Taiwan Today

After the negative growth experienced in 2001--the worst performance in modern Taiwan history--the economy has started to regain strength. But numerous challenges will need to be faced for Taiwan to demonstrate its long-term economic competitiveness.

Last year when Taiwan registered minus 1.91-percent growth in gross domestic product (GDP) as calculated by the Directorate General of Budget, Accounting, and Statistics (DGBAS), the national statistics office, it was the first time in Taiwan's post-World War II history that negative economic growth had been recorded.

Before 2001, in fact, the Taiwan economy had failed to attain GDP growth of at least 5 percent only five times during the past fifty years of economic development. The first case was in 1974, when Taiwan's economy was battered by the first international oil crisis, and real GDP growth sank to only 1.16 percent. The second time was 1975, the year President Chiang Kai-Shek passed away and the oil crisis continued, when GDP growth rebounded somewhat from the previous year to reach 4.93 percent. The third time was in 1982, when the second international oil crisis took place and drove economic growth down to 3.55 percent. In 1985, Taiwan put the Labor Standards Law into effect to improve workers' welfare, but its provisions presented a burden to the small and medium enterprises that were the driving force of the economy. Simultaneously, a financial scandal broke out involving the Tenth Credit Cooperative, a financial institution run by a legislator, causing a tumult in the stock market. Real GDP growth was held to 4.95 percent that year. The last previous experience with low growth was in 1998, when the spread of the Asian financial crisis hit the global economy sharply--and economic growth in Taiwan slowed to 4.57 percent.

Looking back over the past half century, Taiwan's economic growth averaged 8.23 percent during the 1950s, 9.15 percent in the 1960s, 10.23 percent in the 1970s, 8.15 percent in the 1980s, and 6.37 percent in the 1990s--a record of solid economic performance that shows why Taiwan has been considered a model for economic development.

Several factors contributed to Taiwan's economic recession in 2001. The first one was the slowdown in the global economy. According to the International Monetary Fund, real GDP growth for the worldwide economy dipped from 4.7 percent in 2000 to 2.4 percent in 2001. The decline in the economic growth rate in the United States last year was especially steep--from 4.1 percent to 1.2 percent. Considering that the United States is the largest market for Taiwan's exports, the slowdown in the US economy inevitably took its toll on Taiwan's manufacturers. Other economies such as Japan and Europe were also affected by the economic downturn, and were therefore unable to take over the leading role as engines for global economic growth. With GDP growth announced at 7.3 percent, China continued to experience vigorous growth in 2001. Given the complexity of the cross-Strait relationship and China's limited role as a market for other country's exports, how ever, a strong performance by the Chinese economy did not help Taiwan's economy much.

The second factor contributing to Taiwan's recession was the economy's overdependence on the so-called high-tech industries (broadly defined to include information technology [IT], chemical materials and products, machinery, transportation equipment, and precision machinery). In terms of production value, the high-tech sector accounted for 54.3 percent of manufacturing production in 2000, compared with only 35.3 percent in 1991. The share of exports for high-tech products also increased from 36.3 percent in 1991 to 55.8 percent in 2000. This specialization in high-tech industries helped Taiwan to sustain economic growth during the Asian financial crisis of 1998 when other economies were suffering. But in the second half of 2000, it became evident that many IT products were in oversupply. Especially after the collapse of the dot-com bubble, many Internet companies disappeared. The oversupply phenomenon grew even worse in 2001, as many companies cut their computer expenditures and component suppliers were forced to adjust their inventories. In the US economy, private investment registered double-digit decline in three consecutive quarters. Consequently, Taiwan's high-tech industry suffered a serious setback in exports, which meant that so did the economy as a whole.

