TAIPEI — Taiwan opened its doors Tuesday to investment by mainland Chinese companies in 100 sectors, from retail to restaurants to manufacturing of cars and personal computers, a major step forward for improved ties between the longtime rivals.

Chinese businesses have been lining up to expand in Taiwan since a month ago, when Taipei introduced regulations that will bring the first Chinese investment allowed on the island in 60 years. Taiwan began accepting applications Tuesday.

The opening is part of an effort by President Ma Ying-jeou, who took office in May last year promising to look for common ground with China. His government announced the planned investment opening in July.

Chinese investment is still excluded from Taiwan's most economically vital industries, the manufacturing of semiconductors and LCD displays, and those sensitive to national security, such as telecommunications. But the opening trend could help reshape the island's economy and increase integration with the mainland.

The government is also hoping improved relations with China will attract investors from other nations, who have largely focused on the mainland market.

"We hope the policy would attract Chinese investors and eventually foreign investors," said John Deng, vice minister of the ministry of economic affairs, at a news conference announcing the opening.

For years, investment across the Taiwan Strait has been one-way. Taiwan estimates the island's companies have poured more than $77 billion into China since the early 1990s, and the real number could be two-to-three times that, including unregistered investments.

But Taiwan has long barred mainland companies from investing here, a legacy of the civil war that divided the two sides in 1949, and of fear in the island that China could use its economic heft to dominate Taiwan.

Since President Ma took office, and as Taiwan's export-heavy economy has struggled with the effects of the global recession, Taipei and Beijing have held a series of high-profile meetings to expand economic ties and transportation, including the first regular commercial air traffic and shipping links.

Taiwan seeks to sign a trade agreement with China slashing remaining tariffs and other trade barriers by the end of this year.

The result of these efforts has been a steady stream of tourists and, more recently, the first visits by groups of Chinese executives seeking investment opportunities.

Impediments remain. The first major Chinese investment deal, an April agreement by state-owned wireless carrier China Mobile Ltd. to pay about $527 million for 12% of Taiwan's Far EasTone Telecommunications Co., has yet to be approved by Taipei, and is unlikely to pass. Telecom services are conspicuously absent from the sectors now officially open for investment.

For investors in newly opened sectors, the application process could be difficult. The Ministry of Economic Affairs will hold a cross-agency review of applications monthly, and applications might be rejected when advanced technologies are involved.

Many people in Taiwan fear China could use its economic might to influence the island politically. The opposition Democratic Progressive Party said it will to push for a referendum on the trade deal with the mainland. "Taiwan is losing its economic autonomy and is likely to become another Hong Kong," said Chiu Tai-san, a former legislator with the Democratic Progressive Party and previous vice chairman of the Mainland Affairs Council, which overseas Taiwan's China policy. Hong Kong, a former British colony, reverted to Chinese rule in 1997 and has increasingly found prosperity as a service and logistics center for the Chinese economy.

But foreign businesses — whose investment in Taiwan has been declining in recent years — are welcoming the trend. Normalization "is upgrading Taiwan's economic strategic position," says Jerry Fong, an official with the European Chamber of Commerce Taipei.

One focal point of Chinese investment has been the Taipei 101 office tower, which when it opened five years ago was the world's tallest building. Built to be an icon of Taiwan's progress, the 509-meter jade-color tower was largely a white elephant, with almost half of its office space empty. Now representatives from major Chinese companies such as Lenovo Group Ltd., Sinosteel Corp., and Tiens Group Co. occupy the high-profile address. The building is now 80% occupied.

Anticipation of more Chinese renters has helped lift average rental rates in the area around Taipei 101 by 5% to 10%, says King Chiao, president of Hsin-Yuan Business Rehouse Co., a Taipei office brokerage.

The tower's shopping areas are now busy with shoppers from across mainland China. In the first six months of this year, the number of visitors to Taipei 101's observation deck rose 30% from a year earlier, almost all because of Chinese tourists, says Michael Liu, a spokesman for the building.

Beijing has been eager to use its economic clout to woo the island's population. China claims Taiwan as part of its rightful territory and aims to eventually bring it under Chinese control. Chinese President Hu Jintao has publicly encouraged Chinese enterprises to invest in Taiwan.

Beijing has sent a series of business delegations to the island in the past month, signing deals with a nominal value of $68 billion — although it's unclear how much of that will be realized. Prominent Chinese restaurant chains, including Quanjude Co. and Guobuli Group, have been gearing up to open Taiwan branches, according to the companies. Mainland restaurant chains have the green light to apply to invest in Taiwan.

Some other changes are under way. The number of Chinese tourists surpassed 300,000 in the first four months of this year, compared to 320,000 for the whole of 2008, According to Taiwan's Tourism Bureau. The influx has been helpful at a time when Taiwan's economy, battered by weak demand for its high-tech exports, has posted contractions for two consecutive quarters.

