This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 04 TAIPEI 003734 
 
SIPDIS 
 
SENSITIVE 
 
DOT FOR ASSISTANT SECRETARY KARAN BHATIA 
 
DEPARTMENT FOR EAP/RSP/TC 
 
DEPARTMENT PASS AIT/W 
 
E.O. 12938: N/A 
TAGS: ECON PREL EAIR PGOV OVIP TW
SUBJECT: Scenesetter for DOT A/S Bhatia's Trip to Taiwan 
 
REF: A) AIT TAIPEI 3523, B) AIT TAIPEI 3563 
 
Summary 
------- 
 
¶1.  (U) The United States' unofficial relations with Taiwan 
focus on regional security and trade.  Taiwan is considering 
the purchase of USD 18 billion in military equipment from 
the U.S.  Outstanding trade issues include intellectual 
property rights, pharmaceuticals and telecommunications 
market access, and rice imports.  December 11 legislative 
elections will determine if President Chen's Democratic 
Progressive Party will gain control of Taiwan's legislature 
for the first time.  The economy is returning to strong 
growth after Taiwan's first recession in half a century. 
Despite the impact of cross-Strait political tensions, the 
economy increasingly depends on exports to Taiwan's PRC- 
based manufacturing.  The primary concern of Taiwan's 
aviation industry is the lack of direct air links with the 
PRC.  (End summary.) 
 
U.S.-Taiwan Relations - Security and Trade 
------------------------------------------ 
 
¶2.  (U) On January 1, 1979, the United States changed its 
diplomatic recognition from Taipei to Beijing.  In the U.S.- 
P.R.C. Joint Communique that announced the change, the 
United States recognized the Government of the People's 
Republic of China as the sole legal government of China and 
acknowledged the Chinese position that there is but one 
China.  The Joint Communique also stated that within this 
context the people of the United States would maintain 
cultural, commercial, and other unofficial relations with 
the people on Taiwan.  In April 1979 the Taiwan Relations 
Act (TRA) created the legal authority for the establishment 
of the American Institute in Taiwan (AIT), a private 
nonprofit corporation.  U.S. Government visitors to Taiwan 
are considered AIT consultants while conducting USG business 
in Taiwan and must travel on a tourist passport.  Travel by 
USG senior officials to Taiwan is carefully controlled and 
rare; your visit will attract attention. 
 
¶3.  (U) Under the Taiwan Relations Act, the United States is 
committed to offering military equipment that Taiwan needs 
to defend itself.  The Legislative Yuan is currently 
considering a USD 18 billion special budget, which will 
allow Taiwan to purchase diesel submarines, P-3C anti- 
submarine patrol aircraft, and PAC-III anti-missile 
batteries.  Consideration of the budget bill has been 
delayed until after the December 11 elections. 
 
¶4.  (SBU) Market access and trade issues are the main 
concerns in U.S.-Taiwan economic relations.  Taiwan joined 
the WTO in 2002 and committed to reduce barriers to trade in 
several areas, including telecommunications and government 
procurement.  Many of these commitments remain incomplete. 
For several years, intellectual property rights have also 
been a key point of contention.  Taiwan has been a center 
for piracy of optical media and has seen an influx of 
counterfeit products, including pharmaceuticals and branded 
goods, from China.  However, in the last year, Taiwan has 
improved enforcement of its intellectual property laws, 
passed an amended Copyright Law, and proposed legislation to 
create a data-exclusivity regime for pharmaceuticals.  These 
improvements have led the U.S. Trade Representatives office 
to open an out-of-cycle review to consider Taiwan's status 
on the Special 301 Priority Watch List.  The U.S. still has 
concerns about market access for pharmaceuticals and 
telecommunications service providers.  We also continue 
discussions with Taiwan on its tariff and quota regime for 
rice imports.  On November 29, the U.S. and Taiwan will 
resume talks under the Trade and Investment Framework 
Agreement to further progress toward resolving some of these 
outstanding issues. 
 
