Chapter I Introduction

I.2. Literature Review

Economic foundation

Economic fundamentals are at play in cross-strait relations. We find that the taishang and other actors all operate in their own self-interest: the taishang for greater profits, authorities for economic growth and domestic stability, SOEs for their continued profits and rent agreements.

Smith (1776) wrote that self-interest drives market forces, and that self-interested behavior eventually creates benefits and goods for society. Society is a result of profit-seeking behavior, and political economy (in our case the structures guiding economic decisions and market orientation in China, Taiwan, and the provincial case studies) demotes politics while raising society. Smith conceived of the “invisible hand” analogy, in that market behavior is guided by unseen forces that operate better and more efficiently than public policy could direct. Later studies on the invisible hand would define it as “coordination without collusion” (Friedman 1953). Smith found that collusion between the state and companies generates money but no economic growth, effectively working against economic efficiency and the benefit of society.

Steuart (Works, 1805), a contemporary of Smith, finds that social changes come from social processes and forces, and that there is a role for the state in that it must recognize and guide society through the changes, to help the system along correct path dependencies, but not to make the decisions itself.

Chinese trade barriers and protectionism

This research assumes that a fully-integrated Taiwan may have to contend with the mainland’s endogenous border effects that limit domestic trade. A review of theories and research on these phenomena is necessary to draw conclusions regarding the potential success of integration. The study of Chinese provincial protectionism and the rise of trade barriers among the provinces is a relatively new subject. Trade barriers can be considered as any impediments to the free flow of service and goods including tariff-like regulations, outright prohibitions, and geographic obstructions (Young 2000, Poncet 2001, Sun 2013). The rise of this field originates in provincial disparity studies, the roots of which have been linked to China’s liberalization reforms and its fiscal decentralization. The reforms have been found to have also created a direct positive correlation between greater budgetary autonomy of decentralized provinces and the higher rates of trade barriers between the provinces (Poncet 2001, 2003, 2005). The rise of

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interprovincial trade barriers has been found to be a result of provinces abandoning their natural advantages and varied factor endowments in favor of central policies stemming from the 1980s and 1990s that have encouraged provinces to develop their industries and move downstream in the production cycle. This has fostered similar and converged production structures and domestic competition (Young 2000). This study has made social scientists reconsider their classification of the Chinese economy from one monolithic unit to many separate economies.

Studies agree that the best strategy for reform was correctly thought to be continued international integration, but given China’s complexities this had the effect of making the provincial economies more outward looking, further establishing conditions for the low levels of domestic trade we still see in China today (Guthrie 2006). Path dependency in economic development has had the effect of locking provinces into their preferential political economy (Goodman 1997).

Economic decentralization

Excitement over the Chinese market has often developed into self-perpetuating myths about a singular, large market existing in China, that China will modernize through investment, and that market forces have taken control over the economy. China’s economy exists as a continental system, and its scale is so great that many of its provinces dwarf Europe’s largest states in many categories. Taking these and the previous factors into account, it is better to think of the PRC as a series of fragmented markets under the direction of provincial level officials than as a single national economic system (Goodman 1997, Young 2000, Oizumi 2010, Wong 2012).

China’s center of gravity for economic activity exists largely at the provincial level since post-Maoist decentralization handed the reigns of revenue collection and resource allocation over to the provinces as a way to incentivize overproduction for provincial coffers. Decentralization of economic affairs to the provinces had the effect of acting as a surrogate market mechanism, with incentivization acting as a “functional equivalent of privatization” (Cai and Treisman 2007).

Scholars have found that China’s reforms are limited, piecemeal, and incomplete. Nor have they replaced the old system with a functionally better model (Young 2000, Dreyer 2010). The new system does not distribute evenly, and stability and predictability are low. Central government shifts between mass mobilization models and professional development models have established the current incomplete reform arrangement experienced in the PRC today (Wang 2002). Some

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scholars have found that popular enthusiasm for further reforms are low among many of the population, as real change has not happened, and the government has favored “tinkering” with

“easy” reforms rather than addressing major structural overhauls. In either case the central government could regain the power to initiate reforms if it wanted to, but the means to recentralize the economy have “passed from its hands” (Dreyer 2010).2

Scholars have found this semi-reformed market structure has allowed the continued presence of SOEs at provincial levels. SOEs and rent-seeking behavior of private enterprises within the incentivized provincial industrial systems have created high levels of protectionism within the provinces. The defeat of the hard liners during the 1980s created the conditions for SOEs, rent, and capture to develop (Guthrie 2006).

