The weather is usually hot in Taiwan during the Dragon Boat Festival in June, but the 239 employees at Danby Food Industry felt a chill when the 29-year-old cake and cookie manufacturer in Tainan had to shut down, leaving them without jobs.

"Danby is only the beginning," predicts Henry H.S. Kao, vice chairman of I-Mei Foods, one of the giants in Taiwan's food industry. "During the past few years, Taiwan's shrinking domestic demand has already made it very difficult to run a company. Against this backdrop, inflation is making things worse."

Outside Taiwan, The Wall Street Journal also observed that negative factors continue to build up. Due to the subprime mortgage crisis, consumers in the U.S. and Europe have less money to spend, so they are tightening their purse strings. With consumption shrinking, the good times are over for the economy.

From March this year consumer prices have been rising, posting record high after record high. Rising inflation also ate up a big chunk of corporate profits. At the G8 world economic summit just concluded in Japan, discussions revolved around the unsettling question, "Are the oil crises of the 1970s staging a comeback?"

The first oil crisis in 1973 coined a new term, stagflation, which describes a period of inflation combined with stagnation, namely a slowing economy and rising unemployment. In that year, then-miracle economy Taiwan posted a record low economic growth rate of just 1.38 percent, and more than 600 factories went out of business as a result. This time skyrocketing oil prices have come together with full-blown grain shortages. Does that mean we will see another wave of bankruptcies roll in?

Another Bankruptcy Wave?

Hu Chung-ying, vice chairman of the cabinet-level Council for Economic Planning and Development, is eager to deflect such fears: "This is the first time I've heard of a bankruptcy wave! That's improbable. The Directorate for Budget, Accounting and Statistics (DGBAS) forecasts that private investment will reach 5 percent, and the industrial parks are even rushing to acquire more land!"

Yeh Wan-an, advisor to the Chung Hua Institution for Economic Research (CIER), lived through the 1970s oil crises. He believes that the current consumer price crisis is a far cry from that of the 1970s when prices soared as much as 47 percent. This compares to just 3.3 percent today. Moreover, Yeh argues, petroleum amounts to just 12 percent of Taiwan's imports compared to around 20 percent in the 1970s, so that the negative impact on the island economy from rising oil prices has become smaller.

Yet Roscher Lin, chairman of the National Association of Small and Medium Enterprises R.O.C., does not buy the official line. "That's a myth," he states flatly. Lin points out that Taiwan's investment rate has always depended on investment by large high-tech enterprises. Thus, if private investment is high, it does not necessarily mean that the entire population is doing well or that small and medium-sized enterprises (SMEs), which account for 98 percent of Taiwanese companies, are doing well. "Taiwan's industrial structure is becoming increasingly M-shaped," says Lin, pinpointing a potential weakness.

Soaring food prices have badly affected certain industries, but their predicament goes unnoticed because small businesses do not grab the headlines. Sunny Chen, secretary general of the Taiwan Confectionary, Biscuit and Floury Food Industry Association, asserts that a great number of bakeries folded over the past year. "The only thing is that they are not famous enough, so no one knows about this," says Chen with a sense of frustration.

Figures from the Ministry of Economic Affairs show that last year a total of 47,531 companies were dissolved, or had their registration revoked or voided – an almost 30 percent rise over the previous year. (Table 1) From January to April this year, these figures continued to rise, increasing by 12 percent over the same period last year.

Lin has observed that over the past two years many SMEs gave up because their owners felt it was not worth the effort, given the minimal profits they were making. The Taiwanese have always liked to open their own companies, because they can make more money being their own boss than if they work as an employee. But now that an entrepreneur might make even less than a salaried worker, yet still has to put up with all the trouble and risks involved in running a company, many are choosing to close shop.

Commodity Prices the Last Straw

Domestic demand in Taiwan shrank rapidly over the past two years due to spiraling credit card debt. Starting last year a string of fraudulent bankruptcies erupted, such as the closure of the Alexander Health Club group, Taiwan's largest fitness-center chain. And just as Taiwan's credit- and cash-card debt crisis had finally been contained, the subprime mortgage scandal slowed down economic growth around the globe. Now commodity prices have become the final straw that is breaking the back of SMEs.

