(Reprinted from HKCER Letters, Vol. 19, March 1993)
Economic Relations between Taiwan
and the United States
Analyses of trade relations between any two countries usually focus on the barriers which stand in the way of trade between them, although such barriers and the intergovernmental disputes they give rise to are matters of minor importance when compared with the benefits from trade. This article begins with an examination of the magnitude of trade between Taiwan and the United States, followed by an examination of the barriers which each side imposes to imports from the other. Subsequently, we consider two especially thorny trade-related issues, intellectual property rights and exchange rate protectionism.
The Extent of Trade Relations between Taiwan and the U.S.
The U.S. has a population ten times that of Taiwan and an economy (as measured by GDP) that is thirty times bigger. Naturally, therefore, the U.S. is more important to Taiwan than Taiwan is to the U.S. The U.S. is Taiwan's single largest export market, and from 1970 to 1991, accounted on average for about 40 percent of total exports. The U.S. is also an important source of imports in Taiwan, accounting for about 23 percent of the total, which is second only to Japan's share of 30 percent.
Taiwan naturally plays a much smaller role in U.S. trade. Although it is the United States' sixth largest trade partner, it accounts for only about 3 percent of U.S. exports and 5 percent of U.S. imports. What is striking, therefore, is the incongruity between Taiwan's minor role in the U.S. economy and the enormous pressure that the U.S. has put on Taiwan in recent years to increase its import from, and decrease its exports to, the United States.
However, it is not Taiwan's share in U.S. exports or imports but rather the bilateral trade imbalance that has motivated U.S. trade policy towards Taiwan. The U.S. trade deficit that emerged in the 1980s became a rallying point for protectionists, and Taiwan was one of the targets, even though the U.S. trade deficit with Taiwan never amounted to more than a fraction of one percent of U.S. GDP and was never greater than about ten percent of the overall trade deficit. It is worth pointing out that, in per capita terms, the trade imbalance slants in the opposite direction, with the Taiwanese spending (in 1991) on average US$700 per person on U.S. goods and the Americans spending on average only $90 per person on Taiwan-made goods.
Taiwan's trade surpluses with the U.S. in the 1980s, while small in U.S. terms, assumed very large proportions in the Taiwan economy. Taiwan's bilateral surplus with the U.S., which matched more or less its overall surplus, rose to an unprecedented level of about 20 percent of its GDP in the mid-1980s. The magnitude of Taiwan's bilateral and overall surpluses in the mid-1980s suggests the possibility that the government may have manipulated exchange rates and macroeconomic policy toward that end.
U.S. Barriers to Trade with Taiwan
Through successive rounds of multilateral trade negotiations, the average tariff rate in the U.S. has been lowered to 6.7 percent on industrial goods and 8.6 percent on agricultural goods, averaging 7.0 percent overall at the end of 1991. On certain products that are of particular importance to Taiwan, however, U.S. tariffs far exceed the average, as for example on textiles and garments which are Taiwan's second largest export to the U.S. and which face an average tariff rate of about 17 percent. In addition to tariff protection, the U.S. maintains import quotas on certain products, but none of these is especially important to Taiwan.
Tariffs and quotas are not, however, the principal instruments of trade policy in the U.S., since tariffs cannot be raised or quotas imposed unilaterally without violating legally binding GATT agreements. Instead, the U.S. has pursued its protectionist objectives in recent years by means of the various forms of administered protection which are sanctioned by the GATT, and by negotiated "voluntary export restraint" agreements (VRAs) which circumvent the GATT altogether.
Forms of administered protection used by the U.S. include anti-dumping and countervailing duties, and the invocation of Section 337 (of the 1930 Tariff Act) and Section 301 (of the 1988 Trade Act). In the 1980s, of the number of cases investigated and of those in which action was taken, Taiwan does not appear to have been investigated or penalized disproportionately. However, Taiwan is the most frequently targeted violator of Section 337, which deals with importation into the U.S. of goods which allegedly infringe on U.S. patents, copyrights, or trademarks. The issue of Taiwan's infringement of U.S. intellectual property rights has also been raised under the "special" provisions of section 301, and we return to this issue in more detail below.
Taiwan has also been the subject of more than its share of general Section 301 cases in which it is alleged that U.S. rights under trade agreements have been violated. Taiwan has been subject to six investigations under Section 301, but it has escaped U.S. retaliation by conceding to U.S. demands, an illustration of the asymmetry of power in bilateral trade relations between the U.S. and Taiwan.
This asymmetry is further reflected in the various "voluntary" export restraint agreements (VRAS) that the U.S. has negotiated with its weaker trading partners including Taiwan. As of mid-1991, the U.S. had some 83 VRAs covering imports of various products. All together, U.S. imports subject to VRAs amounted to about 10 percent of total imports. With the exceptions of one VRA with the European Community and five VRAs with Japan, all of the U.S. VRAs are with small and/or developing countries. In the case of Taiwan, VRAs with the U.S. currently apply to exports of machine tools and textiles and apparel.
