Taiwan's Economy and the Myth of Free Market

Taipei skyline (Photo by CEphoto, Uwe Aranas via Wikimedia Commons) 

In a world dominated by neoliberal mainstream economic thinking, the wealth of nations is often explained in culturalist terms. A country is rich because its people are hard-working and enjoy the freedom to pursue profitable economic activities. A country is poor if its people are lazy and / or its politicians are corrupt and inefficient. However, it would be wrong to underestimate the role of the government in promoting economic development, especially in the case of Taiwan.

First of all, an industrial revolution does not come about through hard work alone. Asian people have always been renowned for their laboriousness, but for a long time their industry lagged behind that of the West. A rural country whose people are mostly hard-working peasants does not automatically shift production from agriculture to industry.

Economists Ha-Joon Chang and Erik Reinert have explained that rich countries did not actually get rich through free market and free trade, but through conscious economic policies which supported the entrepreneurial spirit of individuals. Paradoxically, when rich countries get rich, they forget - or want to forget - how they have become wealthy, and turn to culturalist theories ("we are rich because we are hard-working, diligent, smart, superior" etc.).

Culturalist theories were at the heart of Western imperialism. Because Western countries had industrialized first, they began to think that they were superior to non-industrialized countries. Instead of explaining industrialization in terms of economic policy, Western intellectuals explained it in terms of "racial" or "cultural" superiority, thereby assuming that non-Western countries could never get rich and powerful because they were simply "inferior". It is little wonder that Westerners are always stupefied and disoriented when a formerly rural country industrializes (Japan, the Asian Tigers and China being the most notable examples).

The way in which people interpret the connection between economy and culture is sometimes emblematic. In hindsight, what once seemed a secret of success may later be seen as a disadvantage. One interesting example is what Chinese intellectual Liang Qichao (1873-1929), wrote about the pace of life in the United States and China at the beginning of the 20th century.

"There are many other ways in which the Chinese character is inferior to that of Westerners. [One of them is that] Westerners work only eight hours a day and rest every Sunday. Chinese stores are open every day from seven in the morning to eleven or twelve at night, but though shopkeepers sit erect there all day, day in and day out, without rest, they still fail to get as rich as the Westerners. And the work they do is not comparable to the Westerners’ in quantity. Why? In any kind of work the worst thing is to be fatigued. If people work all day, all year they are bound to be bored; when they are bored they become tired, and once they are tired everything goes to waste. Resting is essential to human life. That the Chinese lack lofty goals must be due to their lack of rest (see Ebrey 2009, p. 339)."

Nowadays, we can only smile at such explanations. East Asia has caught up and even surpassed the West economically. China is the 2nd largest economy, and it might soon become the 1st. In our time, we hear people bashing the "lazy" Westerners and praising the "hard-working" Asians, while 100 years ago Asians' hard work appeared futile and unproductive, because Asia's economies were underdeveloped and, no matter how hard people toiled, that wasn't enough to trigger a process of industrialization. That's how volatile and inconsistent culturalist theories are.

But how was it possible for countries that were formerly agricultural to industrialize within a generation or two? According to professor Wu Yongping, the precondition for economic development is the emergence of a marketplace that encourages the mobilization of "societal goods" and of individual entrepreneurship in order to create a modern system of production. But, as Mr Wu says, "such a marketplace does not emerge by itself. It is a result of state actions and the interplay between the state and private actors" (Wu 2005, p. 11). State and market are not adversaries. They are interconnected and interdependent.

After World War II, Taiwan's economy faced enormous challenges. Its agricultural production was 45% of that in 1939. Many factories had been destroyed during Allied bombings. In 1948, industrial production was 59% of that in 1941 (see ibid., p. 47). Inflation was skyrocketing, with retail prices increasing about 1000 times between 1946 and 1949. Foreign exchange reserves had been consumed, and the government had to sell part of its gold reserves to make up for the deficit.

Meanwhile, the Guomindang had lost the civil war against the Communists, and the government of the Republic of China moved to Taiwan, followed by millions of mainland refugees. Because of the threat coming from mainland China and the need to secure its rule in Taiwan, the military expenditure of the Guomindang one-party-state was enormous. Chiang Kai-shek was first and foremost a military leader, and he always prioritized the army.

The importance of the military in the Guomindang one-party state derived from the bitter lesson learnt by Sun Yat-sen after the 1911 Revolution, when the Republic of China was de facto taken over by Yuan Shikai first, and then by warlords. In the subsequent years, Sun Yat-sen, assisted by Soviet advisors, militarized the Guomindang. Chiang Kai-shek became the leader of the newly-founded Whampoa Academy, which emulated the structure and methods of the the Red Army. From that time on, the Guomindang would focus on cementing its rule by force. This tradition of putting military interests before civil and economic interests was continued in Taiwan.

