Foreign Relations of the United States, 1952–1954, China and Japan, Volume XIV, Part 1

S/P–NSC files, lot 62 D 1, NSC 128 Series

No. 28
Report Submitted by the Senior Mutual Security Member of the NSC Staff (Roberts) to the Steering Committee on NSC 128¹

confidential

[Washington,] May 28, 1952.

U.S. Economic Assistance to Formosa

a. present and projected aid programs for formosa

1. Objectives

MSA is carrying on an economic aid program in Formosa with the following major objectives: (1) to maintain economic stability; (2) to lend economic support to the U.S. military assistance program; (3) to increase agricultural production and improve conditions of the farm population; (4) to rehabilitate and further develop basic utilities and industries, thereby providing the means for making Formosa more nearly self-supporting.

2. Program amounts

The program for the current fiscal year 1952 totals $81 million, and the proposed program for fiscal 1953 is $115 million, broken down by major categories as follows (in thousand dollars):

	FY52		FY53
Public Health		250		160
Agriculture, Forestry, Fisheries		*19,335		*21,075
Transportation, Power, Public Works		5,630		4,550
Manufacturing and Mining		3,550		3,785
Engineering Advisory Services		650		690
Education		35		20
Public Administration		255		345
Maintenance of Essential Supply:
Civilian requirements	38,570		49,375
Common-use items	12,725	51,295	35,000	84,375
Total		81,000		115,000

The above dollar amounts for the two fiscal years do not furnish a realistic comparison of aid furnished since a supplementary FY ’51 allocation of $41.6 million was made two weeks before the end of the fiscal year 1951 and is being used concurrently with FY ’52 funds. This supplementary allocation raises the effective program total for FY ’52 to $122.6 million, as compared with $115 million for FY ’53.

[Here follows discussion of each of the program categories listed above, the status of the current aid program, ways in which the economic aid program supported the military assistance program, and MSA efforts to promote the production of key items in the Formosan economy.]

d. analysis of economic situation

Formosa is faced with the problem of maintaining economic stability, which is vital to the defense of the Island, without domestic or foreign exchange resources adequate for the purpose. Although rich in natural resources, the Island’s productive facilities have been subjected to severe strain by wartime bomb damage, disruption of traditional trade patterns and, most significant of all, by the necessity of supporting the Chinese Government and its armed forces. Formosa’s indigenous population of approximately 7.5 million, as compared with 5.7 million before the war, is swollen by the presence of about 2 million mainlanders, of whom a substantial portion are military personnel and their dependents. The combined tasks of supporting an increased population, effecting some measure of reconstruction of productive facilities, and improving the capabilities of the armed forces, have proved impossible without major U.S. economic aid.

Japan utilized Formosa primarily as a colony from which to draw foodstuffs and raw materials in exchange for manufactured goods. Large quantities of rice and sugar were exported to Japan, and today these two items earn nearly 90 percent of Formosa’s export exchange. At the same time, Japan installed on the Island a power system, as well as transportation and industrial facilities, including railroads, petroleum refinery, aluminum plant, iron and steel works, and fertilizer factories. These facilities were inherited by the Chinese in various stages of disrepair ranging from complete destruction by bombing to deferred maintenance. With MSA aid and with their own funds, the Chinese have rehabilitated and in some cases expanded these industries to meet increasing domestic needs. Production of key agricultural and industrial commodities has recovered since the war (with the notable exception of sugar) and in many instances has expanded beyond pre-war peaks. Increases in production of food crops are meaningful chiefly in terms of increased export earnings, as the Island is largely self-sufficient in foodstuffs. Larger local production of such items as cotton textiles and chemical fertilizers are significant in that they cut down import requirements and help close the balance of payments gap. In 1950 and early 1951 this gap was covered by drawing down of Chinese-owned gold and foreign exchange reserves to the point of near-exhaustion. At present, the gap is being filled by MSA aid. In 1951, MSA financed about 40 percent of Chinese imports.

Japan has traditionally been Formosa’s chief trading partner, taking 93 percent of exports and supplying 86 percent of imports in 1937. Disruption of the Japanese market at the close of World War II was one of the serious economic difficulties facing Formosa. In 1950 and 1951 Japan was again Formosa’s dominant trading partner, taking about one-third of its exports (mainly sugar and salt) and supplying about the same proportion of its imports (exclusive of MSA-financed imports). Chief imports from Japan include textiles, fertilizers, and machinery of various kinds. Trade with Japan has been fostered by a trade agreement signed in September 1950 and continuing in force up to the present; it is expected that the recent signing of a peace treaty² will be followed in the near future by negotiation of a new trade agreement.

Aside from Japan, Hong Kong and Malaya are the chief destinations of Formosan exports in the Asiatic area, while Hong Kong, India, and Australia are the most important suppliers in that part of the world. The United States is also an important source of Formosan imports, 19 percent of the total in 1950. If MSA-financed imports are included, imports from the United States assume sizable proportions. (Of all MSA-financed deliveries from June 5, 1950 to December 31, 1951 totalling $71.0 million, $39.0 million or 55 percent originated in the United States.)

Internally, the Formosan economy is faced with an ever-present threat of inflation, primarily due to chronic government budgetary deficits caused by the necessity of maintaining the 600,000-man military establishment. During 1950 and early 1951 the government covered most of its domestic budget deficit by liquidating gold and foreign exchange reserves, and financed the remainder by proceeds from the sale of MSA commodities, bond issues (largely forced loans), and inflationary measures such as note issuance and bank advances. By early 1951 gold and foreign exchange reserves had reached dangerously low levels. Had it not been for increased MSA aid during the fiscal years 1951 and 1952, a serious inflationary situation would have developed which might have well led to complete economic collapse. The 1952 budget has been planned with the benefit of advice of MAAG and the MSA Mission; and a system of budgetary controls has been instituted; consequently it is hoped that, with the help of sales proceeds from the planned level of MSA aid, there will be no need to resort to inflationary deficit financing during the current calendar year.

