Because of China's refusal to give up using force to resolve the Taiwan issue, the cross-strait relationship is still in a hostile state. However, along the dark tunnel a dim light is emerging bringing the prospect of improved Taiwan-China relation. One the one hand, Taiwan's new president, Chen Shui-bian, has constantly released goodwill since his election victory, and on the other, both sides of the Taiwan Strait are expected to enter the WTO this year. It is a historical opportunity for the two sides to strengthen economic cooperation. If any breakthrough in the development of the cross-strait relation can be achieved as a result, not only will it be beneficial to the economies of Taiwan and China, especially to China's economic development, but it will also be a significant anchor to the stability and development in Asia.

This paper starts with a review of the bilateral economic relation of the past decades till May 20 of 2000. It then introduces the China policy of Taiwan's new government. How China reacts to Taiwan's new government after joining the WTO will determine the future development of the cross-strait relationship. To this connection, a few possible scenarios are analyzed and followed by the conclusion.

I. Review of Taiwan-China economic relations before May 20 Policy

Before the open door policy of 1979 China's economy was closed to the outside world; the Chinese economy was closely integrated with the former communist bloc. The first decade of opening up saw very limited progress in improving the relation with the global economy, due to the great systemic differences between the two types of economy and challenges to the horrendous task of transformation and restructuring.

Bilateral relations between Taiwan and China remained extremely hostile before the 1990s. The Nationalist government retreated to Taiwan in 1949 and had since then barred the exchange of activity in any form. The situation started to improve in the late 1980s after forty years of separation. The martial law was abandoned in 1987, which subsequently gave green light for the Taiwanese residents to visit China. For the first time in four decades, people in Taiwan were allowed to freely visit China. In 1991 the Chinese communist was no longer officially treated as a renegade group. Bilateral economic and personnel exchanges have escalated over the past decade.

Much as though economic activities and tourist visits at the private sector between the two sides grew rapidly, official exchange was surpassed. The major obstacle to normalizing the relations between Taiwan and China has been China's refusal to treat Taiwan as a sovereign state and conduct dialogues on an equal footing. With China's threatening warning of using military force against Taiwan, active engagement with China has been almost impossible because Taiwan has too much at stake, especially national security. Political standoff has impinged on economic activities. Taiwan has so far banned direct links of trade, shipping and postal correspondence with China. Investment in China is also scrupulously regulated.

Trade development Limit on trade with China was gradually deregulated from 1987.

Total trade with China recorded remarkable growth since 1987 when the martial law was abandoned. Before 1987 bilateral trade volume was volatile mostly due to macroeconomic destabilization of the Chinese economy since opening up of 1979. In addition, China's import was circumvented by scant reserves of foreign exchange. In a command economy import was under careful control by the state in China. In 1984 Taiwan relaxed control on the export to China via Hong Kong and Macao, which amounted to allowing the private sector to conduct indirect trade with China. Indirect trade was made legal in 1985 when the government declared not to intervene in transhipment trade. Barriers to export to China were largely dismantled since 1990. In contrast, indirect import from China was by and large regulated late into the 1990s. A considerable amount of China-made commodities was not allowed to enter Taiwan.

Bilateral trade growth has been boosted by Taiwan investment in China

Taiwan's exports to China have been derived from the business sector's investment in China to a great extent. When Taiwan invested increasingly in China, demand for machinery, intermediary products from Taiwan also grew. However, constraint on import from China with only very limited categories of commodities being allowed to come to Taiwan had slowed the growth of import. Therefore Taiwan ran considerable trade surplus with China. According to estimates by the Mainland Affairs Council of Taiwan, trade surplus stood US$3.6 billion in 1990, and grew year on year to $18.5 billion in 1997. For comparison, in the same year Taiwan recorded an overall $7.6 billion of trade surplus. One of the driving forces of the surging export to China was found in the change of prices of international production factors. Taiwanese companies used to produce domestically and then export to the West. With gradual movement of production lines to China, Taiwanese enterprises now export machinery and intermediary raw materials to China and reprocess by utilizing cheaper labor and land for final export to Europe and the US. As a result, Taiwan businesses have generated massive exports to Western markets for China. That is, trade type of Taiwan businesses changed from export of final consumer products to the West to export of machinery and intermediary and raw materials to China for further processing and destined for the West for final consumption.

Taiwan Investment in China

Background

Taiwan started large scale outward direct investment in the 1980s. Before 1987 when foreign exchange, may it be for tourist or overseas investment purpose, was still under strict control. However, in the 80s the Taiwan currency was under strong pressure of appreciation due to rapid accumulation of foreign reserves. As a result, control on remittance of reserves to abroad became lax. In particular, remittance for financing outward investment was less strict. However, investment in China was still closely regulated. Indirect investment in China was not officially recognized until 1990, though such activity dated back to 1983. By 1999 Taiwan investment in China is still classified as three categories among more than 9,000 items. The first category of investments are strictly forbidden, which account for 3.7% of the total. The second category consists of 34.4% of the total and needs to be approved on a case-by-case basis. The rest, or 61.9% of the total, belongs to the third category of investments that are allowed, which include mainly traditional labor-intensive industries. However, the new government is now considering giving the green light to some of the items that have been forbidden. Restrictions on the second category are also likely to be relaxed and hence more items will become allowed to invest in China.