The third factor was the continued migration of Taiwan's manufacturers to China to take advantage of cheaper costs there for land and labor. According to Taiwan's official statistics, over one-third of outgoing foreign direct investment was bound for China. The real figure is much higher, since many companies invest in China via places such as the Virgin Islands and are registered in China as foreign entities. On the one hand, the relocation of production in China provided a means for Taiwan companies to reduce costs and enlarge their market share in the global arena. But on the other hand, this relocation--coming at a time when Taiwan's economy was weak--exacerbated the pains at home. For example, many people in Taiwan were thrown out of work as factories closed down here to move to China. The impact was greatest in industries such as textiles and low-end electronics, where the production process has become standardized and reducing costs is a prerequisite for survival. Compared with the high-tech sector, those industries are usually much more labor-intensive, so when they relocated to China, unemployment in Taiwan jumped substantially. The average unemployment rate in 2000 was only 2.99 percent. By the end of 2001, it had soared to 5.22 percent.

The fourth factor weighing down the Taiwan economy was the problem of bad loans in the financial sector. The ratio of non-performing loans increased from 6.20 percent at the end of 2000 to 8.16 percent at the end of 2001. It was natural for the number of non-performing loans to rise during a period of poor economic performance, but the relocation of many industries to China made things even worse because some of them left their debts behind in Taiwan. In addition, since Taiwan banks lack any branches in China, it was very difficult for them to monitor the borrowers' real situation there. As a result, the non-performing loans accumulated faster than normally would have been the case. Another factor was that the mounting unemployment made it impossible for many people to pay their mortgages on time. Given the increasing level of non-performing loans, a problem of credit crunch ensued. Financial institutions became much more reluctant to grant new loans to either businesses or individuals simply because they did not wish to see their loan portfolios continue to deteriorate. Even though Taiwan's central bank cut the discount rate and the prime rate eleven times and reduced interest rates by 2.5 percentage points, the value of loans granted by financial institutions shrank by 3.09 percent in 2001.

Last but not least in slowing the economy was the domestic political contention. In 2000, conflict between the ruling Democratic Progressive Party and opposition parties reached a peak over the issue of whether construction of the fourth nuclear power plant should be continued. In 2001 the political clashes continued, with immediate impact on the central government's supplemental budget. To boost domestic demand, the Executive Yuan had proposed a stimulus package worth NT$810 billion (US$23 billion). But the opposition parties dominating the Legislative Yuan cut the budget by NT$70 billion (US$2 billion). In addition, assistance to certain local projects could not be realized in the absence of permission from the Legislative Yuan, further constraining the government's efforts at fiscal expansion.

The economic situation in 2002 has begun to look more optimistic. Following the September 11 terrorist attacks in the United States last year, the global economy passed through the cyclical trough in the fourth quarter of 2001 and began to show signs of recovery. For instance, the US economy recorded a 1.2- percent growth in the fourth quarter, which was much higher than expected. Recently reported economic data such as consumer spending and housing starts have continued to be strong. Activity in the manufacturing and service sectors has also been picking up, and inventories began shrinking at an accelerating rate. Confidence among producers as well as consumers is on the rise . All these elements have indicated that the US economy has already departed from the recession. It is now generally believed that the US economy will experience a strong turnaround in the second half of 2002. As the powerhouse of the global economy, the United States would certainly pull the other economies along with it on the ride to recovery.

With a more favorable external environment, Taiwan is expected to register a mild rebound in 2002. The DGBAS projected a 2.29-percent growth for 2002. Private forecast institutions have been even more optimistic. For example, the Taiwan Institute of Economic Research (TIER), the largest independent think tank in Taiwan, predicted 2.38 percent. Academia Sinica's Institute of Economics had the highest projection, 3.08 percent. Private consumption and trade performance will be the driving forces. Private investment, however, is expected to remain rather weak, which has become a matter of concern for the government. In recent years, the major private investment projects have come mostly from the high-tech industries. If the international IT industry is able to recover, therefore, it would spur domestic manufacturers to resume investment. For 2003, Taiwan's economic outlook is considerably brighter, with TIER forecasting a 4.5-percent GDP growth. Much depends on the global economy, which most forecast institutions see as experiencing much higher growth next year.

