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Challenging Neoliberalism

Globalization and the Economic Miracles in Chile and Taiwan

Cal Clark and Evelyn A. Clark

Neoliberalism, which advocates free markets without government interference, has become increasingly utilized and controversial over the last three and a half decades. This book presents case studies of Chile and Taiwan, two countries that seemingly prospered from adopting neoliberal strategies, and finds that their developmental histories challenge neoliberalism in fundamental ways.
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Chapter 4: An overall model of development in Taiwan

Globalization and the Economic Miracles in Chile and Taiwan

Cal Clark and Evelyn A. Clark

Challenging Neoliberalism

This chapter presents an overall model of economic and social development in Taiwan. In particular, we identify four stages in the country’s postwar development: (1) a stage-setting period during the 1950s, that created the foundation for (2) the export-led boom based on light industry during the 1960s and early 1970s, which created the resources for (3) industrial upgrading from the late 1970s to the late 1980s, which was followed by (4) slower growth as economic maturity was achieved but also a “political miracle” in the form of a fairly rapid democratic transition and consolidation over the last 25 years. As we shall see, there are strong but complex linkages among these four stages. For the first three stages and for the democratization in the fourth, resources that were created in one period helped promote the transformation to the next. During the last period, in sharp contrast, the legacies of past successes have contributed to economic and political problems.

SETTING THE STAGE

The incorporation of Taiwan into the Republic of China at the end of World War II after half a century of Japanese rule was quite inauspicious at first. Despite the fact that the Taiwanese or Islanders, who had come to Taiwan before it became a colony, welcomed Chinese troops as liberators, Chiang Kai-shek and his Kuomintang (KMT) or Nationalist party viewed the Taiwanese as collaborators with the hated Japanese. In the economic sphere, the KMT used Taiwan as a source for resources in its battle with the Chinese Communist Party (CCP) in the Chinese Civil War. Thus, they dismantled factories and grabbed raw materials for shipment to the mainland. In addition, the rampant inflation on the mainland was quickly transmitted to Taiwan. These economic problems were exacerbated by the harsh political repression imposed by the island’s military commander Ch’en Yi, which sparked a spontaneous uprising on September 28, 1947. A compromise between Ch’en and the Taiwanese leaders seemed to settle the crisis. However, KMT troops from the mainland invaded the island in mid-March, killing over 20,000 Taiwanese and singling out the intelligentsia and leadership class for slaughter. Although Ch’en was quickly replaced by a more conciliatory leader and was later publicly executed, the trauma and hatred remained. When Chiang evacuated to Taiwan in late 1949 after losing the Civil War on the mainland, hence, the top levels of political officials were primarily Mainlanders who came with the KMT and constituted about 15 percent of the population (Lai, Myers, and Wei, 1991; Phillips, 2003).

The Kuomintang continued its highly repressive policies for several decades, in what came to be called the White Terror. In contrast, it also sought to avoid the mistakes that had led to its defeat in the Chinese Civil War. Economically, this concentrated on curbing the horrendous inflation of the late 1940s, developing agricultural policies that appealed to the peasantry, and promoting economic development to strengthen the nation, especially the military, and increasing the government’s popular legitimacy. Politically, Chiang cracked down on corruption (which gave him an excuse to defeat his rivals within the KMT) and allowed local elections, in a successful attempt to play off local Islander political factions against each other (Clark, 1989). Figure 4.1 summarizes how these two somewhat contradictory general strategies created the major dynamics of Taiwan’s political economy during the 1950s and early 1960s.

Raging inflation in the late 1940s (about 500 percent annually during 1946–48 and a stupendous 3,000 percent in the first half of 1949) presented the regime with an extreme challenge that had to be overcome before any growth policies could be introduced, especially in view of the widespread perception that the devastating inflation on the mainland had played a major role in the KMT’s defeat there (Eastman, 1984; Young, 1965). The regime therefore implemented a stringent stabilization program in the late 1940s and early 1950s. This package included high interest rates, as well as the imposition of tight government controls over the financial system (for example, the state dominated the banking sector), aimed at controlling money supply and credit availability. In addition, the government began to follow a conservative fiscal policy of maintaining balanced budgets, and benefitted from a large inflow of U.S. aid (Kuo, 1983; Li, 1988; Lundberg, 1979).

These stabilization policies proved to be highly effective. The inflation rate fell to 300 percent in 1950 and 30 percent in 1951–52, and then averaged less than 10 percent for the rest of the decade. The attempt to control money supply and credit worked well as the velocity of money (that is, the ratio of national income to money supply) dropped sharply in the early 1950s. The government was also able to maintain a balanced budget as public spending remained stable, at slightly over 20 percent of GNP with defense and administration having the highest priority (Kuo, 1983; Lin, 1973; Lundberg, 1979). Tibor Scitovsky (1986), furthermore, has argued that this anti-inflation policy produced several important spin-offs which stimulated industrialization during the 1950s. In particular, high interest rates spurred savings and created incentives for labor-intensive production which, in turn, created small-scale businesses that could respond more flexibly to market conditions. In so doing, the door was opened to Islander entrepreneurs to become involved in what would become a miracle economy.

Figure 4.1  The dynamics of Taiwan’s stage- setting period

Perhaps the most commonly cited reason for the Kuomintang’s defeat on the mainland was its alienation of the peasantry that allowed Mao Zedong to gain a mass basis for the CCP, which was attributed to its reliance upon landlord support and/or lack of control over much of the territory of China (Duara, 1988; Eastman, 1984; Johnson, 1962; Kapp, 1980). Once the KMT arrived in Taiwan, however, it faced a very different situation. The regime controlled all the land on a relatively small island and had few ties with either the peasants or the land-owning gentry. Thus, the government had few obstacles against implanting whatever policies it desired. General Ch’en Ch’eng, who had some experience with land reform on the mainland, was appointed Governor of Taiwan at the beginning of 1949 and almost immediately initiated a series of reforms that transformed the rural areas. The agricultural reform proceeded through three major stages. First, within three months of taking office, Ch’en Ch’eng reduced agricultural rents by a quarter, to 37.5 percent of production. Second, between 1948 and 1958 the government conducted a series of sales of a fifth of the island’s cultivated land that it had confiscated from the Japanese after retrocession. The current cultivators of these public lands were given the top priority to purchase them, and other tenant farmers got second priority. The price was set at 2.5 x the annual yield of principal crops, which made it affordable; and limits were set on the amount that could be purchased to prevent new concentrations in landholding. The third and capstone phase of the agriculture reform was the land redistribution program that was implemented in 1953. Under the Land to the Tiller program, landlords were forced to sell agricultural holdings over about three hectares for 2.5 × the annual yield – which was significantly under-priced; and the payments were made in 70 percent commodity bonds and 30 percent shares in four government corporations. The land was then sold at the same price to tenant farmers who had to pay it off over ten years (Ho, 1978; Koo, 1968; Yager, 1988). In Figure 4.1, the White Terror, in addition to the ‘Desire to avoid mistakes made in China’, is represented as influencing the land reform program because one effect of the program was to weaken the Islander gentry economically.

The agricultural reform had a considerable impact on rural life. The rent reductions and land redistribution affected a quarter of the land and almost half of the agricultural population on the island. One major effect was on land ownership. As a result of the Land to the Tiller Act, the proportion of full owners jumped from 38 percent to 55 percent between 1952 and 1953, and then steadily rose to over 80 percent by the 1980s. Thus, the land reform had the intended effect of creating a nation of agricultural smallholders (CEPD, 1987) who had strong individual incentives to innovate in order to increase production. The reform also had a significant impact on peasant incomes. Samuel Ho’s (1978: 169) complex calculations found that the agricultural policies resulted in a net income gain of 18 percent in 1949, which jumped to 38 percent in 1953 and 44 percent in 1959.

Land reform per se was not the only important facet of upgrading agriculture in Taiwan during the 1950s. The radical change in land tenure was complemented and supported by a program of increased investment and a widespread and aggressive program of agricultural extension work to stimulate the introduction of new techniques. This program was directed by the Sino-American Joint Commission on Rural Reconstruction (JCRR), which assumed overall responsibility for development projects implemented by 300 local farmers’ associations that promoted technology applications, created marketing and credit cooperatives, and constituted a successful grass-roots approach to stimulating agricultural growth. Because of this sophisticated structure, new technologies could be introduced rapidly throughout the island (Li, 1988; Shen, 1970; Yager, 1988). Taiwan also clearly made a strong commitment to agricultural modernization. During the 1950s, agriculture accounted for about a fifth of national investment and averaged a 14 percent real (that is, inflation-adjusted) growth rate. The application of fertilizers, one of the principal working capital inputs, grew rapidly during the 1950s, increasing by almost 50 percent between 1952 and 1958 (Ho, 1978; Thorbecke, 1979).

