BUSINESSWEEK ONLINE : AUGUST 14, 2000 ISSUE
INTERNATIONAL -- ASIAN COVER STORY

A nightmare come true. That's how China's leadership saw the presidential victory of longtime Taiwan opposition leader and independence advocate Chen Shui-bian in March. Chen's election fanned fears in Beijing that the island, which it regards as part of China, would finally declare independence from the mainland. If that happened, China was prepared to declare war. Since then, Chen has done much to assuage those fears. He has promised not to formally declare independence unless China attacks. He has practically begged China to sit down and negotiate. Faced with a growing economic imperative for closer relations, he has dropped Taiwan's refusal to allow direct trade, transportation, and postal links with China.

At the same time, though, he has kept up his provocative rhetoric. In one of his first interviews since taking office in May, the 49-year-old President declared himself the leader of a ''sovereign and independent country.'' Referring to China's attempts to intimidate voters with threats during the election campaign, he charged that Beijing ''does not understand the Taiwanese people.'' Citing 70% public approval for his policy of standing up for Taiwan's sovereignty, Chen urged Chinese leaders to ''learn from the election result.''

Chen believes tempers are now cooling in Beijing. Officials in Taiwan, both local and foreign, say both sides want negotiations soon. ''They're looking for an excuse to talk,'' says a foreign observer. The next move could come after the August summit of Chinese leaders at the resort of Beidaihe, where the vexing question of Taiwan will top the agenda.

But even though China has shown some signs that it might be willing to talk, any real easing of tensions in the Taiwan Strait remains far off. The biggest sticking point is Chen's steadfast refusal to bow to Beijing's demand to accept its definition of the One China policy--which means accepting Beijing's sovereignty over Taiwan--before talks can start.

EXPECTING A BROADSIDE. Chen's planned foreign travel in mid-August won't make relations any easier. He has scheduled a swing through Central America and Africa, home to the 29 countries that still grant diplomatic recognition to Taiwan instead of China, as well as a refueling stopover in Los Angeles. The trip will certainly anger Beijing, which is obsessed with denying diplomatic recognition to Taiwan, and U.S. officials are bracing for a broadside.

Political sparring aside, economics plays a big role in driving improved relations. Mainland-Taiwan economic ties are approaching a crossroads as both countries enter the World Trade Organization, probably before the end of this year. As both sides implement WTO provisions, they'll have to end many restrictions and implement direct trade. Taiwan companies have invested about $40 billion in China. The figure is climbing sharply, powered by a wave of high-tech investment. But Chinese authorities are for the first time putting pressure on Taiwanese-founded businesses in the mainland, especially those headed by Chen supporters. Such pressure tactics might work, but could just as easily trigger an anti-Beijing backlash.

Neither side's leaders can ignore domestic politics. Chen's administration has made several missteps. In late July, he was forced to sack a senior official after live television showed four people swept to their deaths in floods: Rival government agencies had squabbled over rescue efforts. Taiwan Vice-President Annette Lu continues to espouse a more stridently pro-independence line than Chen, provoking suspicions in Beijing that she is expressing Chen's real opinion.

Meanwhile, China's President Jiang Zemin refuses to be the one who loses Taiwan. His fear: Taiwan is stalling for time, betting that support abroad, especially in the U.S., will grow for Taiwan's independence aspirations. Yet if he plays the bully, he risks alienating U.S. public opinion. If he does nothing, Taiwan may slip slowly away. The Portuguese dubbed Taiwan Ihla Formosa, or ''beautiful island.'' But for China, it remains one ugly problem.

By Mark L. Clifford in Taipei

Can a patient, determined democrat wear down Beijing's hard-liners? Taiwan President Chen Shui-bian, the 49-year-old former-opposition lawyer who has just finished his second month on the job, is betting that the answer is yes. Despite browbeating from the mainland, Chen shows no signs of being rattled. Indeed, he says, signs are emerging that pressures may be easing. Chen's strategy for Taiwan's survival as an independent country: Hold out an olive branch by offering to sit down and talk, but don't give ground on the issue of sovereignty. And bet that U.S. backing and a hunger to get into the WTO will restrain Beijing from lashing out militarily.

