Taiwan Today

Taiwan has experienced an extraordinary rise from the authoritarian and mainly agricultural society of the 1950s to today's democratic high-technology powerhouse whose industrialists direct impressive webs of economic activities that extend far beyond the nation's borders. Advances in digitization have enabled these entrepreneurs to reorganize activities that were once carried out by vertically integrated companies into global value chains, making it possible for them to establish powerful market positions. This impressive performance has also generated anxieties attendant on globalization that are common to other industrialized states. Jobs are being lost to lower-wage societies, and the rapid movement of capital, goods, and services across national borders causes concerns about loss of control. In the case of Taiwan, the transfer of activities to China and the establishment of new businesses there rather than in Taiwan threaten to hollow out the domestic economy. Though at first confined to low-end skills and manufacturing, this transfer has evolved into more skilled and technical design work, and eventually into top-tier positions in research, development, and product definition.

The question of whether Taiwan can respond to China's rise and, if so, how, has engaged economists and policymakers both domestically and elsewhere. The latter group includes analysts at the Industrial Performance Center at the Massachusetts Institute of Technology, and this book is the first in a series that will examine the impact of globalization on industry in advanced and developing economies. Four sectors--electronics, software, automobiles and auto parts--were chosen as target industries, since they represent a range from high-tech sectors experiencing rapid and continuous technological innovation to lower-tech sectors with slower technological turnover and heavy competitive pressures from lower-wage societies. Several hundred interviews were conducted and preliminary observations discussed with researchers in both the United States and Taiwan. The result is an impressive volume whose conclusions both surprised and convinced this reader.

The authors introduce two broad ways of thinking about the consequences of globalization. Convergence theory, popularized by Kenichi Ohmae's The Borderless World (1990), posits that when national controls over borders disappear and capital, goods and services move freely, the central institutions of economic life in all countries will eventually converge on common structures and practices. Firms that make the same products and compete across world markets will evolve similar technological and organizational patterns; systems of production and distribution will become increasingly alike. Essential choices will be made by interactions between and among consumers and product manufacturers and to the extent that governments try to intervene on behalf of perceived national interests, this will have a detrimental effect on this best of all possible worlds. At the other end of the theoretical spectrum are national models, whose approach to globalization begins with the fact that there are diverse forms of capitalism in the world. Each has institutions that link companies to society and to government in ways that produce ongoing differences in economic performance. In this view, globalization not only preserves, but may even reinforce national characteristics. Aware that one can massage data into "evidence" for one's preferred theory, the authors have chosen to allow their material to speak for itself.

Convergence of Factors

For Taiwan, there appears to be an interplay of convergence and national factors, with the former being more important than the latter. In Taiwan, as in Japan and South Korea, the state bureaucracy played a major role in identifying, encouraging, protecting and financing leading sectors of the economy. However, whereas Japan and South Korea made large firms the linchpin of their respective industrialization policies, the Kuomintang government tightly controlled Taiwan's large firms, both public and private, because it feared the emergence of powerful groups in civil society that could challenge its hold on power. When, after three decades, these fears began to ease, it was small and medium-sized companies that drove economic modernization and export-led growth. With the semiconductor industry an important exception, the tremendous growth in Taiwanese exports from the 1970s on did not come from firms that the government had picked and funded, but from smaller, less-privileged companies that had emerged from the crucible of fierce competition.

Contributor Dan Breznitz's examination of the role of state power in the integrated circuit design and software sectors finds both successes and failures. The government created public research institutions to carry out most research and development up to the level of working prototypes, which were then turned over to private industry for final development and integrated design. Although this division of labor is credited with establishing Taiwan's leading role in the global information technology (IT) industry, it may also limit the nation's ability to excel in cutting-edge innovation. The system supports technological absorption and excels in second-generation innovations--meaning innovation that seeks to improve the production and reliability of products based on new technologies that have been developed elsewhere. But it may not be able to help Taiwan's companies to develop their own innovative, original IT products. Additionally, an institutional environment of regulations and service and financial industries has evolved around the system that may inhibit the formation of more original research and development companies. For example, the nation's stock option rules give enormous advantages to companies that have already gone public which make it possible for them to hire the best engineering graduates--meaning that new, innovative private companies find it very difficult to recruit top-tier talent.