Measuring China’s trade barriers

Interprovincial protectionism studies have discovered that not only do domestic barriers exist, but their rates have increased over the past several decades. Application of the border effect model finds that globalization has driven local governments to adopt market segmentation policies resulting in international trade that “crowds out” interprovincial trade (Poncet 2005, Shantong and Shaojun 2011). Provinces are following a dual-preference for trade that reinforces domestic barriers. International trade is preferred, especially for investments, but provincial officials further push trade barriers up by incentivizing consumers choose local, same-province products over international or interprovincial products (Poncet 2005). These findings indicate that significant border effects and barriers still exist despite mandated stipulations from the World Trade Organization (WTO) that China enact policies to permit the free movement of market goods among the provinces (Poncet 2005).

Wong’s measurements of trade barrier effects from 2012 find that domestic protectionism and trade barrier levels are not as bad as previous studies have suggested, however these rates are rising as provinces continue to increase their presence in the global market. Wong uses the gravity equation, wherein “the ratio of the local purchases of two regions over their respective bilateral trade” gives an “expression” of trade barriers. Her study finds that similar domestically manufactured goods will have different prices in different provinces. She concludes that this indicates extremely limited levels of cross-border trade throughout China. Wong’s study finds

2 June T. Dreyer, China’s Political System: Modernization and Tradition, 2010, p. 137.

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that SOE presence, rather than geography, is the most important factor in creating trade barriers (Wong 2012). Other studies have found that interprovincial administrative trade barriers grew as market reforms have deepened due to provincial protectionism before relaxing slightly between the years 1991 and 2007 (Fang, Qi, and Lin 2013). Other studies have shown that geographic considerations significantly impact the development of market mechanisms. For example, one study has found that the coastal provinces are much more liberalized and express a lower rate of SOE interference due to their proximity to the coast and international transportation networks.

This same study finds that the general opening up of the inland provinces has eroded the advantages enjoyed by the coastal provinces as investment locations have generally started trending westward (Sun 2013). In this study it appears that economic disparity and the resulting SOE and protectionist phenomena are a product of the combination of geographic, policy, and network factors.

The assertion that China’s general opening up has reduced the advantages of the coastal provinces needs further investigation. Several contemporary studies have found that the coastal provinces have managed to retain their advantages. In one study the trend of greater investment heading inland has only been identified along the inner fringes of the coastal provinces and not necessarily throughout the inland provinces themselves (Oizumi 2010). Sun and Oizumi both identify cities located along rivers as being the catalysts for local growth. Oizumi’s study in particular identifies the inland prefecture-level cities of China’s coastal provinces as being the main beneficiaries of China’s general opening up, achieving rapid growth since 2010. His research highlights the inward movement of investment, and its reluctance to leave the relative assured safety of the coastal political economies. Additional research finds other reasons for the slow pace of investment and trade to penetrate inland has been due to investor confidence.

Coastal provinces are still the more preferred areas for investment due to their longer experience with market liberalization, fewer SOEs, and the compounding factor of FDI accumulation generating greater profits (Poncet 2003, 2005, Shantong and Shaojun 2011).

Some studies have shown that trade liberalization efforts in China have been relatively unsuccessful. Flow irregularities have been discovered between Hong Kong and China where WTO commitments and domestic policy aimed at trade liberalization have been sidestepped in favor of controlling the types of capital imported. Manipulation of exchange rates to protect the mainland economies have also proven difficult for investors to avoid. A recent study has

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identified that major irregularities are due to underreporting of exports and overstatements of imports, often associated with offshore “roundtripping” that creates inflated FDI figures. Fung, Yau, and Zhang have found that firms are incentivized to export excess money offshore to return as overstated inbound FDI. Their work has identified the worst offenders of trade irregularities are SOEs (Fung, Yau, and Zhang 2011).