In the 1950s, the odds were all against Taiwan. It was a small island, severed economically from mainland China, but also from its former colonial master, Japan. It was ruled by a party that was notoriously corrupt and inefficient, and which had failed to transform China into a modern economy. So, how did Taiwan manage to become a "miracle" economy in just a few years?

One of the most important factors in the creation of Taiwan's industrialization was the ideological shift that occurred in those years within the Guomindang. Previously, mainstream Guomindang economic ideology was statist. The planned economy was regarded as the most suitable solution for China's development. There were two reasons why the Guomindang leadership believed in the planned economy. First, Sun Yat-sen, despite not being a Marxist, was in favour of heavy government intervention in the economy. In Fundamentals of National Reconstruction, he wrote:

"What we must guard ourselves against is control of industries by private interests, which will result in the domination of capitalists, thus giving rise to class distinction and unequal distribution of wealth [...]. All the enterprises [...] of monopolistic nature should be assigned to the State for development (Sun 1953, p. 192)."

Second, the Guomindang wanted to maintain its firm grip on society by controlling the economy. A free economy also requires freedom of action for individuals, and it allows the creation of a powerful class of entrepreneurs. The Guomindang feared that this would weaken its position of command.

However, after 1949 some Guomindang leaders realized that the economic development of Taiwan was the only guarantee for the survival of their regime on the island. One of the architects of Taiwan's economic policy was Chen Cheng, who served as premier between 1950 and 1954 and again between 1958 and 1963, and as vice-president between 1954 and 1965. He was the second most powerful man in Taiwan after Chiang Kai-shek.

Chen Cheng (traditional Chinese: 陳誠; simplified Chinese: 陈诚; pinyin: Chén Chéng; 1897 – 1965) was a military commander who had taken part in the Northern Expedition and the Sino-Japanese War. He didn't know much about economics, but he was known as a man who was opened to new ideas and who understood the importance of economic development. He orchestrated many of the most successful economic policies of postwar Taiwan (see Wu 2005, p. 58).

Chen Cheng and other economic bureaucrats brought about an ideological shift from a planned economy to a "planned market economy", or "planned free economy". They convinced Chiang Kai-shek that economic development was fundamental for Taiwan's survival. Taiwan had to improve its balance of payments, be independent of American aid, and become self-reliant. Since the reforms did not affect military expenditure, Chiang agreed to try (Wu 2005, pp. 62-63). The idea of what a "planned free economy" meant was summarized in the following article which appeared in 1953 on major newspapers:

"Under current circumstances, Taiwan's industrial development should be fast and resource-saving. However, these two goals cannot be achieved in a laissez-faire economy. They rely on the government's involvement in economic activities, sound plans, and supervision of the implementation of the plans. Nevertheless, here "plan" [refers to something] completely different from that found in the centralized planned economies in the communist countries, which manipulate all production tools and control all economic activities. 

Here "plan" means that after considering the whole situation and keeping its eye on the commonweal, the government decides the direction and goals of industrial development for a certain period. The government decides which industries should be given priority, and which are less important and therefore should be delayed. The government should also decide the extent to which a certain industry develops as well as the limits of its development. Meanwhile, each industry and each enterprise within the sector have ample freedom to perform. So it is a free market" (Wu 2005., p. 67).

American advisors agreed with this view. They believed that market mechanisms could not work in an unstable and underdeveloped economy such as Taiwan was at that time, and that industrialization, higher standards of living, and self-reliance, were more important than textbook economics. In this respect, American positions have become much more rigid and ideological in recent years. The failure of the Iraq post-war economic policies, which were based on privatization, deregulation, free trade and free market, is one of many examples of such dogmatic approaches to development.

During the first decades of its rule in Taiwan, the Guomindang state actively controlled: 1) foreign exchange; 2) imported goods; 3) credit through state-owned banks; 4) allocation of US aid; 5) interest rates; 6) factory licenses; 7) allocation of raw materials; 8) taxes; 9) allocation of industrial land.

With the First Four-Year Plan (1953-1956) and the Second Four-Year Plan (1957-1960), the Guomindang government sought to promote targeted industries: cement, textiles, paper, plastics, man-made fibers, and glass. There were two reasons why these industries were chosen. First, they were of strategic importance for the whole economy. Second, making those products at home rather than buying them from abroad saved precious funds that Taiwan desperately needed. Import substitution policies remained a constant concern of the government for many years.

Moreover, by actively controlling the economy the Guomindang could still pick winners and losers according to people's political views. In this way, the Guomindang could create consensus, develop the economy, and at the same time favour friends and punish foes.

The lack of foreign exchange and the need to develop domestic industries led to protectionist policies. Imports were strictly controlled. To avoid overinvestment, the government put barriers on certain economic sectors to prevent too much competition. A few private enterprises chosen by the government were protected from foreign and domestic competition through government control, and many of these developed into large enterprises and business groups in the 1960s and 1970s.