Another important facet of Taiwan’s agricultural development was the diversification of production away from its traditional main crops, such as rice, sugar, and sweet potatoes, to new ones, such as soybeans, citrus fruits, vegetables, fish, and livestock production. Increased agricultural production, which grew 6 percent annually in real terms between 1952 and 1958, and diversification produced a corresponding increase in the general population’s food consumption. Both the quantity, as indicated by calories, and quality, as indicated by proteins, of Taiwanese diets increased considerably. Indeed, by the 1960s food consumption in Taiwan was generally superior to other developing societies and about equivalent to Japan. It was also above the generally recognized standards for dietary adequacy of the World Health Organization (WHO) (Thorbecke, 1979). In addition, the massive land reform played a central role in the precipitous drop in income inequality, as measured by the income of the richest fifth of the population to that of the poorest fifth, which dropped from 20.5 in 1953 to 11.6 in 1961 (Fei, Ranis, and Kuo, 1979; Greenhalgh, 1988b).

Agriculture, furthermore, generated a considerable surplus that was used to finance industrialization. Lee Tung-hui (1971), the future President of Taiwan, estimated that the resource flows out of the agricultural sector equaled 25 percent of agricultural production and 12 percent of net domestic product. The government played a central and direct role in this extraction of resources. To some extent this was based on tax collections, land repayments, and other direct collections from the rural sector, as the state directly received 12 percent of farm incomes in the 1950s. The principal outflow, though, was caused by what was called the “hidden rice tax.” The government acquired over half the rice crop at artificially depressed prices, while selling fertilizer to farmers at inflated ones (Kuo, 1983; Lee,1971). Raw and processed agriculture products also supplied the bulk of Taiwan’s exports (85–90 percent) up through 1958, which was especially valuable given the nation’s chronically negative balance of trade during this period (Thorbecke, 1979; Yager, 1988).

Even though agriculture became a lagging sector in the 1970s (Huang, 1981; Yager, 1988), an evaluation of Taiwan’s agricultural policies during this stage-setting period would rate them as highly successful. Land reform, investment, and intensive extension work brought considerably increased production and productivity. These, in turn, led to rising income and decreasing income inequality in rural Taiwan, a more adequate supply of cheap food, exports to mitigate balance-of-payments problems, and a significant surplus that was transferred to support industrialization (Kuo,1983; Lee, 1971). Almost everybody seemed to be benefitting!

Taiwan’s economic strategy during the 1950s was not just limited to reviving and stimulating the agricultural sector. In addition, the regime hoped to spark industrialization by promoting the production of light industrial goods that were being imported. Because Taiwan had developed a significant amount of small-scale and geographically dispersed light industry before the devastation of World War II, the initial industrialization policy was much more a case of utilizing a “backlog of unexploited production opportunities” than of starting from scratch, similar to the postwar reconstruction of Europe (Kuznets, 1979). However, given the primarily agricultural nature of the economy and the social and political chaos of the late 1940s, promoting industrial development must have appeared to be a particularly daunting task.

Still, Taiwan moved aggressively to promote import substitution in a variety of light consumer goods by sealing off the domestic market. The end of the colonial relationship with Japan followed by the loss of markets on the Chinese mainland reinforced this decision because of the lost special treatment for Taiwan’s agricultural exports and the opportunity to replace previously imported Japanese manufactures. Tariffs were raised, with the average minimum rate doubling from about 20 percent in 1948 to over 40 percent in 1955; and “effective” tariff rates were estimated to have been much higher than the nominal ones. Import restrictions for specific goods, especially luxury items, were implemented and expanded over the 1950s. Foreign exchange rates were manipulated to discourage imports and dampen inflation. For example, multiple exchange rates were introduced in 1951, and the NT dollar (NT$) was overvalued. As would be expected, nondurable consumer goods received the greatest protection under these various devices, while imports of plant equipment were given the most favorable treatment (Ho, 1978; Lin, 1973; Scott, 1979).

This import-substitution program was quite successful, at least in the short run. For example, by 1953 many light industrial goods were selling in Taiwan for 50 percent or higher above world prices, providing a strong incentive to enter these industries. Taiwanese entrepreneurs responded quite well to these incentives. For example, the share of imports in domestic consumption dropped radically in a variety of light industries between 1948–50 and 1958: 83 percent to 0 percent for flour, 22 percent to 0 percent for cotton yarn, 59 percent to 0 percent for cotton fabric, 100 percent to 1 percent for synthetic yarn, 100 percent to 0 percent for bicycles, 72 percent to 31 percent for electric bulbs, and 59 percent to 25 percent for iron and steel sheet, plate and bars. For all manufacturing except food processing, imports had fallen to 24 percent of total supply in 1954. Thus, Taiwan was able to expand its industrial base from primarily food processing to other light industries, such as textiles, bicycles, leather and rubber goods, chemicals, and wood products. Overall, the share of consumer goods in total imports was cut in half from 20 percent to 9 percent between 1952 and 1955 (Lin, 1973; Scott, 1979).

The good performances of both the agricultural and light industry sectors fueled an economic dynamism that must have been quite surprising given the chaos of the late 1940s, as real economic growth averaged 10 percent a year for the first half of the 1950s and almost 7 percent for the second half. Total energy consumption, a leading indicator of development, almost tripled between 1952 and 1961. In particular, the industrial sector began to take off. Although growth rates fluctuated widely, industrial production averaged a strong expansion of 11.5 percent annually between 1952 and 1959; and over this period industrial production’s share of net domestic product jumped by almost a half, from 11 percent to 19 percent. The savings rate in Taiwan averaged 9 percent a year, just under the 10 percent level that is usually considered necessary for economic takeoff (Rostow, 1960). However, because of foreign aid the investment rate averaged a more robust 15 percent. Finally, unemployment averaged in the 4–6 percent range during the 1950s, which was quite good by the standards of most developing nations (Ho, 1978; Lin, 1973; Myers, 1984).

Another central aspect of Taiwan’s development during the 1950s was its extreme dependence on the foreign aid that it received from the UnitedStates. America extended $1.5 billion in economic aid, of which slightly more than 80 percent was in the form of direct grants, as well as $2 billion in all-grant military aid, before the program was terminated in 1965 when the two countries agreed that Taiwan’s growth had become self-sustaining. American aid, for example, financed Taiwan’s balanced budgets, which would have been in deficit by 25 percent without the support. Just as importantly, if not more so, aid flows during the 1960s averaged 40 percent of Taiwan’ gross domestic capital formation and accounted for 74 percent of the net investment in infrastructure and 59 percent of agricultural investment. As a result, it has been estimated that Taiwan’s growth would have been cut in half during the 1950s and early 1960s in the absence of American aid (Jacoby, 1966; Lundberg, 1979).

Taiwan did two things that promoted the development of human capital. At the elite level, its ambitious economic strategy necessitated bringing well educated and well trained technocrats and administrators, many of whom had been educated in leading American universities, into the middle levels of the regime (Gold, 1986; Winckler, 1988). At the popular level, the government instituted mandatory primary schooling which it later expanded from six to nine years. In addition to this compulsory education, opportunities for secondary and higher education were greatly expanded over the colonial period. This may well have reflected the traditional emphasis on education in Chinese culture. For example, the 1947 constitution mandated that the central government should spend at least 15 percent of its budget on education, science, and culture (Chen, 1981; Wei, 1973).

Finally, the Kuomintang reforms opened the door, albeit quite narrowly during the 1950s, for Islanders to improve their status in society. The Land to the Tiller program greatly benefitted Islander tenant farmers, and Islanders were the primary beneficiaries of the improved educational system. In addition, the import-substitution program opened up another avenue for advance for native Taiwanese who possessed the skills and resources to become entrepreneurs. For example, many former landlords used their compensation from the land reform program for business start-ups (Cole, 1967; Ho, 1978).

Despite the harsh White Terror that was directed against anyone who was perceived as challenging the regime, the KMT tried to gain political support by allowing limited participation. Although almost all local officials had been appointed during the colonial period, the Chiang Kai-shek administration, once it moved to Taipei, almost immediately began to set up a system of elected local governments; the first local elections were held in 1950–51. The KMT dominated these elections, in large part because the creation of new parties was prohibited by the martial law that had been declared during the Chinese Civil War. What this system did was to encourage pre-existing local factions to join the KMT. The Kuomintang then played them off against each other, since there was intense competition among Islander political groups in many localities. In addition, a few independents won office as well. Thus, local officials were forced to become responsive to their constituencies, although the less salubrious phenomena of corruption and vote-buying were also fostered. More broadly, local elections almost inevitably led to the “Taiwanization” of the government and the party because Islanders had a huge advantage at the polls. In contrast, the KMT enjoyed a political monopoly at the national level because they refused to hold elections until they had reconquered China (Clough, 1978; Tai, 1970).

THE LIGHT INDUSTRY EXPORT BOOM

Import substitution usually runs into problems over time, and Taiwan was no exception in this regard. The very success of import substitution meant that the domestic market was becoming saturated with Taiwan produced light industrial goods, so that there was little room to continue expanding production. For example, domestic demand accounted for 90 percent of the increase in non-food production between 1954 and 1961. Furthermore, the strong protectionist walls encouraged inefficiency and created monopoly profits. Consequently, the economy began to slow down in the late 1950s and early 1960s, although the real growth rate was still in the 6–7 percent range. More problematically, manufacturing’s contribution to national product stagnated at 15–17 percent; there was little increase in the savings rate; inflation began to rise again, averaging 15 percent in 1959 and 1960; and unemployment moved upward as well (Ho, 1978; Lin, 1973).