In one of his first interviews since taking office on May 20 (see below), Chen gave no quarter to Beijing. While indicating his eagerness to talk with Beijing and speaking about a "moral obligation" to promote peace and stability, Chen claimed that the mere fact that tensions with China had not escalated marked a triumph for his policy of standing up for Taiwan. He spoke boldly of Taiwan as "a sovereign and independent country" and said that it was his duty to protect the interests of the people of Taiwan. He also gave support for Washington's controversial "Star Wars" missile shield, known as Theater Missile Defense, saying it was necessary because of China's deployment of missiles.

MAINLAND INVESTMENTS. Taking aim at Beijing's leaders, Chen bluntly accused Beijing of not understanding Taiwan's people and said that the mainland leadership was being misled by Taiwanese visitors more intent on currying favor with Beijing than in representing the true picture on the island. And pointing to the 70% popular approval ratings of his cross-Strait policy and the backlash against Beijing's attempts to intimidate Taiwan's voters in the last two presidential votes, Chen urged Beijing to "learn from the election result" and "get to know me."

Certainly, China is getting to know Taiwan investors very well indeed. Despite tensions, entrepreneurs continue to pour money into mainland projects. Taiwanese businessmen are seeking Taipei's approval for ever-more sophisticated high-tech investments and want Chen to follow through on his promise to end a ban on direct trade and transportation links. But after pushing the idea for years, China suddenly appears cool to it. And for the first time, Beijing is pressuring Taiwan-backed mainland businesses to help bend the new President to China's will.

Still, Chen hopes relations with China have stabilized and may even be improving. More moderate remarks coming out of Beijing recently -- most notably from former Chinese Foreign Minister Qian Qichen -- may mean that relations are set to improve, says Tsai Ing-wen, Chairperson of the cabinet-level Mainland Affairs Council in Taipei. Officials in Taiwan, both local and foreign, say that the two sides are looking for a way to jumpstart negotiations. Any move will probably not come until after China's leadership holds its annual August meeting at the seaside resort of Beidaihe, where the vexing question of Taiwan will top the agenda.

FOCUS ON PRIORITIES. Chen's travel plans won't make restarting talks any easier. Chen said that he will ignore Beijing's threats and go to the inauguration of the new Dominican Republic president later this month. His trip to the Dominican Republic will be part of a larger swing through Central America and Africa, home to some of the few remaining countries that still grant diplomatic recognition to Taiwan. The trip will certainly anger China. Further complicating the diplomatic tangle is a planned refueling stop for the Presidential jet in Los Angeles. U.S. officials already are bracing themselves for a broadside from Beijing.

Methodical and coherent though Chen may be in person, his government is starting to look frayed after just three months in power. In late July, Chen was forced to replace his Vice Premier after a tragic flooding accident that took the lives of four people. Television cameras captured the agony of the victims trapped for hours, while government agencies squabbled among themselves over who was responsible for rescuing them, until rising waters swept the quartet to their deaths before a nationwide audience. And concerns about economic policies has knocked 20% off the stock market since April. Vice-President Annette Lu, cut out of the inner power circle, is shaping up as one of the Administration's most high-profile critics.

These troubles mean that Chen is scaling back his agenda of domestic reform. While vowing to push ahead with his anticorruption campaign, Chen acknowledged that reform of the business empire of the former ruling party, the Kuomintang, was "not a priority." With his Democratic Progressive Party controlling only a minority in the Legislative Yuan, Chen needs to stay focused on bigger issues -- above all else, China.

Following are edited excerpts of an interview, done in Taipei's grand, Japanese colonial-era neo-Victorian Presidential Office Building on July 27, with Chen by Business Week Asia Regional Editor Mark L. Clifford:

Q: What do you hope to accomplish vis-a-vis China during your term in office?