The prospect of more Chinese investment and signs of improvement in the global economy have driven Taiwan's benchmark stock index up 40% so far this year. Shares in hotel companies like Formosa International Hotels Corp., a five-star chain, have led the rally.

Economists say that substantial economic benefits might take a while to show, but over the longer term the impact on Taiwan could be significant. "The structure [of] investment spending will change from being highly geared to the volatile export sector to investment in the domestic sector," said Sharmila Whelan, an economist at CLSA Asia-Pacific Markets.

AT A recent congressional hearing I cautiously noted some “glimmers of hope” that the economy could stabilise and perhaps start to rebound later in the year. I was asked if this meant that we should cancel much of the remaining spending in the $787 billion American Recovery and Reinvestment Act. I responded that the expected recovery was both months away and predicated on Recovery Act spending ramping up greatly. Only later did it hit me that I should have told the story of 1937.

The recovery from the Depression is often described as slow because America did not return to full employment until after the outbreak of the second world war. But the truth is the recovery in the four years after Franklin Roosevelt took office in 1933 was incredibly rapid. Annual real GDP growth averaged over 9%. Unemployment fell from 25% to 14%. The second world war aside, the United States has never experienced such sustained, rapid growth.

However, that growth was halted by a second severe downturn in 1937-38, when unemployment surged again to 19% (see chart). The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy. One source of the growth in 1936 was that Congress had overridden Mr Roosevelt’s veto and passed a large bonus for veterans of the first world war. In 1937, this fiscal stimulus disappeared. In addition, social-security taxes were collected for the first time. These factors reduced the deficit by roughly 2.5% of GDP, exerting significant contractionary pressure.

Also important was an accidental switch to contractionary monetary policy. In 1936 the Federal Reserve began to worry about its “exit strategy”. After several years of relatively loose monetary policy, American banks were holding large quantities of reserves in excess of their legislated requirements. Monetary policymakers feared these excess reserves would make it difficult to tighten if inflation developed or if “speculative excess” began again on Wall Street. In July 1936 the Fed’s board of governors stated that existing excess reserves could “create an injurious credit expansion” and that it had “decided to lock up” those excess reserves “as a measure of prevention”. The Fed then doubled reserve requirements in a series of steps. Unfortunately it turned out that banks, still nervous after the financial panics of the early 1930s, wanted to hold excess reserves as a cushion. When that excess was legislated away, they scrambled to replace it by reducing lending. According to a classic study of the Depression by Milton Friedman and Anna Schwartz, the resulting monetary contraction was a central cause of the 1937-38 recession.

The 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy after an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently. If the government withdraws support too early, a return to economic decline or even panic could follow. In this regard, not only should we not prematurely stop Recovery Act spending, we need to plan carefully for its expiration. According to the Congressional Budget Office, the Recovery Act will provide nearly $400 billion of stimulus in the 2010 fiscal year, but just over $130 billion in 2011. This implies a fiscal contraction of about 2% of GDP. If all goes well, private demand will have increased enough by then to fill the gap. If that is not the case, broad policy support may need to be sustained somewhat longer.

Perhaps a more fundamental lesson is that policymakers should find constructive ways to respond to the natural pressure to cut back on stimulus. For example, the Federal Reserve’s balance-sheet has more than doubled during the crisis, drawing considerable attention. Monetary policymakers have made it clear that they believe continued monetary ease is appropriate. Moreover, the Fed’s credit programmes are to some degree self-eliminating: as demand for its special credit facilities shrinks, so will its balance-sheet. But now may also be a sensible time to grant the Fed additional tools to help its balance-sheet contract once the economy has recovered. Some have suggested that the Fed be authorised to issue debt, as many other central banks do. This would enhance its ability to withdraw excess cash from the financial system. Granting such additional tools now could provide confidence that the Fed will be able to respond to inflationary pressures, without it having to create that confidence by actually tightening prematurely.

Now is also the time to think about our long-run fiscal situation. Despite the large budget deficit President Obama inherited, dealing with the current crisis required increasing the deficit substantially. To switch to austerity in the immediate future would surely set back recovery and risk a 1937-like recession-within-a-recession. But many are legitimately concerned about the longer-term budget situation. That is why the president has laid out a plan to shrink the deficit he inherited by half and has repeatedly emphasised the need to reduce the long-term deficit and put the debt-to-GDP ratio on a declining trajectory. In this regard, health-care reform presents a golden opportunity. The fundamental source of long-run deficits is rising health-care expenditures. By coupling the expansion of coverage with reforms that significantly slow the growth of health-care costs, we can dramatically improve the long-run fiscal situation without tightening prematurely.

As someone who has written somewhat critically of the short-sightedness of policymakers in the late 1930s, I feel new humility. I can see that the pressures they were under were probably enormous. Policymakers today need to learn from their experiences and respond to the same pressures constructively, without derailing the recovery before it has even begun.