Breznitz found that the public research institution-based industrial technology of Taiwan has helped the growth of private industry when the public research institutes see private IT firms as their final customers, and where these research institutions have created multiple and broad interactions with the private IT sector on such issues as policy development, knowledge and information, finance, and personnel. They have been least helpful when the institutes compete directly with the private sector for customers. The author suggests that a useful model for a future software-focused government agency would be Ireland's National Software Directorate, whose sole aim is to assist private industry and does not involve itself with actual software development. With a staff of only ten permanent employees, the NSD concentrates on policy formulation and information gathering, and initiates and looks after several innovative policy initiatives.

Autos Still Healthy

A study of Taiwan's automotive industry finds it to be quite healthy. In contrast to the rapid decline in output and employment in other traditional sectors like textiles and garments, the automotive sector actually grew over the past decade, although ongoing constraints are imposed by the small size of the domestic market and the industry's heavy reliance on Japanese technology. Taiwanese firms have carved out an important niche in aftermarket parts, with the United States taking 35 percent of the country's exports followed by Japan at 6 percent and Indonesia at 4 percent. Auto parts are replicated using coordinate measurement machines and computer-aided design/computer-aided manufacturing, with detail work finished by a five-phase machining center. Although small, local firms in Southeast Asia or China may be able to undercut a Taiwanese firm on labor costs, they are generally unable to make the investments in electronic data interchange that make rapid response possible. The ability to forecast demand effectively, process electronic orders from buyers, plan and track production and manufacture auto parts in a flexible fashion mean that Taiwanese firms are becoming the key force behind efficient commodity chains in this sector.

Authors Edward Cunningham, Teresa Lynch, and Eric Thun suggest that the government could enhance the nation's competitive edge through such means as creating a coherent process of standardization and certification, supporting a sophisticated testing center, strengthening its role as a clearinghouse for aftermarket parts and assisting in establishing a cooperative form of brand promotion. Models for this final suggestion are California orange growers' collaboration on the Sunkist brand, and New England dairy farmers with Hood products: these provide advantages to small-scale manufacturers and distribute profits more equitably among retailers/distributors, producers, and end consumers.

On the crucial question of the vulnerability of the Taiwan miracle to an ascendant China, contributor Edward Steinfeld believes that it is a mistake to conceptualize China as aggressively climbing an established ladder of development and, in the process, threatening to supplant its more advanced predecessors who are clinging desperately to the rungs above. Digitization, by facilitating the management and transmission of vast amounts of information, has allowed the codification of highly sophisticated processes of production. Once codified, processes can be split into discrete modules, and standards established to ensure their connectivity. Modularization thus permits activities that once had to be located within and managed by a single firm to be spread out across vast geographic and organizational distances. While modularization thus offers new opportunities, it also creates major vulnerabilities for Chinese and other new participants in the production chain. Fully modularized components entail the manufacturing of standardized, non-differentiated products. Firms focusing on such activities have little choice but to compete on the basis of low cost and high volume. Additionally, they run the risk of being displaced by the next low-cost entrant, particularly since fully modularized products are easily substitutable: From the consumer's point of view, the only distinction is price.

China's Problems

Chinese firms' mastery of modularized production accounts for China's emergence as the workshop of the world. Yet it also accounts for the fact that Chinese firms, for all their success, have had little luck in capturing many of the higher-value manufacturing and overall supply chain management activities that are still dominated by overseas firms--which are often Taiwanese. Chinese firms seeking to break out of this constraint have a number of options. A modularized producer can try to control the supply chain by actively setting rather than passively accepting rules of connectivity through creating the modularized product that everyone else must design around--for example, an Intel processor. Alternatively, the producer can shift away from modularization, moving backward toward more integral processes that must be coordinated and co-designed with other partners in the production network. Finally, the company can compete by providing key services such as overall product definition, branding, and marketing, that shape the entire supply chain and determine a significant portion of the value of the final product.

However, all of these options require innovation on a level that poses a daunting challenge for even the most sophisticated commodity producers. Much of China's domestic industry is composed of small-scale firms competing intensely on the basis of price discounting. In theory, this could be the prelude to industry-wide shakeouts that would eliminate smaller firms and consolidate activities into a few larger producers, who could then engage in industrial upgrading. Thusfar, however, there is little evidence that such a progression is taking place. Instead, a pattern of corporate organization has persisted that sets China's firms apart from many of their global counterparts, and certainly from the lead firms in world supply chains. Chinese companies tend to be both newer and smaller in scale than their foreign counterparts. Even the PRC's more famous brands like Lenovo have modest revenues, while Haier, the world's fifth largest producer of large electrical home appliances like washing machines and refrigerators, is dwarfed by companies like Whirlpool and General Electric.