Politics - More Divided Government? 
---------------------------------- 
 
¶5.  (U) When Taiwan's President Chen Shui-bian was first 
elected in 2000, it marked the first transition of political 
power in Taiwan since World War II and the consolidation of 
democracy in Taiwan.  Chen's independence-leaning Democratic 
Progressive Party (DPP) has asserted increasing control over 
the executive branch bureaucracy, which had been dominated 
for decades by the Kuomintang (KMT).  In March 2004, Chen 
was narrowly reelected with less than 50.1 percent of the 
popular vote.  A controversial shooting incident the day 
before the election, in which Chen and Vice President 
Annette Lu were mildly injured, and the KMT candidates' 
refusal to accept the results of the 2004 election have 
contributed to a particularly bitter partisan environment. 
 
¶6.  (SBU) Legislative elections scheduled for December 11, 
2004, will determine whether Taiwan will have another three 
years of divided government.  The KMT, with its opposition 
partner the People First Party (PFP), forms the "Pan-Blue" 
alliance, which controls the Legislative Yuan, Taiwan's main 
legislative body.  The DPP with its "Pan-Green" partner, the 
strongly pro-independence Taiwan Solidarity Union (TSU), 
hopes to take control of the legislature for the first time. 
Many observers predict that neither camp will have a strong 
majority.  Both camps will need to form ad-hoc alliances to 
move legislation.  That could slow passage of needed 
economic and financial reforms, but it could also discourage 
legislation that might increase cross-Strait tensions. 
 
Economy - Resurgent Growth 
-------------------------- 
 
¶7.  (U) Taiwan is the 17th largest economy in the world. 
For nearly 50 years before 2001, Taiwan experienced rapid 
economic expansion, low unemployment, and low inflation -- 
often called "Taiwan's Economic Miracle."  In 2001, the 
economy contracted for the first time since 1952, largely 
due to fallout from the global high technology industry 
downturn that reduced demand for exports in the key markets 
of the U.S., Europe and Japan.  After two more years of 
disappointing growth in 2002 and 2003, the economy has 
boomed this year with double-digit export growth. 
Economists predict that Taiwan's economy will once again 
return to strong growth in 2004, with real GDP growth 
reaching nearly 6 percent. 
 
¶8.  (U) Exports of information technology and other high- 
tech goods continue to be one of the main drivers of 
Taiwan's economy, even as many firms move manufacturing 
operations to China or Southeast Asia.  In the first half of 
2004, Taiwan's exports grew 26 percent over the same period 
last year.  Semiconductors have been an especially important 
component of Taiwan's economic success.  Today, flat panel 
displays are also playing an increasing role.  Taiwan's 
government has plans to continue to stimulate the growth of 
these high-tech sectors, as well as to develop new 
technologies such as biotechnology and nanotechnology. 
Taiwan's government also hopes to diversify Taiwan's economy 
beyond manufacturing into digital content, logistics, 
finance and other services. 
 
¶9.  (U) Taiwan's macroeconomic policy has sought to maintain 
stable exchange rates, low inflation and low interest rates. 
Taiwan, after China and Japan, has the third largest stock 
of foreign exchange reserves in the world.  It has made 
progress in strengthening a banking system that was in 
serious trouble in 2001 and 2002 and improving the 
supervision of financial institutions.  However, the Taiwan 
government has yet to fully deal with a number of insolvent 
institutions.  Taiwan's eroding tax base, a "no new taxes" 
pledge, and growing social welfare costs have left the Chen 
administration with a large budget deficit and limited 
options to pursue new spending on key economic and defense 
objectives.  The budget crunch will continue unless Taiwan 
manages to choose between the politically unfeasible options 
of raising taxes, cutting popular social programs, or 
running historically high deficits.  None of these 
alternatives will be politically palatable, especially if 
political power is evenly divided in the Legislative Yuan. 
 
