Will Taiwan's Economy be Marginalized by China? A Macro-economic Policy Coordination Approach

Abstract

In Taiwan, economic marginalization has become a major concern that has resulted from the fast growing Chinese economy, imbalanced cross-strait economic and political relations, and a failure to participate in important international trade and financial organizations. Is a China-Taiwan policy cooperative mechanism the best choice for Taiwan's economic welfare? This paper is to measure Taiwan's economic marginalization by an international policy coordination approach instead of the conventional free trade agreements. We simulate macro-economic adjustments of Taiwan and its main economic partners (China and the US) according to the different institutional scenarios and economic shocks. The baseline simulation and sensitivity analyses imply that at the current stage policy coordination between China and Taiwan cannot come into effect without the US's participation.

Keywords:

• China
• Taiwan
• marginalization
• macro-economic policy coordination

Acknowledgements

The paper extends my early Chinese draft that was presented at Asian Crisis VI (University of Tokyo) in English. Comments and suggestion from the participants, in particular the discussant Junji Yano, as well as from Giovanni Di Bartolomeo, Dong-chen Fu, Joseph Plasmans, I-chun Liu, Chi Schive, Yin-kann Wen, are gratefully acknowledged.

Notes

1. For instance, Taiwan was isolated from the endorsement of the Chiang Mai initiative in 2000, the Closer Economic Partnership Arrangement (CEPA) between Hong Kong and China in 2003, establishment of the Association of South East Asian Nations (ASEAN) + 3 in 2004, the East Asian Summit (EAS) in 2005, and the establishment of Asian Currency Units. Besides, Japan's Economic partnership agreements (EPAs) never include Taiwan. The negotiation of the US-Taiwan free trade area has lasted for over a decade.

2. For instance, the CGE models by Chan (2004) and Chen et al. (2004). Chen (2003) made an industrial evaluation about Taiwan's economic dependence on China. Lardy and Rosen (2004) discuss the possibility of the US-Taiwan free trade agreement (FTA) and indicate that the direct economic benefit to the US of a prospective US Taiwan FTA would be modest.

3. Unlike the World Trade Organization (WTO), the ASEAN-China FTA still lacks a Dispute Settlement Body, and prohibits the importation of many goods from China.

4. A recent example can be found on the conclusions made by Asian Development Bank's (ADB) 2006 annual meeting (http://www.adb.org/media/printer.asp?article id=9830 (accessed 5 May 2006).

5. As Wyplosz (2004) observed, East Asian interest in regional exchange rate arrangements currently seems mainly defensive, a consequence of the crises of 1997–1998.

6. Since 2005, ASEAN, China, Japan and South Korea have strengthened the network of currency swap and repurchases. The funds are estimated to be about 75 billion US dollars. Wyplosz (2004) argues that the Chiang Mai Initiative (CMI) is similar to the European Monetary System (EMS), but in theory the latter provided for automatic and unlimited support of bilateral pegs. In contrast, the amounts to be swapped within the CMI are limited, hence unlikely to be commensurate with the amounts that markets can mobilize.

7. It was proposed by the ADB's 2006 annual meeting. This idea is similar to the so-called “two-speed Europe”. See http://www.adb.org/media/printer.asp?articleID=9830 (accessed 5 may 2006).

8. According to conventional Optimum Currency Area (OCA) theory, many requirements, such as degrees of openness, labor mobility and symmetric demand-and supply-side shocks, must be satisfied before an OCA can be established.

9. McKinnon (2005, chapter 7) states that Robert Mundell changed his focus from conventional OCA theory (the Mundell I model) to the necessity of international risk sharing (the Mundell II model) because of tlie high degree of international capital mobility caused by the collapsing of the Bretton Woods system and the failure of static price expectation since the 1970s. In other words, the European Monetary Union (EMU) and other similar arrangements around the world are not from the Mundell I of the 1960s but from the Mundell II of the 1970s.

10. Empirics (e.g. Bayoumi & Eichengreen, 1993; De Grauwe & Vanhaverbeke, 1993) indicate that the EMU can be established before achieving the criteria of conventional OCA theory.

11. American Chamber of Commerce in Taipei (2004, p. 8).

12. A research report published by Taiwan's Ministry of Economic Affairs (2005) indicates Taiwan's concern regarding the consequences of its failure to participate in the CMI.

13. The relative prices would be the main factor to decide on the competitiveness among the economies involved in case there was only a single currency in the area (that is, all s _ij equal to zero).

14. But the details are available on request.

15. See Lardy and Rosen (2004).

16. Dehaene (2000, p. 132) said that “during my visits to those regions as Prime Minister of Belgium, it struck me that the European Union was their model of integration.”

17. See Petit (1990, pp. 147–148).

18. World Economic Outlook by the International Monetary Fund (IMF) (2003, chapter 3) pointed out the problem of the emerging economics’ huge public debts.

19. Note that the EM is not the only concept to define a game solution. For instance, a coalitional Nash equilibrium game (e.g. Plasmans et al., 2005) allows the entrance of a new member if we add the external stability property, in, which the economic loss of each non-member of the coalition must be lower than the economic loss that the same non-member faces when it decides to join the coalition.

20. If matrix M shown in Equation (10) has more than three positive eigenvalues multiple equilibria arise, whereas if this matrix has less than three positives eigenvalues no equilibrium exists (for more details see Engwerda, 1998). Here we only report a representative case there exist multiple equilibria.

21. However, Mundell (2000c, 2005) argues that a fixed exchange rate system can work only if there is mutual agreement on the discipline of inflation.