Export-oriented small and medium sized enterprises (SMEs) have played a key role in Taiwan's economy over the past 30 years. Their limited size makes them flexible, allows for quick responses, and saves on overhead costs. But their small size makes them more fragile financially, and they also lack the advantages of economies of scale in information gathering, marketing, and budgeting for R&D.
In the following article, Dr. Hsueh Li-min, a Research Fellow at the Chung-Hua Institution for Economic Research, takes a close look at what has made Taiwan's SMEs so successful in the past, and indicates how this experience can be translated into future competitiveness both at home and in the international market place. This is an edited version of a paper she presented in November 1989 at the "Conference on Hungary Into the Nineties" in Budapest.
The average GNP growth rate of nine percent over the past 30 years has transformed the ROC on Taiwan into one of the very successful newly industrialized economies. Small and medium-sized enterprises (hereafter referred to as SMEs) in Taiwan have played a more important role in this process than in South Korea or other developing countries.
There are about 750,000 business establishments in Taiwan, almost all of which (98.5 percent) are classified as SMEs. Since 1982, the cutoff amount beyond which a firm passes into the large enterprise ranks has been set at a little over US$1.5 million (owner's equity for manufacturing, and gross sales for others). Nearly two-thirds of the SMEs are in the commerce sector (which includes wholesale and retail trade and the restaurant business), and roughly 17 percent are in the manufacturing sector. SMEs account for nearly half of GNP from the manufacturing and commerce sectors, employ about 60 percent of the labor force in these two sectors, and account for 60 percent of exports from all sectors of the economy. These proportions have remained relatively stable over the years. [See FCR November 1988 for detailed industry-by-industry data on SMEs].
Many economists believe that the export-expansion policy pursued by the government since the 1960s is largely responsible for Taiwan's rapid economic development. Under this policy, entrepreneurs in Taiwan exploited all the opportunities for exporting goods and services by setting up numerous small factories and trading companies. Export-oriented SMEs took the leading role in industries making electronic items, plastic products, shoes, sporting equipment, apparel, fabricated metal products, machinery, and processed food.
The predominance of SMEs in Taiwan's economic development has had several positive effects. First, they are concentrated in labor-intensive industries and thus create many jobs. SMEs have also contributed to balancing the development of urban and rural areas. Many small SME factories were set up near villages and small towns. Rural employment in the manufacturing sector in creased 12.1 percent in 1971-76, whereas in urban areas, the corresponding in crease was a lesser eight percent. The rural-based SME factories greatly in creased the non-farm income of rural households and helped to slow the migration of rural workers to the urban areas.
A third positive effect of the predominance of SMEs has been their contribution to the even distribution of income among households. The "Gini coefficient" (a the-lower-the-better measure of income equality or inequality) gradually decreased from 0.360 in 1964 to 0.303 in 1980 (it began rising slowly in 1980). Another measure for income distribution shows the total income of the highest one-fifth of the population compared to that of the lowest fifth, expressed as a ratio. In 1964 this ratio was a fairly high 5.3 (it was 20.5 in 1953), but it went down to 4.2 in 1980, and in 1987 rose to 4.7.
There are two reasons for the equal income distribution during this period: labor income, as a percentage of domestic income from all the factors of production (land, labor, capital, and entrepreneurship), increased from 48.14 in 1964 to 61.03 in 1987 because of the rapid growth of labor-intensive SMEs; the second reason is that numerous risk-taking SME owners who profited from the economic climate in Taiwan also prevented the concentration of wealth in the hands of a chosen few. [Although data for 1988-89 are not yet available, experts estimate that these income distribution figures are now less favorable.]