Another major problem for an import-substitution program like Taiwan’s is that light industry generally requires the importation of both capital goods and raw materials. These increasing imports, in turn, can create balance-of-trade and balance-of-payments problems, which is what happened in Taiwan. Taiwan had a consistent trade deficit of $75 million every year throughout the 1950s, which amounted to over 50 percent of exports and a significant 4–8 percent of GNP, and which could only be sustained by large amounts of American aid. This balance-of-trade problem began to escalate in the late 1950s. Imports as a proportion of GNP jumped from 10.5 percent in 1955 to 16.4 percent in 1959, driven by a rising demand for capital goods whose share of total imports almost doubled, from 15 percent to 28 percent between 1954 and 1960. Taiwan’s protected industrial products were far from competitive on international markets, as indicated by the overwhelmingly agricultural nature of its export mix. Thus, agriculture’s inability to keep up with escalating import needs caused a near doubling of the trade deficit to about $130 million annually in the early 1960s (Lin, 1973; Scott, 1979).

Taiwan’s import-substitution strategy for promoting industrialization and economic development was quite successful in the short term. However, by the early 1960s import substitution was clearly running out of steam. The government, hence, faced a choice among three economic strategies. It could continue as before and hope that the economic situation did not get out of hand. Or, it could attempt to move on to “second stage” import substitution in heavy and capital-intensive industry. Or, it could open itself to the global economy in the hopes of becoming internationally competitive in its current labor-intensive light industries and of promoting development through the large-scale exportation of these products. This strategic decision was a momentous one, and Taiwan’s economic miracle essentially resulted from making the right choice.

As discussed in the analysis of how the light industrial boom stimulated an economic miracle in Taiwan during the 1960s and early 1970s, opening the country’s markets to global economic forces produced momentous and almost immediate results. Figure 4.2 outlines these dynamics. The reform package of the early 1960s led to a rapid growth of light industrial exports which included both the establishment of foreign firms in EPZs and the rapid expansion of indigenous SMEs. Consequently, the manufacturing sector expanded significantly which, in turn, stimulated a jump in Taiwan’s overall growth rate. Furthermore, the central role of SMEs in the export boom continued both the nation’s pattern of geographically dispersed industrialization and the economic empowerment of the Islander business community. Finally, both a strong record on overall growth and the special nature of industrialization combined to reduce poverty and income inequality of the island. Much of this was discussed in the section on Taiwan’s market opening in Chapter 3. Here, we discuss several aspects of this stage of development that were not covered previously in any detail: Taiwan’s policies toward FDI, the role of the SMEs and the geographically dispersed manufacturing in the boom, the growing power of Islander entrepreneurs, the better social outcomes that resulted from the export boom, and the challenges that arose to this stage of Taiwan’s economic miracle.

Figure 4.2  The dynamics of Taiwan’s light industrial export boom

Considerable controversy surrounds the activities of foreign capital and MNCs in developing nations. On the one hand, neoliberals contend that foreign capital contributes much needed capital, technology, and marketing networks (Balassa, 1981; Friedman, 2001). On the other, the critics of neoliberalism argue that foreign firms denationalize important economic sectors, use inappropriate capital-intensive technologies, and ultimately extract a large “surplus” from the domestic economy (Biersteker, 1981). In reality, foreign capital in Taiwan did not appear to bring most of the problems raised by the opponents of neoliberalism. First, Taiwan’s economy was certainly not denationalized. Electronics was the only sector in which foreign firms even approached dominance. Moreover, the ratio of FDI, which provides the strongest controls, to other forms of foreign investment (that is, portfolio and loan) was fairly low and decreased over time, from 36 percent in the 1960s to 22 percent in the 1970s. Overall, FDI never constituted more than 10 percent of total manufacturing investment. Second, MNCs did not form enclaves but became increasing linked to the domestic economy. For example in the early 1970s, foreign firms made about half of their purchases locally. Third, while the MNCs were initially more capital-intensive than domestic companies, this difference narrowed appreciably over time; and, indeed, a good deal of the FDI was located in EPZs to take advantage of low-cost labor. Fourth, over time foreign-invested firms became much more export-oriented. For example, MNCs established before 1960 exported only 18 percent of their output, but the share of exports in total output rapidly escalated to 37 percent for those established in 1961–66 and 75 percent for those established in 1967–71. Fifth, international groups, such as large Japanese trading firms and American retail chains, assumed a leading role in marketing Taiwan’s exports. For example, in 1970 about half of all exports were marketed through foreign companies. Finally, the profits of foreign capital obviously did not prevent Taiwan from developing a very dynamic economy (Gold, 1988; Gregor, 1981; Haggard and Cheng, 1987; Lin, 1973; Ranis and Schive, 1985).

This very significant contribution of foreign capital to Taiwan’s development program resulted from Taiwan’s successful management strategy. The regime, with its memory of “unequal treaties” and foreign enclaves in nineteenth- and early twentieth-century China, was quite sensitive to the need to control MNCs so that their activities helped, rather than hindered, the nation’s developmental efforts. In particular, the regime moved to channel foreign capital into the new dynamic export sector, to ensure its integration with the whole economy through domestic content legislation and limitations on the number of expatriate managers, and to maintain the monopolies of state corporations in the heavy and capital-intensive industries usually dominated by foreigners. The government’s ability to regulate foreign capital, in turn, rested on the high profits that were available in Taiwan. Thus, Taiwan’s ongoing economic success gave leverage to the state to harness foreign investment to the nation’s development goals (Gold, 1986, 1988; Haggard and Chen, 1987; Ranis and Schive, 1985; Scitovsky, 1986).

SMEs provided the dynamism for Taiwan’s export boom from the 1960s through the 1980s. The SMEs in Taiwan pursued highly entrepreneurial strategies that Danny Lam (1992) has termed “guerrilla capitalism.” This includes extreme flexibility in rapidly filling even small orders, attention to quality and design, audacious bidding, participation in complex networks of subcontracting, and only partial observation at best of government regulations and international laws, such as those regarding intellectual property rights. The SMEs also demonstrated a remarkable capacity to innovate and upgrade their operations. Thus, while guerrilla capitalism took off in the textile and shoe industries in the 1960s, such entrepreneurs moved into low tech electronics assembly in the 1970s; and some were able to upgrade into more sophisticated high tech production in the 1980s.

The success of the SMEs is explained by several of their organizational characteristics. Using an extensive network of subcontracting relationships among all industry competitors was a surprisingly common pattern in Taiwan. Therefore, although it is true that the winning contractor benefitted the most from a lucrative foreign order, that firm was able, in effect, to have the slack capacity of the entire industry available to it through subcontracting. This prevalence of subcontracting networks was facilitated by the prevailing pattern of ownership, because almost all firms in a particular industry owned each other’s shares. Subcontracting enhanced the efficiency of the market in two ways. First, it allowed the winning contractor to make above-normal profits through his knowledge of the local industry. Thus, he would normally subcontract to firms that had surplus capacity which they would sell at marginal rather than full cost. Second, it kept other firms in business and allowed them to become more efficient through “learning by doing.” This process explains how a layer of small firms could circumvent the limitations that would normally be placed on them by under-capitalization and the inability to handle large orders. This intricate subcontracting network, therefore, made Taiwanese industry able to respond more as a unified organism rather than as discrete units (Greenhalgh, 1984, 1988a; Kuo, 1998; Lam, 1992; Skoggard, 1996).

The dynamic of moving from textiles to electronics in the late 1960s and 1970s also involved applying the principles of guerrilla capitalism to acquiring technology transfers from the foreign MNCs that initially dominated Taiwan’s electronics industry, especially the export sector. Ironically, the drive for an indigenous industry was fueled by the rapid growth of MNC assemblers and component-makers. As with any industry experiencing rapid growth, there was a large turnover of labor and management as new arrivals acquired skilled managers by hiring talent from established firms. Thus, every new entrant created more and more opportunities for both the trained local staff and the expatriate staff of the established firms. Naturally, wages and benefits for experienced and skilled managerial staff ratcheted upwards with each new entrant. As experienced managers left established firms, more opportunities opened up for junior staff to move upwards. This rapid turnover, in turn, quickly created a large number of highly trained managers who had extensive experience with a number of firms. The geographic proximity of the firms to each other made it all the easier for staff to move around. Furthermore, being a relatively small industry, friendships between managers were rapidly made and extensive networks of staff from ostensible competitors became commonplace.

Local managers soon realized that, in fact, the MNC operations were not highly sophisticated. Managers who worked in assembly operations, hence, quickly saw that they were often capable of setting up their own operations with relatively little capital. Naturally, many of them jumped at the opportunity and left their MNC employers to establish assembly operations of their own. Sometimes this was done entirely independently, sometimes in collaboration with a few colleagues, and other times with the support of large local conglomerates who wished to enter a new business. These new entrants then competed for subcontracts for subassembly from other firms. Over time, these relatively unsophisticated assemblers would learn to build more and more complex assemblies, then either learn or purchase designs from experienced designers, and ultimately begin to manufacture full assemblies for simple consumer electronics products like radios. Gradually, their sophistication improved enough to build tape recorders, record players, and other more sophisticated consumer electronics goods (Kuo, 1998; Lam, 1992; Lam and Clark, 1994; Schive, 1990; Wang, 1992).