Taiwan ran significant trade surplus and the NTD appreciated massively.

Taiwanese businesses relocated to China for one very important reason. After the open-door policy, the Chinese adopted policy that welcomed foreign direct investment for lack of international reserves and technology, managerial and marketing skills that accompany FDI. Special economic zones were established and provided foreigners with preferential measures. China particularly welcomed Taiwanese investors for political as well as economic motivation. Moreover, Taiwan companies were faced with changing domestic economic environment in the 1980s because of appreciation of the domestic currency, resulting from the constantly rising trade surplus as well as rapid increase of wage rates. In 1981 trade surplus registered US$1.4 billion, equivalent to 2.9% of GNP. It grew year on year and climaxed in 1986 to US$15.7 billion, recording 20.3% of GNP. As a result, the NTD appreciated against the US dollar abruptly. In 1985, the exchange rate of the NTD against one US dollar was 39.85. In 1987 it was down to 28.55; by 1992 it was 25.4. In that period the NTD appreciated more than 60%.

Taiwan companies relocated production bases to China

In the 1980s Taiwan's export industry still concentrated in relatively labor intensive products. Rapid appreciation of the national currency eroded Taiwan's international competitiveness. Pressure on readjustment and restructuring was further heightened because of the soaring wage and land price. Companies sought overseas destinations for cheaper labor and land for controlling operation costs. Before 1990 Taiwan's outward investment concentrated in Southeast Asia due to the government's go-south policy. The subsequent gradual deregulation has brought about a surge of Taiwan investment in China.

Table 1 tells the fact of rapid development of indirect investment in China. According to Taiwan's official figures, Taiwan approved US$174 million and 237 projects in 1991. In 1993 it grew to US$1.14 billion and 1,262 projects. Since a lot of investment activities took place long before government's legalization, these were called for registration and became official record, which amounted to US$2.028 billion. By 1999 the approved projects accumulated at 22,134 with a total amount of US$14.495 billion. This accounts for more than 40% of Taiwan's total outward investment. With the granting of the permanent normal trade relation by the US to China, and the prospect of the entry to the WTO before end of this year, investment by Taiwan business has accelerated. For the first four months of this year total projects in China recorded 198, up more than 66% compared to last year, while approved amount increased 147% to US$735 million.

The Chinese authorities recorded higher figures of Taiwan investment

Current investment in China is conducted in an indirect way, namely, it can be done via overseas affiliated companies. Many investments were not filed with Taiwan authorities. It is no wonder that the actual investment in China must have exceeded Taiwan's official figures. Data released by China provides good reference. According to the Chinese authorities, Taiwan has invested 43,516 projects in China so far. The contracted amount accumulates at US$43.8 billion, or 23.9 billion for realized amount. Both significantly surpass Taiwan's official data. In reality, as Taiwan companies become larger in scale, more and more have multinational operations. The distinction between investment sources from Taiwan-origin and foreign-origin has demarcated.

Taiwan has become the second biggest investor in China and nvestors are still eager to pour money into China. Even though China very often would like to suggest how much money Taiwanese businesses have earned from their investment in China and downplay the importance of Taiwan investment, FDI is still the key to China's sustained economic growth and the successful reform on state-owned enterprises (SOEs). That is why China has to open its market by joining the WTO. China needs foreign capitals to privatize its inefficient enterprises and modernize corporate management and infrastructure. It also needs to introduce foreign competition to bring efficiency gain. Joining the WTO is the start to meet the two ends.

However, potential destabilizing factors also lie in the WTO membership. FDI is critical for the Chinese economy, and hence China must keep foreign investors' confidence in the future of its economy. Joining the WTO will increase competition, and many of the Chinese SOEs will have to go bankrupt. Massive unemployment is almost inevitable, which could cast great shadow on social stability. Political stability and social order is one of the determinants of FDI. To keep FDI flowing in, China must continue to improve its investment environment. In this regard, China's administration efficiency has left much to be desired because corruption has been so rampant that investors have been deterred.

II. Cross strait economic relations after President Chen's inauguration

In his victory speech, President Chen sent a clear message that he is willing to conduct extensive, constructive communication and dialogue with China with the utmost goodwill and determination to maintain peace and stability in the Taiwan Strait. He even went so far as to propose negotiating with China the issue of direct transportation links, business and investment links, something that China has long advocated but the former ruling party was reluctant to give way. The low profile the president kept so far has downplayed the possibility of imminent conflicts and his restraint won both domestic and international acclaims.

