Crisis of Confidence

Behind Taiwan's economic malaise lies a failure of leadership

Jonathan Adams

Far Eastern Economic Review, July/Aug 2006

In the shadow of the world’s tallest building, Taipei 101, a team of roller-skating models wheeled by in red wigs, white hot-pants and red sequin halter-tops—touting a new graphics card for computers.

Inside five nearby convention halls in the upscale Xinyi district, some 30,000 foreign buyers babbled away in English, Mandarin, German and Hindi, while ogling the hi-tech world’s latest gizmos: sports-car themed laptops, smart-phones and massive flat screen TVs. This was early June’s Computex—a boisterous carnival for geeks that’s on track to becoming the world’s largest computer trade show, overtaking CeBIT in Hanover, Germany. Computex is proof positive that Taiwan’s firms remain the vital heart of the global electronics manufacturing business, and that Taiwan has kept pace with the cutting edge of globalization.

And yet, despite the beaming models in body-hugging vinyl and all the new gadgets, a gloom lurked beneath the surface of this year’s show. In conversations with staff from a handful of Taiwan’s top technology firms, an odd refrain emerged: the tech industry may be thriving, but Taiwan’s broader economy is in trouble.

The disconnect was all the more jarring when such comments came from people holding some of the island’s best-paid jobs in its brightest sector. Said a PR representative from one of the island’s top contract manufacturers: “You turn on the TV every day and see bad news about the government and about the economy. How can anyone be confident about Taiwan’s future? I’m afraid [Taiwan] will keep declining.”

What’s going on here? Surely the economy isn’t doing as badly as all the pessimism—or the island’s sensationalized media reports—would suggest. In fact, in some respects the economy is doing quite well. Unemployment recently hit a five-year low of 3.78%; the island’s exports surged to a record high in May ($18.93 billion), led by strong demand for electronics. And Taiwan ranked an impressive fifth in the World Economic Forum’s latest global competitiveness report, beating out other Asian rivals such as Singapore (6th) and Japan (12th).

To be sure, there are plenty of real economic challenges: household disposable income growth has stagnated; the island’s manufacturing base has hollowed out; South Korea has emerged as a key competitor; and Beijing is working to marginalize Taiwan from the trend of Asian economic integration.

But Taiwan’s economy isn’t doomed, and the island has the capacity to meet the challenges ahead. The best explanation for Taiwan’s angst is more than just economic, it’s psychological: What Taiwan is facing is a crisis in confidence.

Red herring

It’s easy to be misled into thinking that the root of the problem is Taiwan’s troubled relations with China. Chen Shui-bian’s government is widely criticized for antagonizing Beijing and not moving fast enough on opening cross-Strait economic links—which the opposition says is stunting the island’s development. Led by Kuomintang (KMT) chairman Ma Ying-jeou, Mr. Chen’s opponents want to establish both direct air links and a raft of closer economic ties with China.

But Mr. Chen’s Democratic Progressive Party (DPP) is wary of China, and wants to encourage businesspeople to diversify to places like India. The government’s fear is that overdependence on China will play into Beijing’s long-term strategy, in which cross-Strait economic integration is the slippery slope that will lead to political unification.

Moreover, they’re concerned about eroding Taiwan’s competitive edge by allowing its best technology to go to China. They’ve therefore prevented the island’s firms from moving cutting-edge chipmaking technology to China, for example, and have kept in place a regulation capping Taiwanese firms’ investment in China at 40% of their paid-in capital.

The public increasingly supports links as a way to help the economy: according to a Gallup poll conducted last year, nearly 70% support direct cross-Strait passenger flights (up from 50% just two years ago) and 62% support allowing more Chinese tourists to visit Taiwan. The island’s voters are therefore inclined to reject economic isolationism—which means that the 2008 presidential election will likely be won by a KMT candidate who promises closer economic links (presumably Mr. Ma), or a DPP candidate who successfully co-opts that issue.