Industrial growth was not, as in many other developing nations, concentrated in a few urban areas. Rather, because of the legacy of the Japanese colonial era, the excellent transportation system developed in the postwar era, Taiwan’s rural electrification program, and an increasingly educated population, a wide dispersion of manufacturing enterprises occurred in small cities and rural villages. For example, between 1951 and 1971, the proportion of firms located in the capital and largest city Taipei only increased from 15 percent to 18 percent, whereas the proportion of firms located in the next four largest cities actually decreased by about the same amount from 19 percent to 17 percent. This pattern was also advantageous because it provided ready part-time employment for underemployed people in the agricultural sector (Ho, 1979; Ho, 1980; Ranis, 1979).

More broadly, several central elements in Taiwan’s traditional Confucian culture, furthermore, appear to have stimulated the small-scale companies and flexible and aggressive entrepreneurship that marked Taiwan’s economic development up through the industrial-upgrading stage. First, the Confucian value system provided, at least in theory and often in practice, a flexible social hierarchy with considerable upward mobility opportunities that were determined by a person’s ability. Although education and civil service examination scores, rather than entrepreneurial skills, were most important for this mobility until the twentieth century, the absence of a rigid inherited class system was certainly important in stimulating widespread business activities in Taiwan. Second, the strong emphasis on family in Confucian culture provides an incentive for savings and entrepreneurship to build family fortunes, analogous to the individualism that has been viewed as underlying western capitalist development. Consequently, Taiwan’s economy was dominated by family firms, with extended families required to run large-scale firms (Fei, 1986; Greenhalgh, 1984, 1988a; Harrell, 1985; Li, 1986; Pye, 1985; Winckler, 1987; Wong,1986). According to Susan Greenhalgh (1988a), such firms are marked by strong personal loyalty, rapid informal communications, and decentralization and diversification – all of which promote flexibility and risk-spreading.

The rapid growth of SMEs also began to empower the Islander business community. Indeed, the Kuomintang may have given preference to an industrial structure that was relatively decentralized so as to inhibit the emergence of large, strong, and concentrated interest groups (Chu,1999; Tan, 2001). However, the very rapid growth of the private sector during the 1960s and 1970s opened up an avenue for the advance of native Taiwanese who had the resources and skills to become entrepreneurs and, consequently, the major beneficiaries of the escalating profits in the export sector. In fact, by the early 1970s private entrepreneurs, most of whom were Islanders, had surpassed all but the top regime officials in terms of income, standard of living, and perhaps even social status. Taiwan, hence, seemed to be evolving into something of a dual elite structure in which Mainlanders dominated the top party, government, and educational positions, while Islanders dominated the business establishment (Cole, 1967; Gates, 1981; Gold, 1986; Numazaki, 1986).

Rapid industrialization in the 1960s and early 1970s, in combination with the leading role of geographically dispersed SMEs, also brought an increased standard of living and decreased income inequality for the population at large. First, food consumption and especially dietary quality rose substantially, as indicated by a 15 percent increase in caloric intake and a 30 percent jump in protein consumption between 1960 and 1972. Second, the number of health personnel nearly doubled between 1958 and 1973; and the communicable disease rate dropped a dramatic 20-fold over the same period. Third, in education, the real expenditures per student, which had stagnated during the 1950s, doubled between 1962 and 1972; and the number of primary school students going on to junior high jumped from about a half in the early 1960s to over 80 percent a decade later. Fourth, the share of household income that was spent on food fell from 53 percent to 42 percent during the 1960s, implying that a significant increase in disposable income occurred (Galenson, 1979b; Lin, 1973; Wang, 1981). Last but far from least, Taiwan differed markedly from the normal development pattern in which industrialization and growth first produce greater inequality in income and wealth, and only lead to greater equality after a significant lapse of time (Kuznets, 1955). In Taiwan, by contrast, income inequality fell sharply during the 1950s, primarily due to the land reform program. Over the next decade, rapid industrialization produced a tight labor market and rising real wages, which averaged 5.2 percent per year between 1960 and 1972. Consequently, the ratio of the income of the richest fifth of the population to that of the poorest fifth dropped from 11.6 in 1961 to 4.5 in 1971, a level equivalent to the inequality that exists in the developed world. Thus, Taiwan could claim with a good deal of justification that it had achieved “growth with equity” (Fei, Ranis, and Kuo, 1979; Greenhalgh, 1988b).

In the late 1950s and early 1960s, to sum, the government took a fateful gamble that Taiwan could become internationally competitive in the production of labor-intensive manufacturing based on a low-cost labor force that in comparison to other developing countries was relatively well educated and skilled. This strategy turned out to be tremendously successful. Exports rose substantially, producing strong economic growth without significant inflation. Rapid growth, in turn, produced enough resources both for high savings and investment rates, and for appreciable gains in the popular standard of living. The tight labor market and rising wages, however, suggested that this strategy might face some long-term constraints because Taiwan was gradually pricing itself out of the low-cost labor niche in the global economy. This long-term challenge was then greatly exacerbated by the global economic crisis that erupted in October 1973 when the Arab oil embargo and subsequent escalation in oil prices shook both the developed and developing worlds. Taiwan certainly appeared to be a prime candidate for economic devastation. It imported almost all of its energy products and, as a highly trade-dependent nation, was extremely vulnerable to global inflation and instability in the international markets for its manufactured products.

INDUSTRIAL UPGRADING

Taiwan faced two distinct economic challenges in the mid-1970s. First, just as in Pinochet’s Chile, the surge in energy prices had a horrendous impact on the domestic economy. Second, Taiwan faced growing pressures on its exports due to, ironically, its growing prosperity and rising wages. As illustrated in Figure 4.3, the government was quite successful in first implementing a very successful stabilization program that had the economy back on track in 1976, and then pursuing a two-pronged strategy of industrial upgrading that moved the economy significantly higher up the international product cycle. Economic success, in turn, created a significant middle class, and there was some significant progress as the regime moderated somewhat from “hard” to “soft” authoritarianism.

The surge in oil prices sent major shock waves through Taiwan’s economy. As would be expected, this surge created major inflationary pressures as the inflation rate exploded sixfold from 8 percent in 1973 to 48 percent in 1974. Moreover, sophisticated analysis of input-output tables indicated the energy prices per se accounted for only slightly more than half of the inflationary spike. Ironically, Taiwan’s very success in export-led growth was beginning to overheat the economy. In particular, the country’s huge trade surpluses stimulated a considerable jump in the growth of money supply from 15 percent annually during the 1960s to 30 percent in 1971–72, and 50 percent in 1973 (Kuo, 1983; Schive, 1987). The global and local inflation, in turn, put an immediate damper on Taiwan’s export performance as exports declined by 6 percent in real terms in 1974 and 1975, cutting their contribution to GNP from 42 percent in 1973 to 35 percent in 1975. These problems in the export sector had a major adverse impact on Taiwan’s economy. The overall real growth rate collapsed from 12.8 percent in 1973 to 1.1 percent in 1974 (see Table 4.1). With the drop in exports, manufacturing suffered a marked decline as its share of GNP diminished from 37 percent of GNP in 1973 to 29 percent two years’ later. Economic distress caused a significant decrease in the savings rate as well. Real savings, which had grown by 20 percent a year in the early 1970s, fell by 8 percent in 1974 and 11 percent in 1975. Foreign investment was withdrawn as well, as it fell from 8 percent of total gross domestic capital formation in 1973 to 3 percent over the next three years. Finally, the popular standard of living was squeezed, as the growth in real manufacturing wages fell from 14 percent in 1972 to 1 percent in 1973 and −9 percent in 1974 (Clark, 1989; Ho, 1978).

Figure 4.3  The dynamics of industrial upgrading in Taiwan

Table 4.1  Taiwan’s real economic growth during industrial upgrading

197312.8%
19741.1%
19754.3%
197613.9%
197710.1%
197813.9%
19798.5%
19807.4%
19815.7%
19823.5%
19838.3%
198410.7%
19855.0%
198611.5%
198712.7%

Sources: CEPD (1987), p. 1; CEPD (2009), p. 17.

The government responded quickly and actively to control this growing economic chaos. As in the early 1950s, it took aggressive actions to bring inflation under control. First, the regime applied monetary and fiscal measures in a deflationary manner. High interest rates were used to discourage spending and stimulate savings, and sharp controls were put on the money supply whose rate of growth dropped precipitously from 50 percent in 1973 to 10 percent in 1974. In the fiscal realm, government spending was cut sharply from 23 percent to 18 percent of GNP between 1973 and 1974. The regime also tried to control inflation by managing price increases through the monopolies exercised by such state corporations as the China Petroleum Corporation (CPC) and the Taiwan Power Company. Initially, the CPC tried to absorb the escalating oil prices, but when this proved impractical the government opted for a one-time large price increase to provide certainty for the future and prevent an inflationary psychology from taking hold. In combination, these policies proved to be quite a success in a remarkably short time, as the inflation rate plummeted from 48 percent in 1974 to 5 percent in 1975 (Kuo, 1983; Lundberg,1979).