Taiwanese companies are now facing the most severe cost pressures in 27 years. According to the DGBAS Wholesale Price Indices by Stage of Processing, the costs of goods purchased for raw materials rose 48.5 percent in May this year over the same month last year. But at the same time manufacturers only dared to raise their selling prices for finished goods by 3.5 percent, thus shouldering the lion's share of the soaring costs themselves. Never before has the DGBAS registered a higher discrepancy between the two figures. (Table 2)

In other words, manufacturers have to shoulder rising costs, but cannot pass them on to customers and consumers. In the short term the price hikes have to be absorbed by the enterprises themselves, which easily leads to cash flow problems. Henry Kao of I-Mei Foods therefore predicts that another wave of bankruptcies is bound to come rolling in. He argues that price hikes will spread. Once goods become more expensive, landlords will ask for higher rents. Moreover, utility rates will also rise, which will again force shop and restaurant owners to mark up their prices.

HSBC chief economist (Asia-Pacific) Peter Morgan has reported that in Asian countries including Taiwan, imported inflation – caused by rising prices for imported goods - has already spread to core consumer prices. Taiwan's core consumer price index has risen more than 2 percent for the past six months, while service sector prices rose by 2 percent for three months in a row, posting a nine-year high.

Squeezed between large enterprises that control raw materials on the one hand, and retail distribution outlets on the other, SMEs take the brunt of the price explosion. Lin explains that the raw materials market is dominated by a few large enterprises with monopoly-like powers. When an upstream producer decides to raise prices, the small enterprises lack the heft for negotiating better conditions.

An even greater nightmare is when small companies cannot get their hands on urgently needed supplies, not even for a lot of money. Then they are at the mercy of middlemen. SMEs also have to put up with unfair treatment in other areas due to their lack of negotiating clout. It is not out of the ordinary that small companies get paid by the buyer as late as nine months after delivering their goods.

"Presently the large companies are sucking the blood from the SMEs. If the government does not solve the problems of speculative hoarding and unfair trading practices, more and more SMEs will fold," says Lin, fuming with anger. Lin is adamant that the Fair Trade Commission and the Ministry of Economic Affairs should give up their wait-and-see attitude and take concrete action.

Eric Lee, top manager of Kaohsiung-based Taiwanese pastry maker Jiu Zhen Nan, knows what smaller companies are up against: "Right now, only bigger and better-known companies are able to control costs," he says, describing the key issue – securing stable supplies at reasonable prices. Lee has therefore taken contingency measures. Starting this year he began to pay a 20 percent deposit to stock up on packaging materials for the entire year. In the past he would settle accounts for flour every quarter, but this year Jiu Zhen Nan already made advance payments for a nine-month supply of flour to make sure not to run out of this key ingredient during the brisk Mid Autumn Festival season. He has also already paid for a year's supply of butter. "Before, we would make out a 30-day or 60-day promissory note, but now we always need to pay cash," says Lee, elaborating on the new, tougher business environment.

Shrinking Demand Sparks Concern

Aside from cost pressures many companies have already begun to worry that domestic demand will shrink even further. Johnny Kuo, spokesman for Hunya Foods, which is famous for its 77 Chocolate snacks and Rivon wedding cakes, concedes that there is little that Taiwan's government can do to help embattled SMEs, because raw material prices are soaring worldwide. He says manufacturers now worry that the current public outcry over skyrocketing prices will ultimately affect people's readiness to buy.

"The government can't just say short-term pain is better than long-term pain, because it's the man in the street who feels the pain," argues Henry Kao of I-Mei Foods. Instead, he suggests, "In these times the government must let people and enterprises feel that it is attaching importance to this problem and propose a set of complementary measures to prevent people from anticipating further price hikes."

Commercial and investment banks have already begun to do research on how to counter the widely held notion that "inflation is here to stay for a while." In his report "How High Inflation Could Change the Whole World" published this June, Bank SinoPac chief economist Huang Yin-ji noted that blanket price hikes will raise companies' abilities to transfer costs to customers. But on the other hand, rising prices will lead to falling purchasing power, so that all in all, enterprises will have to live with smaller profit margins. "I would suggest that banks be more cautious when it comes to granting loans," he added.

Under the shroud of high inflation and faced with cost pressures ranging from raw materials to capital, enterprises will enter a period of retraction. It seems that tough times are lying ahead.

Translated from the Chinese by Susanne Ganz

Chinese Version: 通膨震撼　倒閉潮來了？