A: As president of the Republic of China and as a leader of a country in the Asia-Pacific region my natural obligation and mission is to jointly work with other leaders of Asia-Pacific nations to promote peace and stability in the region. We must promote peace and stability in the Taiwan Strait. This is not only my top priority -- it is a moral obligation.

Next of course, we need to clean up Taiwan politics. We must ensure economic prosperity and progress. As a leader I will work hard to terminate black gold or corruption in this country while at the same time working to create an improved climate for investment and business.

To lead Taiwan into the 21st century we must also make Taiwan into a new indicator of high human rights standards in the world. While we have made a number of reforms in our constitution in the process of democratization, there are a number of problems currently. I hope there is the opportunity to make additional reforms and improvements in the Constitution.

In terms of economic development, I hope that the phrase 'Green Silicon Island' will become a new name for Taiwan. I hope that by the year 2010 Taiwan will become a pioneer in digital economy.

Q: How will you, as you put it in your inaugural speech, "expand Taiwan's room for survival in the international arena," and how does your planed forthcoming trip to Latin American and Africa fit in with this goal?

A: In my May 20 inaugural speech, I said that "Taiwan stands up." Standing up means that I must also go out into the world as the leader of a sovereign and independent country. We must naturally push our diplomacy. We hope that Taiwan will take part internationally. The people in this country expect the government to take them back into the United Nations. Naturally, we face some difficulties, but we must not give up. At the same time, we must try to participate in other international organizations, including nongovernmental organizations.

During my Presidential inauguration, many heads of state visited from other countries to celebrate with us. While some other leaders of nations were not able to come, they nevertheless sent high-level or special delegations. These representatives of countries that are Taiwan's diplomatic friends invited me to visit [their] countries to strengthen relations. I hope to have the opportunity to reciprocate and on behalf of the Taiwanese people to thank them for their friendship and support. We hope to enhance the substantial relationship between the Republic of China and our diplomatic friends.

As to whether I or not I will travel, when I will travel and which countries I will visit -- all these issues are being arranged right now by the relevant government institutions. We will make a formal announcement when these issues are settled.

Q: Aren't you concerned that Beijing will be enraged by these visits?

A: I believe that, as President of a sovereign state, going abroad and exchanging meetings with our diplomatic friends is my duty. I believe I will be supported by our citizens for representing our interests on their behalf.

Q: What role would you like the U.S. to play?

A: I believe that permanent peace and the security and stability of the Asia-Pacific region are not only in the interests of Taiwan but also in the interests of the U.S. Therefore security and stability in the Asia-Pacific region is the common language between Taiwan and the U.S. I believe we can cooperate on this.

Therefore the concern on behalf of the U.S. for the Taiwan Strait and Cross Straits relations is quite normal. For the U.S. government and [its] people, improvement of Cross Straits relations is in their interest. I think the U.S. can play a more active role. I think the role of the U.S. can be [as] a balancer and stabilizer.

Q: Are you in favor of the proposed Theatre Missile Defense system? If so, would you like to see it extended to Taiwan?

A: The issue of TMD exists because of the deployment of missiles [by China] across the Taiwan Strait. This has been a threat to the peace and stability of the Asia-Pacific region. This is why the U.S. is considering the development of TMD.

Furthermore, TMD is not yet fully researched and developed, and it is too early to say whether Taiwan would invest in this project, but the government is seriously studying this policy. The decision to join is not a unilateral decision on our part. It also depends on the attitude of the U.S. as well as the threat imposed by the PRC's missiles.

According to opinion polls in Taiwan most people want to invest in TMD. We know that TMD is not absolute in terms of resolving our problems. It is not 100% secure. In addition to TMD, we must exert creativity and wisdom to improve Cross Straits relations.

Q: What is that creativity and wisdom?

A: This is related to the improvement of Cross Strait relations. We know that the purchasing of weapons does not provide 100% security. Taiwan's security does not rely only on traditional defense. It must incorporate political, economic, social, and energy-resource security, as well as the broader issue of regional security. We must not believe in [only] the hardware of weapons nor do we want to start an arms race.

