Thomas White Global Investing

Country Profile

Taiwan

November, 2008

Thomas White International, Ltd.

Thomas White Global Investing 2

Thomas White Global Investing

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Country Profile

Taiwan: Giving New Meaning to “Madein Taiwan”

Increasingly dynamic and

diverse, Taiwan, also known as

Taipei, China, is the world’s 24th

largest economy, the 16th largest

exporter, and the 16th largest

importer in merchandise trade.

Taiwan is an archipelago of 86

islands, with the largest, Taiwan

Island, comprising almost 98%

of the country’s land mass of

13,900 square miles. One of

Asia’s “Four Tigers,” along with

South Korea, Singapore and

Hong Kong, Taiwan has

transformed itself through

decades of hard work to a well-

industrialized and mature

economy. Today, it is an

important economic and trading

center with one of the world’s

busiest ports in Kaohsiung.

From being an underdeveloped,

agriculture-based island, Taiwan

has grown to be a world-class

leader in technology. A recipient

of U.S. aid in the 1950s and

1960s, Taiwan is now a major

foreign investor, an aid donor,

and holds the world’s fifth-largest

stock of foreign exchange reserves. Growth has been painstaking. Taiwan

was first transformed from a Dutch East India Company colony to the home

for a Ming-loyalist regime. It endured centuries as a province under the Qing

Empire, followed by a Japanese occupation, and eventually more than 50

years under the Kuomintang (KMT). Yet, despite being only a third the size of

Virginia or a little smaller than Switzerland, Taiwan has overcome its physical

limitations and challenges to remain one of the economic centers in Asia.

Taipei, the capital of Taiwan, is a bustlingcity, with skyscrapers jostling with ancienttemples. Vibrant with modernity, the city isthe economic center of Taiwan, with mostof the textile and electronics offices havingtheir centers here.

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An island of refuge for the fleeing

The islands of Taiwan were first occupied by the Japanese as far back as the

12th century. Later on, in

1590, Portugal became the

first European nation to set

foot on the island, which they

poetically named Ilha

Formosa, meaning beautiful

island in Portuguese. A tug of

war then followed with the

Dutch and the Spanish all

vying for possession of

Taiwan. Eventually, the

Dutch held sway, claiming

occupancy of the P’enghu

Islands in 1622. The Dutch

occupation, however, was

short-lived. Once the ruling

Ming dynasty in China was

overthrown by the Qing

dynasty, change was

inevitable on the tiny island.

Eventually, Cheng Cheng-

kung, known as Koxinga in

the West, and one of the

most famous resistance

fighters against Manchu rule,

immigrated to Taiwan. Large-

scale immigration of Chinese

began in the 17th century,

especially from the coastal

provinces of Fujian and

Kwangtung, as they fled to

escape the oppression of the

Manchu. Taiwan grew during

this phase as an anti-Manchu

base. Cheng’s death hastened the end of Manchu resistance, and in 1683,

Taiwan finally surrendered to Qing rule. Peace, however, was to be elusive

for the long-suffering island as it was ceded to Japan, under the Treaty of

Shimonoseki, following the end of the Sino-Japanese War. Infrastructure was

developed under the Japanese but the Taiwanese seethed under the yoke of

occupation, and several revolts rocked the island, all of which were brutally

put down by Japan. In 1945, with the surrender of Japan in World War II, both

Taiwan and the P’enghu Islands were declared a province of China. At this

Chiang Kai-shek, who fled to Taiwan after theKuomintang suffered heavy losses in the civilwar with the Communists, became theRepublic of China’s first president in March1948. He ruled Taiwan with an iron hand,imposing martial law. Yet, he was responsiblefor implementing land reforms, and launchingfive successive four-year economicdevelopment plans that laid the foundation forthe meteoric rise of Taiwan, imposing martiallaw.

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time, Taiwan was governed from Nanjing by the KMT led by Chiang Kai-

shek. However, enmeshed and embroiled in a bitter civil war with Mao

Zedong’s Communist Party, the Kuomintang fled to Taiwan upon its defeat.

Establishing the Republic of China, Chiang Kai-shek ruled as the first

President of Taiwan. Despite attempts by China to invade Taiwan, the island

nation gained the support of the U.S., helping it to resist Chinese incursions.