Guanxi business practices

The concept of guanxi (關係) is an often overlooked element when considering trade with China and general business practices. Studies have found that guanxi exists in business culture and transactions on both sides of the Taiwan Strait and can have a strong impact on trade flows and investment networks. Guanxi is a principle used more and more in mainland business and is a key organizational principle in Chinese culture. It allows individuals to grow networks beyond the family (Hamilton 1998) and creates networks of obligation and indebtedness through social relations and can be thought of as a social tool to keep social networks open for

“instrumental ends” (Guthrie 2006). In China guanxi is important for securing business transactions, though it does not drive market relationships. The work-unit system of communist China was made of patron-client guanxi relations for securing resources, and guanxi was essential in creating transactions in a post-Mao China that had a lack of experience with business. As the PRC moves further away from organizing around the family, party-state, and work-unit systems, the guanxi system comes more and more into play (Guthrie 2006).

Role of the Taishang in China

The taishang in China have been subject to many studies on cross-strait relations as well as business behavior and economic development within the mainland. Findings are straightforward and tend to agree that the taishang are some of the catalysts for China’s developing production industries as well as the engine for massive growth in China. Conclusions as to the implications of taishang in China have been mixed as they are seen on both sides of the strait as both the drivers of Taiwan’s economy as well as a tool for the PRC to manipulate and penetrate Taiwan.

Several studies indicate the most crucial aspect of taishang migration to the mainland has been in the transfer of talent. Chinese industry has learned how to advance and how to do business from the taishang in areas of technological know-how and management operations

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(Reid and Rigger 2008). Taishang have proven incredibly difficult for the government in Taipei to control, and the government often having to play “catch up” to the taishang’s behavior, essentially acting as a rubber stamp of approval for their activities (Guthrie 2006). Taishang will use intermediaries for investments if direct investments cannot be made. Reid and Rigger (2008) estimate that in the first decade of the 2000s 75 per cent of British Virgin Islands and Cayman Islands investments, and 15 per cent of Hong Kong investments in China are in fact Taiwanese in origin.3 This lack of control over taishang investment and their movements with market forces has allowed scholars to identify them as significant indicators or bellwethers for locations with proper market mechanisms for investment.

Regional trade

In its pursuit of investment locations starting in the 1980s, and particularly of “Go South”

and “Go West” investment policies in the 1990s, Taiwan has been found to be one of the leading initiators of regional trade structures in east Asia. The regional proliferation of FTAs is creating a new trend in regionalization and international division of labor and supply chains. “Factory Asia” is driven by intra-regional trade, and that regionalization is driven by FDI investors.

China’s entrance in the regional trade architecture in the 1990s has only served to deepen regional economic interdependence (Wu 2010).4

ECFA’s benefits and weaknesses

At the core, academics understand ECFA as a tool to facilitate trade and investment across the strait. Reading any further into the analyses often brings up conflicting conclusions among scholars. As a subject of study it is clear that not enough time has passed in order to give ECFA a fair assessment. Some view ECFA as an annexation tool of the PRC (Huang 2010).

Others assess ECFA as an economic tool with a heavy political nature (Tsai 2010, Huang 2010).

The international community views the trade agreement in a positive light, considering it beneficial.

Critics of this trade agreement have made many foreboding and ominous predictions, and critics have seen Ma’s policies as resulting in the fall of Taiwan to the PRC (Sutter 2011). PRC strategy is to force Taiwan into one direction, into the “One China Market” (also referred to as

3 See Toy Reid and Shelly Rigger, “Taiwanese Investors in Mainland China: Creating a Context for Peace?,” August 2008, p. 9.

4 Rong-I Wu and Tsai-Lung Hong, “Economic Integration in East Asia—Taiwan Perspective,” 2010, p. 33.

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the “Common China Market”) China’s tactics have been called “boar hunting” in which Beijing’s harassment and international blockades of Taiwanese bilateral agreements is similar to a hunter forcing a boar into a trap where the only route for “escape” is to continue further into it so the hunter can easily capture his prey (Huang 2010). Critics argue that Chinese domination over Taiwan’s economy through the ECFA will impact the role Taiwanese small and medium enterprises (SMEs) traditionally play such as speeding up the rate that Taiwanese companies in China will buy from local intermediary suppliers rather than relying on imports from Taiwanese networks for their production supplies (Wilson 2014).

