufacturers, including Toshiba, Sony, Matsushita Electric Industrial, and Canon have all announced plans to expand manufacturing operations in China.³⁵ In many instances research and development activities are following to access China’s growing pool of low-cost engineering talent. According to news reports, Matsushita has opened a research and development laboratory for household appliances in Suzhou, the Nomura Research Institute has begun outsourcing software projects to China, and Toshiba is planning a tenfold increase in the number of engineers at its chip development center in Shanghai.³⁶ Hitachi, Sony Pioneer, Fujitsu, and NEC reportedly are among other major Japanese firms that have announced plans to establish research and development units in China as well.³⁷

While there are indications that China may be diverting trade and investment away from some of its neighbors, there are also indications that China is expanding its own trade with many of these countries. According to a report issued by the Singapore Government, bilateral trade between China and the ASEAN-5 (Singapore, Indonesia, Thailand, Malaysia, and the Philippines) has expanded at an average rate of 16 percent per year, growing from $7.1 billion in 1990 to $29.6 billion in 2000, with ASEAN-5 imports from China generally running only modestly ahead of exports.³⁸ The report further noted that while China has not been a significant investor to date in the ASEAN region, "[w]ith the PRC continuing its economic reform and its transition to a market economy, it will play an increasingly important part as a key exporter of capital to Asia."³⁹ In January 2002, CNOC, China’s state-owned offshore oil company, reportedly paid $585 million to a Spanish firm to acquire its assets in a major Indonesian oil company.⁴⁰

In addition to its WTO entry, China is expanding its economic integration with its Asian neighbors through other arrangements. At the ASEAN summit in November 2001, ASEAN leaders endorsed a proposal to create a free-trade area with China over the next 10 years.⁴¹ This arrangement suggests both a desire by the ASEAN countries to take advantage of China’s economic growth through expanded market access and a strategy by China to prevent its Asian trading partners from throwing up protective barriers. A report prepared by an ASEAN-China joint experts group predicts that an ASEAN-China free-trade agreement would increase ASEAN’s exports to China by 48 percent and China’s exports to ASEAN by 55 percent, and would increase ASEAN GDP by 0.9 percent and China’s GDP by 0.3 percent.⁴² Such an arrangement would establish China as the leader of an economically powerful Asian trading block, one that can be expanded to cover a broader area of Asia in the future.

There are a number of reasons that the leading Asian economies are presently undergoing economic slowdowns and experiencing financial instability. Many of these economies have never fully recovered from the Asian financial crisis of the late 1990s and are still struggling to implement necessary structural economic reforms. Compounding these problems is the global economic slowdown, particularly in the United States, which is impeding their ability to export their way back to financial health.

It is clear, however, that these countries are becoming increasingly concerned about how their economies are being impacted by China’s emergence as a regional economic power. China is garnering levels of FDI well in excess of its neighbors and its export growth is ahead of most as well. In addition, many Asian economies can no longer compete against China as a low-cost manufacturing center and their manufacturers consequently are moving significant facilities there. While continued analysis is needed to assess the extent to which China’s increasing FDI and export production levels are displacing trade and investment in other Asian countries, it seems evident that China’s emergence as a major trading nation has to some degree been at the expense of its neighbors.

China’s WTO entry likely will accelerate these current trends. China’s attractiveness as a destination for FDI should be enhanced post-accession. Moreover, as trade barriers to Chinese goods are lowered by WTO members, China’s export production may surge as well, displacing exports from its neighbors and potentially lowering world market prices for many of these items. At the same time, however, a more open Chinese market may create new export opportunities for its neighbors and China’s economic growth may lead it to become a significant source of investment capital for its neighbors.

China’s entry into the WTO will not impact all of its neighbors equally. Those countries whose economies are the most dependent on labor-intensive exports (e.g., textiles, electronic goods) can be expected to be the most negatively impacted as they compete directly with Chinese exports, while countries that produce higher-end goods, or produce exports for which China is a significant importer (e.g., certain electrical components, mineral/natural resource products), are more likely to be positively impacted.

