The following article by Dr. Schive Chi, a professor of economics at National Taiwan University and one of Taiwan's most respected domestic economists, assesses these complex trends and their impact on Taiwan's economy from the perspective of Taiwan's trade imbalance and its ongoing process of economic restructuring.
Taiwan's rapid economic growth in the 1980s, averaging approximately 7.9 percent per annum, has been characterized by large trade and savings surpluses. Table 1 shows that the exports/GNP ratio (exports as a percentage of Gross National Product) remained around 48 percent between 1980 and 1983, then increased to 55 percent in 1987 and 1988.
But the imports/GNP ratio declined steadily until 1987. The net effect is clear: Taiwan started to deviate from balanced trade in 1980 and began accumulating a rapidly growing trade surplus. By 1986, the trade surplus accounted for 21.2 percent of GNP, which was not only a record level for Taiwan, but was also unparalleled among other trade surplus countries. Although this figure dropped sharply to 10 percent last year, bringing more balance to the import and export figures, the trade imbalance still raises serious problems.
The external trade imbalance, indicated in Table 1, can be interpreted from the perspective of the domestic economy. According to macroeconomists, domestic expenditure is comprised of the following: consumption, government spending, investment, and exports minus imports. National income, on the other hand, is composed of consumption, savings, and government taxes. Therefore, net exports (exports minus imports) equal the government budget surplus (taxes minus spending) plus net savings (savings minus investment). If the government budget is more or less balanced, then the trade surplus will be equivalent to net savings. The former may be referred to as the external imbalance and the latter as the internal imbalance.
The figures in Table 1 strongly confirm this interpretation. The savings ratio in Taiwan fluctuated between 30 percent and 33 percent between 1980 and 1985, but jumped to 38.7 percent and 40.4 percent in 1986 and 1987 before declining again to 34.7 percent last year. Meanwhile, the investment ratio has decreased steadily from 34.3 percent in 1980 to 15.8 percent in 1986, then increased slightly to show a moderate improvement in 1987 and 1988. Therefore, inadequate investment over the years has been the major cause of the widening savings-investment gap. This problem has been augmented by an extremely high savings propensity among people in Taiwan, which has also contributed to the net savings ratio rising to the extraordinary level of 20 percent in 1986 and 1987.
Real Effective Exchange Rate
When exploring the source of the external imbalance indicated in Table 1, economic theory suggests that any market disequilibrium is attributable to a malfunctioning of the price system, which means that market gaps between supply and demand should be eliminated by price adjustments, and that a persistent market gap implies a deficiency in the price mechanism adjustment.
Chart 1 presents Taiwan's balance of payments as well as two measures of Taiwan's "real effective exchange rate" (REER) given in reciprocal terms and weighted by exports as well as total trade. By taking into account both the changes in nominal exchange rates and price variations in Taiwan's major trade patterns, the reciprocal of the REER of the NT dollar reflects the competitiveness of Taiwan's exports (imports) in the international (domestic) market. Thus, a weak NT dollar encourages Taiwan's exports, other things being equal, and creates a trade surplus.
Since Taiwan's external trade was balanced in 1980, the reciprocals of the NT dollar's REER have been measured using 1980 as the base year. The three curves shown in Chart 1 all move in a similar fashion. More precisely, a one-year time lag may be detected between the movement of the REERs and the trade imbalance. For instance, the first drop in the reciprocal of the REER in 1980 and then a six-year increasing trend of the reciprocal of the REER preceded the accumulation of the trade surplus, while a sharp reverse in the REER which occurred in 1987 did not dampen the trade surplus until a year later.
It is evident that Taiwan's booming exports in the early 1980s have benefited from the weak NT dollar. Thus, in spite of a sharp appreciation of the NT dollar against the US dollar — an increase of 40 percent since the middle of 1986 — the REER of the NT dollar simply went up to 100 percent by 1988 (or the reciprocal of the REER fell to 100 percent). Thus, the sharp appreciation of the NT dollar solely against the U.S. dollar during the later period was basically a means to correct the undervalued NT dollar by taking into account all the currency movements of Taiwan 's major trading partners.
Domestic Investment
An inadequate level of domestic in vestment in Taiwan has been the main cause of excess domestic savings. Table 2 illustrates this decline. First, while increases in stocks usually accounted for 2 to 3 percent of GDP (Gross Domestic Product), or around 10 percent of the gross capital formation in the 1970s and early 1980s, the absolute amount of inventory started to decrease in 1983 due to deflation and, in some cases, better inventory management. The wholesale price index decreased on the average by 1.68 percent between 1983 and 1987. Table 2 indicates that the decrease in inventory accounted for an average 0.8 percent of GDP since 1982, but for 1.2 and 2.3 percent of GDP in 1985 and 1986, respectively. Therefore, a declining price level and some improvements in inventory management have led to a negative growth of stocks, which explains the drops in the investment ratio of around 3 to 4 percent since 1982.
Second, the main drop in investment came from consecutive declines in gross fixed capital foundation in all three sectors, namely, the government, public enterprise, and private sectors. Among these three, the share of public enterprises dropped significantly from 10.6 percent in 1980 to 4.2 percent in 1988. Both the shares accounted for by the government and the private sector also fell by between one-fourth and one-third between 1980 and 1987.