Primarily because of the budgetary imbalance, domestic prices have risen sharply during the past two years. The rate of increase, however, slowed down considerably in 1951 (and so far in 1952) as compared with 1950. The primary reason for the improvement is no doubt the large increase in the import of goods and the anticipation of continuing MSA assistance. But another reason is that money wages have risen less rapidly than prices; thus a decline in real wages has been experienced. Tremendous pressure for increased wages in behalf of troops and civil servants is indicative of this situation. The inflationary pressure hidden in this reduction of workers’ real income is becoming critical. Higher money wages if sanctioned may prevent any further decline of price levels, even if programmed MSA deliveries are maintained as scheduled.

The inflationary impact of unbalanced budgets, while reduced by the imports of MSA commodities, has also resulted in a sharply increased money supply. Despite this factor, however, the government’s budgetary situation and the resulting price inflation have caused a paradoxical shortage of money for financing productive enterprises. High interest rates, together with heavy taxation and fear of confiscation, have been strong deterrents to productive investment. Consequently, government financing and the MSA counterpart fund have been the only effective channels for providing short term capital needed to maintain and increase production.

The role of government corporations in the Formosan economy is significant, both because of the preponderance of government ownership in the Island’s industrial economy, and because of the sizable share of government revenues which is contributed by these corporations in the form of income taxes, dividends, profits, and bond purchases. For a variety of reasons, many of the government corporations are continually faced with a lack of working capital to carry on operations. Because of the key position of these corporations from the standpoint of government finance, production levels, and close tie-in with the levels and structure of foreign exchange rates, MSA is working through several channels to improve their operations and financial condition. A Management Control Advisor on the Mission staff will offer technical assistance to these enterprises in the field of management and organization. In addition, a proposed contract with the Public Administration Service will provide for a comprehensive survey and recommendations on the management and accounting controls and methods of these corporations. On the technical operations side, the services of the J.G. White Engineering Corporation staff in Formosa are continually being utilized toward improved operating efficiency.

An assessment of the circumstances under which Formosa could become self-supporting must take into account, as the most important single factor, the burden of high expenditures for the maintenance of a military establishment. At present military costs constitute 80 percent of the national budget, and nearly 50 percent of consolidated national, provincial, and local budgets. As long as conditions in the Far East require continued emphasis on military defense, it will be impossible for Formosa to be entirely self-supporting.

Substantial progress, however, can and is being made along lines other than curtailment of military expenditures. For example, efforts to increase agricultural and industrial production are bearing fruit in increased export earnings from sugar, rice, tea, fruits, and other items, and decreased import requirements of such commodoties as soy beans, fertilizers, and textiles.

Difficult to gauge quantitatively, but nevertheless important as factors tending toward attainment of self-support, are the expected benefits from more complex relationships of developmental projects to various sectors of the economy: for example, the relationship of a new 6,500-foot highway bridge to agricultural yields in hitherto underdeveloped areas; the relationship of increased power output to irrigation and hence to agricultural yields; the relationship of more rational government budgeting to price stability. The hope is that the beneficial effects of such relationships as these will culminate in a steady decrease in the need for U.S. aid.

As against the favorable factors, indicators of economic weakness are likewise apparent; for example, public sensitivity to commodity shortages can be quickly translated into radical fluctuations of prices and interest rates. Pressures to expand military expenditures are stimulated by hopes of returning to the mainland. Because of military expenditures, essential government services such as the extension of adequate farm and industrial credit are being neglected or deferred. Gold and foreign exchange reserves are precariously small, considering the amounts which should prudently be held for currency backing and contingencies.

On the assumption that favorable factors in the economy will offset factors of economic weakness, substantial progress toward the goal of self-support is foreseeable by the end of FY’53.

1. This report was circulated to the Steering Committee on NSC 128 with a covering memorandum of June 4 by Lay. The Steering Committee on NSC 128, consisting of the Senior State, Defense, Mutual Security, JCS, and CIA members of the NSC Staff, was constituted at a meeting of the Senior NSC Staff on Apr. 29, according to the record of that meeting, in order to prepare for Senior Staff consideration a draft of the report called for by NSC Action No. 624-b. (S/P–NSC files, lot 61 D 167, “Formosa”) The record of a meeting on May 6 of the Steering Committee on NSC 128 states that the Committee agreed that the CIA should be requested to prepare a special estimate, the Senior Defense member should prepare a report on the current and projected military advisory and assistance program for Formosa, the Senior Mutual Security member should prepare a report on the current and projected program for economic assistance to Formosa, the Senior CIA member should prepare a report on current and projected activities in this general area, and upon receipt of these reports, the Steering Committee would determine subsequent procedure for the preparation of the report called for by NSC Action No. 624-b. (S/P–NSC files, lot 61 D 167, “Formosa”) For text of NSC 128, Mar. 22, see the memorandum by Foster, Document 11. Regarding NSC Action 624-b, see footnote 6, Document 14.
2. Includes $18.9 million of fertilizer imports in FY ’52 and $20.4 million in FY ’53. [Footnote in the source text.]
3. Includes $18.9 million of fertilizer imports in FY ’52 and $20.4 million in FY ’53. [Footnote in the source text.]
2. For documentation relating to the signing of a peace treaty between Japan and the Republic of China on Apr. 28, see the compilation on Japan in Part 2.