Taiwan Barriers to Trade with the U.S.
While trade liberalization in the U.S. has been conducted mainly through multilateral negotiations, in Taiwan it has been undertaken unilaterally and has occurred in three distinct phases. The first phase culminated in 1958 with a 250 percent nominal exchange rate devaluation and the removal of quantitative restrictions on permissible imports. These measures were the key elements of the "export promotion strategy."
The second phase of trade liberalization began in the 1970s as it became obvious that foreign exchange was not the constraint to growth. After several years of trade surplus, the share of importable items that were controlled and prohibited was drastically reduced from 42 percent to only 2 percent.
The third phase was initiated in the late 1970s and was accelerated in the 1980s, again in response to growing trade surpluses, especially with the increasing U.S. pressure on Taiwan to liberalize. After passing a tariff reform bill in December 1991, the average nominal tariff stood at 8.9 percent, a full 85 percent lower than it was a decade and a half earlier. In agriculture, tariffs remained relatively high, at an average rate of about 23 percent in 1992. Agricultural imports are also subject to licensing, and in some important instances (e.g., rice and rice products), they are banned altogether. Import barriers in agriculture probably cost the U.S. more exports than in any other area of protectionism in Taiwan.
The Issue of U.S. Intellectual Property Rights Protection
Because of its political status, Taiwan cannot subscribe to the two major international conventions on copyrights, the Berne Convention and the Universal Copyrights Convention. Issues related to intellectual property rights were covered by bilateral agreements until 1970 when Taiwan enacted its first copyright law. Under pressure from the U.S., that law has been repeatedly modified and amended, the last time in April 1992 after the U.S. designated Taiwan a "priority country" under Section 301 of the Trade Act. The United States' current complaints are not so much concerned with the content of Taiwan's copyright law as with the way the law is enforced.
Piracy of book copyrights has declined significantly in Taiwan in recent years, in large measure as a result of a stricter enforcement of the law and increasing government pressure on the industry to cooperate. The government is apparently less able or willing to protect U.S. intellectual property rights in the case of videocassette and computer software. The U.S. industry argues that the government has been more reluctant to clamp down on piracy of videos and software because of domestic political considerations, which is also what underlies agricultural protectionism in Taiwan. Agricultural protectionism in Taiwan, however, does not deviate as far from international standards of practice as does its violation of intellectual property rights. It is unlikely, therefore, that Taiwan will continue for very long to avoid complying with accepted international procedures for protecting intellectual property rights, especially if its application to the GATT is granted.
The Theory of Exchange Rate Protection
For a small country where prices of tradable goods in terms of foreign exchange are given, the government can expand tradables output by a nominal devaluation, increasing the relative price of tradables relative to non-tradables. However, the devaluation will shift absorption to non-tradables, creating an excess demand for non-tradables. In order to prevent this excess demand from raising the price of non-tradables and negating the initial devaluation, the government must reduce aggregate expenditure.
Thus, manipulating the exchange rate is not sufficient to achieve the objectives of exchange rate protection since, to work, it must be supported by a combination of monetary and fiscal policies that reduce absorption. The government may accomplish this by reducing its own absorption or by inducing the private sector to reduce its. If the counterpart of the trade surplus is a rise in foreign reserves, then the monetary authorities will have to undertake sterilization to prevent the money supply, and hence domestic absorption, from increasing. Continuous sterilization is difficult unless the government continuously runs a fiscal surplus. Furthermore, capital controls may be required to prevent capital inflows in response to the high interest rates needed to keep absorption in the private sector from increasing. Exchange rate protection is, in other words, a complicated matter made all the more difficult to implement the longer it is pursued.
Exchange Rate Protection in Taiwan?
In 1988 the U.S. Treasury concluded that Taiwan was manipulating its U.S. dollar exchange rate for the purpose of "preventing effective balance of payments adjustment and gaining unfair competitive advantage in international trade." Bilateral negotiations subsequently led to Taiwan's adoption of a Trade Action Program in 1989 whose main aim was to reduce Taiwan's bilateral trade surplus with the U.S. Leading government officials in Taiwan have recently expressed pride and satisfaction in seeing their overall and bilateral U.S. surpluses come down under this plan. However, the U.S. Treasury in 1992 again cited Taiwan for manipulating its U.S. dollar exchange rate to gain "unfair" advantage.