But if closer cross-Strait ties are inevitable, they are not a cure-all for Taiwan’s economic woes. To be sure, direct flights would save businesses huge amounts of money and the hassle of having to travel to the mainland through Hong Kong or Macau. And an influx of Chinese tourists would provide a shot in the arm for the island’s services and tourism sectors, which have struggled, while the tech firms in Hsinchu rake in revenues. Both measures would provide an undeniable psychological boost for the island.

However, the beneficial effects of direct links are too often exaggerated—and an overemphasis on what they can deliver distracts attention away from Taiwan’s deeper, longer-term challenges.

“I don’t think [direct links] are the key factor that will help improve Taiwan’s competitiveness,” said Johnny Chiang of the Taiwan Institute of Economic Research (TIER). “The real economic problems still have to be solved by Taiwan itself.”

TIER conducted a study last year that assumed the Association of Southeast Asian Nations, plus China, Japan and South Korea would form a free trade area and exclude Taiwan. Without direct links, it was estimated that Taiwan’s GDP would drop by 1.87%. But with direct links, the effect was only slightly blunted, to a 1.35% drop. And analysts estimate the boost from Chinese tourism made possible by regular flights would only be about $600 million, in what’s currently a local $12 billion industry.

In fact, many in Taiwan are less focused on China than on South Korea, which has emerged as a key competitor in an array of electronics and other exports. There’s been much hair-pulling on the island over the fact that South Korea’s per capita GDP last year surpassed Taiwan’s. Anxiety was heightened in May when Deputy U.S. Trade Representative Karan Bhatia gave Taiwan the cold shoulder on negotiating a U.S.-Taiwan FTA—which the Chen administration dearly wants—and then jetted off to South Korea for FTA talks with Seoul.

Taiwan has attempted to seek greener pastures by inking FTAs with its handful of Central American allies, including Panama and, most recently, Nicaragua.

Such agreements are only marginally helpful. The solutions to Taiwan’s economic problems won’t be found far across the Pacific, but rather much closer to home.

Challenge of liberalization

The island’s fundamental long-term challenge is how to manage the transition from export-led manufacturing to a services-based economy amid fierce, unprecedented competition brought on by globalization.

Duncan Wooldridge, a Hong Kong-based economist with the investment bank UBS, traces stagnant incomes to the previous decade, when Taiwan’s small- and medium-sized manufacturers began getting squeezed. China’s surging economy growth drove up commodity costs while overseas customers demanded lower prices, prompting Taiwan firms to shift productions offshore—mostly to China—hollowing out the island’s manufacturing sector and forcing many unskilled workers into the lower-paid services sector.

That squeeze—what Wooldridge calls the “terms of trade shock”—combined with the collapse of the tech bubble in 2000 to deliver a one-two punch to the wallets of many Taiwanese. Inflation-adjusted household disposable income growth, which averaged more than 6% per year in the 1990s, dropped sharply to around 1% on average since 2000. Real wages so far this decade have been flat or in decline.

In response, the Taiwanese turned to credit to keep up their buying habits, which fueled a recent bubble. While Taiwan’s problem was small compared to a similar binge earlier this decade in South Korea, media coverage of suicides and crimes involving so-called ka nu, or card slaves, have fueled the popular perception of an economy gone off the rails.

But Mr. Wooldridge says the ka nu are just a symptom of Taiwan’s broader challenge: how to create income growth that’s not just limited to just a few lucky sectors. That challenge is shared by manufacturing-based economies that are struggling to move up the value chain amid fierce competition. And the solutions are those any economist would recommend.

“I don’t view what ails Taiwan’s economy as being fundamentally driven by a China problem, because no one else in the region has been able to avoid these challenges,” said Mr. Wooldridge. “The longer-term issue is fundamentally how to get household income back up, and that’s going to require broad-based liberalization, a restructuring of the services sector and an effort to move up the ladder to higher value goods.”

Businessmen in the high-tech industry are forging ahead on their own, by moving aggressively into branding to create a higher value-added model. And Taiwan is well-positioned to benefit in hot industries like LCD panels for new slim-screen TVs: The nation’s scrappy firms last year overtook South Korea’s as the top producer of flat panels.