Taiwan's SMEs have succeeded because they are dynamic, flexible, quick to adjust to the changing environment, and good at identifying opportunities for making profits. But they are currently facing a period of structural change. Taiwan is no longer short of capital, but it is short of labor. The labor shortages create higher labor costs as well as a scarcity of suitable personnel for new operations, thus hampering the flexible response for which Taiwan's SMEs have been justly famous. In addition, the value of the New Taiwan dollar (NT$) has appreciated 36 percent against U.S. greenback since 1983. As a result, the survival of labor-intensive SMEs is being threatened by competition from factories in places such as Thailand, Malaysia, and mainland China. Upgrading SME technology, management, and R&D is definitely necessary, but several bottlenecks exist that will make further development difficult.
One problem for SMEs is their lack of international marketing information. SMEs usually do not have the ability and the economies of scale to establish marketing channels or to advertise. They stick to their specialized expertise in export manufacturing and leave the overseas marketing to foreign trading companies, many of which are Japanese. For example, according to one informed observer, Japanese companies are believed to have handled about 60 percent of Taiwan's textile exports, although some U.S. and European importers have also set up offices in Taiwan to deal directly with local manufacturers, including many small ones. The SMEs have found that they are much better at producing products than selling them at home or abroad.
In general, small factories in Taiwan produce products according to the buyers' designs and under the buyers' brand name (the so-called original equipment manufacturing, OEM). This arrangement creates great uncertainty for Taiwan's SME factories, because as soon as foreign buyers find that the cost of Taiwan's products are no longer competitive, they turn to other sources, leaving the SME high and dry.
Taiwan's OEM is by its very nature inflexible and highly vulnerable to business decisions made elsewhere, with scant attention to the needs and interests of the SMEs. In response, the government has encouraged the development of local brand names for many years, and a few companies have been successful in doing so. For example, Acer personal computers and Pro-Kennex tennis racquets both grew from small-sized firms and are now marketing internationally. But the lack of marketing capability is still a bottleneck in the development of most SMEs in Taiwan.
Another problem is the lack of management skills. Most SMEs are family businesses. In 1985, 37.15 percent of the SMEs were organized as corporations, 69.78 percent as proprietorships, and 1.12 percent as partnerships. But even the ones officially organized as corporations were in reality managed like proprietorships, which means the finances of the company and its owners were not clearly separated. Their presence on the roll of corporations is more nominal than real.
The SME Administration established by the ROC government in 1981 has launched a series of programs for upgrading the management skills of SME directors. The program emphasizes the basics, such as accounting, financial management, inventory control, quality control, and personnel management. Because of budgetary limitations, these programs can only reach a limited number of SMEs. On the other hand, officials are not sure the limitations are all that painful to the intended recipients. According to a survey by the SME Administration in 1986, small businesses are less interested in securing help to improve their management from government agencies or consulting firms than are medium-sized firms.
Because of rising labor costs in Taiwan, SMEs need to upgrade their production technology and become more capital-intensive and labor-saving, but they are running into problems because they lack investment information, R&D capability, and capital. In response to these difficulties, many SMEs have moved their labor-intensive factories to other developing countries such as Thailand and Malaysia instead of upgrading their operations in Taiwan or investing in promising new industries.
Because SMEs usually do not perform any R&D, spending by Taiwan in this area is still far behind that of developed countries. In 1985, for example, R&D spending as a percentage of GNP was 1.06 for Taiwan, 2.83 for West Germany, 2.53 for Japan and 2.72 for the United States. Of total R&D expenditure in Taiwan, the private sector accounted for less than 50 percent.
To supplement the deficiency of private R&D, the government in 1973 established a large-scale national lab known as the Industrial Technology Research Institute (ITRI). SMEs can con tract with ITRI to solve a specific technical problem or, going the other way, ITRI can transfer the technology they have developed to SMEs. The institute has made a significant contribution to the development of the high-tech electronics industry in Taiwan.
