Trouble In Taiwan – Risks From The 2016 Election by Bill O’Grady of Confluence Investment Management

Trouble In Taiwan

Taiwan held elections on January 16th and the Democratic Progressive Party (DPP) won a resounding victory over the Kuomintang (KMT). This election will likely raise tensions between Taiwan and Mainland China (People’s Republic of China, PRC).

In this report, we will begin with a history of Taiwan. Next, we will recap the election results, discussing what the election means for Taiwan’s foreign and domestic policies, the PRC’s problems with the DPP’s victory and the election’s potential impact on regional stability. As always, we will conclude with market ramifications.

The History of Taiwan

There is evidence that suggests the Han Chinese began settling in Taiwan in the 11th century, although it appears that hostile indigenous tribes hampered development. It wasn’t until 1624 that the Dutch established a commercial base in Taiwan. The Chinese ousted the Dutch in 1662, and the area was ruled by Chinese warlords who were remnants of the collapsing Ming dynasty that was being ousted by the incoming Qing dynasty. One of the Ming loyalists was Captain Zheng Chenggong, who was responsible for removing the Dutch from Taiwan. Zheng1 successfully began a series of raids on the mainland and built the Kingdom of Tungning, which, at its peak, included parts of the central coast of the mainland, partial control of Shanghai and several miles inland along the Yangtze River. Although the Ming eventually regained control of Taiwan and ended the Kingdom of Tungning, Zheng’s exploits serve as a reminder to modern PRC leaders that Taiwan can be a “launch pad” for invaders and thus they see an independent Taiwan as a significant threat.

China maintained control of Taiwan until 1895, when China was defeated in the First Sino-Japanese War. As part of the peace treaty, China ceded Taiwan to Japan. The Japanese began industrialization of the island, building transportation networks, public infrastructure and public schools. It also embarked on a program of suppression and assimilation of the aboriginal people. It conducted aggressive military actions against tribes that resisted Japanese rule but also allowed groups that cooperated to earn second-class citizenship. At the onset of the Pacific War and World War II, thousands of Taiwanese joined the Japanese military. The Imperial Navy operated a base out of Taiwan. In general, many native Taiwanese have a favorable view of Japan, which is unusual in the region.

Japan’s defeat in World War II ended its control of Taiwan. The Nationalist Chinese under General Chiang Kai-shek were given control over the island. The military government run by the Nationalists was corrupt, inefficient and very unpopular with the native Taiwanese. In 1949, after the Nationalists were defeated in the Chinese Civil War, Chiang Kai-shek and his followers fled to Taiwan and established the Republic of China (ROC). As they departed, the Nationalists carried many national treasures and all of China’s gold and foreign currency reserves. Mainland China, controlled by the communists, established the PRC.

Both nations considered themselves the legitimate government of China. The ROC maintained seats in its legislature for the districts on the mainland even though it was impossible to hold elections in those areas. Chiang Kai-shek ruled Taiwan under martial law. The KMT, the political party of the Nationalist Chinese, was the only legal party in Taiwan.

The United States, the primary protector of Taiwan, considered the ROC to be the legitimate government of China until January 1, 1979, when official recognition shifted to the PRC. The ROC lost its status in the United Nations at this time. That same year, the United States passed legislation indicating it would protect Taiwan from mainland Chinese military threats. In 1992, the PRC and the ROC agreed on the “1992 Accord,” which indicated that there was only one legitimate government of China; however, using “strategic ambiguity,”2 both considered themselves to hold that honor.

By the mid-1980s, Chiang Kai-shek’s successor, his son Chiang Ching-kuo, began to liberalize the government. Martial law was eased in 1984 and abolished in 1987. Political parties were allowed; the DPP was established to represent the interests of the native Taiwanese, which account for 80% of the island’s population. In 1991, the KMT finally forced those legislators that held seats for mainland districts to retire, paving the way for legislative elections. In 1996, the ROC held its first presidential election. Lee Teng-hui of the KMT won.

In the 2000 election, Chen Shui-bain of the DPP won the presidency on a platform of defending native Taiwanese rights. He persistently pushed for independence from China. The PRC viewed these threats as the equivalent of civil war, since it treats Taiwan as a province of China. The United States was also unhappy with Chen’s policies as they constantly increased tensions in the region. The Chen administration persisted in not allowing direct transportation, mail and trade links. This did not stop Taiwan investment into the PRC, but it made such activity more difficult. Although the DPP controlled the executive branch, the KMT maintained control of the legislature. The legislature prevented proposals designed to trigger confrontations with the PRC. Chen won two terms in office but the DPP failed to hold power in 2008, and the KMT, led by Ma Ying-jeou, prevailed in the presidential election.

Ma Ying-jeou, unlike Chen Shui-bain, worked hard to improve relations with the PRC. Tourism between the two regions increased; in 2008 less than 10% of Taiwan’s tourists came from the PRC. That number is now over 40% and total tourism is 2.75% of GDP, up from less than 1% in 2008. Ma signed 23 different cross-strait economic agreements, virtually all the pacts negotiated in secret. Currently, about 25% of Taiwan’s exports go to the PRC. Last November, he met personally with General Secretary Xi in Singapore, the first time two leaders from the PRC and Taiwan have met since the schism in 1949.

Unfortunately for the KMT, integrating with the PRC’s economy has led to a “hollowing out” of Taiwan’s manufacturing base. Taiwanese firms, like many firms around the world, found it difficult to compete with the PRC’s low cost manufacturing base. The DPP tends to represent those who have been “losers” in globalization and technological change, whereas the KMT mostly represents the corporate elite who, like establishment elites everywhere, benefit from these factors. Thus, to a great extent, the most recent election reflects the populist sentiment being observed globally.

The 2016 Election

The DPP was led by Tsai Ing-wen, a law professor who studied in the U.S. and Britain. She is a trade expert who negotiated Taiwan’s entry into the WTO. She won a decisive victory, capturing 56.1% of the vote, far outpacing the KMT’s candidate, Eric Chu, who gathered 31.0% of the ballots. James Soong of the People First Party, which caucuses with the KMT, finished third with 12.8% of the vote. Ms. Tsai is the first woman president in Asia who did not come from a political dynasty.

Perhaps even more impressive is that the DPP also won control of the legislature, the first time since 1949 that the KMT hasn’t controlled this body.

Ms. Tsai won by promising generational equality; she won widespread support from younger voters for her positions against the KMT’s PRC-favorable policies and for promises of pension reforms

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