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Taiwan's Statecraft for Economic Resilience amid Globalization

Presentation given by Professor Peter Chow at LSE Taiwan Seminar

Comments by Catherine Thomas, Associate Professor of Managerial Economics and Strategy, LSE

June 14, 2016

In response to Professor Chow's presentation, Dr Thomas stressed that while the recent rise of China in the global economy was due mostly to its abundance of labour, Taiwan still possessed a more endurable and globally scarce comparative advantage of having a set of high-quality institutions that combined both internal security and entrepreneural dynamism. Facing the problems of ageing and high social-security burden, as well as the opportunities of further international economic integration (most notably the introduction of TPP), Dr Thomas suggested that Taiwan's policymakers should maintain an institutional environment conducive to the development of new businesses as well as creative entrepreneural practices, and thus foster greater growth in the age of rising economic globalisation.

Comments

When thinking about Taiwan, the first association that comes to my mind is from 25 years ago, when I was an undergraduate studying economics in the U.K. Other students who were studying Asian languages went off for a year to Taipei to learn Mandarin. Taiwan was perceived as exciting and dynamic, but also as accessible and secure.

What I did not know then, but do know now, is that this perception was in large part due to Taiwan’s set of institutions that include a stable democracy and the rule of law, with a transparent and meritocratic education system and bureaucracy.

The data that Professor Chow presented today about the openness of Taiwan’s economy made sense to me because of this recollection. A country that has long welcomed foreign students is likely to also be outward-looking when it comes to free movement of goods, services, and capital.

Of course, much has changed in the intervening 25 years, but the institutional foundations of the country have not. The features that made Taiwan an appealing location for foreign people, as well as a successful source and host country for goods and services production, have not changed.

The most striking change in the relationship between the West and Asia over the past 25 years has been China’s engagement in the global economy. Though a simplification, it is broadly true that China’s export growth has been fuelled by its comparative advantage in low-skilled labour-intensive production. For this reason, China’s exports grew at an exponential rate after its accession to the WTO in 2001, and the ability to produce manufactured goods at low cost has attracted much FDI into China from foreign firms, including many large and small Taiwanese firms.

While China’s recent internationalization is based on wage arbitrage, which relies on the differences in factor endowments between connected countries, Taiwan’s relationships with its trading partners are more similar to those of a Western economy. Taiwan is capital-intensive and skilled-labour-intensive, particularly when compared to its geographically close neighbours.

Both theory and history teach us that global trade and investment are engines of local economic growth. To understand the forces that will shape the region’s future development, it is important to consider, in relative terms, the fundamental conditions that promote trade and growth in connected countries. What are Taiwan’s relative endowment advantages that could form the basis of future growth? National statistics tell us that Taiwan’s labour force is highly educated and that it is a wealthy country, in both absolute and relative terms. We also know that it has a set of national institutions that provide the best foundation for new business development and growth.

I argue that high-quality institutions are Taiwan’s greatest source of comparative advantage. Labour can be trained and capital can arrive from elsewhere, but both these forms of endowment acquisition would be constrained by poorly functioning institutions (Alfaro et al., 2007 and 2008). This need not be the case in Taiwan. Taiwan’s traditional endowment-based sources of comparative advantage promote trade in high-value added goods and services, particularly in technology-related sectors, and associated investment flows. And, high-quality institutions are increasingly complementary to these forms of global engagement, due to greater demands for knowledge protection, contract complexity, and stakeholder protection.

So what, then, are the problems that might hinder Taiwan’s growth in the global economy? Professor Chow highlighted some concerns related to domestic factors of production and current domestic policy.

First, he mentioned the aging population and high social security burden. Younger people work hard, are flexible, can acquire relevant skills, and are more entrepreneurial. A recent paper by Lazear et al. (2016) illustrates an important link between population demographics and new business. The authors map out a positive correlation between the entrepreneurship rate at a given age and the share of a country’s workforce that is young. Their explanation for this relationship is that when the workforce is younger, workers are required to make managerial-level decisions at a relatively young age. That is, they become a boss much sooner. Thus, they learn the required managerial skills to set up businesses while they are still young enough to have the energy to do so. If this theory is correct (the paper is still in working paper form), local demographics are important. When fertility rates are low, as they are in Taiwan and in several other developed Asian economies, the inward migration of young, bright workers is a key policy that can foster future growth.

