2023.03 The Taiwan Banker NO.159 / By David Stinson
A US-Taiwan trade agreement may transform the financial sectorBanker's Digest
The relationship between Taiwan and the US has previously been defined by hard power. For a short window, Taiwan’s dominance in semiconductor fabrication seemed like an exception to this pattern, demonstrating Taiwan’s excellence in what was then a niche field of greatest interest to gamers. By late 2018, it was known that Intel, as the last production line remaining in the US, would exit the foundry business. By 2020, the pandemic introduced supply chain resilience into the popular lexicon, challenging the longstanding emphasis on efficiency. In 2021, semiconductors became a global economic bottleneck, and by 2022, with the US export controls aimed at China, semiconductor fabrication was firmly recognized as an element of hard power. Although Taiwan’s achievements in semiconductor hardware marked a definite moral victory, its newfound power was in fact projected just as much towards the US as towards China, its ostensible threat. This orientation manifests a longstanding US complaint about Taiwan’s defense planning: the military seems much more concerned with attracting (or demonstrating) American support than carrying out its functional purpose. Mutual soft power It has only been a few years since the American commitment to Taiwan became clear. In fact, even today, the US still may be unable to replace Taiwan’s capacity to respond to so-called grey zone attacks below a certain threshold, which it is now asking Taiwan to give up in order to be more prepared for a single catastrophic scenario. It is requesting a high degree of trust. The recent Taiwan Policy Act allowed the US to refuse weapons sales it believes are not suited to the asymmetric strategy it favors. “Real friends twist arms,” wrote two military scholars in a commentary on the Act. As sincere as this attitude may be, it is nevertheless an awkward way to conduct diplomacy. Taiwan may not have many options for partners, but this doesn’t mean that the US can forget the traditional tools of statecraft. This counterintuitive deficit in soft power on the part of the US forms the background to the current negotiations for a Bilateral Trade Agreement (BTA). 39% of Taiwan’s total exports went to China and Hong Kong in 2022, a figure which goes against the recent trend of decoupling, and makes Washington anxious for a variety of reasons. Chips make up a major portion of that figure; Taiwan will urgently need an alternative export market after TSMC’s one-year reprieve on the US semiconductor order expires. At the same time, a BTA could also provide Taiwan opportunities to develop its own international ‘brand’ in a way that is less intrusive to the global economic order. Aside from semiconductors, another one of the products for which Taiwan is best known internationally is bubble tea. This example points to a new path forward for Taiwan’s soft power. Originally a specialty product for Taiwanese communities in California, bubble tea later became a regional item in the US with subcultural appeal. A generic consumable however has no implications for politics; the missing ingredient has been international trade. Commercial relationships can create stakeholders with the standing to speak informally on behalf of their home country. A BTA could help blur the relationship between business and culture, giving both Taiwan and the US a foundation for their relationship outside while sidestepping the contentious issue of formal recognition; integration of consumer markets could help Taiwan build local, consumer-oriented champions. New frontiers The sustained commercial contact from a BTA could allow certain aspects of American business culture to rub off on Taiwan. One important example might be in the software sector. For all the US handwringing about its comparative disadvantage in hardware, it also important to realize that Taiwan’s software sector is in a similar situation. In theory, Taiwan has the technology talent, but its success in manufacturing creates a persistent brain drain effect. Even worse, whispers in the US defense community suggest that Taiwan’s porous counter-intelligence may be a factor inhibiting closer military-to-military cooperation. While chips remain a theoretical mode of attack, most vulnerabilities of a more practical nature involve software. The best defense in this regard will be to have a flourishing software sector. Rather than talent, the bottleneck for software is management, and beyond that, financing arrangements. Since the sector is light in tangible assets, flexible financing is often required. Although many aspects of the ongoing trade negotiations are secret, indications are that the US is advocating for certain structural reforms, which may include the financial sector. Although without pointing to any specific sectors, the Negotiating Mandate released at the start of the negotiations in August made specific note of state-owned enterprises as one of its 11 points. “The United States and Taiwan will seek to address the significant distortions that can occur to international trade and investment from the nonmarket practices of state-owned and state-controlled enterprises and government designated monopolies, including through the adoption of provisions designed to create a level playing field for workers and businesses when competing against these entities in the international marketplace, including by ensuring that these entities act in a commercial manner, are regulated impartially and do not provide or receive trade-distorting non-commercial assistance.” A mid-January update also mentioned that “services domestic regulation” was one of the topics discussed in the latest round of negotiations. Even with a more open financial sector, US-invested institutions are unlikely to compete against their existing domestic counterparts, particularly in the already-oversaturated retail banking sector. Instead, they will more likely aim to open up new frontiers. Investment banking, for instance, is one area of finance which has remained dormant in Taiwan. The reasons are largely legal, which could help explain the focus on regulation. Fork in the road A BTA would not be entirely without cost for Taiwan on an economic level. The Negotiation Mandate also includes a point on labor protection. Taiwan’s large migrant labor population could emerge as a friction point. Here, it may be helpful to consider the US domestic politics of international trade, because labor rights are frequently cited as a reason to avoid trade altogether. In contrast to the previous administration, President Biden understands the importance of international economic ties for diplomacy, but he is still unwilling, or politically unable, to make that case at home. The Inflation Reduction Act has caused frictions with trading partners in Europe and Asia regarding green supply chains, and Biden’s recent State of the Union speech called for “buy American” provisions on construction materials, to bipartisan applause. It is quite possible that Taiwan will be insulated from the political considerations that might affect other bilateral relationships. Indeed, Taiwan’s exclusion from the Indo-Pacific Economic Framework for Prosperity (IPEF) – an initiative announced last year whose ambition has generally underwhelmed trading partners – is precisely what gives the administration some flexibility to consider Taiwan’s particular situation. At the same time, competition with lower-cost manufacturing centers is exactly the sort of situation that tends to arouse the suspicions of labor activists. Thus, even if the agreement is successful in the short term, labor rights will remain a potential vulnerability in this high-stakes relationship, overshadowed by other issues to be sure, but still undesirable. Improvements in this area could raise labor costs, but in the longer term could also help accelerate Taiwan’s economic transformation. Taiwan has no choices without tradeoffs, in either the economic or military realm. In some cases, the stakes are large and complex. These dilemmas exist precisely because Taiwan is not starting from zero. It already possesses certain advantages, which it now has the opportunity to trade away in exchange for others. In this case, the alternative appears more sustainable than the status quo.