The production relocation to China will probably lead to structural unemployment in the economy, particularly with unskilled labour

CSFB analyst

But while electronics sales are predicted to pick up later this year - boosting the Taiwanese economy - the longer-term problem is the increasing attraction of China for global technology companies.

Global IT slowdown

The global slowdown in IT and the pricking of the internet bubble has hit the country hard.

The global downturn has hit Taiwan hard

Taiwan was considered to have achieved an economic miracle, becoming one of the world's top producers of computer technology.

One estimate is that one third of computer parts and components in the US are made in Taiwan.

An estimated 32% of their exports are IT related, and this figure could be boosted by related exports, such as plastics.

Semiconductor boom and bust

Semiconductors - a notoriously cyclical industry - was one of the great boom industries of the Taiwanese economy.

This time last year was a great time to make semiconductors, as internet frenzy reached fever pitch.

One year on, most inventories are high and orders are falling.

The global semiconductor market will likely shrink 13.5% in 2001 to $176.79bn because of sluggish demand for PCs and cellphones, the World Semiconductor Trade Statistics Group said earlier this week.

However it does predict that demand for personal computers and mobile handsets could pick up in the second half of this year and this should help the ailing Taiwanese economy.

Magnetic China

But Morgan Stanley Dean Witter's economist Andy Xie says only about two thirds of the slowdown can be attributed to the global IT slowdown.

The other third can be explained by the fact that industry is relocating to mainland China.

This relocation has accelerated in the last twelve months, with industries encouraged by incentives offered by the Chinese government.

Given that Chinese labour costs are only 5% of Taiwan's, and that the two countries share similar education system and infrastructure, the attraction for business is clear.

This creates clear challenges for the Taiwanese economy and could create issues for the Bush administration if its computer industry is reliant on parts from China.

"They will have to develop a strategy about what new economic activity will replace the ones that have left," Andy Xie said.

Structural problems

CSFB's regional economist Dong Tao foresees that the Taiwanese economy will pick up in the fourth quarter or the beginning of next year.

But he agrees that Taiwan will have several structural problems to grapple with.

He said: "The production relocation to China will probably lead to structural unemployment in the economy, particularly with unskilled labour."

The slow demand in world markets is one of the factors helping China, as companies hope to cut costs by moving there.

Motorola and Intel are among those who have begun to pour dollars into China, probably also attracted by the huge domestic market.

China's ambitions are high. Shanghai - which already makes half of all the chips in China - aims to surpass South Korea and Taiwan in chip production by 2010.

But while these forecasts and ambitions are impressive, China could yet find dominance of the market a shallow victory.

It could find itself the home for low-tech assembly in an industry where technological horizons are always changing.

This does provide a window for Taiwanese growth.

"What Taiwan can do is to try hard to upgrade its industrial base and move it in the direction of the knowledge economy," CSFB's Mr Tao said.

Some industrialists have dismissed China's aspirations.

Taiwan Semiconductor Manufacturing Company president F.C Tseng points out that in the short term at least mainland China can only import components to create low-level products.

The current Taiwanese policy bars local businessmen from investing over $50m for a single project on the mainland. Investment in the mainland was legalised in 1992

While this limits the extent to which Taiwanese know-how can move to the mainland, many business people have found ways of circumventing the strict rules on investing in high-tech industries and infrastructure.

It is unclear if these rules will be relaxed.

"The Taiwan government will reserve its control over China-bound investments to a certain extent after joining the WTO," John Deng, vice chairman of the cabinet level Mainland Affairs Council, which charts the country's mainland policy, said in the Commercial Times.