The United States has a clear strategic interest in the financial stability and continued economic development of its key Asian allies. Promoting Asian economic integration was a stated goal of U.S. support for China’s WTO membership. However, as the foregoing discussion highlights, it is not clear whether China’s WTO accession will have positive or negative economic implications for its Asian neighbors over the long-term. If China’s future economic growth comes at the expense of its neighbors, the consequences could include a more severe Asian financial crisis coupled with social and political instability in the region.

China’s influence in Asia has been enhanced as a result of its growing economic clout. Many of the Asian economies that have traditionally seen the United States as their major trading partner are now looking to strengthen their trade ties with China. The decision by ASEAN leaders last November to pursue a free-trade area with China demonstrates this trend. At the ASEAN summit where the proposal was approved, Singapore Prime Minister Goh Chok Tong noted that "[f]or us to depend on the U.S. alone as a market for growth for east Asia will be much more difficult in the future, because the U.S. economy is going to slow down."

Japan has become increasingly wary of China’s growing influence in the region and reportedly was shocked when it learned of the proposed China-ASEAN free-trade area.⁴³ During Japanese Prime Minister Koizumi’s trip to the ASEAN region in January, he floated the concept of establishing a broad-based Asian "economic community," that would include China, perhaps to counter China’s attempts to forge its own regional free-trade relationships.

The United States has a critical interest in China’s economic integration in Asia because it gives all parties a vested interest in avoiding hostilities. At the same time, China’s economic integration with its neighbors raises the prospect of an Asia economic area dominated or significantly influenced by China. If so, the United States may find that its leverage and influence in the region, even with its traditional Asian allies, may wane to some degree, particularly with regard to economic and trade matters.

• The Commission recommends that the Congress should encourage the Administration to initiate consultations with other Asian countries to assess and make recommendations on the impact of the "hollowing-out" phenomenen with respect to China on regional economies and on U.S. economic relations with the region.

ENDNOTES:

1. Ing-wen Tsai, Ph.D., "A New Era in Cross-Strait Relations? Taiwan and China in the WTO," Heritage Foundation Lectures, No. 726, 14 January 2002 (lecture delivered 13 December 2001): 63.
2. Ibid.
3. U.S.-China Security Review Commission, Hearing on China Sectoral and WTO Issues, Written Testimony of Rupert J. Hammond-Chambers, 14 June 2001, 1.
4. U.S.-China Security Review Commission, Hearing on Bilateral Trade Policies and Issues Between the United States and China, Written Testimony of Merritt Todd Cooke, 2 August 2001, 1.
5. Ibid., 2.
6. Tsai, "A New Era in Cross-Strait Relations," 62.
7. Mainland Affairs Division Economic Development Advisory Conference, "Final Summary Report," 26 August 2001. <http://www.gio.gov.tw/taiwan-website/4-oa/20010826/2001082602.html> (30 May 2002).
8. Ibid.
9. Chen Shui-bian, "Address at the Closing Ceremony of the Economic Development Advisory Conference," 26 August 2001, <http://www.gio.gov.tw/taiwan-website/4-oa/20010826/2001082601.html> (30 May 2002).
10. Tsai, "A New Era in Cross-Strait Relations," 63.
11. Jason Dean, "Oil Firms From China, Taiwan Sign Joint Exploration Deal," Asian Wall Street Journal, 17 May 2002, A3.
12. Eric Ng, "Cross-strait pact takes off," South China Morning Post, 30 August 2001; Joseph Lo, "China Air buys stake in Eastern Cargo," South China Morning Post, 7 September 2001.
13. Jason Dean, "Sampo, Haier Forge Appliances Deal," Asian Wall Street Journal, 21 February 2002.
14. Tyler Marshall, "Cross-Strait Trade Poses a Question," Los Angeles Times, 4 September 2001, sec. A1.
15. Shu Shin Luh, "Taiwan Strait just Wafer-Thin," South China Morning Post, 27 March 2002; "Taiwan: Plans to Move Fabs to China Delayed," Taipei Times, 15 May 2002.
16. Mark Landler, "From Taiwan, A Fear of China Technology," New York Times, 3 October 2001, sec. C, p. 1; Jason Dean and Terho Uimonen, "Taiwan Chip Makers Set Their Sights on China," Wall Street Journal, 1 April 2002, sec. A, p. 8.
17. Landler, "From Taiwan, A Fear of China Technology," sec. C, p. 1; Luh, "Taiwan Strait just Wafer-Thin."
18. Premier Yu Shyi-kun, "Policy Statement on the Liberalization of Mainland-bound Investment in Silicon Wafer Plants," 29 March 2002, <http://www.gio.gov.tw/taiwan-website/4-oa/20020329/2002032901.html> (13 June 2002).
19. "Taiwan: Plans to Move Fabs to China Delayed," Taipei Times.
20. John Tkacik, "Taiwan Dependence: The Strategic Dimension of Cross-Strait Trade and Investment," The Costs of Conflict: The Impact on China of a Future War (SSI: 2001), p. 56.
21. Tsai, "A New Era in Cross-Strait Relations," 63.
22. Cooke, Written Testimony, 1.
23. Mark Landler, "China Feud Has New Risks for Taiwan," New York Times, 28 July 2001, sec. C, p. 1.
24. Hammond-Chambers, Oral Testimony, 241.
25. World Trade Atlas, cited in Allen Lenz, Statistical Summary of China’s Trade Patterns, Report prepared for U.S.-China Security Review Commission, October 2001, Table 2, 5.
26. Ibid., 4.
27. UNCTAD World Investment Report 2001, Annex Table B.1, cited in Allen Lenz, The Role of Foreign Investment in China’s Trade and Economic Development, Report prepared for U.S.-China Security Review Commission, March 2002, Table 1, 7.
28. China Statistical Year Books 2000 and 2001, Table 17-15, cited in Allen Lenz, The Role of Foreign Investment in China’s Trade and Economic Development, Report prepared for U.S.-China Security Review Commission, March 2002, Table 10, 25.
29. "Clouds over Hong Kong," The Economist, 14 August 2001, 57.
30. Gerald, P. O’Driscoll, Jr., Kim R. Holmes and Mary Anastasia O’Grady, "Index of Economic Freedom," The Heritage Foundation and The Wall Street Journal, 2002.
31. Vanessa Gould, "Chamber Seeks Open Trade Gates," South China Morning Post, 13 March 2002.
32. Richard Borsuk, "Southeast Asia Makes Plans to Join China’s Party," Wall Street Journal, 7 March 2002, sec. A, p. 20.
33. Mark O’Neill, "Even Winners Worry Over World’s Workshop," South China Morning Post, 30 October 2001.
34. Amit Prakash, "South Korea Must Form Economic Alliance with China," Dow Jones Newswire, 15 October 2001.
35. Clay Chandler, "A Factory to the World," Washington Post, 25 November 2001, sec. A, p. 1.
36. James Brooke, "Japan Braces for a 'Designed in China' World," New York Times, 21 April 2002.
37. Ibid.
38. "China’s Rising Investment In Southeast Asia: How ASEAN And Singapore Can Benefit?" Singapore Ministry of Trade and Industry, 2001 Annual Report, 99. <http://www.mti.gov.sg/public/PDF/CMT/NWS_2001Annual_China.pdf?sid=92&cid=1034> (17 June 2002).
39. Ibid., 100.
40. Sadanand Dhume and Susan V. Lawrence, "Buying Fast into Southeast Asia," Far East Economic Review, 28 March 2002.
41. John Burton, "Asian Leaders Look to Free Trade Area with China," Financial Times, 7 November 2001.
42. "ASEAN Secretary-General Calls For ASEAN Economic Integration To Compete With China" ASEAN Press Release, 7 March 2002 <http://www.aseansec.org/%5Cnewdata%5Casean_compete.htm> (17 June 2002).
43. Barry Wain, "Japan’s Push to Counter China’s Sway in Southeast Asia Runs into Difficulty," Wall Street Journal, 14 January 2002.