Did Taiwan manipulate its exchange rate and macroeconomic policy to favor the traded goods sector at the expense of the non-traded goods sector? Consider first the movement of the exchange rate. The NT dollar depreciated against the U.S. dollar in the first half of the 1980s, nominally by about 10 percent and in real terms (adjusted for changes in relative consumer prices) by about 20 percent, and then subsequently appreciated by about 40 percent both in nominal and real terms. In terms of relative unit labor costs, however, Taiwan appears to have achieved no gain in competitiveness vis-a-vis the U.S. from the depreciation of the NT dollar in the early 1980s. On the contrary, labor costs in Taiwan relative to the U.S., adjusted for relative productivity change and the exchange rate, increased over the entire period from 1976 to 1990, but especially rapidly with the nominal appreciation of the NT dollar after 1985. On the face of it, therefore, it is not obvious that authorities in Taiwan manipulated the exchange rate to increase competitiveness of the traded goods sector, though they may have done so to avoid losing competitiveness.
Since the key to exchange rate protection is a macroeconomic policy aimed at reducing absorption and keeping it down, what one might expect to find in an economy practising exchange rate protection is a rising government budget balance. In the case of Taiwan, this critical piece of evidence is missing. The general government budget balance, while positive in the 1980s, did not increase during the period of high and rising trade surpluses. In fact, the government's saving-investment balance fell somewhat in the 1980s, offsetting a concurrent rise in the saving-investment balance of state enterprises. It is not the public sector, but instead the private sector, which accounts for the bulk of the country's surplus of savings over investment.
The rise in the private sector saving-investment balance, to as high as 17 percent of GNP, was a result of both a fall in the rate of investment, which occurred from 1979 to 1982, and a subsequent rise in the rate of savings, from 1983 to 1987. These movements could be attributable to a tightening of monetary policy if there were evidence of rising interest rates in the 1980s, but there is none. Instead they appear to be autonomous shifts in the rates of saving and investment that are mainly due to exogenous events.
It seems reasonable to hypothesize that the decline in the investment rate from 1979 to 1982 was related to the United States' withdrawal of diplomatic recognition in 1979. Such an event could not but have weakened investor confidence in Taiwan's economic future. Investor confidence may have been further undermined in the early 1980s by the rapid increases in production costs from rising oil prices abroad and increasing relative unit labor costs at home. Furthermore, nominal and real interest rates in the U.S. were rising to all-time highs, providing further incentive to shift savings abroad.
The rise in the rate of private saving from 1985 to 1987 is more difficult to explain. Perhaps it is associated with the concurrent boom that occurred in real estate and the stock market, which may have generated increments to income that were perceived by households as transitory and thus saved rather than consumed. It is also possible that the financial boom, together with the enormous increase in the Central Bank's foreign reserves, may have created expectations of inflation which households may have responded to by increasing their savings in anticipation of future losses. Whatever the reasons behind the rising saving-investment balance in the 1980s, it is not obvious that it was directly engineered by government policy.
The main counterpart of Taiwan's trade surpluses during the 1980s was increases in the Central Bank's foreign reserves, which by 1992 reached a staggering US$90 billion. The Central Bank did in fact sterilize its accumulation of foreign reserves by reducing its stock of domestic assets. This policy was further reinforced by controls on the inflow of capital which would have otherwise lowered interest rates and stimulated private domestic absorption.
It seems, therefore, that while the government may not have initiated a policy of exchange rate protection, it did nonetheless aid and abet the emergence of the large trade imbalances in the 1980s by sterilizing its reserve accumulations. If the government had not absorbed the trade surpluses in its reserves, the currency would have appreciated sooner and by greater magnitude than it did, possibly causing a great deal of unemployment. Having absorbed the trade surpluses in its reserves, if the government had not sterilized them, the consequence would have been an acceleration of inflation and a real appreciation, with much the same outcome. The case can be made, therefore, that Taiwan's macroeconomic policy in the 1980s was prudent and responsible, which is perhaps more than can be said about U.S. macroeconomic policy in the 1980s.
Residents of Taiwan and the U.S. no doubt derive substantial economic gains from trading with each other. The two governments nonetheless impose certain barriers to trade between them, though these barriers are not of great significance, except perhaps with respect to agricultural imports in Taiwan, and textiles and garments imports in the U.S. Protection of U.S. intellectual property rights in Taiwan is a legitimate issue, but one that in all likelihood will be resolved in due course. The bilateral trade imbalance, on the other hand, is an entirely bogus issue that unfortunately will probably not disappear as long as the U.S. has an overall trade deficit around which American protectionists can rally.
The prospects for stronger and more mutually beneficial economic relations between Taiwan and the U.S. can best be served by strengthening the multilateral trading system. Taiwan has made an important contribution to this by applying for accession to the GATT, promising to bring its trade policies into conformity with GATT principles and the practices of other developed countries. The United States, unfortunately, is not doing its part, which is to provide a leadership role in restoring the principles of multilateralism and nondiscrimination in international trade.
Professor James Riedel teaches at The Johns Hopkins University and is on the Board of Advisers of the Centre. The above article is based on a luncheon talk he delivered at the Centre recently.