INTELLIGENCE MEMORANDUM TAIWAN'S CAPABILITY TO FINANCE ADDITIONAL MILITARY OUTLAYS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001600020116-1
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 13
• Document Creation Date: December 22, 2016
• Document Release Date: May 17, 2010
• Sequence Number: 116
• Publication Date: August 1, 1969
• Content Type: IM

DIRECTORATE OF
INTELLIGENCE
'secrer
Intelligence Memorandum
Taiwan's Capability to Finance Additional military Outlays
ER IM 69-114
August 1969
Copy No. 4 a
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WARNING
This Ocwnent contains information affecting the national
defense of the United States, within the meaning of Title
18, sections 793 and 794, of the US Code, as amended.
Its transmission or revelation of its contents to or re-
ceipt by an unauthorized person is prohibited by law.
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CENTRAL INTELLIGENCE AGENCY
Directorate of Intelligence
August 1969
INTELLIGENCE MEMORANDUM
Taiwan's Capability to Finance
Additional Military Outlays
Introduction
The US military grant aid program which has
supplied almost all of Taiwan's weapons, spare parts,
and other supplies is being phased out. Military aid
deliveries, which totaled $3.2 billion from.1949
through 30 June 1969 and averaged about $95 million
annually in the five years ending 1968,* will average
only about $45 million annually during the next five
years. Despite this cut in aid, Taiwan wants to
modernize its armed forces and, because it has almost
no capability to produce the more complex military
hardware, will have to purchase these items abroad.
According to joint estimates by the Defense and
State Departments, Taipei will spend $238 million
in foreign exchange on its military establishment
during the five-year period 1969-73. Of this amount,
$213 million will be necessary to maintain the pres-
ent flow of equipment and in this way offset the da-
cline in US grant military aid. The remaining
$25 million is a partial repayment, made during
1969-73, of a $100 million loan now being negotiated
which will be used to purchase the equipment needed
* Changed from fiscal year (1 July-30 June) basis
to a calendar year basis to fit in with other data.
Note: This memorandum was produced solely by CIA.
It was prepared by the office of Economic Research
and was coordinated with the Office of Current
Intelligence and the Office of National Estimates.
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to modernize Taiwan's armed forces.* This memo-
randum estimates Taipei's ability to earn the
necessary foreign exchange under various growth
assumptions.**
The 25 m1lZion represents principal and interest
payments during the five-year period on commercial
'Loans contracted to finance equipment purchases of
$20 million annually for a total of $100 mi ZZion.
** For a detailed discussion of the methodology
used to make these estimates, see the Appendixes.
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Military Spending and Economic Growth
1. Nationalist China has maintained an excep-
tionally large military establishment since it left
the Mainland in 1949. Its forces, numbering about
600,000, constitute a very high, although declining,
share of the population (4.5 percent in 1969).
Military expenditures have consistently accounted
for about 05 percent of central government outlays
and about half of all government spending. Self-
financed military expenditures -- excluding foreign
aid -- are equivalent to about 9.4 percent of gross
national product (GNP) in 1969.
2. Thus far, military spending has not hindered
economic growth. During the 1950s the economy was
supported by massive amounts of US economic and mili-
tary aid, and even though US economic aid was phased
out in the 1960s, the economy still expanded at
impressive rates. The growth of output, exports,
investments, and savings has been so rapid that
reductions in economic assistance have had only
marginal effects. Some 30 percent of the annual
increase in GNP has been saved. Moreover, some mili-
tary expenditures had positive indirect effects on
economic growth. The army taught young men from
rural areas discipline and skills and provided em-
ployment for Mainland Chinese who otherwise would
have been difficult to integrate into the civilian
economy. Without the military services there.
probably would have been a larger amount of unemploy-
ment or underemployment.
3. Taiwan is one of the few less developed
countries to have achieved an average annual growth
rate of nearly 10 percent for a decade. By 1968,
GNP reached $4.2 billion -- about $300 per capita --
and the overall per capita level and the broad
structure of output in Taiwan was similar to that
of Japan in the mid-1950s.