The rationale behind the changes in investment behavior varies among these three sectors. Briefly, the decline in investment in the public sector may not be an unwelcome result due to concerns about efficiency, although the delay of public investment in power plants may result in some shortages in electricity supply in the near future. In addition, the government's misjudgment of the rapidly growing demand for public goods has created a serious shortage of public investment on many fronts.
For example, transportation facilities are far behind in terms of meeting demand in general, not to mention that the construction of the first mass rapid transportation system in the Taipei municipal area began only recently. Driving in Taipei city has become next to impossible not because of the high prices of cars, but because of the inadequate road facilities and shortage of parking space.
There are in fact numerous infrastructural problems tied to insufficient investment. For instance, many areas in Taiwan, including Taipei, are still frequently threatened by floods because flood control projects have not yet been completed. There are also glaring needs for modern sewer systems, public parks, more breathable air, and a greatly improved environment. In short, there are many challenges to be met by public investment, and these should be able to keep pace with the economy, especially when Taiwan has accumulated the world's largest foreign exchange reserves apart from Japan.
Manufacturing
Table 3 provides some indications of the current and future position of the manufacturing sector in Taiwan. First of all, Taiwan's extremely large manufacturing sector, which accounted for 43.5 percent of total GNP in 1987, is quite high compared with other countries. For instance, the two front runners among the industrialized countries, Japan and West Germany, had manufacturing sectors that accounted for only around 30 percent of total GNP in the early 1980s. The same figure for South Korea was 28.1 percent in 1985, and that for the U.S. a mere 20.9 percent. Therefore, Taiwan's manufacturing sector has not only been very large in the past, but is presently also far ahead of other countries by a significant margin based on the most recent data available.
But is Taiwan's current economic structure unprecedented? Chart 2 shows the patterns of the growing manufacturing sector relative to the total economy during the period 1970-84 for various countries. Three types of patterns relating the three groups of countries are readily identified. First, Taiwan, South Korea, Malaysia, and Indonesia belong to the developing country group and show an increasing trend as their economic development has been manifested by a growing manufacturing sector in the economy during the period observed.
Second, the developed countries including West Germany, the U.S., Belgium, and the Netherlands all reveal a declining trend, which implies a gradual shrinking of the manufacturing sector in relation to the rest of the economy. Japan and to some extent West Germany belong to the last group of countries, which at first have an expanding manufacturing sector as a proportion of GNP that later declines in the so-called inverted U-shaped curve.
The information contained in Chart 2 suggests that the manufacturing sector usually plays an increasingly important role in the earlier stages of development as manifested by the increasing trend exhibited by the curves of those developing countries. At the opposite extreme, a matured industrialized economy relies less and less on the manufacturing sector. Thus, Japan and West Germany, for which the data cover a longer period of time from 1950 to 1984, show a more interesting and long-term development pattern for the manufacturing sector. That is, this sector at one time led the expansion of the economy, but its contribution declined when the economy reached a certain high income level.
In the case of Taiwan, the manufacturing sector has obviously explored a wide range of development opportunities within a relatively short period of time and has had a maximum contribution to economic growth. If Taiwan follows the industrialization pattern of Japan, West Germany, and other developed countries, its industrialization may also have reached its peak and the share of manufacturing may well begin to decline.
Conclusions Policy Implications
Taiwan's economy has been constantly changing during its rapid process of development. In the 1980s, the economy has relied heavily on trade, and has been dominated by the manufacturing sector, of which the heavy and chemical industries have accounted for more than 60 percent. But the most spectacular characteristic of Taiwan's economy in the 1980s has been its extremely large trade surplus and excess savings. A weak NT dollar, among other things, was basically responsible for the trade surplus. As for the very large excess savings, inadequate domestic investment has been the main factor causing such an internal imbalance.
Despite a clear shift toward more spending on luxury items, excessive savings remain a serious problem.
A breakdown of the investment sources indicates that the lack of public investment and new projects by public enterprises has contributed to a large proportion of the decline in domestic capital formation. With respect to the investment from the private sector, it seems that the slowdown of the rapidly expanding manufacturing sector has also been partly responsible for this situation.
In the 1980s, the manufacturing sector in Taiwan has accounted for one of the world's highest proportions of GDP. If Taiwan is to follow a similar development pattern to those of Western countries, or of Japan in particular, then the manufacturing sector may no longer maintain its leading role in expanding the economy as previously. This does not mean that this essential sector is no longer important, but that its relative position in the economy will most likely decline.
Within the manufacturing sector, some structural changes are expected to take place. The labor-intensive and polluting industries will cease to grow, and will even decline because their comparative advantage will change as the social costs of pollution are internalized. As for the labor-intensive industries the outflow of domestic investment will surely accelerate the process of structural change. New industries such as the information and service industries will grow faster, and the conventional export industries will introduce more automation in order to survive.
If the development trends in the Taiwan economy outlined above are correct, the following policies should be adopted: (1) public investment should be increased; (2) there should be further deregulation in the private sector, and the financial sector in particular; and (3) greater promotional activity should be undertaken to develop high-technology and automated industries in order to smooth the process of economic transition.