Hollowing out and interdependence

Central to critics’ appraisals of Taiwanese-Chinese economic integration, and thus central to this research are the concepts of core-periphery theory and the trend of region-to-region hollowing out, two theories proposed by scholars relating to asymmetrical trade theory. Core-periphery theory applies trade asymmetry in cases where one economy behaves as a magnet for other economies’ activity. Core-periphery theory states that large markets will make smaller regional economies into peripheries through their size advantages, and that markets mean ample economic growth opportunities (Huang 2010). ECFA critics argue that China is coercing Taiwan into a trap, and that core-periphery theory is what really benefits the PRC. Huang suggests that ECFA is simply a peripherization tool China is using. Additional arguments suggest that ECFA will allow asymmetrical interdependence to expand, drawing Taiwan further to the core (Sutter 2011). Hong Kong, for example, has not been able to shake itself out of the periphery role that it has fallen into (Yang 2005). Scholars note that because Hong Kong is not a centrally-controlled city within the PRC it has slipped in importance into a periphery role, and as of 2010 social inequality and poor living standards have been allowed to continue for over 1.2 million Hong Kongers (Huang 2010).5 Within the mainland Guangdong was found to be the center for the domestic core-periphery model with both positive and negative spillover effects occurring between it and its neighboring provinces (Ying 2000), however additional tests could not determine that Guangdong itself was the sole core for spillover effects experienced by other provinces (Groenewold et al. 2008). Regardless many scholars recognize the effects of China’s pull over Taiwan. Tan (2016) has developed a model showing that Taiwan’s economic fate

5 Tien-Lin Huang, “ECFA and the Core-Periphery Effect,” 2010, p. 86.

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would be sealed to peripheral status should it lose its mechanical manufacturing backbone. Her model suggests that Taiwan should seek FDI from more advanced economies while it is similarly approving outbound FDI (OFDI).

Critics of ECFA have also highlighted that the type of hollowing out that Taiwan is experiencing is different from the industrial hollowing out that has plagued Japan since the 1980s. Taiwanese and Japanese hollowing out are frequently compared, but some recent research suggests that the Taiwan-China model is much more dangerous to Taiwan’s national growth and security. Nobel Prize-winning economist Paul Krugman proposed that region-to-region trade is different from international trade in that it creates much more severe hollowing out effects that are often seen in local-level cases, similar to how one city may drain the economy of another nearby city. International trade is different in that while it may create some hollowing out, its intention is mutually beneficial rather than competitive (Tsai 2010). The migration of many talented Taiwanese to the PRC has led to economic security vulnerabilities including a hollowing-out of the Taiwanese economy and low domestic growth rates (Chu 1999). Tsai points out that the high rates of cross-strait free movement is unheard of in international scenarios and suggests that Taiwan and China trade has shifted to a region-to-region model. Using the computer chip industry as an example, Tsai explains how Taiwan’s trade interaction with China is different from that with the United States and warns that ECFA will kill Taiwan’s economy in the same way that other region-to-region trade models kill smaller economies.6

The phenomena and theories addressed so far lead the paper to the next area, one which has been written about extensively, and is central to the analysis of the benefits and disadvantages of trade integration between Taiwan and China. Interdependence between the parties, pressure exerted by economic actors upon other actors, and the hollowing out effect that Taiwan experiences in its moves toward greater trade relations with the mainland are all events that are interwoven and must be reviewed together to make sense of the trends that scholars have helped to uncover.

Cynical observers have put forward the argument that Taiwan has always remained dependent upon other economies and has simply shifted from dependence on the American economy to the Chinese economy (Wilson 2014). As much as critics of integration push their case that Taiwan is the only party that experiences dependence in the model, it is not true. While

Cynical observers have put forward the argument that Taiwan has always remained dependent upon other economies and has simply shifted from dependence on the American economy to the Chinese economy (Wilson 2014). As much as critics of integration push their case that Taiwan is the only party that experiences dependence in the model, it is not true. While

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