Another important instrument that the government possessed was credit. Until 1959 Taiwan's financial system was entirely state-owned. Besides, Taiwan received large amounts of foreign aid, and it was the government that decided where that money should go. In the 1950s, Taiwan received 100 million US dollars worth of foreign aid, at a time when Taiwan's export amounted to just 120 million US dollars. Foreign aid was mostly used to purchase foreign machinery and materials (Wu 2005, pp. 106-109).

State-owned enterprises (SOEs) also played a major role in Taiwan's economic success. Their major contribution was their pioneering role in economic sectors that either required too much capital for private entrepreneurs to invest, or whose prospects for profit were uncertain. Moreover, SOEs maintained the amount of investment high even when the economy was sluggish, like during the 1970s oil crisis.

Taiwan's Development Strategy

With the First Four-Year Plan (1953-1956) the Taiwanese government aimed at promoting industrialization. In this period, exports were given little attention, while emphasis was placed on import substitution and boosting domestic production. The focus was on basic areas of industrial production which were deemed essential and in which the island was heavily dependent on imports (cement, glass, fertilisers, textiles etc.). Only agricultural products like tea, pineapples, sugar and rice, which had already developed during the Japanese colonial era, were exported in considerable amounts and promoted by the government (Hsueh / Hsu / Perkins 2001, p. 15).

The government's approach to achieving import substitution was interventionist to an extreme degree. To begin with, the government identified promising investment opportunities, drew up plans, and invited particular private entrepreneurs to carry them out, arranging low-interest loans and foreign aid funds for those who did. Since government owned the banks and directly controlled the allocation of aid funds, directing resources to the favored sectors and firms was easily managed (ibid.).

At the beginning the key industry was textiles. The textile industry was quite developed in mainland China, and after 1949 many industrialists moved to Taiwan and Hong Kong. Between 1951 and 1953, the Taiwanese government provided factories with cotton and other raw materials, and then it bought the finished products. This policy removed the risks inherent in the laissez-faire system and boosted industrial production, so that the domestic market grew rapidly and soon saturated.

To implement the import-substitution policy luxury goods and goods already produced in Taiwan couldn't be imported, and nominal import tariffs remained high, averaging 38.2 percent. The NTD (New Taiwan Dollar) was devalued, and the exchange rate was unified.

Starting in the late 1950s, when the economy had stabilized, the government shifted to the promotion of exports through several measures. Some of them were:

- import tax rebates;

- low-interest export loans;

- export processing zones;

- statute for encouraging investment;

The tax rebate system returned the duty on imported goods that were used to process products destined for export. The administration of tax rebates became very complex and expensive. The governments had over 7,000 standards for different kinds of export goods by 1968.

Low-interest exports loans were designed to promote exports by granting cheaper loans to companies that exported their goods. For example, in 1957, when the programme was started by the Bank of Taiwan, loans returned with foreign currency had an interest rate of 6%, while for those returned in local currency the interest rate was 11.88 % (ibid. pp. 24-26).

The intervention of the state was also felt through the creation of state-owned enterprises and the active promotion of certain industries. The expansion of the textile and plastic industries created domestic demand. Consequently, the government promoted the petrochemicals sector through the China Petroleum Corporation, a state-owned enterprise. The first naphtha cracking plant, opened in 1968, produced 54.5 tons of ethylene per year (ibid., p. 39). The state also nurtured the nascent electronics industry. 

The expansion of exports led to rising demand for the shipping sector. The government therefore decided to acquire ships and also develop Taiwan's own shipbuilding capabilities. In the late 1960s the largest shipbuilding facility belonged to a state-owned enterprise, Taiwan Shipbuilding Co. When the production capacity became insufficient, a new state-owned enterprise, the China Shipbuilding Corporation, was set up. The government had a 45% share in the company, Oswego Corporation of the United States invested 25%, and other domestic and foreign investors invested the rest (ibid., pp. 43-44).

"[T]he role of the state in the industrial economy of the 1950s through the 1970s was large. Government restrictions on imports for the purpose of promoting domestic industries were pervasive throughout these three decades. Tariffs were high, domestic content requirements for joint ventures were common, and government gave certain firms outright monopolies of the domestic market. In the case of several important heavy industries [petrochemicals, shipbuilding, steel, automobiles, etc.], the government turned the development task over to state-owned enterprises and supported them with government-controlled funds (ibid., p. 47)."

The success of Taiwan's emerging industries is inexplicable without a clear understanding of conscious economic policies on the part of the state. In the post-war period, Taiwan did not have any particular advantage or technological expertise in these industries. Nor can one argue that Taiwanese people are culturally or genetically more inclined to succeeding in certain economic areas than other people. It is therefore fundamental to understand economic development from the viewpoint of the interdependence between government policies and the private sector.