Despite the past and current successes of SMEs, there is growing concern about their future. Observers point out that SMEs have inefficient management systems, lack R&D, and are too small in scale, thereby hindering attempts to upgrade Taiwan's economy.
While the number of larger-scale enterprises has grown in recent years, the most important industries in Taiwan are still relatively labor-intensive and export-oriented, in part due to the economic environment. For example, financial and taxation systems are not conducive to their expansion, and businessmen in fact sufficient understanding of modern business management concepts.
As a result, SMEs continue to dominate the lion's share of the economy. Given intensifying international competition in their traditional areas of production, however, pressures for change are becoming over whelming. Survival is at stake.
In the following article, Dr. Wu Hui-lin, a research fellow at the Chung-Hua Institution for Economic Research in Taipei, analyzes the past and prospective roles of SMEs in Taiwan's economy, including suggestions for governmental policy adjustments to tackle the new economic realities.
Small and medium-sized enterprises (SMEs) have long been of key importance to the health of Taiwan's economy, but they now face increased competition from abroad, forcing another stage of development. Continued local production of labor-intensive, low-value items may bring disaster as enterprises in Malaysia, the Philippines, mainland China, and other locations take increasingly large shares of the market in these products.
But there is a question at this juncture about how much the government should be involved in the process of transforming SMEs into more competitive entities. One view holds that the government must protect them, even though there is a need to enlarge their scale of operations, and to be very much involved-and even intervene-by set ting policies to encourage and regulate SMEs.
An alternative idea, which also has considerable support, calls on the government to reduce its involvement in business regulation and concentrate instead on creating a marketplace environment where SMEs can compete with each other in an open, fair, and just manner—and let the fittest survive.
Since the general governmental policies of internationalization and liberalization have taken root in recent years, the latter point of view has become more widely accepted. Given this situation, analysts now ask what the future holds for Taiwan's SMEs. Are they here to stay no matter what the governmental policy may be, or must they grow larger and larger or fail? Are there any other alternatives?
Full utilization of labor—the main reason for Taiwan's impressive growth. But priorities have shifted to introducing modern management and high technology.
Answers to these questions necessarily involve accurate information about the formation, roles, contributions, and current difficulties of SMEs, especially in light of Taiwan's shifting economic base as it moves from labor-intensive products to producing more value-added goods and services.
According to the World Bank's definition, "small and medium enterprises" have less than 100 employees. But various countries have adopted different definitions, based upon domestic policy decisions. In Taiwan, for instance, the definition of SMEs has changed four times since 1967. According to the latest version (issued in July 1982), an SME is "a manufacturing, processing, or handicraft enterprise having paid-in capital of less than US$1 million, and having total assets of not more than US$3 million; an importer/exporter, a commercial firm, a transportation company, or other service establishment having an annual turnover of not more than US$1 million; or a mining enterprise having paid-in capital of less than US$1 million."
But no matter what definition has been used in the past three decades, Taiwan has established a firm reputation for being awash with SMEs. From 1961 to 1985, according to official statistics, each year SMEs accounted for 98 percent of the total enterprises in Taiwan, and for three years it was even more than 99 percent.
The percentage of output represented by SMEs is substantial. In manufacturing, for instance, SME output represented 27 percent of the total in 1971, rose to 47 percent in 1976, and was still as high as 45 percent in 1981. (The main reason for the 20 percent increase in 1976 was a change in the definition of SMEs which increased the number of regularly employed persons from less than 100 persons to no more than 300 persons.)
In 1981, the number and ratio of SMEs reached almost 99 percent of the total businesses, but the output ratio was only 45 percent. It is clear that the average scale of operations—represented by output—of the large enterprises was 100 times that of the SMEs. Those SMEs engaged in mining and quarrying, and those in business services, had a similar size distribution.
The commercial sector presents a different pattern. In 1976, the output ratio of SMEs was 84 percent, and the firm number was also over 99 percent. In other words, commercial business in Taiwan is almost completely dominated by SMEs, large enterprises being not only few in number but also low (16 percent) in terms of the volume of output ratio.
