Taiwan looks to China to grow high-tech operations

Although the two countries do not formally recognize each other, Taiwanese companies are rapidly opening factories on the mainland and working to persuade their government to relax a host of regulations to allow even greater expansion.

Taiwanese companies, for instance, are not permitted to move notebook or semiconductor manufacturing facilities to mainland China because of national security laws. Technically, Taiwanese companies are not even in China. Instead, they form shell corporations in the Cayman Islands and funnel investments to China. That's starting to change, though.

"By the end of this year, the People's Republic of China will have an opportunity to take over Taiwan in terms of IT products," said Victor Tsan, director at the Institute for Information Industry, an analyst organization.

Taiwan is third in production of computer products with roughly $40 billion U.S. in output, most of which is resold under brand names such as Compaq and Cisco. China is fifth in production and growing.

"We have a shift of manufacturing to areas with cheaper factors of production," Tsan said.

Dealing with the Chinese government represents another problem. A full-blown military conflict, executives in Taiwan say, is highly unlikely. Nonetheless, "risk" is one of the most commonly used words in the business community when it comes to China. Targeted taxation, ad hoc regulations and other bureaucratic interference are some of the fears.

The push toward China comes from both necessity and opportunity. China is rapidly taking over PC and electronics manufacturing, which has been a mainstay of the Taiwanese economy. A company can save approximately $20,000 NT ($650 U.S.) per manufacturing employee per month by moving to China, Tsan said.

Rather than fight the trend, Taiwanese companies are increasingly emphasizing product design, inventory management, software-hardware integration and other professional services, said Stanley Huang, director of marketing and business management at Intel. Call centers and warranty service operations for major U.S. companies also are being taken over by Quanta, Mitac and other Taiwanese contract manufacturers.

In this scenario, U.S. PC companies will largely become marketing and sales organizations, while Taiwanese companies will handle logistics, operations and engineering. They will also manage manufacturing in China.

"Every time I go to China I can visibly feel the difference," Huang said. "Every time, it becomes more efficient."

To ensure that other companies do not get to China first, the Taiwanese are investing heavily. Sixty percent of high-tech operations in China are owned by Taiwanese companies, Tsan said. Thirty-three percent of Taiwan's output was made in China in 1999, up from 29 percent in 1998.

Along with its growing manufacturing role, China also is expected to become a huge consumer of computer products.

"China is definitely an import market for Taiwan," said Wen Chi Chen, CEO of Via Technologies. "Most of China is using Via chipsets."

Added Ching Hsiao, CEO of The Enovation Group, a Taipei-based incubator: "Now the No. 1 goal is the potential market size. You can't ignore them The probability of a war is minimal."

The sticking point, however, is China itself. Although war is unlikely, many fear that the government will impose onerous or arbitrary regulations.

The two countries are also locked in a bitter dispute over Taiwan's status as an autonomous nation, a feud that intensified after the March election of President Chen Shui-bian, whose party advocates national sovereignty. Chen has said he will not seek independence this term. China still seeks unification above all else.

"Acer on the mainland is keeping a low profile because they support the new government," Tsan said. "(Acer chairman) Stan Shih is trying to explain his position."

The absence of normal relations further complicates matters. Because the countries do not recognize each other, there are no treaties to modulate changes, such as how tax laws are enforced.

"All of our investment is not protected," said Calvin Wu, director of sales for Micro-Star International, a major motherboard manufacturer with operations in China.

Like many other Taiwanese companies, Micro-Star's China facilities are registered to an overseas shell company. The Taiwanese government knows of all these operations. "They don't stop it, and they don't promote it," Wu said.

China, however, is at a transition point and is beginning to examine how it regulates high tech, said one local investment banker. Like Taiwan, China may give more tax credits or streamline bureaucracy for any company involved in electronics.

"On the surface you see a lot of tension, but when you look at it from the point of view of negotiation, it makes more sense," Hsiao said. "And these are not two-party negotiations. It is a multiparty negotiation?Talk has to be tough at this point, at least on the surface."

Taiwan should "increase interaction with China," Robert Mundell, a professor of economics at Columbia University and recipient of the 1999 Nobel prize for economics, said at the 2000 World Congress on Information Technology. "With China joining the WTO, it will not be a threat to Taiwan."

Several issues pending before both governments could indicate how fast economic interdependence will occur. The Taiwanese government, for instance, is considering raising the amount that Taiwanese companies (through their shell corporations) can invest.

A relaxation on the ban preventing semiconductor and notebook operations would also represent a significant step forward. A proposal for passing a "national security tax" on Taiwanese companies in China drew a wave of criticism.

A shift in notebook policy could be particularly significant, Tsan said. Portables represent the bedrock of the industry, although local manufacturers saw average notebook prices slide by 32 percent in 1999. In an effort to lower labor costs, 3 percent of Taiwan's capacity has moved to the Philippines. If normalization with China occurs, 30 to 50 percent of the country's notebooks could be manufactured on the mainland by 2002, Tsan said.

"It all depends on notebooks," he said.