Q: Relations seem stuck. Do you see any signs of progress, or are you disappointed at the lack of progress?

A: Although there are no significant breakthroughs, the situation has not worsened.

Q: Does China require radical change before reconciliation can occur?

A: Recently, I have noticed that U.S. Secretary [of State Madeline] Albright and Secretary [of Defense William] Cohen have visited China. In terms of Cross Straits relations, our information tells us that it is not seen as tense right now. There is not a sense of urgency or of crisis.

How we should grasp that opportunity is the greatest issue right now. We hope to sit down and resume negotiations. We can only do that by offering goodwill and through the wisdom of leaders on both sides. I have confidence that relations can improve.

I have noticed that there have been some adjustments and differences in some statements by PRC leaders before the March 18 elections and after the May 20th inauguration. I do not know if this can solve the problem. However, we prefer to interpret such adjustments as indications of goodwill. We feel it is most important to sit down and talk without prejudice before reaching an ultimate resolution. We should put aside our differences and seek a foundation that is acceptable to both sides.

Q: Can China and Taiwan negotiate on the basis of the 1992 agreement about "one China"? If so, what is your understanding of that agreement?

A: According to our understanding, in 1992 there was discussion of a so-called "one China". However, there was a disagreement and no consensus. Most Taiwanese people cannot accept Taiwan becoming a second Hong Kong or a second Macao. They cannot accept the one country-two systems policy [applied to Hong Kong and Macao], nor can they accept the "one China" principle interpreted as Taiwan becoming part of the PRC.

Q: But if you go abroad and you are not willing to accept the one China policy won't relations with Beijing get worse?

A: It is most important to please the Taiwanese people. I must [represent] the Taiwan people. Everything I do must be accepted by the people. It is a democratic country and I cannot do whatever I wish without respecting the wishes of the people.

Over the past few months, it has been clear that Cross Straits relations have not deteriorated. I will continue to express sincerity and goodwill, and I call on the leaders of the other side to react with sincerity and goodwill. With wisdom and creativity, the two leaders can sit down and negotiate the question of the future of "one China."

Q: Are you disappointed that China hasn't responded to your offer of allowing direct trading and transportation links?

A: As long as Taiwan's national security is maintained under the principle of market functions and mutual benefits, this government can adjust the present policy in regards to the three links. Whether we care [to talk] about the mini three links or in a broader sense, it requires officials on both sides to sit down and talk.

Q: What can China learn from your election, and do you expect your election to act as a spur to democratic change in China?

A: First, democracy, freedom, and human rights are universal human values. No individual political party or government can block the development of these values. Neither can they ignore public opinion in Taiwan.

Second, as a democratic country we feel that the spirit of democracy is in the alternation of power from one party to another through a process of a peaceful transfer of power. This is a necessary trend in democratic countries. Taiwan has not been left out of this trend. It also illustrates that a political party, no matter how hard it tries, cannot govern forever. There will always be a time when it must step down or transfer power.

Third, the election results demonstrate that the leadership in the PRC does not understand the Taiwanese people. Over the past two presidential elections, they have applied the same methods of threats and intimidation. However, the choices of the people of Taiwan have proven them wrong.

Finally the PRC doesn't understand the DPP nor do they understand me. They believed that a DPP victory would bring a declaration of independence. Thus far, my Cross Strait policy has been supported by 70% of the people in this country. It represents a consensus of the Taiwan people. The PRC leadership listens to people who visit China and often mislead them. The information they get is far from the truth. This leads to miscalculations and misjudgments on their part. They must learn from the election result. They must see our sincerity in improving relations. They should see the gestures made by the new government. They need to get to know me, and they need to get to know the DPP.

Q: Are you concerned that China could use Taiwan's business community as a wedge to divide Taiwan, as happened in Hong Kong in the runup to the 1997 handover?