Leadership vacuum

But outside the tech sector, the Taiwanese are badly in need of leadership. And this is where Taiwan’s politicians—both the government and the opposition—have failed its people. What’s missing is a broad, long-term vision for where the country is headed and how it will meet the tough economic challenges ahead. The lack of such a vision is probably the single best explanation for the deep unease felt by many Taiwanese about their economic future.

To be fair, the government has offered an array of plans. It initiated a “two trillion, two star” program of incentives to boost production in its leading high-tech sectors: semiconductors and flat panels. It is also bolstering emerging sectors that look promising: Deputy Minister of Economic Affairs Chen Ruey-long recently touted the government’s efforts to jumpstart the energy conservation and renewable energies industries. And Mr. Chen has paid plenty of lip service to privatizing state-dominated industries and liberalizing the financial sector.

But these initiatives have not been tied together into an overarching vision that could give the public a sense of national purpose and direction. Moreover, Mr. Chen’s government has been blasted for its amateurish approach to economic management, erratic policy-making, failure to consult and heed expert opinion, and inability to create a good investment environment. And many feel the government has moved too slowly on liberalizing of the financial sector, which is seen as crucial for making Taiwan’s firms more competitive.

The problems can’t all be laid at Mr. Chen’s feet, however. Taiwan has been paralyzed by deep political gridlock. A conference in 2001 was convened to achieve a consensus on economic direction, but many of its conclusions have yet to be implemented—and since then, relations between Mr. Chen’s government and the opposition-controlled legislature have deteriorated into an all-out warfare. The opposition has pursued a scorched-earth policy that’s rendered the government completely dysfunctional on a wide range of issues. And the opposition has also failed to articulate a comprehensive economic vision for Taiwan that goes beyond the mantra of direct flights with China.

In fact, the political gridlock has become so bad that many in Taiwan have taken a “plague-on-both-their-houses” attitude and begun to question whether their young democracy is capable of making the tough collective decisions needed in order to move forward.

“Who in Taiwan has a blueprint for what Taiwan will look like tomorrow? What’s the business plan? Why should I vote for any of these parties?” asks Pamir Law Group’s managing partner Nicholas Chen.

The way forward

Vincent Siew believes he has the answer. Sitting in his sunny second floor-office in a leafy Taipei neighborhood, the former premier and economics minister lays out the broad outlines of a study to be submitted at a national economic conference scheduled for late July. Mr. Siew, now the chairman of the Chung Hua Institute for Economic Research, says that it’s critical for the nation to map out a 10-year economic plan at the conference. “This conference must have a long term vision—and with that vision, people’s confidence could be restored,” he said.

Mr. Siew’s plan calls for both closer economic integration with China and an FTA with the U.S. But the centerpiece is an upgrade of Taiwan itself. The plan’s highlights—what Mr. Siew calls “bridges, brains and branding”—are echoed by others: Taiwan should aim to become a global service center by 2015, bring in more foreign talent, and innovate up the value chain. He points to European countries like the Netherlands, Finland and Ireland as models for Taiwan, and says the nation should develop a “small but beautiful” economic strategy to capitalize on the advantages of its nimble, small and medium-sized enterprises.

That all sounds great in theory. But there’s cause to be skeptical. Will the nation’s politicians be able to put aside their “gotcha” politics long enough to truly focus on the nation’s economic future—particularly given the opposition’s recent push to oust the president by any means? Some relief from the political logjam may come next year, when constitutional changes create a more stable two-party system in the legislature.

But to listen to Mr. Siew, Taiwan may not be able to afford to wait that long.

“The day is coming when people will stand up and say, ‘We won’t let these irresponsible politicians play these games that hurt our economy and our livelihood,’” he said.

Until the island’s political leaders can put aside their squabbling and communicate a plan for the nation’s economic future, the Taiwanese will be left to lurch ahead in the dark on their own—and that’s not likely to bolster anyone’s confidence.