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Time for Tsai's Taiwan to tilt toward Japan

The landslide victory of Tsai Ing-wen's pro-independence Democratic Progressive Party in Taiwan's recent presidential election has ignited speculation about possible tensions with Beijing. Less often discussed is Taiwan's relationship with its rich neighbor to the north. Cooler relations with China almost certainly mean stronger ties with Japan, just as the reverse held true under the presidency of Beijing-friendly pragmatist, Ma Ying-jeou of the Kuomintang Party.

     Politics often follows economics; hence Taiwan's rapprochement with the mainland of the past 12 years and the ascendancy of Ma's KMT over the same period. China's supercharged growth spurt presented an irresistible opportunity to Taiwan's larger companies, which became major contributors in the huge influx of foreign direct investment into the People's Republic.

     Today 40% of Taiwanese exports go to China and Hong Kong, against just 11% to Japan. On the back of its Chinese operations, Taiwanese contract manufacturer Hon Hai Precision Industry Co., better known as Foxconn, has become a vast enterprise, with a turnover of $140 billion and more than 1 million employees.

     Ma's administration made this possible by removing various impediments to closer economic ties and upholding the "1992 Consensus," a politically convenient formula that allowed each side to claim that there was "one China" while retaining that title for itself. Tsai and her DPP predecessors have never accepted this line.

     From Beijing's point of view, the carrot has worked much better than the stick -- so far, at least. Back in 1996, there had been a severe bout of cross-strait tension when China showed its displeasure with the explicitly pro-independence Taiwanese President Lee Teng-hui by conducting missile tests within 40km of the Taiwanese coast. The result was a dangerous standoff and a show of force by the U.S. Navy, which sent two aircraft carriers to the area.

     Nobody wants to see a repeat of that today, when the stakes are so much higher for all parties. Yet even from a purely economic view, some distancing of Taiwan from mainland China is highly likely. Indeed ex-president Ma's famous handshake with Chinese President Xi Jinping in Singapore last November -- which celebrated the first meeting between a leader of the KMT and a leader of the Chinese Communist Party since Mao Zedong met Chiang Kai-shek in 1945 -- may prove to be the highwater mark of cross-strait relations.

China's sweet spot turns sour

A key driver of bilateral relations is the Chinese economy. Even by official numbers, it is no longer the fastest growing major economy in the world; today India has that distinction. More to the point, the combination of rising wages and a currency that has strengthened 40% in real terms over the last eight years has substantially reduced China's competitive advantage as factory of the world.

     If the authorities in Beijing manage a seamless transition to a consumption-driven economy, then China will remain a huge, dynamic market for goods and services. Yet many of the large Taiwanese companies present in China -- such as Foxconn, Quanta Computer Inc. and Giant Manufacturing Co. -- are global players which have manufacturing operations there for reasons of cost and efficiency.

     The final consumers of the products they manufacture are still mostly in the wealthy countries of the Organisation for Economic Co-operation and Development. Likewise most of the 40% of Taiwanese exports that go to Hong Kong and China are components -- such as computer chips and LCD panels -- that end up in products sold elsewhere in the world.

     Of course complex supply chains cannot be replaced at the drop of a hat. Yet over time, cost should prove a crucial factor for new investment flows. Like U.S. and Japanese companies, Taiwanese manufacturers will be examining alternative production bases.

     Furthermore, what has worked well for major Taiwanese companies has not necessarily benefitted Taiwan's domestic economy and the living standards of ordinary people; hence the KMT's loss of popular support. Tsai will need to prioritize these issues over the interests of big business if she is to maintain her political authority.

Taiwan's "Japan"

The combination of China's rapid growth and Japan's long period of inward-looking stagnation meant that Japanese-Taiwanese relations were downgraded. Even so, Japan has remained a significant source of FDI, usually ranking first or second on a flow basis, and is also a major supplier of imports, mainly capital goods and components vital to Taiwan's own exports. The two economies are congruent in other ways too. Gross domestic product per head is similar, as are their rankings on the Heritage Foundation's economic freedom index, on which Taiwan is 5th in Asia and Japan 6th, whereas China comes 30th.

     The movement of people is revealing too. Over the past few years, Japan has experienced an enormous boom in inbound tourism, with the highest number of travelers by far coming from China. But looking at the numbers in proportion to each country's population shows a different picture. The 5 million mainland arrivals in Japan in 2015 constitute just 0.3% of the Chinese population. By contrast, the 3.7 million Taiwanese arrivals amount to 16% of the entire population.

     Taiwan's unique perspective on Japan is apparent in popular culture. A good example is the 2014 movie Kano which tells the true story of a high-school baseball team from a poor area of southern Taiwan that makes it to the final of the national championship. What makes the film unusual is that it is set in the 1930s; the coach is Japanese; the team multi-ethnic; and the championship takes place in the Koshien stadium in Osaka. "Japan" means something totally different to Taiwan today than it does to China or Korea.

Time to hedge bets

According to National Chengchi University polls, public support for unification in Taiwan has fallen from 21% in 1995 to 9% today, whereas support for independence has risen from 11% to 20% over the same period. Events such as the apparent abduction from Hong Kong of bookshop personnel involved in publishing embarrassing tales about China's leaders are hardly likely to swell the pro-China numbers. The cautious majority, 60%, favors the status quo -- but, depending on China's internal politics, the status quo may not be particularly stable.

     The challenge for Tsai will be to diversify Taiwan's economic bets -- by strengthening ties with Japan and other regional players -- while averting a 1996-style breakdown in relations with Beijing. A surge in two-way FDI and strategic merger and acquisition deals would be the clearest sign of greater intimacy between Taiwan and Japan and would strengthen political ties. An early application to join the U.S.-backed Trans-Pacific Partnership is another option for Taiwan.

     If it plays its cards right, Taiwan could become a logistics hub for northeast Asia, perhaps taking over some of Hong Kong's role as the mainland's footprint there becomes ever larger. The alternative - that is, gradual absorption into a nervy, volatile greater China, is looking less and less attractive.

Peter Tasker is an analyst with Tokyo-based Arcus Research.

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