On the other hand, in the utilities (electricity, gas, and water), transport and storage, and communications industries, large enterprises have the higher percentage in terms of both number of firms and total output. These industries are all regulated by the government and may operate only as public enterprises.
Scholars generally agree that SMEs create job opportunities, thereby making social policy targets such as social stability, a fair income distribution, and balanced urban-rural development more easily achievable. Moreover, SMEs in Taiwan tend to specialize in labor-intensive production, which contributes substantially to employment and to exports. The number and share of SMEs engaged in various categories of manufacturing, for example, illustrates the pervasiveness of SMEs in the economy.
Studies of Taiwan's trade development indicate that the main reason for its successful growth is that it has been based primarily on the principle of comparative advantage, which stresses full utilization of the relatively abundant labor available on the island. This export-oriented strategy has resulted in highly specialized labor-intensive industries that account for a substantial portion of Taiwan's exports.
According to estimates made by the Medium and Small Business Administration of the Ministry of Economic Affairs for the period from 1978 to 1985, the shares of the export earnings of the SMEs for the respective years have consistently been above 60 percent (except for 1984's 59.2 percent), averaging 65 percent. Thus, in the export sector SMEs are clearly the prime mover behind Taiwan's rapid growth. The ratio of export sales earnings to total sales earnings for SMEs was still below 60 percent before 1979, but it increased to 66.7 percent in 1980, and has remained over 70 percent up to the present, indicating the heavy dependency of SMEs on foreign markets.
In brief, more than 60 percent of the exported manufactured products from Taiwan come from SMEs, and these enterprises derive more than 70 percent of their sales earnings from the export trade.
Given such an export-oriented economy, it is to be expected that the main features of SMEs would include a sensitive response and flexibility in adjusting to foreign market variations to retain competitiveness. (Because the structure of Taiwan's domestic market is much different, it requires different sorts of sensitivities and marketing techniques. Local economists refer to this as a "dichotomous market structure.")
When trying to assess the underlying reasons why SMEs continue to prosper in Taiwan and playa vital role in promoting export and economic growth, it is clear that the question ·of "economy of scale" is foremost; in significant ways, the Taiwan experience departs from normal economic expectations.
There are two traditional expectations relative to economy of scale: One is that new firms may have relatively small-scale operations at the point when they enter the marketplace, but in the long run they ought to grow in size, meaning that the relative market share of SMEs should decline. But from the evidence of the steadily increasing share of SMEs in Taiwan, this deduction seems to be unfounded.
A second possible expectation is that small firms may still operate inefficiently if they enjoy high protective barriers, that is, a protected market. But protective measures are only effective for the domestic market, not for the export market. This means that if SMEs are inefficient, then they should be primarily oriented toward the domestic market. Again, this is not the case in Taiwan, for local SMEs have an overwhelmingly high export-orientation. Therefore, despite their limited size, SMEs in Taiwan cannot be considered inefficient.
This seems to go against the general proposition that export businesses need significant economies of scale to be internationally competitive. The evidence gathered from industrialized countries, such as Japan, France, and Belgium, shows that large firms rather than small ones play vital roles in their export businesses. This raises the question of how Taiwan's SMEs can operate prosperously and efficiently in the export market without economies of scale.
One important difference in Taiwan's SMEs is that they emphasize manufacturing rather than marketing. Much of the island's export production is OEM, or "original equipment manufacturer," meaning that products are produced in accord with designs, and in line with market plans, made by foreign companies. Until recently, few local brandname products entered the international market; materials used for foreign brand products constituted the greatest percentage of total export production. As a result, local manufacturers were not involved in marketing—nor did they gain marketing experience. Marketing functions were instead performed by Japanese general trading companies, multinational trading companies, and foreign importers.