The U.S. continued to support Taiwan, promising to defend the country in

case of outside attack. The Nationalist Army was trained and equipped by the

U.S., and along with substantial aid from its benefactor, Taiwan enjoyed

spectacular economic growth, building on the infrastructure laid by the

Japanese. By the 1960s, after the U.S. had injected around $4 billion in

Taiwan, the country progressed to such an extent that such aid was rendered

superfluous. However, Chiang Kai-shek, who was elected President for the

fifth time in 1972, witnessed increasing criticism against what was termed

dictatorial rule. At this time, China was also increasing pressure on the

international community to acknowledge Taiwan as its province. The result

was that by 1981 very few nations maintained diplomatic relations with

Taiwan including close ally U.S., which formalized diplomatic relations with

China following President Reagan’s historic maiden visit to the Communist

country in 1972. Disillusioned with the lack of support from the international

community, Chiang Kai-shek, who died in 1975, was succeeded by his eldest

son, Chiang Ching-kuo. Martial law, which had been imposed since 1949,

was lifted in 1987. The first Taiwanese president, Lee Teng-hui, headed a

government that in 1988 moved towards empowering more Taiwanese in the

government. Since then, changes have been swift. In 1991, Taiwan proposed

a long-term, three-phase reunification plan with China, along with plans to

restructure the government. More political miracles occurred when Lee Teng-

hui won the first popular election for president in 1996. Relations with China

reached a new low when pro-independence Democratic Progressive Party

(DPP) candidate Chen Shui-bian was elected president.

Today, the head of state remains the president, elected by popular vote for a

four-year term. Having made the transition from a one-party regime to a

democracy, Taiwan is now headed by President Ma Ying-jeou from the

Nationalist (Kuomintang) Party, who defeated DPP’s candidate Frank Hsieh

in March 2008. Hsieh’s defeat marked the end of eight years of DPP rule, and

the return to power for the Nationalist Party. Ma is also known to be pro-

China, and his election was greeted with delight by Beijing, especially after

former president Chen Shui-bian proposed the controversial Four Wants and

One Without policy. In this policy, Chen said that Taiwan wants

independence and a new constitution, and wants the rectification of its name,

as well as development. He insists that politicians in Taiwan would be divided

only on the question of unification or independence.

Taipei is the heart of modern Taiwan – a bustling, traffic-clogged city that is

the center for the KMT-dominated national government, and the seat of its

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executive offices, cabinet ministries, and the supreme courts. The city is

also the stronghold of the ethnic mainlander, or wai-sheng jen, who continues

to exercise fair dominance in government.

Japanese, Chinese and Western fusion

Taiwanese culture is a fusion of indigenous customs with Chinese, Japanese

and Western traditions. The birthday of Ma-tsu is a celebration with great

fervor all over Taiwan, and is a major event in the island’s religious and

cultural calendar. Buddhism, Taoism and Chinese folk religions have all held

their pride of place in

Taiwanese society

over the years. Other

important festivals

include the Hungry

Ghosts Festival, the

Lantern Festival, the

Dragon Boat Festival

and Lovers Day, all of

which are popular in

China too. During

these festivals, hakka

people make a

variety of traditional

ban rice patties.

Since Taiwan is an

archipelago of more

than 88 islands,

several tribes on

some isolated islands managed to retain their aboriginal status. Indigenous

tribes include the Amis, Atayal, Bunun, Rukai, Puyuma, Sao, Tao, and the Zou.

Remnants of Taiwan’s colonial culture can be found throughout the country.

There are around 12 indigenous tribes recognized by the government, which

have a combined population of 464,000. Each group has carried through

centuries their unique customs – for example in the Atayal tribe, face

tattooing and cloth weaving are dominant.

Mandarin Chinese is the official language, while Min Nan Chinese or

Taiwanese as it is more popularly known, is widely spoken on the island. The

combination of popular songs (ge zih) with the performing style of che gu or

cart drum opera led to the birth of the traditional Taiwanese opera.

Taiwanese cuisine can be divided into Holo (Minnanese), Hakka and

aboriginal dishes. “Pearl Milk Tea,” which is made with flour balls and

aromatic milk was invented in Taiwan, and has spread in popularity

throughout the world. Also famous is Taiwanese glove puppetry, which has

Taiwanese opera is believed to be unique to Taiwan in

terms of its origin and development. The form

supposedly had its origin in songs from Ilan County.