With inflation coming under control, the government moved quickly to promote a recovery by using public spending and investment to reinvigorate the economy. In 1974, then, the government simultaneously applied both the brake of deflationary monetary and fiscal policies and the accelerator of greatly increased public investment, which jumped by 50 percent in real terms in 1974 after 10 percent increases in the previous two years, primarily through loans by the government-controlled banks to state corporations. By 1975, the economic situation had changed considerably. Inflation had clearly been tamed, but the effects of the crisis were still quite evident in sluggish growth and export performance, and in a disastrous drop of 44 percent in private investment. The government responding by removing the fiscal brake but keeping the investment accelerator pushed down. Real state investment grew by 23 percent; and bank loans to state corporations by 43 percent. As a result, the public share in gross domestic capital formation jumped to a dominant 58 percent. In addition, the government provided a fiscal stimulus by restoring the drastic cuts in government spending. Taiwan’s successful stabilization program, in turn, quickly led to a revival of the nation’s international export competitiveness as total exports, which had declined by an average of 6.5 percent in 1974 and 1975, leaped by 46 percent in real terms in 1976. The recovery of foreign trade brought a surge of economic growth with it in 1976. Real economic growth shot up to double digits of 14 percent in 1976, 10 percent in 1977, and 14 percent in 1978; and industrial production increased even faster. Savings and investment, both domestic and foreign, recovered strongly as well, even though public investment was reduced to normal levels once economic recovery got under way. Even more spectacularly, real wages in manufacturing averaged 13 percent increases during 1975–77, by far the largest three-year spurt in the history of Taiwan (Kuo, 1983, 1985; Li, 1988; Ranis, 1979).

In sum, the strong external economic shock resulting from the Organization of Petroleum Exporting Countries (OPEC) embargo had only a fleeting impact on Taiwan, unlike its more devastating consequences for many other countries in both the developed and developing worlds. This was partly because Taiwan had developed a strong and expanding economic base that could absorb the shock. Still, the Chiang Kai-shek government must be given considerable credit for responding with a sophisticated and subtle program. Even before the debate about “stagflation” had really commenced, the regime successfully blended deflationary and stimulatory policies, and fine-tuned government policies in response to rapidly changing macroeconomic conditions.

This remarkable rebound still left Taiwan with the long-term problem that it was pricing itself out of the global niche in cheap light industrial products. The country responded with two separate efforts in industrial upgrading which started in the 1970s. One was an explicit government effort to accelerate Taiwan’s development of heavy industry. The primary vehicle for this was ramping up the Ten Major Development Projects in heavy industry (steel, petrochemicals, shipbuilding, and nuclear energy) and infrastructure that had been started in the early 1970s. This provided more incentives for upgrading labor-intensive production and reduced transportation and supply bottlenecks (Li, 1988; Ranis, 1979). In a structural sense, the expanding heavy industries were somewhat diverse. Some, such as steel, were led by state corporations while others, such as petrochemicals, involved a complex set of large domestic firms (for example, Formosa Plastics), foreign multinationals, and state corporations (Gold,1986; Haggard, 1990; Noble, 1998; Schive, 1987; Wu, 1985).

The other prong in Taiwan’s industrial upgrading during the 1970s and 1980s was based, at least initially, on a much more bottom-up rather than top-down approach in that it was primarily initiated by the sector of SMEs who, in general, only had tenuous ties with the government. The SMEs, as described in the last section, had been the central driving force in the export boom of light industry, and they played a surprisingly large role in the economy up through the mid-1980s when they still accounted for almost half of manufacturing production and two-thirds of total exports (Fields, 1995; Hu and Schive, 1998; Kuo, 1995; Lam and Clark, 1994; Myers, 1984; Wu and Huang, 2003). The SMEs pursued highly entrepreneurial strategies and also demonstrated a remarkable capacity to innovate and upgrade (for example, from the textile and shoe industries in the 1960s to low tech electronics assembly in the early 1970s). By the late 1970s, some were venturing into high tech electronics; and scientists, especially some returning from the United States. became involved in the industry as well (Greenhalgh, 1988a; Kuo, 1995; Lam and Clark, 1994; Wang, 1995; Wu and Huang, 2003). While private firms dominated the emerging high tech industries, the government assumed a very important facilitating role as government research labs developed and commercialized the new technologies and the state invested heavily in the Hsinchu Science-Based Park that brought together government labs and high tech firms (Amsden and Chu, 2003; Breznitz, 2007; Greene, 2008; Mathews and Cho, 2000; Wang, 1995).

In combination, these two types of industrial upgrading were quite successful, although growth in the late 1970s and 1980s went through business cycles as Taiwan had to endure the effects of the second oil crisis 1980–82. Table 4.1 shows that the ensuing downturn was longer but not as sharp as the crisis of 1974–75. The economic growth rate declined steadily for four years (1979–82) but only dipped below 7 percent in the last two; and the peak of inflation (19 percent in 1980 and 16 percent in 1981) was less than half the inflationary spike in 1974. Given the success of the stabilization program in the mid-1970s, the government implemented these policies again. Deflationary monetary and fiscal policies were imposed; and energy policies were enacted to make production less energy-intensive. These policies had almost immediate effects. Inflation almost completely disappeared by 1982; large and rapidly increasing trade balances re-emerged in 1982; and energy consumption only increased slightly. Unlike the first oil crisis, taming inflation and running a trade surplus did not immediately reinvigorate the overall economy. Indeed, it was the economic recovery of the United States, Taiwan’s major export market, which started in the middle of 1983, that brought Taiwan its last period of double-digit growth: 11 percent in 1984, 12 percent in 1986, and 13 percent in 1987 (Clark, 1989; Gold, 1986).

Once growth took off again in the mid-1980s, both types of industrial upgrading proved to be quite successful because, as shown at the bottom of Figure 4.3, it more than counterbalanced the movement of Taiwan’s labor-intensive industries offshore that commenced in earnest in the mid-1980s. The heavy industry strategy soon bore fruit as, for example, heavy industry grew at an annual rate of 12.2 percent during 1977–86 compared to 7.8 percent for light industry; and the fastest growth for individual products was generally recorded by sophisticated manufactures. Thus, although import substitution generally had not had much impact on the overall economy after the export boom started, significant import-substitution gains were made during the 1980s in such industries as iron and steel, electronics products, artificial fabrics and fibers, heavy chemicals, and rubber (Schive, 1987).

The upgrading of Taiwan’s SMEs and the transition to high tech industries proceeded apace as well. During the period of industrial upgrading, the SMEs certainly played a central role in the dynamism of the economy. During the late 1970s and early 1980s, for example, they constituted just under half of manufacturing production and over 80 percent of commercial sales (Wu, 1988). SMEs also employed 61 percent of all Taiwanese workers in 1976. They were also crucial to the export drive as they accounted for 68 percent of all exports in 1981, although this share began to decline soon thereafter (Wu, 1988; Wu and Huang, 2003). More generally, small businesses played an atypically large role in Taiwan’s economy during the export boom and industrial upgrading periods. For example, Howard Pack (1992: 104) concluded that “by international standards the typical size of firm in each sector is remarkably small” in Taiwan.

The new economic strategy also changed Taiwan’s policy toward foreign capital. As described in the last section, foreign capital played a very significant role during the export boom by providing technology and especially by integrating Taiwan into international marketing networks. With Taiwan’s continued dynamic growth, though, these contributions became less important. For example, foreign capital’s share of total investment slipped to the 2–3 percent range after 1973; and local businesses accounted for 75 percent of production during the 1970s, while their share of exports in the electronics sector almost doubled from 29 percent in 1974 to 50 percent in 1980. The strategy of industrial upgrading created a stronger need for technological development. To some extent, this was pursued by creating sophisticated government research labs and encouraging research and development (R&D) activities by local companies, but the state also moved to attract foreign capital in the hope of promoting technology transfer. Thus, many of the regulations governing foreign capital were loosened and liberalized during the 1980s. This resulted in the steady increase of foreign investment, from $164 million in 1977 to $1,223 million in 1987, which was equivalent to about 6.5 percent of investment for 1985–87, with most of it concentrated in heavy and high tech industries (Fuller and Rubinstein, 2013; Kuo, 1983; Ranis and Schive, 1985; Simon, 1988). In general, Simon (1988) concluded that Taiwan was fairly successful in promoting technology transfers to upgrade its industrial structure, although limited government leverage and indigenous technological sophistication put definite constraints on these efforts in the 1980s.

By the late 1980s, Taiwan was beginning to experience a revolution in the popular standard of living as well. Between the 1950s and 1980s, for example, the crude death rate was more than cut in half; life expectancy increased from 58 years to 72; the quantity and quality of Taiwanese diets increased considerably; the living space per person quadrupled; the percentage of houses with electricity tripled to 99 percent; the literacy rate doubled to 90 percent; and education through junior high school became nearly universal. During the decade between 1977 and 1986, the proportion of household budgets devoted to food dropped by almost a quarter from 41 percent to 32 percent, indicating an increase in disposable income; the number of health personnel doubled; and the real amount of educational spending doubled as well. Also highly relevant for the quality of life, Taiwan had completed the demographic transition by the late 1980s as its fertility rate had dropped to just over 1. In comparative terms, furthermore, Taiwan ranked closer to the developed than the developing countries on the index of “physical quality of life” that is based on literacy, infant mortality, and life expectancy by the early 1970s, and had one of the fastest rates of growth on this index during the 1950s and 1960s (Morris, 1979). Taiwan, therefore, was well on the way to developing a broad-based middle class as the 1980s ended, spurred by a combination of the excellent educational system and the growing number of professional and business jobs (Fei, Ranis, and Kuo, 1979; Hsiao, 1991, 2012; Li, 1984; Tsai, 1987).