Given these circumstances, Taiwan's SMEs specialized in the manufacturing and the production of mostly labor-intensive products. Even the so-called "export" trading companies in Taiwan only offered their services in terms of communication and paper work and rarely performed genuine marketing functions.
The whole system of Taiwan's rapid industrialization and rapid economic growth has been based on this pattern of the international division of labor, and is the reason why SMEs in Taiwan have been able to avoid being restricted by economies of scale in international marketing while still being able to specialize in the manufacturing business. This has also been the fundamental driving force behind Taiwan's economic development: growth led by exports.
At this juncture in Taiwan's economic development, it is clear that while local SMEs have been able to successfully exploit their small-scale advantage in production, in general they do not enjoy much power in marketing their exports, nor do they derive any mark-up value from their selling efforts. This leads to a question about the future: will SMEs grow into larger enterprises as Taiwan's economy restructures?
SMEs face some daunting difficulties. Although their business activities are successful, they often encounter problems that larger enterprises are generally able to avoid. Most of these arise from a lack of working capital and a lower level of technological knowledge and experience.
Some noticeable categories of problems confronting SMEs include the following: (1) an inability to provide sufficient collateral, the lack of a sound accounting system, and an insufficient expertise in capital planning; (2) a shortage of management expertise, and negligible consensus on suitable and simplified management systems; (3) the possession of only limited knowledge and, in many cases, the inability to conduct independent R&D.
Moreover, SMEs confront a disorganized and highly competitive market with but limited capacity for marketing their products, especially in terms of foreign markets. Consequently, their potential export business is chiefly dominated by foreign trading companies. A vicious circle has resulted, as the lack of capital, technology, and management expertise restricts the growth of SMEs, and the smallness of their scale of operations restrains them from engaging in international marketing, which in turn hampers their growth.
Declining local production—labor-intensive SMEs producing low-end products are folding or moving overseas.
Faced with this situation, public debates on industrial policy have become more intense. In order to break this vicious circle, some experts have urged government intervention in the form of incentive measures as a means to encourage the development of big trading companies. Coupled with this idea, they encourage establishing a long-range program to support strategic industries. This may be termed the school of "interventionism. "
On the other hand, others argue that the vicious circle is due primarily to the inefficiency of local financial institutions. Therefore, improving the functions of the financial market is a fundamental prerequisite to the resolution of this problem. From this point of view, deregulation rather than further intervention in the banking system is seen as the key step towards breaking this cycle. This is the school of "liberalism."
No consensus has yet been reached between these two schools. Meanwhile, export-oriented SMEs are still the main contributors to Taiwan's economic growth. But how long will this last? What are the immediate prospects for Taiwan's SMEs?
There is no question that SMEs have played a significant role in promoting exports and creating jobs in the course of Taiwan's economic development, a result that has been fundamentally achieved by exporting labor-intensive manufactured products and promoting an export-oriented growth strategy. Up to this point, SMEs have overcome international marketing constraints by relying heavily on the assistance of foreign institutions. Fortunately, Japanese and foreign trading companies have taken on this role and have helped Taiwan's SMEs exploit their relatively small-scale production advantage.
But when looked at from another angle, such export-oriented SMEs are restricted to some labor-intensive and a few mature-technology industries. Other SMEs are restrained from upgrading their technology, enlarging their scale of operations, and promoting their marketing capability. Therefore, most export business continues to be chiefly controlled by foreign trading companies.
In order to break through these present barriers of small-scale and limited marketing capacity, a new consensus on business orientation is needed. Not to reach one in the near future may create severe economic difficulties, for the prospects of SMEs depend on the kinds of adjustments made in industrial policy, trade policy, financial reform, tax reform, and other structural measures which have not yet been formulated and implemented. The prospects, as a result, are not altogether positive. While there is room for optimism given the past record of Taiwan's SMEs, success in the future will require more than hard work. Basic changes in the economic infrastructure of Taiwan are necessary—changes that will alter an unfavorable and regulated economic environment. How rapidly and effectively this is done may well determine Taiwan's survival in tomorrow's world markets.