The Impact of Free Trade Agreement on Taiwan’s Trade Dependence upon China: An Application of Gravity Model

This paper contains two parts. Part I aims to use the gravity theory to forecast Taiwan’s ratio of dependence on exports to China. If ECFA is assumed to be abolished, it is estimated that the tariffs of Taiwan’s exports to China will increase annually. To this end, Taiwan’s ratio of dependence on exports to China would decrease. If the elasticity of substitution in the gravity theory is five, then Taiwan’s ratio of dependence on exports to China will decrease from 15.51% in 2014 to 14.5% in 2018. If the elasticity of substitution is 10, then its ratio of dependence on exports to China will be reduced to 13.55% in 2018. As a result, in 2018, the estimated interval of Taiwan’s ratio of dependence on exports to China will fall between 13.55% and 14.5%. It is found that when tariffs are increased, the higher the elasticity of substitution is, the more obvious the width of decrease in Taiwan’s ratio of dependence on export to China’s is. Next, hypothesis testing is made with estimated value and real value. In different elasticity of substitution, the ratio of dependence on export of the following year can be successfully evaluated by applying the gravity theory. In part II, the impact of Korea signing FTA with China to Taiwan will be assessed. Korea has actively signed a free trade agreement with various countries recently. Among its trade partners, U.S.A. and China are the major economies. As China-South Korea Free Trade Agreement (FTA) was signed in 2015, the future trend is still unclear. On the foundation of U.S.-Korea FTA, the estimation of the trade loss of Taiwan will be made under the condition that Taiwan is not engaged in any FTA. After the simulation, it is found that the amount of Korea’s export value to China will increase by US$50.077 billion because of China-South Korea FTA. On the contrary, Taiwan will have a US$969 million loss on export value to China because of China-South Korea FTA.