Another factor inhibiting consolidation and upgrading is that Chinese firms tend to be extremely localized in terms of their actual operations, even though their output often ends up either in foreign hands or in overseas markets. The localized nature of Chinese commercial networks means that Chinese firms tend to integrate into global supply chains at a relatively shallow level. For example, in a World Bank survey conducted in 2001, only 15 percent of the manufacturing firms reported designing parts for foreign customers, and only 7 percent provided customers with research and development or other specialized services. This indicates that the respondents are essentially "rule takers" in the modularization process. These results are all the more surprising because the Bank's survey sample specifically targeted higher-tech sectors--the very ones in which one would expect high degrees of innovation, networking, and development of firm-specific proprietary knowledge. While Chinese enterprises face great pressures to upgrade their technological capabilities, the "innovations" they report are almost exclusively geared toward cost-cutting rather than allowing them to charge a higher price, such as the development of intellectual assets, production skills, modes of serving customers or actual products.

Pointless Diversification

The response to this situation of pressure to cut costs often leads to another activity that survey respondents refer to as innovation: the introduction of new products or entirely new lines of business. But, since many others in the business environment leap onto the same new product lines, commodity producers end up chasing one surplus market after another. This is true even for China's more advanced branded companies. Leading television manufacturers, for example, have moved aggressively into producing mobile phones to escape declining profits, and microwave oven manufacturers have jumped into producing air conditioning units. They are again competing only on the basis of discounting and razor-thin margins.

The decentralization promoted by Deng Xiaoping's economic reforms has caused other problems. Early in the reform era, these manifested themselves in regional trade wars and overt barriers to interprovincial trade. When the central government cracked down on these, localities developed more sophisticated strategies such as selective enforcement of product standards, more rigorous registration and licensing requirements for outsiders, and prejudicial application of health standards. Local administrative intervention frequently blocks rational mergers and acquisitions, and often imposes irrational mergers that force financially sound companies to assume ownership of insolvent ones in order to avoid bankruptcy and an increase in the locality's unemployment rate. Moreover, the absence of effective legal institutions encourages rent-seeking behavior that erodes trust in commercial transactions. A saying common in China is a propos: "you sue, but the court won't accept your case; the court accepts your case, but won't begin the trial; the court issues a judgment, but then doesn't enforce it."

It is possible that these problems represent teething pains: new Chinese competitors, like those of Japan, Taiwan and South Korea who preceded them, will overcome barriers and figure out how to produce inexpensively, introducing products overseas first into lowest-end market segments, gradually building market share, and then proceeding to become dominant in high-value products. However, Steinfeld points out, rising Chinese firms today are operating in a very different era in which the methods of the past are not directly applicable. First, it is activities rather than whole industries that move today from developed to rising nations. Second, when the "Asian tiger" competitor companies emerged, they were rising against relatively stable incumbents whose focus was still on manufacturing, and whose products could be substituted by lower-cost alternatives. Today, however, in large part because of modularization, the incumbents--global lead firms like IBM, Motorola, and Dell--are hardly stationary. They have completely transformed themselves, moving away from manufacturing and increasingly focusing on the service side of production: overall product definition, design, marketing and supply- chain management. Rising firms may be capturing manufacturing activities, but the former manufacturers are increasingly specializing in high-value non-manufacturing activities, either retaining control of the supply chain's rules of connectivity or of activities that truly remain integral and proprietary. In short, the theory of industrial catch-up does not seem to apply to the situation Chinese companies find themselves in.

Taiwan undoubtedly faces extraordinary pressures from globalization. But Taiwanese firms, particularly in their core areas of excellence like high-end electronics, remain decidedly in the driver's seat, even as they extend their geographical reach across the PRC. To stay competitive, they must continue to shed low-value activities to China and elsewhere. In this era of sweeping transformation, Taiwanese firms, through their flexibility and entrepreneurship, have proven capable of retaining control over the most desirable manufacturing activities and moving away from those that are less desirable. Taiwanese firms have in many cases remained deeply embedded in social and commercial networks in some of the most dynamic regions of the world, such as Silicon Valley. It is in these networks that Taiwan's true competitive advantage resides. And it is in enhancing these networks, whether through facilitating human capital flows or deepening research connections, that the authors suggest the Taiwan government should channel its development efforts.

Copyright (c) 2007 by June Teufel Dreyer