Several issues are crucial for Taiwan's long-run future development. First, how to stay competitive in the environment of globalization is the top priority. According to the World Competitiveness Yearbook 2001 published by the International Institute for Management Development, Taiwan ranked eighteenth in terms of competitiveness among forty-nine major industrialized economies. In another report published by the World Economic Forum (WEF), Taiwan ranked seventh among seventy-five economies. In WEF's report, Taiwan ranked fourth in the technology category but only fifteenth in its macroeconomic environment and twenty-fourth in public policy. From this report we know that Taiwan is highly competitive in terms of technological innovation, but that government policy and the overall economic environment need further improvement to catch up with other advanced economies. Taiwanese companies possess a relative advantage with regard to management and production. But in terms of the value chain (the so-called "smiling curve"), production earns the smallest return compared with the upstream elements of research and technology as well as the downstream sales channel. That is why Taiwan's government is so eager to encourage companies to develop toward both ends of the smiling curve, which have higher "value -add."

The second issue is related to the complexity of the cross-Strait relationship. During the past, Taiwan and China lacked close economic ties in terms of trade and investment. But as the Chinese economy gradually started to develop, Taiwanese investment began to pour in. In 2001, the share of Taiwan's foreign direct investment in China reached 38.8 percent, far exceeding the amount of Taiwan's investment in any other area. With accession by both Taiwan and China to the World Trade Organization (WTO), even more Taiwanese companies are now aiming at the Chinese market. From the perspective of globalization, Taiwan should allow manufacturers to relocate in China in order to reduce costs. But how to prevent a hollowing-out effect in Taiwan is a very tough problem--especially when the Chinese market is not yet mature and its government is still hostile to Taiwan. To put all the eggs in one basket not only would increase the economic risks but might even jeopardize national security. Recently, a heated debate took place over whether the government should allow Taiwan's semi conductor companies to invest in China. Both the pros and the cons have their points. But in no other country would you find this kind of issue sparking such an intense public debate.

The third issue affecting Taiwan's economic future is how to cope with the overdependence on high-tech industry. As a small economy, Taiwan relies heavily on trade for economic development. According to trade theory, Taiwan should specialize in some specific product categories in order to reap the benefits of international trade. For years, Taiwan's economic success was built on this development strategy. But as technology has grown more complex, the cost of developing new products has increased at the same time as the product life cycle has shortened. Examples of this phenomenon are the semiconductor and TFT (thin-film transistor or flat panel display) industries, where you have to continue to invest heavily just to stay alive. Hence, it would increase the risks if Taiwan relies on only a few products. The next high-potential industry on the government's development agenda is the biotech industry, and the Chen Shui-bian administration has pledged to invest NT$10 billion (US$286 million) each year to support that development. But in the short run, Taiwan's economy will continue to depend on the existing high-tech industries.

The fourth issue is reform in the financial sector. The ratio of non-performing loans has already reached a historical high level. How to help financial institutions to write off their bad loans will be crucial to the success of reform. Under the current system, if banks want to sell off collateral (especially real estate), they must go through the courts. But with the real estate market in depression and insufficient judicial personnel working on this problem, resolution will take a long time to accomplish. On the average, the courts need three to five years and 3.8 auctions to sell a piece of property, and the banks are able to redeem only 10 to 15 percent of the value of their original loans. Through the establishment of asset management corporations (AMCs) and financial asset servicing corporations (FASCs), the government is trying to speed up the process. However, only one AMC and one FASC have been established so far, and the effect on resolution of bad loans remains to be seen.

A related issue is how to enhance the competitiveness of domestic financial institutions, especially after Taiwan's WTO accession. In the past two years, the Legislative Yuan has passed several relevant laws such as the Banking Law revision, Financial Institution Merger Law, and Financial Holding Company Law. Financial holding companies can run operations that combine banking, insurance, securities, and other financial services and hence should be more competitive than those which can run only one line of business. At the end of 2002, the Ministry of Finance will permit the establishment of thirteen financial holding companies. But this is only a first step, and it will take time for them to fully develop business synergy.

Overall, Taiwan's economy is at a crossroads. The threat of a rising Chinese economy poses a challenge, but as long as Taiwan focuses clearly on domestic needs to improve its investment environment, Taiwan's economy will not become marginalized. With this country's diligent workforce and the flexibility and rapid adaptability of its industry-- plus the adoption of correct government policies and heightened infrastructure investment--Taiwan's economy will continue to perform well in the future, just as it did in the past.

Copyright 2002 by Wu Rong-i and Cheng Cheng-mount.