Two important medium-term challenges face the authorities: to
nurture new sources of growth and to redress income inequalities.

The growth engine of recent decades—electronics—has faced significant competition from low-cost producers.Most labor-intensive production has relocated to the PRC. Firms in Taipei,China still make
some high-value products and play a dominant role in regional supplychain management, but profit margins have been squeezed and their linkages to the domestic economy weakened. This is reflected in a reduction in manufacturing to 21.4% of GDP in 2006 from 37.6 % in 1986. Services, which accounted for 73% of GDP last year, are mainly oriented toward the domestic market and are dominated by small and medium enterprises, so are unlikely to expand at much faster rates than they do now. New growth sources would be fosteredif manufacturers moved further up the value chain and services firms tapped into regional markets.

Although the economy has a relatively equal income distribution,
income disparities have widened over the past decade. Only the highestearning 20% of households enjoyed gains in income in 2001–2005, partly because corporate and investment income outpaced wage income, helped by corporate tax breaks. Incomes for other groups stagnated or declined. Unskilled workers were the major losers as manufacturers relocated abroad. Some middleincome earners also suffered because of subdued growth in real wages and a disproportionate tax burden on salaried employees. The widening income gap will restrain expansion in consumption, make it more difficult to win public support for further economic liberalization, and could even induce social tensions.