A: We have noticed that the PRC has used tactics of trying to split our society. In the past, they have done this through selected businesses or industries. We have noticed that recently not only do they apply such methods through businesses, [but] they have also been reaching out to political parties and legislators. They are even extending their influence to representatives of the government and the military, as well as overseas Taiwanese groups. I think it is not so important to notice how they split or pressure our society. It is more important to put our attention on how to build confidence among ourselves to build solidarity so that we have greater strength to resist outside pressures.

Q: What will you do to promote greater Taiwanese investment in the mainland?

A: Promoting Cross Straits relations and the three direct [transportation and trading] links is already the set policy of the new government. To do so we must sit down and talk. Without doing so, there will be no breakthroughs.

By the end of this year, it is very likely that both sides will be joining the WTO, and this will of course affect direct investment on both sides. Once both sides join, the question of opening up direct investments will have to be further examined and implemented.

Q: How, specifically, do you propose to eliminate "black gold" and do away with the widespread perception, especially among Chinese outside of Taiwan, that the island's "democracy" has been little more than a "mafia-ocracy"?

A: The termination of black gold policies and corruption is a top priority of this government. Right now the relevant agencies are preparing to act. I expect grand action after the end of this term of the Legislative Yuan.

Q: What moves are you making to dismantle the KMT business empire and how important a priority is this?

A: For the KMT party assets, there are still many questions as to how much they have as well as the source of such assets. Right now there are still efforts being made to clarify these questions. This issue is not a priority.

Q: Was President Lee Teng-hui's formulation of "special state-to-state relations" correct?

A: It is not appropriate for the new government to criticize or comment on the former President's positions. However, as the President of the ROC, it is my obligation and responsibility to maintain sovereignty, dignity, and security, and to enhance the well-being of Taiwan's people.

In my May 20 inaugural speech, I emphasized that the improvement of Cross Strait relations must be based on the principles of democracy and parity. The leaders of both sides must respect the will of the people. Only the 23 million residents of Taiwan have the right to decide their future.

Q: What lessons do you draw from the Korean summit and from Kim Dae Jung's "sunshine diplomacy" that preceded it?

A: The greatest lesson we have learned in witnessing the two Korean leaders is that they sat down and reconciled. They have been able to put aside prejudices and differences. Only by putting aside such prejudices and differences in Cross Straits relations can reconciliation occur. We believe it is also essential to put aside our differences in search of some consensus.

Although the two Koreas and the Cross Strait relations result from very different historical circumstances, reconciliation is a global trend. If [both Koreas] can sit down, why can't the leaders on the two sides of the Taiwan Strait sit down?

Huang Chun-che flips on the police-issue siren in his Nissan Cefiro and steps on the gas as he winds through downtown Dongguan. Huang has just finished blasting clay pigeons at the skeet-shooting range he manages, a place where he and other Taiwanese businessmen living in the southern Chinese city go to let off steam. Weaving from lane to lane, Huang gripes that the tangled traffic is making him late for the next appointment. But it is a snarl he helped create. In the last 10 years, Huang, and others like him, transformed what was a sleepy city into a veritable Taiwan Town.

Located in the middle of Guangdong province's industrial-export belt, Dongguan is home to some 40,000 Taiwanese and 3,000 of their factories. Their imprint is everywhere--from the luxury villas to the flashy karaoke bars where businessmen flirt with young women. In the city's northwest, China's first Taiwanese-run school is nearing completion. Every week, it seems, a delegation of Taiwan officials arrives to check out the community or meet with Dongguan officials.

It's a collaboration that has flourished across China: Some 250,000 Taiwanese on the mainland run factories and companies responsible for some 12% of the country's exports. Taiwanese investors have pumped some $40 billion into the mainland economy. Their real contribution may be even greater, since many disguise their activities through Hong Kong front companies to avoid antagonizing their own government, which has long been leery about becoming too dependent on China.