4. The mainspring of growth has been the vig-
orous rise in exports at an average annual rate of
22 percent since 1960. This extraordinary perform-
ance was made possible by a rapid diversification of
exports. For example, sugar accounted for more than
half of all exports in 1958 but for less than 6 per-
cent in 1968. Besides penetrating specialized agri-
cultural markets with such high-value products as
mushrooms, asparagus, and pineapples, Taiwan has
3
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spectacularly increased exports of manufactured
goods by more than 34 percent annually since 1960;
by 1968, manufactures accounted for 53 percent of
total exports. Textiles have been the leader, but
there also has been a sharp rise in exports of prod-
ucts such as electronic equipment, plastic articles,
plywood, and chemicals.
5. Exported manufactures have been produced
primarily in new plants built with US, Japanese,
and overseas Chinese capital and have been sold
mainly in the US market. Capital has been attracted
to the island by an abundant, hard-working, and
relatively easily trained but low-wage labor force
and by a stable government offering excellent tax
and other benefits to new export industries.
6. Thanks to an export-oriented growth pattern,
Taiwan has avoided the balance-of-payments problems
characteristic of so many less developed countries.
In most developing countries, industry is oriented
to import substitution and produces almost solely
for the domestic market under heavy protection from
foreign competition. Almost invariably, production
costs are too high to permit exports. This form of
industrial development often fails to reduce depend-
ence on imports because of the increasing require-
ments for imported materials and components. Moreover,
import substitution becomes more difficult as a
country moves from the simple to the more sophis-
ticated industrial products and technologies.
7. In Taiwan net export earnings from new indus-
tries have risen at phenomenal rates, while payments
for imports of machinery have largely been deferred
because these imports were mostly covered by private
foreign investments. At the same time, the value of
agricultural exports was boosted through diversifi-
cation and increased local processing. Thus foreign
Exchange earnings were more than sufficient to pay
for imports, even'at very high rates of economic
growth.
8. During the 1960s, Taiwan was able to finance
an annual growth of 15 percent in imports, to increase
foreign exchange reserves, and to greatly reduce its
reliance on US economic aid. In the early part of
the decade, as high as 37 percent of imports were
financed either by US grants or highly concessionary
loans; by 1968, about 1 percent was so financed.
Since 1965 there have been virtually no new US
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economic assistance commitments, and most funds
previously committed had been utilized by 1968.
Because most of the $1.1 billion in US economic aid
received since 1949 represented grants or highly
concessionary loans, debt repayments have been very
low. In 1968, debt servicing amounted to less than
6 percent of total foreign exchange earnings.
Financing Additional Military Spending
9. Now that almost all imports are self-financed
or paid for from non-concessionary loans, a contin-
uation of past export and production trends will
lead to an accumulation of large foreign exchange
surpluses unless new uses are found for this money.
If, for example, the rate of growth of exports is
the same in the next five years as in the past five
years, Taipei will probably accumulate a foreign
exchange surplus of about $1.1 billion -- about
five times the estimated military outlays of $238 mil-
lion.* As foreign investment grows, debt repayment
also will increase, but the ratio of debt service
(investment income payments and debt repayment) to
foreign exchange earnings (exports and other current
account earnings) by the end of the period would be
only about 13 percent. This ratio compares favorably
with countries growing much less rapidly and very
favorably with those experiencing rates comparable
to Taiwan. Japan and Mexico, for example, have debt
service ratios of around 50 percent. Despite these
high ratios, foreign investors continue to demonstrate
confidence in these countries because of the rapid
growth of production and exports and because the
governments maintain political stability.
10. For the next five years the chances for main-
taining export growth rates as high or nearly as high
as in the last few years appear very good. In the
first half of 1969, exports increased by almost
30 percent over the same period in 1968. Approved
foreign investment, which leads to increased exports
of manufactures, increased by more than 30 percent
in value in 1968 and accounted for about 25 percent
effect of the war on Taiwan has been yeru small
* The war in Vietnam boosted Taiwan's exports by
about $70 million in 1966, but these have since
fallen greatly and since 1968 the direct economic
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of the value of all such approvals since 1952.
Furthermore, the Kaohsiung Export Processing Zone
(similar to a free trade zone) has reached'nearly
half the expected annual export capacity of at least
$160 million per year; a second and larger export
processing zone will be opened in 1970, and a third
zone is in the advanced planning stage. Exports of
agricultural products should also do well. The
important food canning industry already has plans
to diversify its'export product line and promote
foreign sales through a joint council.