Once the factors of production are in place, Taiwan’s high-quality institutions must be allowed to nurture new business development and growth. This can happen only with bureaucratic efficiency and flexibility, as well as limits on red tape, to ensure free and ready access to the inputs to production. In other words, well-functioning factor markets and limits to the regulatory burden provide a fertile ground for growth. Ensuring these protections will help Taiwan benefit from its institutional comparative advantage on the world stage.

Could this be seen as a new form of industrial policy? In the industries that have come to dominate the world economy over the last few decades—often the fastest-growing industries in terms of value added—firms use technology and human capital intensively rather than large-scale capital investment. Even in manufacturing sectors, capital is commoditised, and ideas and talent are scarce. A new form of industrial policy for Taiwan might be a microeconomic approach that protects and supports the entrepreneurial environment and attracts and develops resources that are globally scarce. There is a role for government in making this happen, but it is about encouraging a supportive environment rather than undertaking direct economic activity itself.

It is well known that Government is the efficient provider of public goods. These are the goods, as well as services, that can provide positive externalities to parties other than the market participants on the buy and sell side, whose private incentives would lead to under-provision. Public goods that are particularly valuable to new business development include infrastructure investment in physical and digital assets, as well as in providing education in skills that are relevant to modern technology.

There are at least three major issues that we have not discussed today. First, growth that involves the reallocation of productive resources to different purposes is likely to also redistribute how the returns to productive resources are shared among members of society. Aspects of social policy that are not addressed in today’s discussion include how to approach the social security burden of an aging population. The only reassurance that can be given here is that dividing the returns from any economic undertaking is almost necessarily less controversial when there are more returns to be shared. The second issue is how to approach the volatility and risk associated with exposure to global shocks. Third, in this discussion, I’ve focused on Taiwan in relation to China and Western trading partners. I have not discussed how Taiwan compares to the more similar local economies of Korea, Japan and, to some extent, Hong Kong and Singapore.

Finally, I would like to comment on Professor Chow’s detailed discussion of the Trans Pacific Partnership, or TPP, (Chow, 2016). While the TPP policy detail is currently fairly opaque, it is clear that the intention of the partnership is to allow for greater economic integration among member countries. Given its local institutional comparative advantage, it is likely that Taiwan’s potential benefits from future membership are disproportionately large. The costs of meeting membership requirements are also likely to be relatively low for Taiwan, given the starting conditions. Harmonisation of trading standards, regulations, and processes will not detract from its current competitive advantage, as it will do for countries whose trading platforms are based on flexible low-skilled labour. Overall, the improvement that the TPP seeks to bring about in the ease of doing business internationally is going to be hugely complementary to the current key features of the Taiwanese economy.

In a future of increased global connectedness, where economic activity will combine inputs of various kinds from all parts of the world to an ever-greater extent, Taiwan’s position as an accessible and secure country in East Asia holds great promise.

References

Alfaro, L., S. Kalemli-Ozcan, and V. Volosovych (2007), “Capital Flows in a Globalized World: The Role of Policies and Institutions.” In Capital Controls and Capital Flows in Emerging Economies: Policies, Practices, and Consequences, edited by Sebastian Edwards. Chicago: University of Chicago Press.

Alfaro, L., S. Kalemli-Ozcan, and V. Volosovych (2008), “Why Doesn’t Capital Flow from Rich to Poor Countries? An Empirical Investigation,” Review of Economics and Statistics 90, 347-368.

Chow, P. 2016. "Mega Regionalism and the Trans Pacific Partnership Agreement"Forthcoming.

Lazear, E., S. Janssen, J. Liang, N. Westergard-Nielsen, and J. Wang. Microfoundations of Entrepreneurship, Working Paper.

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