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Taiwan's Economic Miracle

State Capitalism Drives Innovation


Taiwan's economic miracle turned an agricultural backwater into a world powerhouse. Can today's officials show as much resolve as the engineers of that miracle in revitalizing Taiwanese industry?



State Capitalism Drives Innovation

By Isabella Wu
From CommonWealth Magazine (vol. 427 )

At the beginning of the 21st century, Middle Eastern aristocrats brandish their petrodollars around the globe to buy ports and property and create a new future for the Arab world. Newly rising China, emboldened by its massive foreign exchange reserves, has bought stakes in the world's leading financial institutions and caught the fast train to economic prosperity.

In these perilous times of global economic volatility, the once forgotten, often nebulous concept of "state capitalism" is coming back into vogue.

In reality, state capitalism is the force behind tiny Taiwan's economic status, its indispensable role in the global supply chain, and its evolution into a high-tech bastion. The government harnessed its power to steer the economy and convert limited land and resources into development technology, transforming Taiwan from an agricultural society into an industrial economy and moving the country toward economic modernization.

A pivotal element of the strategy was the creation of export processing zones (EPZs).

Looking back at the Taiwan of the 1960s, per capita income was below US$200, more than 70 times less than it is today, and commodities were generally in short supply.

Agricultural Taiwan did not have foreign exchange reserves, making it nearly impossible to import foreign equipment and raw materials, and its weak industrial base meant job opportunities were scarce. The Nationalist government's retreat from China after losing China's civil war had brought an extra 1 million people to the island, creating an extra burden on limited resources. Meeting the needs of this new society posed a severe challenge to authorities.

The first response to that challenge was an innovative economic experiment in the southern city of Kaohsiung.

A Miracle Born in Southern Taiwan

The initiative was built on the back of a project to reclaim the shoreline of Kaohsiung's port and expand the harbor. Dredging in the harbor began in the 1960s, paving the way for deep-water wharves to jut out of the expanded waterfront and extend into the ocean. More significantly, the silt dredged out of the harbor was used to create a long, narrow landfill that would become ground zero in Taiwan's economic miracle.

It was on this landfill in Kaohsiung's Cianjhen district that Taiwan's first export processing zone – the Kaohsiung Export Processing Zone – was created in 1966. "It was the first of its kind in the world," says Taiwan Thinktank chairman Chen Po-chih. In designing this global first, "the government was cautiously testing the waters."

At that time, both the developed United States and developing Hong Kong had free trade areas, where goods could be imported and exported tariff-free or transshipped. The tasks performed in the areas were relatively simple, however, making the free trade area model less attractive to Taiwanese officials, who needed to create large numbers of new jobs.

To meet the country's goals, financial officials K.T. Li and Yen Chia-kan came up with the idea of an export processing zone – a combination industrial park, duty-free zone and free trade area – to serve potential investors in manufacturing facilities through a single channel. The EPZ concept offered tax incentives to lure investors, and their factories would provide substantial numbers of job opportunities.

The concept may seem simple now, but it required that factories be built, duty-free import and export regulations be drafted, and workers recruited, and involved the participation of the Ministry of Economic Affairs, the Ministry of Finance and the Council of Labor Affairs. A mini-Cabinet needed to be installed inside the export processing zone, and integrating the functions of the different agencies proved difficult. There were other challenges as well, such as coordinating with the fire department, and getting the police department to help prevent thieves from stealing goods in the middle of the night.

This new initiative became Taiwan's economic miracle and social innovation.

The zone's investment incentives and other complementary measures succeeded in luring foreign enterprises to build manufacturing facilities in Taiwan and take advantage of Taiwan's relatively cheap labor to export goods and earn foreign exchange.

"At the time, the advanced markets of Europe and the United States had 700 million people, while Asia's Four Little Dragons had a total of 50 million. No matter how much they produced, it wasn't enough," Chen says in describing the international division of labor in the late 1960s, within which Taiwan astutely positioned itself. "That launched Taiwan's economic golden age," not only helping the country to quickly accumulate foreign exchange reserves, but also giving many Taiwanese people their first taste of making money.

The Road Packed with Workers

Export Processing Zone Administration deputy director general Jerry K.H. Chen, who grew up in Kaohsiung, still remembers the scene every time he accompanied his mother to the Cianjhen district to visit his grandmother.

"In the evening, thousands of bicycles would crowd through the gate of the export processing zone," he recalls. "The road was packed with female workers who had just gotten off work." Although Jerry Chen was still a young man at the time, he remembers feeling that society was full of energy and hope, because the processing zone gave everybody a job.

In setting up the zone, the government quickly achieved its goal of attracting investment, building up foreign exchange reserves, and increasing job opportunities. By 1970, the combined revenue of Taiwan's EPZs had exceeded US$100 million, and as of 2005, they had generated an accumulated trade surplus of US$47 billion, nearly 20 percent of the country's overall trade surplus during that time. They also had a major impact on the Taiwanese economy, generating NT$15 billion a year in economic activity and tax revenues.

Though the EPZs brought immediate benefits, they also had a positive long-term influence on Taiwan's economic development, giving birth to the island's new trillion-Taiwan-dollar industries.

Pulling up outside the main gate of the Taichung Export Processing Zone (known previously as the Tantze Industrial Zone), one immediately sees the plant of Taiwan's new touch panel star, Wintek Corporation. "Everyone knows the Tantze export processing zone was the birthplace of Taiwan's optics industry," boasts Maw-shin Hsu, the director of the Export Processing Zone Administration's Taichung branch.