The opera is omnipresent on almost every major

occasion, be it a birthday, wedding or a festival.

Today, nearly 200 troupes perform on the operatic

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Taiwan and the World

Nominal GDP ($) 383.3 billion

GDP Rank 24/185

Per Capita GNI ($) 17,230

Per Capita GNI Rank 50/224

Population Rank 98/224

Geographical Area

Rank

138/250

Global

Competitiveness

Rank

14/131

Economic Freedom

Index Rank

25/157

Major Industries Electronics, Computer

Peripherals,

Petrochemicals,

Textiles, Plastic and

Rubber Products,

Basic Metals

its roots in Taiwan’s folk society. In fact, long before television made its

appearance in Taiwan, glove puppetry was the main form of entertainment.

Accompanied by music,

the puppets wear highly

colorful costumes that

enable the audience to

decipher their “social

class.”

Industrialization and

foreign trade spur growth

Taiwan’s economic growth

has been nothing short of

spectacular. Hailed as one

of the Asian Miracles of the

modern era, Taiwan in the

1960s and 1970s was

heavily dependent on

foreign technology and aid,

especially in the electronics

and information technology

industry. The country’s

gross domestic product

(GDP) grew in real terms

by 44 times from $1.7

billion in 1952 to $282

billion in 2001. Even per

capita income increased 16

times from $196 in 1952 to

$12,678 in 2001. This

growth was sustained even during the great Asian financial crisis, which

severely affected countries such as South Korea and Thailand, but left

Taiwan relatively unscathed. Taiwan’s GDP declined by only 2% in 1998.

Much of this growth can be traced to strong industrialization. Manufacturing

production, which accounted for 84% of industrial production in 2001,

expanded by 130% (in real terms) over the period 1986-2002. (Source: ADB).

Today, Taiwan is a modern, developed economy with heavy emphasis on

services, manufacturing and high technology.

Since the 1960s, Taiwan’s government was known for adopting export-

friendly policies, while instituting reforms that led to greater agricultural

productivity. Foreign trade spurred Taiwan’s growth for the next 50 years.

Gradually, as manufacturing and industry developed, export composition

changed from mainly agricultural commodities to industrial goods. Of special

importance was the electronics sector, which became the single largest

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recipient of U.S. investment. The share of the industry sector increased

from 26.9% of the GDP in 1960 to 45.7% in 1980. Today, manufacturing

accounts for 27.5% (2007 estimates from CIA World Factbook) of the GDP.

Major manufactured products include petrochemicals, electrical and

electronic machinery, paper products, and basic metals. Similarly, the

services sector increased its share in the GDP from 44.6% in 1960 to 54.6%

in 1990 and 71.1% in 2007, (2007 estimates from CIA World Factbook) buoyed

by strong growth in the financial, insurance, and retail subsectors. Today, the

most important services are finance, insurance, and business services,

followed by wholesale and retail trade. Tourism remains an important

economy driver, as almost 3.7 million visitors toured Taiwan in 2007.

Meanwhile, agriculture has been declining. In 2007, agriculture contributed to

just 1.4% of the GDP, (2007 estimates from CIA World Factbook) as Taiwan’s

economy began to increasingly resemble that of developed countries. Main

crops include rice, sugarcane, tropical fruits and vegetables.

China (including Hong Kong) and the Association of Southeast Asian Nations

(ASEAN) have become increasingly important trade partners for Taiwan

since 2000, though trade with these two regions has grown more slowly in the

last three years. Japan has remained Taiwan's largest supplier of imports,

despite a narrowing share. At the same time, exports to the U.S., Europe,

and Japan have slowed as those of China and ASEAN have increased.

With five container terminals, the Port of Kaohsiung is one of the busiest in Asia

with an annual handling capacity of 10 million twenty-feet equivalent units (TEU).

In 2007, for the first time, Kaohsiung Port exceeded the 10 million mark, handling

10.26 million TEUs, a 4.9% increase from 2006.