Taiwan adopted a series of political reforms that Edwin Winckler (1984) termed a shift from “hard” to “soft” authoritarianism. This political loosening was associated with the growing power of Chiang Ching-kuo, the son of Chiang Kai-shek, who became Premier in 1972, KMT Chair in 1976 after his father’s death, and President in 1978. There were three major components to this partial liberalization. First, Chiang cracked down on corruption, which also provided a means for easing out his rivals. Second, he brought younger and more professionally qualified people into leadership positions and promoted a Taiwanization of higher levels of the government and party. Third, the importance of elections was also increased. This reform movement was certainly cyclical in the sense that domestic and international crises periodically triggered retrenchments and crackdowns, but over time the reforms cumulated and created a firm foundation for Taiwan’s democratic transition (Copper, 1988; Tien, 1989; Winckler,1984). In addition to the ongoing struggle over political power between the Kuomintang and the opposition, independent “social movements,” such as environmental groups and farmers’ and women’s associations (but perhaps surprisingly not labor unions), took the lead in bringing the issues of special concern to themselves to the national agenda during the 1980s (Chen, 1994; Chu, 1994b; Hsiao, 1991, 2012).

The regime was also pushed from below by a growing opposition that demanded the country’s democratization. During the 1950s and 1960s, opposition, which was associated with support for either communism or making Taiwan independent from China, was strongly repressed by the White Terror. The first organized dissent erupted in 1971 as nationalist protests that were at least partially encouraged by the government against the People’s Republic of China (PRC) replacing Taiwan in the United Nations and against the return of the Senkaku Islands to Japan. This new movement from below advocated more effective foreign policies and greater democracy internally, while taking care not to cross the regime’s red lines about advocating Taiwan independence; and the scope of political debate was gradually allowed to expand. While the formation of new parties was still prohibited by martial law, the opposition formed a Campaign Assistance Corps in the late 1970s which helped institutionalize, at least informally, the tangwei (literally those outside the party), thereby enraging the regime. Finally, the tangwei declared the formation of a new party, the Democratic Progressive Party (DPP), in 1986. A political crisis seemed to be imminent when the Ministry of Justice filed charges against the DPP. President Chiang then intervened by announcing that martial law would be ended and that new parties could be formed as long as they supported the constitution and did not advocate either communism or Taiwan independence (Clough, 1978; Copper, 1988; Tien, 1989; Winckler, 1984). This founding of the DPP is widely regarded as the beginning of the democratic transition in Taiwan.

ECONOMIC MATURITY AND DEMOCRATIZATION

Figure 2.2 in Chapter 2 showed that national growth is expected to decelerate as countries make the transition from an industrial to an information-age economy because productivity gains are harder to achieve in most service sectors. This certainly occurred in Taiwan, as illustrated by the data in Table 4.2. 1987 was the last year of double-digit growth with the exception of a one-year spike in 2010. The growth rate then dropped to about 8 percent for 1988–94 and slightly above 5 percent for 1995–2000. The new century was marked by two recessions at the beginning and end of its first decade, with real growth of about 5 percent between them and 3.5 percent after them. In addition and more positively, Taiwan experienced major political change in the form of a successful democratic transition.

Table 4.2  Taiwan’s real economic growth during economic maturity

198712.7%
19888.0%
19898.0%
19908.5%
19917.6%
19927.9%
19936.9%
19947.4%
19956.5%
19966.3%
19976.6%
19986.4%
19995.8%
20005.8%
2001−1.7%
20025.3%
20033.7%
20046.2%
20054.7%
20065.4%
20076.0%
20080.7%
2009−1.8%
201010.8%
20114.2%
20121.5%
20132.1%
20143.7%

Sources: CEPD (2009), p. 17; National Development Council (2014), p. 19.

As indicated at the top left of Figure 4.4, the Taiwan economic miracle continued in what can be called without much hyperbole a stunningly rapid ascent into several important high tech industries. The centerpiece of Taiwan’s high tech revolution was the electronics industry which evolved quite rapidly from low tech assembly to high tech success in just a couple of decades, with the developments of each successive stage creating a foundation for the subsequent upgrading. Alice Amsden and Wan-wen Chu (2003) termed these the television, calculator, and notebook computer eras. In semiconductor technology, Taiwan made extremely rapid progress to reach the world frontier in the early 1990s and was fourth in the world in semiconductor production by the mid-1990s. This success in high tech electronics continued over the next two decades. For example, in 2013 Taiwan, a country of slightly over 23 million people, led the world in the production of 20 products when the offshore production of its firms is counted. These products include notebook PCs (87 percent of global market share), motherboards (86 percent), LCD monitors (66 percent), glass fiber (64 percent), optical disks (57 percent), servers (54 percent), tablet computers (50 percent), and desktop PCs (47 percent) (National Development Council, 2014). Similar progress was also made in heavy industry. For example, China Steel, a state corporation, became the third most efficient producer in the world in the 1990s; and Formosa Plastics, a private conglomerate, established a presence in the United States in the 1980s (Amsden and Chu, 2003; Berger and Lester, 2005; Chang and Yu, 2001; Greene, 2008; Noble, 1998).

Most strikingly, Taiwan’s stunning success in electronics was primarily the result of the domestic industry, according to Amsden and Chu (2003:62):

The declining role of foreign direct investment after the television age in the development of the electronics industry is striking. In the electronic appliance industry, foreign investment was pervasive. By contrast, in the computer industry, it had all but disappeared by the early 1990s.

Taiwan’s high tech revolution, therefore, represented a triumph of indigenous development. The relationship between the government and Taiwanese businesses varied considerably within the high tech sector. Private companies dominated computers and software, while the state had to play a much larger role in semiconductors, especially in providing basic R&D. In particular, the state assumed a very important facilitating role as government research labs developed and commercialized the new technologies and the state invested heavily in the Hsinchu Science-Based Park that brought together government labs and high tech firms. Furthermore, Taiwan is credited with doing an excellent job of continuing to promote technology transfers in an effective manner (Fuller and Rubinstein, 2013; Greene, 2008; Mathews and Cho, 2000; Wang, 1995).

Figure 4.4  The dynamics of economic maturity and democratization in Taiwan

Unlike the previous three periods of economic growth and transformation, however, economic maturity brought a considerable amount of creative destruction (Schumpeter, 1950) as denoted in the middle block on the left side of Figure 4.4. Two important and interlinked components of this were the declining effectiveness of Taiwan’s small and medium industries and the migration of a substantial amount of industry offshore, especially to China. As described in the previous two sections, SMEs played a key role in Taiwan’s success during the export boom and industrial upgrading periods. By the 1990s, however, there were growing challenges to this key sector of the economy. As manufacturers from developing countries in Southeast Asia and especially China entered the global market, Taiwan’s SMEs began to face stiffer challenges to be competitive and remain profitable. In addition to the lower production costs there, the tightening of the labor market in Taiwan produced significantly rising labor costs (SMEA, 2008; Wu and Huang, 2003). Furthermore, most SMEs were not well positioned for industrial upgrading because they did not possess the resources for purchasing expensive equipment or for their own R&D activities. Consequently, Taiwan’s SMEs became increasingly squeezed between the developing countries that could provide cheap manufactured goods and the developed countries that produced the most technologically advanced products. The result was that many rapidly lost their competitiveness on international markets. For example, from a high of 70 percent of total exports in 1982, the SME’s share of Taiwan’s total exports declined to a still respectable proportion of 49 percent in 1997 (Wu and Huang, 2003) and then to a much lower level of 28 percent by 2006 (SMEA, 2008). The relative weakening of the SMEs in Taiwan’s economy was exacerbated by their lack of leverage in the political system. This can be evidenced from the government’s plan to promote an “innovation-oriented industrial policy” in the areas of high tech, biotechnology, information technology, and software (SMEA, 2008). While the official government position is to assist the SMEs toward these high-value-added industries, the reality is that most SMEs (by their structure and resources) are simply not equipped to take advantage of these plans. The liberalization of the political decision-making environment, furthermore, both presents new opportunities for powerful interest groups to influence policy decisions and gives party politicians new avenues to cultivate political and social support. These new avenues and opportunities, while favorable to some, are not particularly helpful for dispersed and weaker interest groups, such as the SMEs (Tan, 2008).

Because of the growing economic pressures on many of the SMEs in Taiwan, their owners started moving their production facilities offshore in the late 1980s. At first, the primary destination was Southeast Asia, but by the mid-1990s the PRC had become the major destination for outward FDI by the Taiwanese business community. Changed conditions in both Taiwan and the PRC combined to funnel much of this investment outflow and the trade that it generated into China. After four decades of almost complete isolation due to the Cold War hostilities between Taipei and Beijing, Taiwan opened the door for cross-Taiwan Strait interactions when it allowed indirect trade through third countries in 1984, and then considerably enhanced the opportunity for “indirect” trade with and investment in the Chinese mainland over the rest of the decade (Cheng and Chang, 2003; Clark, 2007; Kastner, 2009). For its part, China was just switching its strategy for industrial development as well. In particular, the PRC embarked upon an economic reorientation with a “coastal development strategy” aimed at attracting the light and labor-intensive industries that were being priced out of Hong Kong and Taiwan and at using them to emulate the export-led industrialization of the East Asian capitalist nations, thereby creating a strong complementarity between the Taiwanese and Chinese economies. Geographic proximity and a common culture and language reinforced this complementarity, thereby making China an extremely attractive base for Taiwanese firms (Kastner, 2009; Leng, 1996; Lin, 2002; Naughton, 1993, 1997; Wu, 1995).

