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News Release

Bringing Taiwan into Asian Trade Liberalization

December 10, 2004

Contact:    Nicholas R. Lardy    (202) 328-9000

Washington, DC—A new Institute study titled Prospects for a US-Taiwan Free Trade Agreement suggests that China’s long-standing objections to Taiwan’s participation in bilateral and regional trade liberalization could impel the United States to negotiate a bilateral free trade agreement (FTA) with Taiwan and that this is in fact the most compelling reason for the United States to do so. Such an agreement would be most beneficial to the Taiwanese economy if it emboldened other countries in the region to enter into FTA talks with Taiwan despite objections from China.

The pace of regional and bilateral trade liberalization in Asia has accelerated dramatically in recent years. Japan has completed FTAs with Singapore and Mexico and launched talks with South Korea and several members of the Association of Southeast Asian Nations (ASEAN). In November 2004, China and Chile announced they would initiate formal talks leading to an FTA, and China and Australia are expected to begin similar negotiations within months. Most dramatically, ASEAN and China in late November completed their negotiations to liberalize trade in goods, a key step toward the creation of the world’s biggest FTA (by population). Stimulated by this development, both Korea and Japan the following day announced that they too would pursue FTAs with ASEAN. The likely eventual outcome is an ASEAN + 3 FTA, which could be the basis for the formation of an East Asian Economic Community.

Taiwan is conspicuously absent from FTA negotiations. The reason is simple: China has repeatedly warned other countries not to enter into trade negotiations with Taiwan. As a result, Taiwan has been able to complete a trade agreement only with Panama, an extremely minor trading partner. Just the launch of a US–Taiwan FTA negotiation might help break this logjam.

In terms of economic effects, both the United States and Taiwan would gain from a bilateral FTA. The study estimates that the US benefits, though small, are several times those stemming from its already completed FTAs with Australia, Chile, and Singapore. The gains to Taiwan, relative to the size of its economy, would be much larger.

The study cautions, however, that much of the gain in bilateral trade would reflect trade diversion—that is, after a preferential arrangement is concluded, each side would begin to supply goods to the other that previously were produced at a lower resource cost in a third country. This is reflected in the projected commodity composition of increased trade following the establishment of an FTA. Taiwan’s export gains would be primarily in apparel. But Taiwan’s declining share of exports in the global apparel market suggests that this sector is not its comparative advantage any longer and that its gains in the US market would be at the expense of lower-cost producers. US export gains would be concentrated in autos, but the share of the United States in the Taiwanese auto market has been declining for years, again suggesting the absence of underlying comparative advantage.

Despite the prospects for a high degree of trade diversion, a US-Taiwan FTA may still be warranted if it could lead to Taiwan’s inclusion in intra-Asian trade liberalization. The United States has a long-term interest in Taiwan’s continued economic growth and prosperity, which could be undermined if Taiwan is unable to participate in regional trade liberalization. Hence the new study suggests that the idea should be seriously explored.

About the Authors

Nicholas R. Lardy, senior fellow since 2003, was a senior fellow in the Foreign Policy Studies Program at the Brookings Institution from 1995 to 2003 and also served as interim director of the program in 2001. He was the director of the Henry M. Jackson School of International Studies at the University of Washington from 1991 to 1995. From 1997 through the spring of 2000, he was the Frederick Frank Adjunct Professor of International Trade and Finance at the Yale University School of Management. His publications include Integrating China into the Global Economy (Brookings Institution Press, 2002), China’s Unfinished Economic Revolution (Brookings Institution Press, 1998), China in the World Economy (Institute for International Economics, 1994), Foreign Trade and Economic Reform in China, 1978-1990 (Cambridge University Press, 1992), and Agriculture in China’s Modern Economic Development (Cambridge University Press, 1983).

Daniel H. Rosen, visiting fellow, was a member of the National Economic Council staff from 2000 to 2001, where he served as senior adviser for international economic policy. His work has focused on the economic development of East Asia, particularly Greater China, and US economic relations with the region. He is the author of Behind the Open Door: Foreign Enterprises in the Chinese Marketplace (1998) and coauthor of Roots of Competitiveness: China's Evolving Agriculture Interests (2004) and APEC and the New Economy (2002).

About the Institute

The Institute for International Economics, whose director is C. Fred Bergsten, is the only major research center in the United States that is devoted to global economic policy issues. The Institute's staff of about 50 focuses on macroeconomic topics, international money and finance, trade and related social issues, and international investment, and covers all key regions—especially Europe, Asia, and Latin America. The Institute averages one or more publications per month; holds one or more meetings, seminars, or conferences almost every week; and is widely tapped over its popular Web site.

Prospects for a US-Taiwan Free Trade Agreement
by Nicholas R. Lardy and Daniel H. Rosen
December 2004 • 72 pp. • $20.00
ISBN paper 0-88132-367-5