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Economy dependent on imported energy

Taiwan does not have sufficient domestic energy resources and must rely on

imports to meet a large portion of its energy needs. Of Taiwan’s total energy

consumption in 2005, around 45% of was derived from oil, followed by coal

with 36%, and natural gas representing 9%. Because of its low domestic oil

reserves, (Estimated proved oil reserves of 2.38 million barrels as of January 2008),

Taiwan must meet all its oil demand through exports. Taiwan is also the sixth-

largest importer of liquefied natural gas (LNG) in the world and the third

largest in Asia. Most of the electricity in Taiwan is generated from

conventional thermal sources, which accounts for nearly 78% of total

electricity generated. Nuclear sources remain in a nascent stage although

they do account for 18.1% or 38 Bkwh of electricity generated. The country

currently operates three nuclear power plants, but construction of the fourth,

the Kungliao project, has been mired in controversy. At first, the then

President Chen cancelled the construction of the nuclear reactor, aiming for a

vision of a “nuclear-free homeland.” The new KMT government subsequently

revived the project, and the first unit of the Kungliao plant is expected to

begin commercial operations in 2009, with full operations set to be completed

by 2012.

Taiwan’s economy is 71% free, according to the 2008 Index of Economic

Freedom, making it the world’s 25th freest economy. The country scores

significantly higher in the Asia Pacific region, ranking sixth out of 30

countries. The Index notes that the government has continued to liberalize

the financial sector by allowing foreign investment in banks, and gradually

loosening capital controls. At the same time though, Taiwan is officially

isolated in the diplomatic community. In Taiwan, they call China the An-Shan,

meaning mountain. And China is always looming large in Taiwan’s

landscape. Beijing insists that countries cannot have formal relations with

both China and Taiwan, and asks them to choose. Most nations inevitably

choose China. As a result, Taiwan has had formal diplomatic relations with

only two dozen countries, mainly in the Pacific, South America and Africa.

The U.S., however, recognizes Taiwan as an independent state, choosing

instead state-to-state relations. The country is also currently not a member of

key organizations such as the International Labor Organization (ILO), the

International Monetary Fund (IMF), the World Bank (expelled in 1980), and

crucially is not included in the United Nations (UN). It is however, a member

of the Asia-Pacific Economic Cooperation (APEC), the Asian Development

Bank (ADB), and World Trade Organization (WTO) under the name Separate

Customs Territory of Taiwan, P’enghu, Kinmen, and Matsu (Chinese Taipei).

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Challenges for development and economic prospects

Taiwan’s accession to the WTO enabled the tiny nation to seek better

international opportunities as many free-trade agreements were signed.

Despite this progress, crucially, the country’s complex relationship with China

needs to be ironed out.

Although the global financial crisis that is plaguing the world began in 2007,

Taiwan saw growth accelerate that year. Domestic demand picked up, and

exports continued to strengthen as GDP rose to 5.7% in 2007, one

percentage

point above the

average for

2003-2006.

Exports to the

U.S., showed

signs of slowing,

falling by 0.9%

in 2007, but was

offset by strong

demand in

China, and other

markets in Asia.

With the rise in

global

commodity and

energy prices,

inflation rose.

Services grew

at a rate of

4.3% even as manufacturing registered its best performance in more than a

decade. That sector expanded by 10.1% spurred by increased demand for

electronics components, telecommunications products, and chemical

materials. The agricultural sector, on the other hand, was dampened by a

severe typhoon in the fourth quarter, which caused the sector to contract by

2.9%. Despite such a glittering performance, Taiwan’s prospects in 2008-09,

and beyond would be undermined by its excessive reliance on exports as a

main driver of growth. As the U.S. slips further, economic growth is forecast

to decelerate to 4.2% in 2008 although growth is again expected to pick up to

5.6% in 2009, according to the ADB.

Crucial to this growth estimate is the assumption that domestic demand

would provide a fresh impetus and Ma’s new, China-friendly policies might

realize in greater economic cooperation. Despite the weakness in private

consumption, Taiwan’s real GDP grew 4.3% in the second quarter of 2008,

as exports continued to boost overall growth. Although private fixed

investment fell 9.4% in the second quarter of 2008, forecasts from the

Interestingly, Taiwan has one of the world’s highest densities

of convenience stores per person, with more than 9,000

dotting the city landscape. Total retail trade is valued at $96

billion (2006). Among the major retail channels, convenience

stores share around 27% of sales, equaling $6 billion.

