This chapter adopts a signaling game approach to examine the way in which Taipei created a ‘peace dividend’1 by signing the Economic Cooperation Framework Agreement (ECFA) with mainland China as a signal to reveal its conciliatory mainland policy preference to other countries. The cross-Strait relationship between mainland China and Taiwan has been fundamentally changed since the Kuomintang (Chinese Nationalist Party, KMT) was returned to power in 2008. Not only has Taipei adopted far more conciliatory policies towards Beijing, but the latter has also responded positively by reducing diplomatic tensions and offering more opportunities for economic cooperation. On the Taiwanese side, this development has given rise to many new economic opportunities that were nearly impossible when both sides were engaged in confrontations over various strategic issues ranging from Taipei’s memberships in international organizations to US arms sales to Taipei. These new opportunities come in two main forms. First, as an economic inducement to cultivate more pro-unification constituencies, Beijing has launched a series of government procurement projects to increase imports from Taiwan. Second, the reduction in cross-Strait conflicts has also had the positive effect of inducing new private investment and trade from other countries. While both of these are important sources of a ‘peace dividend’ in this new era of the cross-Strait relationship, they actually work on very different principles in terms of how they are generated. The first type of peace dividend, generated by newly created investments and trade from mainland China, mingles both politically-driven purchases by government and state-owned enterprises and economically-incentivized private investments. As far as the former are concerned, an economic cost-benefit analysis is unnecessary, because the government agencies, both central and local, that are behind these purchases care for nothing but the spillover effects and their potential to create closer economic and political ties across the Taiwan Strait. Compared with the first type of peace dividend, however, the generation of the second type faces an information problem that has to be resolved in order for Taipei to improve (or mend) its economic relationship with the rest of the world beyond mainland China. That is, while the political tension2 between Beijing and Taipei has indeed been reduced to a great extent, it does not necessarily follow

that the business communities in the other countries were well-informed about this new development or convinced that the two governments on each side of the Strait were serious about it. As far as Taipei is concerned, this information problem is especially critical. On the one hand, Taipei’s international space in both economic and political affairs has long been squeezed by Beijing, and therefore the tools for the Ma administration to publicize its conciliatory approach internationally have also been limited. On the other hand, the confrontational approach adopted by the former Democratic Progressive Party (DPP) administration under Chen Shui-Bian’s presidency was also very likely to leave legacies behind that would not simply disappear after the power turnover in 2008 and would continue to affect the perception of the cross-Strait relationship around the world. For instance, on 30 August 2008, immediately after the KMT’s presidential candidate Ma Ying-Jeou had completed 100 days in office, various pro-independence activist groups, in collaboration with the DPP, marched through Taipei to protest President Ma’s mainland China policy, which in their view was going to damage Taiwan’s political sovereignty and economic security.3 In other words, given the continuing political pressures exerted by Taiwan’s pan-green coalition on cross-Strait issues, foreign business communities might receive mixed signals regarding the sustainability of the détente across the Strait. As a result, the extent to which Taipei can resolve this information problem will have a profound influence on foreign investors’ political risk assessments and therefore also on how big a peace dividend can be created. We focus on the creation of the second type of peace dividend.4 We propose a theoretical political-economy model that identifies the conditions under which Taipei would send out a costly signal to reveal its mainland policy preference, so that its trading partners, except for mainland China, could be able to assess Taipei’s policy resolve (i.e. a separating equilibrium). More specifically, we view the signing of the ECFA as a costly signal, for Taipei, to convey a credible message internationally that it would adopt a conciliatory approach towards mainland China. The chapter is structured as follows. We first elaborate on how the ECFA can be regarded as a costly signal. We then develop a signaling model with political-economy characteristics that can identify conditions under which a separating equilibrium is possible in settings of both deterministic and stochastic signals. We conclude with some thoughts on possible policy implications.