NEW WAVE. Moreover, Taiwanese investors are moving well beyond the small-time activities of cowboy capitalists like Huang. In many ways Huang, who also manages an office equipment factory, represents the first wave of Taiwan businessmen: makers of low-end clothing, shoes, and furniture. The new wave, by contrast, is dominated by Taiwanese multinationals that are establishing high-tech production lines and sometimes cutting deals with China's most powerful people. For example, Winston Wang, son of Taiwanese petrochemical tycoon Wang Yung-ching, has plans to build a semiconductor plant in Shanghai, according to some Taiwanese sources. His prospective partner is none other than Jiang Mianheng, son of Chinese President Jiang Zemin.

But the March election of Taiwan President Chen Shui-bian is sending jitters through China's Taiwanese community, despite its connections and aggressive expansion. In the past, President Chen has backed independence from China, a matter of grave concern in Beijing. Taiwan investors fret that a diplomatic downturn could derail their ambitious mainland agenda. The disappearance in June of General Pan Hsi-hsien has heightened their anxieties. The former chief of personnel at Taiwan's National Security Bureau, Pan went missing after taking up a senior position with a Taiwan electronics company in Dongguan. The Taiwanese believe he was nabbed by China's State Security Ministry and is being held for questioning. Beijing has not confirmed these reports.

The fear is that Beijing may be trying to use Taiwan businesses on the mainland--especially companies run by the handful of executives who advise President Chen on economic policy--to extract concessions from his government. Who better to push Chen away from independence, the theory goes, than the men with the most to lose in China?

Some Taiwanese warn that political pressure from Beijing could prompt them to curb their expansion plans. But most investors are simply hunkering down for the long haul, hoping that common sense will prevail. ''We're afraid,'' acknowledges C.M. Wu, managing director of Acer Peripherals (Suzhou) Inc., which makes CD-ROM drives, monitors, and other computer gear in China. ''But we still want to expand.''

The truth is, neither Taiwan nor China can afford to disengage. For Taiwanese companies facing rising costs at home, China offers a nearly limitless pool of cheap labor and engineering talent. Taiwan's tech powerhouses also crave access to China's market. For Beijing, the Taiwanese provide plentiful jobs at a time when bloated state enterprises are laying off millions. They also bring the latest technology and management systems, which China needs as it prepares to join the World Trade Organization.

The hope in many quarters is that the burgeoning economic relationship actually will lead to a lasting political thaw. ''Both governments and the people win'' with Taiwanese investment, says H.D. Yeh, chairman of Dongguan Primax Electronic Products Ltd., one of the world's largest computer mice producers and employer of 3,500 workers in China. ''We hope that through this economic cooperation, both governments can keep the peace.''

Beijing certainly has much to gain from seeing the flood of Taiwanese investment continue. Today's biggest investors are the likes of computer equipment companies Proview, Delta Electronics, and Acer. They are building factories that are turning China into a major electronics export platform.

Evidence of the high-tech migration is obvious on the manicured grounds of the Suzhou New District, a special economic zone in Jiangsu, the coastal province where Taiwan investment is growing fastest. Acer Peripherals has sunk $80 million into a 6,000-worker facility. The place resembles a college campus, with training facilities and a soccer field. A few miles away, Sampo Group has opened a $22 million plant that makes parts for personal-computer monitors. Not far off, Yageo Corp.'s $98 million factory produces resistors for such corporate giants as IBM, Acer, and Philips Electronics.

Beijing is rolling out a range of incentives to keep Taiwanese companies happy. Last December, the government made it easier for them to get loans and strengthened laws providing legal protection. Local governments coping with mounting unemployment are slashing taxes and land-use fees. Guangdong's government has opened special information offices for Taiwanese investors and launched a Web site where business people can post complaints and suggestions.

The trouble is that even as China beckons with one hand, it intimidates with the other. Or at least it seems to. Taiwanese factory owners complain of being targeted in a wave of crackdowns by Chinese officials over labor standards and customs rules. Often, it's hard to tell whether the Taiwanese are being singled out. But it seems clear that companies most visibly associated with President Chen are the most likely victims of politics. ''Business leaders who support Taiwan independence and have a bad influence, but still hope to benefit from China's strong economy, are not welcome,'' says Jiang Changfang, a Guangdong official responsible for Taiwan affairs. Chinese officials also have warned Hong Kong companies to shun Taiwanese who oppose Bejing's line.