Thomas White Global Investing 11

government estimate that investment in the second half is expected to

rebound along with a 15.4% increase in government fixed investment.

Industrial production grew 8.1% in the first seven months of 2008, with

manufacturing output jumping 8.8%. With global commodity and oil prices

rising, Taiwan felt the heat as the Consumer Price Inflation (CPI) in July 2008

showed a rise of 5.9% year-on-year, and the Wholesale Price Index (WPI) an

increase of 11.5% year-on-year for the same period. The U.S. sub-prime

mortgage turbulence has been spreading to international financial markets.

Under the worsening global economic environment and strong inflationary

pressure, the downside risk to Taiwan’s economy is increasing. This is a

country that is extremely dependent on oil imports, and the recent spike in

global oil prices, will not help the import oil-dependent Taiwanese economy.

In fact, the International Energy Agency (IEA) estimates that Taiwan will

account for 5.3% of Asian demand for oil by 2030, a staggering figure for an

extremely tiny nation.

One of the key challenges for

Taiwan lies in facilitating more

cross-strait economic

integration. China already

accounts for 40% of Taiwan’s

exports and 70% of its inbound

investment. However, in the

absence of direct cross strait

transportation links, all cargo

must be routed through Hong

Kong or Macau in order to

reach China. Invariably, this

means higher business costs.

Direct transportation links with

China would elevate Taiwan as

a research and development,

logistics, and financial center.

In a step towards a thaw in

relations, the first regular flights

linking China with Taiwan

began operations in July 2008.

The weekend flights link

Beijing with Taiwan’s capital,

Taipei, and the southern port

of Kaohsiung. Taiwan had

barred direct travel for

decades as a security

measure, but had allowed

charter flights on Chinese

holidays in recent years. The

Inspired by Taiwan’s native bamboo plant,

the Taipei 101 Tower is currently the world's

tallest completed building with its 509m

height. The steel-and-glass skyscraper is

reminiscent of a typical Chinese pagoda, and

is located in the heart of Taipei’s business

center.

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move marked a welcome change in Taiwanese-Chinese relations, which

were strained during the eight years that Chen Shui-bian was in power.

Tourism has been steadily picking up, and in 2007, 3.7 million people visited

Taiwan, an increase of 5.58% compared to the previous year. The direct

flights will further aid the development of tourism in the country, as overseas

Chinese contribute to 19.57% of the total visitor arrivals in Taiwan. From just

7,374 Chinese tourists in 1961, 2007 saw as many as 727, 248 visitors, a

jump of 9.49% from 664,198 arrivals recorded for the previous year. On a

worrying note, construction, one of the major indicators of industrial activity,

contracted by 0.4% in 2007. The decline was due to two factors: there was a

concern that housing prices might stabilize, and second, rising prices of

building materials made investment in this sector more expensive. The

Consumer Price Index rose by an average 1.8% in 2007, compared with

0.6% a year earlier, and the average earnings of nonagricultural workers was

2.3%, slightly higher than the inflation rate. During 2007, the Taiwan

currency, the New Taiwan

(NT) dollar, depreciated on average by 0.9% against the U.S. dollar but the

trend has been quite the opposite in 2008. The NT dollar appreciated by

5.6% against the dollar in the January to mid-March period, a fact that is likely

to limit imported inflation. The economy also needs to diversify into high-end

manufacturing and into services. Crucially, as Taiwan’s economy relies

heavily on electronics, a slump in demand in the key U.S. market will have a

dampening effect. That, coupled with rising production costs in China, where

much of the electronics production has been relocated, and the entry of

several more lower-cost countries into the industry, means increased

pressure on producers in Taiwan.

Yet, despite these challenges, Taiwan’s economic miracle continues. The

country has a dynamic, progressive economy, a stable democracy, and

increasing support from its key neighbor, China. Relations with China are

improving steadily, especially under the new leader Ma Ying-jeou and Taiwan

might truly emerge from the shadows of its immense neighbor. Ilha Formosa

has come a long way with modern, teeming cities that justify Taiwan’s status

as a megapolis. As the 21st century moves towards the end of its first decade,

Taiwan has changed – it is no longer a small isolated province of escapism,

struggling for understanding from Europe and America, and battling the might

of China – but a pivotal cog in the reshaped, restructured global economy.

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