11. Even if the export growth rate declined by'
as much as a third -- to 15 percent annually --
Taiwan could still easily manage its planned military
spending and pay for imports required to sustain a
10 percent growth rate in GNP. This would require
about $100 to $200 million in additional foreign
borrowing during the five-year period to meet the
military outlays, to pay for additional debt serv-
icing, and to maintain reserves at at least 25 per-
cent of imports. The additional borrowing should
not prove difficult, however, because of the low
debt service burden.
12. Even in the highly unlikely event that the
export growth rate was cut in half -- to about
11 percent -- Taiwan would probably have sufficient
foreign exchange for the new military purchases as
the rest of the economy slowed down. A major slow-
down in the export sector would reverberate through-
out the economy. Consumer demand would be off, and
investment rates would drop very sharply. For
example, if the present rate of growth of GNP were
to decline from the present 10 percent to 7 percent
because of an export slowdown, the required average
annual increase in domestic investment over the next
five years would be only 5 percent, compared with
15 percent if growth continued at 10 percent. The
resulting decline in demand for consumption and
investment goods would be reflected in a reduction
in the growth of imports. At an 11 percent annual
increase in exports, Taiwan could afford the addi-
tional military burden and at least an 8 percent
annual rise in imports, an amount probably sufficient
to maintain a growth rate in GNP of 7 percent.
13. Some Western observers have voiced concern
about the impact of additional military outlays on
the domestic economy or the government's fiscal
position. But almost all the spending will be for
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foreign goods, and very little money will enter the
local currency stream where it could create infla-
tionary conditions. The tax burden in Taiwan is
still relatively low, and raising revenues to cover
additional military spending should not be difficult.
In addition, the new outlays can be financed domes-
tically through a bookkeeping transaction between
the government and the central bank because the
government does not need local currency to buy these
goods. Moreover, Taipei has shown, and is likely to
continue to demonstrate, considerable prudence in
both fiscal and monetary matters.
14. There is, of course, a possibility that
Taiwan will spend more than $20 million annually on
acquiring more modern military hardware in the next
five years. A key factor in any decision would be
Taipei's evaluation of US intentions to maintain its
presence in Asia, especially the pledge to protect
Taiwan from Mainland incursions. Also important
will be the Chinese Nationalist leaders' assessment
of how much emphasis should be placed on their
pledge to return to the Mainland as a political
tool in maintaining cohesion on Taiwan and its stature
abroad. Taiwan's rapid growth over a decade has given
its rulers increased self-confidence and has somewhat
reduced the friction between the Taiwanese and
Nationalist Chinese because both have obtained
rapidly improving living standards. In addition,
the Mainland pledge has become less important to
Taiwan's political stability. Furthermore, there
is a growing awareness among Chinese Nationalist
leaders that too much military spending could slow
the economy.
Conclusions
15. Taiwan is likely to have sufficient foreign
exchange to pay for the new outlays required to
modernize its armed forces. The most probable
case is a continuing expansion of exports at or near
the previous rate of 22 percent annually. The basic
factors that facilitated the past rapid rise of ex-
ports can be expected to remain operative. Foreigners
will continue to establish export-oriented firms to
take advantage of Taiwan's relatively low-paid,
hard-working labor force and the liberal tax benefits
offered by a stable government. A considerable num-
ber of such investments are now under way, and appli-
cations to establish more enterprises continue to be
filed with the government.
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16. A decline in the export growth rate to 18 per-
cent annually would mark the point at which Taiwan
would have to increase foreign borrowing to pay for
both the military outlays and an expansion of imports
at a rate equal to that of the past eight years.
This should not prove difficult, because debt serv-
icing will be low in comparison to foreign exchange
earnings. If the export growth rate dropped much
below.15percent, an unlikely event, Taipei could
not afford the military outlays unless the expansion
of'non-export-related imports also slowed. Such a
decline would probably occur because the reduction
in export growth would reduce the expansion of
Taiwan's overall economic growth, which in turn
would require less imports.
17. Under any likely circumstances Taipei will
probably continue to pursue prudent and pragmatic
economic policies which will assist in providing
adequate funds to pay for the additional military
outlays.
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Methodology
Two separate procedures were used to determine
whether a specified increase in Taipei's military
expenditures was consistent with continued rapid
economic rowth.
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