The ROC's SMEs have difficulty in obtaining loans, even though Taiwan currently has a substantial capital surplus. The problem is that SMEs do not have a solid accounting system, which makes their financial statements too unreliable to be accepted by banks and other financial institutions. The banks, for their part, have mostly adopted very rigid and conservative loan policies be cause the banking industry has been closely regulated by the government. Securing loans from formal financial institutions has long been a problem for SMEs in Taiwan. Although the proportion of bank loans going to SMEs has in creased over the years, the figure stood at only 36-odd percent in 1986. To raise money, the SMEs are obliged to borrow from relatives, friends, and underground moneylenders at high interest rates.
In response to this situation, the government has set up The Medium Business Bank of Taiwan [sic.], a publicly-owned institution that specializes in SME loans. Besides, there are seven private small and medium business banks that serve SMEs in several local areas. The share of these eight banks in the total value of loans to SMEs was 80.34 percent in 1985 and 76.91 percent in 1986, according to the officially-recorded data.
The government also set up a credit guarantee fund in 1974 to support SME loan applications. In 1986, 10.6 percent of all loans from banks to SMEs was backed by the guarantee fund, an in crease from the corresponding 1982 figure of 6.5 percent. Around 40,000 SMEs have been helped through the guarantee fund since its establishment. Special funds have been available from time to time for SMEs, including a fund for purchasing pollution control equipment, a fund for automation, and a venture capital fund for strategic industries.
SMEs will find it easier to secure loans when the banking system in Taiwan is further liberalized, which mainly means that new private banks can enter the market.
Small and medium enterprises in the commerce sector, such as small grocery stores, restaurants, and bakeries, have been facing severe challenges in recent years from modern supermarkets and multi-national chain stores. This sector in Taiwan was rather conventional and inefficient before these international firms were allowed to come in under the ROC's forward-looking policies of liberalization and internationalization. The modernization of the commerce sector has been moving very fast in recent years, and this has benefited consumers greatly, but it also threatens the survival of the traditional small shops.
The structure of Taiwan's economy is rapidly changing, and new developments include increased growth of high-tech industries and modern service industries, which leaves less room for traditional SMEs to prosper and increase in number. SMEs have to upgrade their management and technology in order to survive and grow during this transition period. Government agencies, coordinated by the SME Administration, have initiated many programs to help them improve. But the only enterprises that will prosper in the future are those headed by entrepreneurs who have the foresight to take advantage of the changing environment and are willing to take risks-which is exactly how they got where they are today.
Financial Resilience: SMEs With A Difference
By Richard Sorich
The "low proportion of equity capital" is one of the proverbial cliches that Western analysts toss around in discussions of East Asian economic development and the financial structure of corporations in the region. There is some debate as to whether this introduces precarious vulnerabilities in countries such as Japan and South Korea because of the heavy dependence on bank credits to provide financial resources that in the U.S. would come from private investments, not from bank loans. Some believe that this system is acceptable in good times but could compound a financial disaster by the weight of loan-burdened corporations crashing down on already crumbling sectors of the economy. Others think that the government-private economic establishment in Japan and its counterpart in South Korea would step in with a firm hand and not allow crises to feed on crises in the disaster scenario of an equity-poor corporate financial structure under stress.
The data on enterprise finances in the ROC on Taiwan show a similar pattern of low owner equity in the corporate structure, but there the similarity ends. In Taiwan, it is the SMEs that have little equity capital and live on borrowed money.
The data on the large firms throws the figures for SMEs into sharp relief and creates a revealing picture of what the SME is all about, financially speaking. The data are a transformation into more convenient form of the copious statistics in Dr. Hsueh's original paper for a Budapest conference in November 1989 (see accompanying article).
Large enterprises have a capital structure more reminiscent of Western-style companies. But because the SMEs dominate the economy, overall it is correct to say that Taiwan's firms are also equity-poor. Taiwan's SMEs do not depend on bank lending, since their loan funds come from a variety of informal sources, many of them family-related. For this reason, it is doubtful that the SMEs are vulnerable to crises in the financial system that people worry about in the case of Japan and South Korea, should there be a serious economic downturn. SMEs are inherently too flexible for that to happen.