Investment in China by Taiwan businesspeople was negligible until the late 1980s but then took off rapidly. Official data almost certainly understate the amount of this investment since many Taiwanese firms sought to evade continuing restrictions. Still, even the cross-Strait investment flows reported to the Taiwan government (for example, $43 billion during the1990s) are impressive. The nature of Taiwan’s foreign investment became more large-scale and sophisticated, as well. Taiwan investors moved from joint ventures to solely owned enterprises, and began to build and supply their own factories. Growing trade was accompanied (in fact, stimulated) by a fairly massive flow of outward FDI. This is because Taiwan companies on the mainland imported machinery and more sophisticated components from Taiwan for the production (primarily assembly) of goods being exported to third markets. Thus, this investment produced a huge surge in exports from Taiwan to China which more than tripled from 5 percent to 17 percent of Taiwan’s total exports between 1989 and 1994, but then stayed at that level for the rest of the decade.

The structure of these ventures was also upgraded from simple assembly to upstream heavy and more capital-intensive or high tech production. In particular, by the mid-to-late 1990s the mix of Taiwan investment in the PRC began to shift from predominantly small businesses in labor-intensive exports to much larger businesses seeking to penetrate the Chinese market in heavy industry (for example, Formosa Plastics) and consumer goods (for example, President Enterprises). By the end of the decade, thus, Taiwanese businesses were making a major contribution to the upgrading of China’s economy. For example, at the beginning of the twenty-first century, it was estimated that nearly 75 percent of China’s information technology exports came from factories owned by Taiwanese (Bolt, 2001; Kastner, 2009; Kuo, 1995; Leng, 1996; Lin, 2002; Naughton,1997).

The two sides went well beyond simple trade or the exchange of goods and services. Rather, Taiwan’s businesses set up integrated production networks across the Strait in which different stages (for example, design and the manufacture of advanced components in Taiwan and final assembly in China) were conducted in Taiwan and the PRC (Bolt, 2001; Chu, 1999; Naughton, 1997; Wu, 1995), creating what Gary Gereffi (1998) has called “commodity chains.” Second, the activities of Taiwanese firms led to a substantial migration of businesspeople to China in the 1990s, resulting in growing Taiwanese communities in many mainland cities with, for example, an estimated half a million Taiwanese citizens living in Shanghai alone. This led some observers to comment upon the growing “Taiwanization” of parts of China (Bolt, 2001; Clough, 1999; Cooke, 2006). Increasing interactions across the Taiwan Strait, moreover, were not just limited to the economic sphere. A very significant number of Taiwanese also rediscovered their “roots” in Fujian Province. For example, Murray Rubinstein (1995) described the fascinating process of cross-Strait “temple politics” in which temples in Taiwan “adopted” older ones in Fujian.

The past two decades, thus, have witnessed a growing economic integration between Taiwan and China. The political relations between the two sides, however, have been anything but calm and stable. Beginning in the 1990s, there have been a series of contretemps across the Taiwan Straits based on China’s claims to sovereignty over Taiwan and Taiwan’s strong rejection of these claims. The tension was especially high during the presidency of the DPP’s Chen Shui-bian (2000–2008) who strongly advocated Taiwanese nationalism. Following the election of the KMT’s Ma Ying-jeou as President in 2008, tensions eased between Taipei and Beijing; and several major economic deals were signed, most importantly the Economic Cooperation Framework Agreement (ECFA) (Bush, 2004, 2013; Clark and Tan, 2012; Tucker, 2009; Zhao, 1999). One would have expected, therefore, that the Chen administration would have seen a decline in economic ties between Taiwan and China, while the Ma administration would have produced a substantial revival in cross-Strait economic ties. However, just the opposite occurred, leading Clark and Tan (2012) to conclude that economic relations between China and Taiwan have been primarily responsive to economic, not political, forces.

Indeed, by the turn of the new century, a new round of increasing economic interactions across the Taiwan Strait commenced, as both trade and investment rose fairly consistently until the disruptions of the Great Recession at the end of the decade. This new spurt of economic interactions between Taiwan and China was driven by several factors sequentially. First, when Taiwan’s economy was growing robustly during 1999 and the first half of 2000, the high tech component of cross-Strait relations especially benefitted (for example, two-thirds of the new investment projects approved during 2000 involved the electronics industry). One major project in this area, a $6.4 billion joint venture for Shanghai semiconductor plants announced in May 2000, was certainly fraught with both symbolic and political significance since it involved the sons of Jiang Zemin, the PRC’s President, and Y.C. Wang, the head of the huge Formosa Plastics empire in Taiwan, indicating that those with the best reason to know believed that cross-Strait relations would not blow up despite Chen’s victory. Second, once the global recession in high tech production hit Taiwan in the autumn of 2000, many domestically oriented businesses on the island tried to expand to the mainland to make up for the deteriorating economic situation in Taiwan (Bolt, 2001; Cooke, 2006). Finally, as Taiwan’s economy picked up again after the 2001 recession, the initial logic of economic expansion reasserted itself (Fuller and Rubinstein, 2013). For example, two-thirds of Taiwan’s outward FDI in 2004 went to China, with 45 percent of it in the electronics industry (Mainland Affairs Council, 2005).

The rapid growth in cross-Strait interactions during Chun Shui-bian’s presidency is quite striking in terms of trade and investment data. Taiwan’s exports to China jumped from $21,000 million to $74,000 million in 2007, which increased their share in Taiwan’s total exports from 17 percent to 30 percent, making the PRC Taiwan’s largest trade partner. As noted above, the official data on Taiwan’s investment in China almost understate the real figures by a considerable extent. Yet, they should indicate trends; and they jumped almost fourfold between 2000 and 2008 (Mainland Affairs Council, 2011). In contrast, despite the signing of ECFA and other trade and investment agreements during the Ma administration, exports have remained at roughly the levels of 2008; and investment, while spiking in 2010–11, was back at the 2008 amount in 2014 (Mainland Affairs Council, 2015).

Yet, the explosion of economic interactions across the Taiwan Strait brought perils with the profits, or “an opportunity full of threats” (Rigger, 2011: 117). First, the very rapid increase of Taiwanese investment in China (and elsewhere) raised fears that the “hollowing out” of Taiwan’s economy would destroy its past progress and current prosperity, especially during the two recessions at the beginning of the twenty-first century. Second, the PRC stands out among developing countries that have been the recipients of the offshore movement of basic industries from the developed world in its ability to upgrade into fairly advanced economic sectors (Naughton,1997). Consequently, the fact that Taiwanese industry is overwhelmingly moving to China, rather than other countries with low-cost labor, represents a more severe threat to the continued viability of its domestic corporations, as indicated by the rapid movement of increasingly advanced semiconductor production across the Taiwan Strait noted above. Finally, the growing economic integration between China and Taiwan creates a unique threat and danger to Taipei because of Beijing’s claims of sovereignty over Taiwan (Chow, 2008; Clark, 2007; Tucker, 2005, 2009), making it vulnerable to the PRC’s using its economic dependence for leverage (Yeh and Chi, 2014) as Nazi Germany did in Eastern Europe during the 1930s (Hirschman, 1980).

These contradictory economic trends created a somewhat mixed picture in terms of economic and social accomplishments. On the one hand, Taiwan has become a fairly prosperous developed nation and a leader in several important high tech sectors, prompting Shelley Rigger (2011) to describe it as a Small Island, Global Powerhouse. In 2013, for example, it had a GDP per capita of $38,200 at PPP (purchasing power parity), which ranked it 29th in the world and only $200 less than Germany; and its social indicators were at developed world levels with a fertility rate of 1.1, an infant mortality rate of 4.9 per 1,000 live births, and a life expectancy of 79.8 years (IndexMundi, 2015). This certainly represents a substantial achievement for a country that appeared to be an economic basket case in the early 1950s.

On the other hand, as we saw, economic growth has declined steadily. One could also raise the question of whether or not Taiwan could take comfort in the fact that its decelerating growth of the last two decades was normal for mature economies. After all, by the early 1990s fears had arisen that the de-industrialization or “hollowing out” of global economic leaders America and Japan would lead to their decline (Alexander, 2002; Graham, 1992; Harrison and Bluestone, 1988). Such fears were exacerbated in Taiwan as even the country’s high tech leaders, such as the Taiwan Semiconductor Manufacturing Corporation, had moved considerable parts of their production to China during the early twenty-first century (Wong, 2010). Furthermore, Taiwan would seem to be at an especial disadvantage in terms of movement along the international product cycle, as sketched in Figure 2.2 in Chapter 2. Similarly to the United States and Japan, it has been pushed out of most basic and lower-end economic sectors. This means that its firms must compete with the world leaders in the most advanced sectors, such as banking and biotechnology. For example, despite their excellent performance in computers and semiconductors, Taiwan has not done very well in biotechnology (Wong, 2010). Thus, Taiwan now seems to be squeezed from both above and below, creating the image of an increasingly boxed-in economy. Finally, Taiwan’s record for growth with equity is eroding as income inequality has risen steadily over the last 35 years, with the ratio of the incomes of the richest and poorest fifths of the population jumping by a half from 4.0 to 6.0 between the beginning of the 1980s and the early twenty-first century (National Development Council, 2014).