Emerging from the Ranks of Developing Countries

The industry's first seeds were planted 39 years earlier, when Germany-based Bosch set up Taiwan's first optical lens factory in the Tantze Industrial Zone and Japan-based camera and lens maker Canon built its first overseas production facility there.

The training these foreign manufacturers gave their employees and the assistance they gave their suppliers served as instrumental sources of "technology diffusion." These foreign giants cultivated talent and fostered technological progress in Taiwan's lens processing, coating, plastic injection molding and even micro-motor sectors.

"The chairmen of Asia Optical and Kinko Optical were both Canon employees," Hsu says in describing the profound impact of foreign manufacturers on Taiwan's optics industry. Today, 80 percent of the zone's production value still comes from optics and electronics.

In just over a decade after the first EPZ was created, Taiwan had emerged from the ranks of less-developed countries and was quickly narrowing the gap with advanced countries. The country's leading export processing zone, an innovation that turned sandy silt into an inexhaustible gold mine, swiftly developed a worldwide reputation. It became the first stop on the itineraries of visiting national leaders, economists, and businessmen from around the world, including countries as diverse as South Korea, Indonesia, Guatemala, El Salvador and Saudi Arabia.

"South Africans not only came to learn. They even hoped a Taiwanese team would help them develop, operate and manage an export processing zone in South Africa," Jerry Chen boasts. When Shenzhen in southern China took its first development steps, it headhunted old hands from Taiwan's export processing zones and even appropriated the term "export processing zones" for their industrial parks.

Government Funds Back the Rise of High-tech

The next economic achievement that caught the world's eye was the development of Taiwan's high-tech sector.

The launch of the world-famous Hsinchu Science Park was a highly visible government initiative, but few people realize that the government played another instrumental role in the rise of Taiwan's high-tech sector and its evolution into a prime target for foreign investment – that of facilitating financing.

Although export processing zones earned Taiwan's first fortune, investment capital remained inadequate and few avenues for raising funds existed.

The banking sector at the time provided only short-term loans, satisfying merely a small part of private enterprises' needs. It did not offer access to long-term financing, so desperately needed by companies to build the new factories and purchase the machinery and equipment that were critical to corporate growth. Some large companies were able to apply for loans from U.S. development funds, but those opportunities did not extend to the small- and medium-sized enterprises (SMEs) that formed the core of Taiwan's industrial base. Lacking collateral and unable to even afford accountants, the SMEs often found themselves scrambling for funds.

The Taiwanese government realized such a need existed, and, in the 1960s and '70s, it established China Development Corporation (later renamed China Development Industrial Bank) and the National Development Fund to provide new sources of long-term financing for Taiwanese businesses.

"China Development provided long-term loans and equity financing to SMEs," says Yang Tze-kiang, chairman of Yangtze Associates, who joined China Development in the 1980s and eventually became president of China Development Financial Holding Corp.

The nature of China Development's loans differed markedly from those of ordinary banks, and its staff needed to be highly familiar with the industrial sector, technology and financial analysis. These were all new skills at the time, and the World Bank actually sent specialists to provide assistance when the corporation was first established.

Looking back at that time in history, Acer Inc. stands out as one of the major success stories of the financing initiative.

Gaining the Confidence of Foreign Investors

In 1987, Acer planned to go public, hoping to attract foreign investment and develop international recognition.

"But we could never agree on a price," recalls Philip Peng, Acer's CFO at the time. Because the information technology industry was not mature, and no other electronics firms were listed on Taiwan's stock exchange, leaving the market without a point of reference, "foreign investors had no idea what constituted a reasonable price."

"Only after China Development invested a few hundred million were foreign investors willing to jump in," Peng says, unable to recall the exact amount of China Development's investment but clearly remembering that it was an important turning point.

As foreign investors made money through Acer, they became increasingly interested in Taiwan's high-tech sector as a whole.

China Development also played a key role in launching Acer's spin-offs, including panel maker Acer Display Technology Inc. and semiconductor producer TSMC-Acer. "Each start-up was a new experiment, without any precedent to lean on," Peng says, and they all relied on China Development for an initial investment. "Only because of that investment did they have an easy time in achieving success," Peng adds.

The Cabinet-run National Development Fund also was established to support Taiwan's industrial growth, and it had an even bigger reservoir of funds at its disposal. Its role continues even today.

In the past three years, National Development Fund deputy executive director James Ho has led a team in creating national investment infrastructure projects that can remain influential for the next 30 years.

The fund compiled information on its positive and negative investment experiences in the past and used it to develop an investment strategy and plan.

"The National Development Fund only invests in big projects. It must invest jointly with a respectable legal entity, and the legal entity must have a bigger stake than the fund," Ho says in describing the system that prevents political interference in investment decisions. "Otherwise, there would be people lobbying us every day."

Even more important is that Ho has built a complete Internet framework, with investment news, a description of the investment process and potential benefits all entered into the information system.

Behind Today's Success: A Strong Will

Looking back with the benefit of hindsight, it is even easier to see the values of the past.

"You absolutely cannot ignore the importance of the strong will (among government officials) at the time to develop the country," says Chu Wan-wen, a research fellow at the prestigious Academia Sinica.

The financial officials who drove the initiatives "were completely different from today's financial bureaucrats. They saw industrial development as the country's savior. They weren't interested in development simply for the sake of development, but rather for Taiwan's salvation and to help it catch up with the West. They were always careful and always thinking 20 years ahead."

The ambition and will of figures like K.T. Li and Yen Chia-kan defined their power.

With a host of new challenges on its plate, Taiwan must now consider how to emulate Li and Yen and once again invigorate the economy in a way that will provide benefits for 20 years to come.

Translated from the Chinese by Luke Sabatier