Prospects for a US-Taiwan Free Trade Agreementby Daniel H. Rosen, Nicholas R. Lardy
A new Institute for International Economics study 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 authors, Nicholas R. Lardy and Daniel H. Rosen estimate 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.
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