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Financial Liberalization and Industrial Development in Taiwan

00/01/06

How did SMEs in Taiwan Survive the Crisis

Chi Schive

Vice Chairman

Council for Economic Planning and Development

and

Professor of Economics

National Taiwan University

1999 Industry Economics Conference

July 12-14, 1999, Melbourne

How did SMEs in Taiwan Survive the Crisis*Chi Schive**1. Introduction

Taiwan has been less affected during the recent crisis in East Asia. We could look at this fact from various perspectives of the cause of the crisis. On the microeconomic aspect, it has been the labor market rigidity, over-concentration of market structure, and influential state-owned enterprises, all of which have retarded the flexibility and upgrading of industries. Such microeconomic feature, however, is not the essential ingredient of Taiwans economy. Taiwans industrial policy, though accentuating the development of large enterprises, has not discriminated strongly against small and medium-sized enterprises (SMEs). In the early period of its economic development during the 1950s and 1960s, Taiwan was abundantly endowed with labor. Without much advanced technology and capital, micro-businesses (living-room factories) could only begin with labor-intensive products, say knitting and handicrafts, and the successful ones grew into SMEs. The offspring of existing firms came to the stage and became another source of SMEs. Very soon, the dominance of SMEs has become a very unique feature of Taiwans industrial organization ever since their very first appearance.

In Taiwan, the efficiency and flexibility of SMEs have raised competitiveness to the extent that they have been able to coexist and compete with large enterprises, thus saving the economy from the dominance of large enterprises. Being efficient and flexible, the SME sector has been constantly adjusting its competitive edge (or niche) in times of great change, needless to say some of its members have grown into larger ones, while more of them just vanished.

Since the mid-1980s, Taiwan has quickened its pace in liberalization (Schive, 1995), accompanied by a noticeable industrial restructuring. Though it is widely held that liberalization threatens existing domestic industries with more competition, efficiency and welfare gain from it proves to have outweighed loss. The SME sector, which largely comprises vulnerable businesses in terms of size and shock absorption capacity, has shown to survive the days of rapid liberalization. The East Asian financial crisis is a test of a different kind to SMEs ability to deal with difficulties and challenges. The hypothesis is that a well-developed SME sector is conducive to Taiwans relative strength shown during the crisis.

Traditional SMEs are not only small, family owned, but have little to do with science or technology. However, in the information age and fast growing high-tech industries, some SMEs have been actively responsive to new technologies and played an important role (Hu and Schive, 1998). The new challenge is still evolving and gaining momentum. The prospects for SMEs in Taiwan to survive this new situation can be looked at from technological capacity and the capacity to foster knowledge-based industries. How have Taiwans SMEs responded to fast technological progress? What are the prospects for SMEs in Taiwan of surviving the information technology (IT) age?

In this paper, how SMEs in Taiwan have responded to one great challenge in the 1990s, namely the East Asian financial crisis, will be addressed. Before going into that direction, however, a highly related topic -- SME response to Taiwans great liberalization movement since the mid-1980s will be discussed. With that foundation, the author will examine SME restructuring since 1990 in response to IT, and opportunities arising from new challenges, the development of global logistics in particular.

2. SMEs and the Great Liberalization in the mid-1980s

In the 1980s, the Taiwan economy was confronted by several problems: mounting trade surpluses, upward pressure on domestic currency, escalating excess savings, and rising cost of labor and land. In response, Taiwan lifted most of foreign-exchange controls, lowered import tariffs, relaxed import restrictions and opened domestic services market for foreign competition. The resulted pressure on SMEs, who were mainly engaged in export business, was overwhelming. Meanwhile, Taiwan had grown from a capital-poor to a capital-rich economy, which was attributable to mounting excess savings. With over two decades of rapid industrialization of export sectors, Taiwans industrialists have developed a strong international network and have accumulated international management skill and technology capability.