In his inauguration speech, President Chen promised to pursue reconciliation with China. Based on the ancestral, cultural, and historical background shared by the two sides of the Taiwan Strait, President Chen called upon the Chinese leaders to deal with the question of a future "one China" with wisdom and creativity.

Great conciliatory intention was evidenced in President Chen's speech. Being a long-time advocate of pro-independence of Taiwan, he pledged, during his term in office, not to declare independence, not to change the national title, not to push forth the inclusion of the "state-to-state" description in the Constitution, and not to promote a referendum to change the status quo in regard to the question of independence or unification, as long as the Chinese Communist Party regime has no intention to use military force against Taiwan.

Contrary to widespread expectations President Chen has kept a very open attitude toward resuming dialogue with China. He is willing to review current policy on direct links with China on the condition that national security is not jeopardized, and to relax control on Taiwan investment in China. I believe this is a good chance that China can start economic cooperation with Taiwan if China is willing to respond to Taiwan's new government. In particular, Taiwan and China will join the WTO this year. Direct links will benefit both sides in addition to facilitating closer cross-strait economic cooperation under the precondition that Taiwan's security is not threatened and an effective mechanism of dispute resolution is established and abided by both sides.

III. Some Scenarios

After all the reconciliatory gestures Taiwan's new president has made, development of future bilateral relationship depends upon how China chooses to react to President Chen's goodwill. There are four likely scenarios.

First of all, if China should be pragmatic enough to respond favorably to Taiwan's newly elected leader, the outlook will be very optimistic. Not only will current ban on direct links of transportation can be dismantled in the near future, existing regulations on investment of Taiwanese companies in China will also be lifted gradually. It is beneficial to both sides' interests, in particular, after Taiwan and China enter to the WTO end of this year.

Secondly, if China chooses to maintain its rigidly staunch stance on "one China" and treat Taiwan's new president with great suspicion, bilateral relations will be at a standstill. Current economic relationship between the two sides will maintain the status quo.

Thirdly, let us assume both Taiwan and China join the WTO this year. If China responds to Taiwan's goodwill and makes reasonable adjustment of its policy toward Taiwan, bilateral relations will be significantly improved under the framework of the WTO. New opportunities for increased cooperation between the two sides will come forth. Both sides can change economic policies by the good reasons of following WTO rule.

On the other hand, should China still take hostile attitudes toward Taiwan after both entering the WTO, the cross-strait relation will improve to the extent that the WTO's rule of law meets the condition that both sides of Taiwan Straits are willing to concede. This is because that China's hostile threat to use force against Taiwan will force Taiwan government to take more defensive measures for the safeguard of national security and interests. Political element will still be a constraint on further improvement of economic relation.

Lastly, should there be an outburst of military conflict in the Taiwan Strait, both sides will have considerable economic losses. It could lead to a retreat of Taiwan investment, as well as FDI of other countries, from China. With Taiwan's increasingly importance in the Chinese FDI, China would incur great costs of export, employment, foreign reserves and production. Most importantly, China could lose its access to global markets and impact on other FDI. Economic stability and the future of its economic reform would also be less bright. In addition, regional stabilization would also be seriously jeopardized. This is the most unfortunate case that no side would like to see.

IV. Perspective of economic cooperation

Looking ahead, economic cooperation between Taiwan and China still hinges on development of political atmosphere and nurture of mutural trust. Any military conflict in the Taiwan Strait will cast great instability in the region. What is at stake is far more than the prosperity of Taiwan and China, but also interests of the East Asian countries and, I believe, the US as well. Both sides of the Strait have tried to avoid such conflict and lessen the probability of future military conflict. At least, President Chen has demonstrated all the goodwill a leader possibly has in his inauguration speech of May 20. The rest of the world can rest assured that Taiwan will not provoke China into using military force against Taiwan. The best opportunity for future cross-strait economic cooperation has been presented to both sides of the Taiwan Strait now. It is obvious that China's renouncing the use of force against Taiwan is a critical element of maintaining the stability and peace in East Asia.

On the other hand, if the cross-strait relation keeps the status quo, economic cooperation between both sides will continue to grow, but with considerable obstacles. Even if the countries in the region and the US are willing to take great efforts to remove these obstacles, under such circumstance, however, room for bilateral economic cooperation will be limited.

China should take good advantage of President Chen's goodwill to make reconciliation with Taiwan; set aside political contentions of the old era and seek to cultivate closer ties. It is a great opportunity for building mutual trust and normalizing bilateral relations with the facilitation of the WTO membership. Closer economic cooperation between Taiwan and China will contribute to stability in Asia and welcomed by countries in the region. I personally think that this is the most major contribution that China can make to the future prosperity and stability of East Asia. It is also most desirable for the governments and people of both sides of the Taiwan Strait.