Last year was a gloomy and disappointing period for Taiwan’s economy due to various domestic and international factors. Many indicators and statistics reflected the dire economic reality the nation faces. For instance, an official estimate of GDP growth rate last year was scaled down from 4 percent to slightly above 1 percent. The export growth rate is estimated to be minus-2.16 percent, the worst since the 2008 global financial crisis. Furthermore, the unemployment rate is not only the worst among the Asian Tigers, but average real wages have also deteriorated to the level of 14 years ago. All these signs seem to provide little confidence for optimism about 2013.
Taiwan’s economic achievements over the past years have been built on its solid foundation and critical position as a reliable supplier of intermediate goods in the highly integrated global production chain. Nevertheless, given the changing dynamics of global production networks in recent years, not only have Taiwan’s advantages gradually lost their luster, but its strengths have also been eroded and faced severe challenges. These ingrained and long-term structural issues may be the fundamental reasons explaining Taiwan’s economic stagnation and setbacks in recent years.
For some time, production networks in East Asia have been explained as a “flying geese paradigm,” led by Japan, through transfers of technology and foreign direct investment to undertake industrial division of labor across different Asian countries. Japan plays the lead goose in a hierarchy of industrial division of labor, followed by a second tier of nations and territories, such as Taiwan, South Korea, Singapore and Hong Kong, to export intermediate goods, and the third tier of Southeast Asian nations like Thailand, the Philippines, Indonesia and Malaysia, as manufacturing and assembling centers. The last group of nations joining this paradigm includes China, Vietnam and other ASEAN nations who provide raw materials and cheap labor as final production bases. In this pattern of industrial division of labor, Taiwan has been able to fully maximize its comparative advantages as an indispensable supplier of intermediate goods.
Nevertheless, this paradigm has experienced significant changes since the early 2000s. It has also been shattered by the impacts of the recent global financial crisis and 2011’s earthquake and tsunami in Japan. As a result, a new wave of industrial relocation and realignment in the global production network has been quietly taking place, which inevitably brings critical challenges to Taiwan’s economy.
The first change comes from increased production capabilities in developing countries. With massive investment inflows flooding into China and ASEAN countries over the past two decades, the introduction of new technologies as well as high-performance production facilities have enhanced the manufacturing capabilities of these emerging economies. Many local firms in China and ASEAN nations have benefited enormously from original equipment manufacturer (OEM) opportunities provided by European and US multinationals in terms of improving their specialization techniques in mass and low-cost production. As a consequence, their industrial capacity to produce intermediate goods and to mutually supply industrial component parts for each other’s needs has been strengthened. Hence, a traditional one-way flow of intermediate goods from Japan and the Asian Tigers to China and ASEAN nations in the flying geese paradigm is no longer self-evident.
In addition, since the 2008 global financial crisis, emerging markets, such as the BRICS (Brazil, Russia, India and China) nations, have swiftly emerged as driving forces propelling the growth of the global economy. This new economic landscape suggests that these emerging markets are likely to play a more important role in leading the way for the recovery of the global economy than the US or Europe. The robust demands from these countries’ rising middle classes along with their insatiable desire for consumer goods imply that the existing model of the global production chain merely focusing on final products in advanced economies may be obsolete and needs to be overhauled.
Furthermore, given that the EU is still mired in its debt crisis and the US has not recovered from its economic downturn, the brighter economic prospects of emerging markets not only provide a silver lining for the world economy, but also suggest that the traditional roles these countries play in the global production chain as the “world’s factory” may no longer be valid. It is worth noting that China has initiated new policies to transform the structure of its economic growth by gradually reducing economic dependence on exports while expanding the weight of domestic consumption. If this strategy succeeds, the traditional global production chain targeting Western countries as the final consumer may need to be reconsidered. Foreseeing huge business potential in emerging markets, unsurprisingly, more multinationals have adjusted their marketing strategies and production models, placing more emphasis on these emerging markets to secure the benefits of their rising prosperity.
Another critical change is the promotion of “re-industrialization” in advanced economies. Traditionally, Western multinationals have been major proponents of globalization. By moving less competitive manufacturing jobs overseas and engaging in worldwide outsourcing for cheaper raw materials, labor and services, these multinationals have established a highly integrated global production network across borders and generated widespread welfare for both advanced and developing economies. However, while people in advanced economies enjoy low-priced goods from all over the world, they also have to bear consequences such as the loss of manufacturing jobs and a high unemployment rate.
Given the importance of the manufacturing sector in terms of enhancing a nation’s economic security, re-industrialization or revitalizing manufacturing policies have been frequently emphasized in advanced economies since the 2008 global financial crisis. US President Barack Obama has promoted re-industrialization and a revival of the US manufacturing sector by encouraging US multinationals to shift their overseas production lines back to the US. Recently, Apple’s chief executive Tim Cook announced that a line of Apple Mac computers will be manufactured in the US this year.
Coupled with soaring production costs in developing economies, an increased number of multinationals have considered shifting production lines back to more developed countries. As a result, advanced economies may revitalize themselves as manufacturing powerhouse and resumes past glories as leading exporting countries, which would be likely to further alter the structure of global production networks.
Another factor shaking production networks has been the impact of Japan’s 2011 disaster and the economic consequences of Sino-Japanese disputes over the Diaoyutai Islands (釣魚台) — known as the Senkakus in Japan — on Japanese companies’ production strategies. The disaster not only led to about US$200 billion in economic losses for Japan, but it also had a widespread impact due to the breakdown of the regional supply chain.
To reduce risks, many Japanese firms begin to consider shifting more advanced manufacturing sectors overseas, instead of insisting on keeping core manufacturing in Japan. In addition, recent anti-Japanese movements not only devastated Japanese firms’ operations in China, but also led to a sharp fall in Japanese investment in China, which suggests that Japanese firms are holding back on their increasing exposure to the Chinese market. In short, these “pushing” factors are likely to affect Japanese firms’ overseas production strategy, so is the structure of global production networks.
In the dynamics of global production networks, Taiwan’s position as a supplier of intermediate goods is likely to be in jeopardy for the following reasons: First, with increased manufacturing capabilities and robust domestic market growth in developing countries, Western multinationals may seek direct cooperation with local firms in emerging markets, passing over Taiwanese firms to shorten production lines. Second, most Taiwanese firms are beneficiaries of the current production network through OEM/ODM (original design manufacturer) models without their own brands. However, one lingering hazard in this partnership for Taiwanese firms is that they are extremely vulnerable to the withdrawal of orders by multinationals when new competitors emerge with more competitive prices.
Against the backdrop of changing global production networks, Taiwan has two approaches it could develop which are not necessarily mutually exclusive. The first is to further deepen and integrate Taiwanese firms into production networks in the Western Pacific to establish a solid foundation for the future leap forward in the global market. The second is to enhance strategic alliances between Taiwanese firms and multinationals in order to penetrate Asian markets. The former focuses on fully utilizing Taiwan’s strengths and places more resources into research and development, brand design and integration capability; the latter aims to promote Taiwan as a creator and designer of Asian lifestyles through merging Western technologies with Asian values and standards in order to satisfy the needs of emerging Asian markets.
With the combination of these approaches for more advanced integration, brand promotion and marketing facilitation, Taiwanese firms can not only secure their indispensability in production networks, but can also improve their positions in the global value chain and re-energize the economy.
Kung Ming-hsin is vice president of the Taiwan Institute of Economic Research. Eric Chiou is an associate research fellow at the institute.