One may conclude that pressure from both external and internal market forces has triggered the great transition for SMEs in Taiwan, who quickly adjusted to the new business environment in the mid-1980s. They reacted with accelerating automation, improving product quality, shifting to production of higher value-added goods, employing foreign labor and relocating traditional manufacturing overseas.

There is abundant evidence that verifies the admirable adaptability of SMEs in Taiwan during the great transition period. Furthermore, in five of Taiwans major export industries, i.e., foods, textiles, plastic products, machinery, and electronics, there was a clear trend toward increased use of automatic machinery after 1987.

Accordingly, manufacturers would be able to increase production with less labor input, implying a gain in labor productivity. Between 1987 and 1991, employment of the manufacturing sector fell 16%, while the manufacturing production index posted a 14% growth. While automation could help reduce production cost, upgrading product quality was in no less degree important in maintaining export competitiveness. With two export price indices: one, unit export price index expressed as total export value divided by export volume while embodying quality factor and two, the commonly used export price index net of quality factor, we can calculate a quality index. Empirical study confirmed the hypothesis nicely (Schive, 1995)

Before the 1980s, foreign direct investment was mainly the domain of multinational corporations. In the mid-1980s, however, SMEs from Taiwan, equipped with their skills, business relations, and capital, were attracted to lower production cost in Southeast Asia and Mainland China. While Taiwans SMEs were extremely experienced in low-skilled and labor-intensive operations, they went abroad to capitalize on neighboring countries abundant labor. It must be noted, however, the absence of de facto control on outward investment and the coming of rather free foreign exchange operations also facilitated the outward investment by firms of Taiwan, SMEs in particular.

Most of the earlier outgoing investors to Southeast Asia were from the traditional manufacturing industries such as textiles, electronics, electrical appliances, paper products, printing, chemical products, metal products and non-metallic products. Later on, services, such as trade, banking and insurance and wholesale and retail, were destined for investment in Hong Kong and Singapore, and so were some capital-intensive industries, such as petrochemical and steel industries.

Instead of eroding domestic manufacturing base, outward investment has been a first step in globalizing local enterprises. Indeed, a survey of 4,056 manufacturers that had invested abroad, showed that 59.6% of these outward investors continued to maintain their investment in Taiwan and 24.3% of them actually planned to expand domestic business operations. The firms most likely to reduce or eliminate operations in Taiwan were manufacturers of ready-to-wear garments, leather, wood materials, and rubber, which were totally losing comparative advantage in Taiwan.

As Taiwan-based firms moved their factories overseas, they created demand for capital and intermediate goods from Taiwan, leaving a significant impact on the patterns and partnership of Taiwans trade. Thanks to growing investment in Southeast Asia and Mainland China, Taiwans trade with these economies has been expanding rapidly since the mid-1980s. Taiwan has also become an important exporter of capital goods and intermediates to the neighboring economies, which in turn produced goods for the U.S. market. At the same time, Taiwans exports have quickly switched away from the traditional labor-intensive products to capital- and technology-intensive one since 1987.

At the company level, Taiwans trade with ASEAN has displayed an increasingly complementary relationship. Intra-industry trade coefficient suggests vast intensification of vertical or horizontal integration among Taiwan and ASEAN.

In sum, Taiwans SMEs took actions that had been uncommon elsewhere during the economys restructuring in the mid- and late 1980s. With such adaptability they survived the transitional challenge.

3. SMEs in Taiwan and the East Asian Financial Crisis since 1997

The impact of the East Asian financial crisis on Taiwan has been latent and relatively mild. On the macroeconomic aspect, economic growth declined moderately from 6.8% in 1997 to 4.8% in 1998. Growth rate of 1999 is expected to climb to 5.1% or even higher. The misery index, measured by the combination of unemployment and inflation, rose only 0.8 percentage point to 4.4% in 1998 and remained considerably lower than the rest of the recession-laden economies of East Asia.

On the microeconomic aspect, signs of slowdown have been detected, yet the resilience of the economy has still been there. For instance, the number of start-u