Unlike the first three periods, political change has dwarfed economic change over the last 25 years. In the popular image at the time, Taiwan’s democratization probably appeared to have been a fairly raucous process, at least in comparison to the stable and peaceful authoritarianism that preceded it. The most salient result of the loosening of authoritarian control in the mid-to-late 1980s was the rapid burgeoning of street demonstrations. A more active legislature was marked by frequent fisticuffs which often received prominent treatment by the world’s media. The growing salience of the national identity issue in the island’s politics following the relaxation of the enforcement of sedition laws, moreover, raised the temperature of political debate considerably (Clark, 1989; Hood, 1997; Sutter, 1988; Wachman, 1994). From another perspective, however, the democratic transition in Taiwan appears to have been much calmer and more consensual. This process went through two critical stages. The first was the removal of authoritarian institutions that prevented a majority of the electorate from directly selecting the government. Key events here included the founding of the DPP, the termination of martial law, and the forced retirement of the “senior legislators” who had been elected on the Chinese mainland in the late 1940s from the Legislative Yuan (Parliament) and the National Assembly (the body that elected the President). The second stage involved the exercising of popular sovereignty by the citizenry in a series of electoral “firsts”: first direct election of the National Assembly and Legislative Yuan in 1991–92; first direct election of the President (which Lee won easily) in 1996; and the dramatic election of the DPPs Chen Shui-bian in 2000, which demonstrated that all things were possible in Taiwan’s democracy (Chao and Myers, 1998; Cheng, 1989; Cheng and Haggard, 1992; Chu, 1992; Copper, 1997; Fell, 2005; Hood, 1997; Rigger, 1999, 2011; Tien, 1996; Wu, 1995).

Taiwan’s democratization has been called a political miracle to match its economic one. Its impact on society has probably been immeasurable, but both positive and negative influences can be discerned. Democracy is generally assumed to make governments more responsive to their citizens, and this is certainly the case for Taiwan. The two major parties often try to co-opt popular issue initiatives from their rivals, and democratic pressures are credited with the development of a welfare state, in contrast to the very limited programs of the authoritarian eras. For example, a universal health insurance program was initiated in the 1990s, which is now one of the top-rated systems in the world (Clark and Tan, 2012; Fell, 2005, 2012; Wong,2004). Similarly, in the short-term, democratization appeared to be moderating political conflict on the island. Initially, many feared that democratization would provoke a destructive polarization over national identity. Actually, through the 1990s the dynamics of democracy had the opposite effect of moderating ethnic tensions. As it turned out, strong association with extremist positions was a loser at the polls because most citizens took a moderate position on the key national identity issues: whether the citizens identified themselves as Chinese or Taiwanese and whether they wanted Taiwan to unify with China or become an independent nation. Consequently, Taiwan’s parties, especially the two major ones, came under significant pressure to take moderate positions on national identity (Hsieh, 2002; Lin, 2001; Rigger, 2001; Wang, 2000), as “electoral” factions were able to somewhat suppress the demands of more “ideological” factions in both major parties (Fell, 2005).

In contrast, democracy also had some unforeseen and untoward consequences. One such issue was the growing problem of political corruption. This came to be called “black and gold politics” – black signifying gangsters, and gold rich businessmen. Politics and campaigning became extremely expensive, forcing politicians to become dependent upon contributions from well-heeled businesspeople. In addition, the growing power of legislatures gave small groups of politicians the power to bestow favors, such as government contracts. Initially, the KMT received most of the blame for corruption, but a series of major scandals during the Chun Shui-bian administration indicated the bipartisan nature of black and gold politics (Chang, 1996; Chu, 1994a; Fell, 2012; Kuo, 1998). A second problem area arose with the growing polarization of Taiwan’s politics in the early twenty-first century around the national identity issue, following the dramatic victory of the DPP’s Chen Shui-bian in the 2000 presidential election. Two distinct types of issues were involved in this polarization. The first was an ongoing struggle over the “localization” or Bentuhua of the country’s politics and especially culture, which was consistently pushed by the Chen administration (Hsiau, 2005; Jacobs, 2005; Lee and Williams, 2014; Lee, 2005; Wachman, 1994). The second involved increasingly tense cross-Strait relations with the PRC (Bush, 2013; Tucker, 2005, 2009). For its part, the KMT returned to a much more “Chinacentric” stance after Lee Teng-hui left the party following its defeat in the 2000 presidential election (Wu, 2011). Indeed, both parties seemed to have reached the conclusion that appealing to their ideological bases would produce more votes than seeking the support of the moderate middle. Still, it seems overly harsh to blame democratization entirely for this dynamic. The general public remains moderate on national identity, and there has been a noticeable decline in the issue’s importance in elections after 2008. Indeed, Taiwan’s democracy now seems to be functioning normally (Clark and Tan, 2012; Fell, 2012; Rigger, 2012).

THE TAIWAN DEVELOPMENT MODEL

Taiwan’s economic and political miracle produced rapid growth and four successful structural transformations during the second half of the twentieth century. To summarize and help understand the nature of Taiwan’s development model, Table 4.3 conceptualizes each of the four economic transformations that occurred during this period in terms of two principal components. The first contains the major economic and political changes that defined the transformation, such as land reform in the 1950s and the explosion of the high tech industry during the 1990s. The second then includes the major resources that were created and/or lost in each period.

Table 4.3 suggests the following pattern or model of successful structural transformation in Taiwan. At each stage, significant economic or political change occurred which resulted in the creation of major new societal resources. These resources, in turn, formed the basis for the upgrading of the island’s political economy in the next stage. During the “setting the stage” period, the government created a skilled technocracy who formulated the plans and policies that promoted the subsequent transfor-mations; the “export boom” created a highly entrepreneurial class in the small and medium business sector which was, perhaps surprisingly, able to upgrade into new industries in the two subsequent periods; and “industrial upgrading” produced advanced capabilities in several heavy and high tech industries and a qualitative jump in human capital as a middle class society emerged in Taiwan. In contrast, the picture for resource creation was much more mixed during “economic maturity” when increased capabilities in high tech industries, political leaders being forced to be responsive to the citizenry, and greater prosperity were counterbalanced by the loss of basic industries, political polarization and gridlock, and a growing vulnerability to China.

Table 4.3  Stages in Taiwan’s development

Setting the stage, 1950s
Basic transformations

Land reform

Import substitution in light industry

Mass elementary education

Co-optation of technocrats into top policy-making positions
Resource creation

Productive capabilities in agriculture and light industry

Human capital (basic education)

Technocratic ability of government
Export boom, 1960s to early 1970s
Basic transformations

Export-stimulating liberalization
Resource creation

Entrepreneurial skills of small business in light industry

Continuing expansion of basic human capital
Industrial upgrading, mid-1970s to late 1980s
Basic transformations

Heavy industry led by state corporations

Beginning of high tech
Resource creation

Productive capabilities in heavy industry

Entrepreneurial upgrading to more sophisticated products

Qualitative jump in human capital (middle class dynamism)
Economic maturity, late 1980s to present
Basic transformations

Political democratization

Prosperity of a developed nation

High tech leader in several major fields, especially electronics

Growing economic integration with China
Resource creation

High tech capabilities

Democracy stimulates major expansion of welfare state
Resource loss

Loss of basic industries and growing problems for small firms

Problems with political polarization and gridlock

Growing vulnerability to China

The observance of this recurring pattern, however, should not be taken to mean that Taiwan has followed an explicit grand design since the early 1950s. For example, there is no evidence and almost no reason to suppose that the architects of Taiwan’s land reform and import-substitution industrialization even dreamed of the country becoming internationally competitive in manufacturing; and Taiwan’s rapid industrial upgrading was almost certainly far beyond the wildest dreams of the advocates of its initial export-promotion strategy. Rather, Taiwan’s development appears to be much more open-ended, with the resources created at one stage permitting more sophisticated responses when subsequent economic challenges arose, which made the absence of a clear-cut resource creation over the last 25 years at least a little threatening.

Extract

This chapter presents an overall model of economic and social development in Taiwan. In particular, we identify four stages in the country’s postwar development: (1) a stage-setting period during the 1950s that created the foundation for (2) the export-led boom based on light industry during the 1960s and early 1970s, which created the resources for (3) industrial upgrading from the late 1970s to the late 1980s, which was followed by (4) slower growth as economic maturity was achieved but also a “political miracle” in the form of a fairly rapid democratic transition and consolidation over the last 25 years. As we shall see, there are strong but complex linkages among these four stages. For the first three stages and for the democratization in the fourth, resources that were created in one period helped promote the transformation to the next. During the last period, in sharp contrast, the legacies of past successes have contributed to economic and political problems.

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