Cross-Strait Tension and Economic Integration 
--------------------------------------------- 
 
¶10.  (SBU) While strained political relations with Beijing 
dominate both Taiwan's domestic politics and national 
security issues, investment in the Mainland and trade across 
the Strait are increasingly the driving forces in Taiwan's 
economy.  The ruling DPP promised early on in the current 
election season to keep cross-Strait relations and issues of 
sovereignty out of the legislative elections.  Nevertheless, 
political rhetoric is again increasingly focused on the 
government's and the president's approach to cross-Strait 
relations.  The official name of the Republic of China and 
President Chen's proposal to write a new constitution for 
Taiwan are also sensitive domestic political issues that 
threaten to increase cross-Strait tension.  Taiwan companies 
that have supported the DPP have found their activities in 
the PRC subject to increased scrutiny. 
 
¶11.  (U) In 2003, China replaced the U.S. as Taiwan's number 
one trading partner.  Exports to the PRC and Hong Kong make 
up 35 percent of Taiwan's total exports.  The PRC accounted 
for more than 70 percent of Taiwan's outward foreign 
investment in the first half of 2004.  Much of Taiwan's 
labor-intensive manufacturing has moved to the Mainland, 
especially in industries like textiles, shoes, toys, 
furniture, etc.  In information technology and other high- 
tech industries, the manufacture of technology and capital- 
intensive components has in large measure stayed in Taiwan, 
while downstream assembly of final products has moved to 
Mainland China.  However, increasingly Taiwan investors are 
moving the manufacture of upstream high-tech components to 
the PRC as well.  Despite pressure from businesses, the 
Taiwan government continues to restrict investment in the 
Mainland for certain categories of high-tech manufacturing. 
Most of the electronics consumer goods manufactured by 
Taiwan firms in the PRC are subsequently exported to the 
U.S., Japan, or Europe.  In that sector, Taiwan's economy is 
not reliant on domestic demand in the PRC.  Other Taiwan 
industries that have high levels of Mainland trade and 
investment, especially the cement, petrochemical and steel 
industries, are more strongly influenced by changes in the 
PRC economy. 
 
Aviation Issues -Direct Links, ICAO, Cargo 7ths 
--------------------------------------------- -- 
 
¶12.  (U) The lack of direct aviation links between Taiwan 
and the PRC is the primary concern of Taiwan's aviation 
industry and the largest remaining obstacle to deeper 
economic relations across the Strait.  In February 2003 
during the Lunar New Year, Taiwan airlines were permitted to 
conduct charter flights between Taipei and Shanghai with 
stops in Hong Kong.  The Chen government has indicated that 
it wants to negotiate direct charter flights in 2005 for 
both Taiwan and PRC carriers with no stopovers as the next 
step toward regular direct aviation links (reported 
reftels).  On both sides of the Strait this is a highly 
charged political issue.  To date, the PRC government has 
not accepted Chen's invitation to negotiate charter flights, 
insisting that Taiwan first accept the "one-China" principle 
and its corollary that cross-Strait flights would be 
"domestic." 
 
¶13.  (U) Taiwan seeks to join the International Civil 
Aviation Organization (ICAO) as a full member or observer. 
Because it is not a sovereign state, Taiwan is excluded from 
such UN organizations and many other international 
organizations.  Entry into organizations such as ICAO and 
the World Health Organization that focus on economic and 
health issues has been a key priority of Taiwan's foreign 
policy.  The U.S. supports Taiwan's efforts to gain 
increased access to ICAO discussions and technical 
information to improve its flight safety efforts. 
 
¶14.  (U) In 2003, AIT urged Taiwan to add "seventh freedom" 
rights for all-cargo services to our bilateral open skies 
agreement and to join the Multilateral Agreement on 
Liberalization of International Air Transportation, which 
includes cargo sevenths.  The Taiwan government rejected 
both proposals.  Taiwan's carriers rely heavily on cargo 
shipments to make them profitable and support continued 
restrictions of international participation in Taiwan's 
cargo routes.  Taiwan's recently concluded bilateral air 
services agreement with South Korea excludes cargo fifth 
freedom rights.  Taiwan and South Korea signed the new 
agreement on September 1 after a dozen years without direct 
air links. 
 
PAAL