TAX CRACKDOWN. Executives at plastic and electronics company Chi Mei Industry certainly believe they are being targeted. Group Chairman Hsu Wen-lung is a longtime Chen backer and now advises the President on economic policy. In May, 20 tax inspectors descended on a Chi Mei plant near Nanjing and scrutinized its books. Company officials say the inspectors found no irregularities but made clear the crackdown was tied to Hsu's support for Chen. The company also says authorities have threatened its mainland customers with special tax scrutiny. Chi Mei has sunk $200 million into China, but now threatens to freeze future investments.

In a move that some Taiwanese analysts viewed as a deliberate snub, high-ranking Chinese officials refused to see Acer Group Chairman Stan Shih, another Chen adviser, when he visited Beijing in April for a computer show. Acer officials in Taipei play down the incident, but its executives in China worry that Beijing could block its future investments. In the past, Acer avoided cross-Strait politics, says J.T. Wang, the Taiwan-based chairman of Acer Sertek Inc., the group's sales and marketing arm. ''But now the politics comes to us.'' That means that Acer must assure Beijing it opposes independence and backs the view that Taiwan is part of China.

But some Taiwanese executives are mostly irritated at their own government. After being badgered by previous President Lee Teng-hui to go slow in China, many expected Chen's election to lead to a friendlier climate. Indeed, during the campaign, Chen vowed to quickly lift decades-old restrictions on direct transportation, communication, and postal links. His top aides suggest they will do so soon.

For now, though, many constraints remain. Taipei still bans investment in finance and transportation as well as in products it considers technologically advanced. Taiwanese companies cannot assemble PCs or motherboards containing anything more powerful than a 486-class microprocessor, for example. Nor are they supposed to make semiconductors and high-speed cable modems. Taiwan's government also has capped individual investments at $50 million and restricted how much capital companies can invest. ''Our businesses should aim for the global market, not the mainland market,'' says Tsai Ing-wen, chairperson of the Mainland Affairs Council in Taipei, which oversees cross-Strait relations. ''We do have a national security concern.''

Not surprisingly, Taiwanese businessmen have devised numerous schemes to skirt the rules. Many route their investments through companies in Hong Kong, the U.S., or Japan. Several Guangdong-based companies admit they don't divulge to Taipei the amount of money they've put in China or disclose whether they are making products on the restricted list.

PRAGMATISM. Despite the mixed signals, there are signs that pragmatism will win out. In July, legislators from Chen's Democratic Progressive Party and the Kuomintang--the old ruling party--visited Dongguan to see how Taiwanese investors are faring. In Beijing, Taiwanese politicians met Vice-Premier Qian Qichen, who called for better contacts. And Tang Shubei, former head of China's Taiwan Affairs Office, attended a Taiwan investment conference in Dongguan.

Many Taiwanese just think the controversy will blow over. There have been many stormy episodes in cross-Strait relations, and each time Beijing has refrained from harming commerce. A crackdown now could discourage the kind of big, technology-intensive investments China needs most. The less optimistic view is that the time is coming for Beijing to tighten the screws. With Hong Kong and Macau safely returned to the motherland, President Jiang and other top leaders have made unification with Taiwan a top priority. And now that some of the island's premier technology companies have big money at stake, Beijing is gaining valuable leverage. Taiwanese industry has long learned to thrive despite political ambiguity. By putting Taiwan's factories at risk, Beijing may be sending the first warnings that the era of carefree neutrality is coming to an end.

By Dexter Roberts in Dongguan, with Alysha Webb in Suzhou, and Mark L. Clifford and Brent Hannon in Taipei

Taiwan's Deep-Pocket Commitment to China

-- Taiwanese companies have invested $40 billion in China's economy

-- 250,000 Taiwanese live and work in China

-- Taiwan-linked companies operating in China now number 40,000

-- Taiwanese companies are responsible for 12% of China's total exports

DATA: Business Week