Taiwan’s Economic Problems

I. Introduction:

Like most countries, Taiwan faces numerous economic problems and challenges. Although some of these problems are different than those of other countries and perhaps require different policies, the first step in solving them is to identify the problems and attempt to understand the major factors involved. This small reading will survey some important economic challenges faced by Taiwan and will then indicate possible choices which Taiwanese have about their future.

  1. Lowering Unemployment

Let’s begin with the unemployment rate. It is not a precise statistic, but it is one that the media is sure to watch. Unemployment is considered undesirable for many reasons. First, it is a waste of labor and entails considerable loss of output. Generally speaking, a one percentage point increase in the unemployment rate, above its average level, reduces economic growth by about 3.1 percent. See the gretl output below.

Taiwan’s average unemployment rate from 1970 – 1990 was about 1.8%. By contrast, according to the DGBAS, the unemployment rate in Taiwan during January of 2014was 3.96 %. Taiwan’s unemployment rate hit a high of 6.13% during August of 2009. It reached a low of 1.56% in 1994. The chart on the next page shows that the unemployment rate for people 20-24 years of age is easily double the national average. In 2009 it hit a high of 16% and currently is hovering slightly above 13%. Unemployment has been elevated since 2001 when Taiwan was gripped in a global recession. Like most countries it has been slow to fall. This is particularly troubling since people who are unemployed for any long period tend to lose skills they need to regain their employment. Greater unemployment also gives rise to greater crime, divorce, and suicide.

The best way to reduce unemployment is to get the economy moving again. An expanding economy nearly always results in an increase in employment and a reduction in unemployment. Sometimes, when the economy is undergoing structural change, unemployment may rise because labor is adjusting to the new conditions of the labor market. Old types of labor are not in demand while new types of labor are not being

sufficiently supplied. Taiwan’s attempt to encourage the development of a high technology economy may have caused a rise in unemployment because of the temporary lack of skills within the Taiwan labor force. Some people have complained that business is investing too much in Mainland China and this is reducing employment opportunities in Taiwan. Other people point to the fact that Taiwan’s economy suffered from the dramatic downturn in the US economy which began in 2008. Other commentators have conjectured that the increasing use of computerization has made labor less important to the production process. Finally, some have claimed that jobs are being taken by the import of cheap labor from Southeast Asia. Can Taiwan's government choose efficacious monetary and fiscal policies which will help to reduce the rate of unemployment? This is something worth pondering.

  1. Stable Inflation

The next economic challenge in Taiwan is to maintain a stable rate of inflation. Taiwan has had a wonderful record on price stability. Inflation can become dangerous to the economic wellbeing of the nation if it rises too high. However, it is difficult to say when inflation is too high. Generally economists believe that double digit inflation is something to be avoided. They typically feel that a 2-3% rate of price inflation is acceptable, especially if it is stable and predictable. But, even this can cause trouble if it remains in place too long and fixed incomes are not indexed. Higher inflation generally causes the monetary authority to take steps to reduce the inflation rate before it increases too much. These contractionary policies usually result in a recession with attendant high unemployment. The cost of inflation is that it takes a recession to lower it to manageable levels.Taiwan has maintained a stable 2.5-3% rate of inflation since the late 1970’s. The "measured" inflation rate hit a high of 16% in the 4th quarter of 1980. This was due to the extraordinary rise in prices caused by the second oil crisis. Some economists feel that such increases in the price level were too short to be classified as inflation. They note that inflation is a situation of a steady and sustained increase in the general level of prices, not an abrupt jump in the price level. As the graph below shows, Taiwan has had negative consumer price inflation or falling prices during 2009 and again most recently in 2015. Falling prices are thought to be bad for the economy because people (and banks!) tend to want to hold money instead of buying things. This reduces spending in the economy and lowers aggregate demand. Some central banks are actually targeting a 2% inflation rate in hopes that this will get people to quit holding money and start buying other things.

Deflation is when inflation turns negative. It usually creates widespread business pessimism that reduces the willingness of business to invest in new equipment. In addition, deflation puts a greater burden on people who are in debt. Taiwan has been using its monetary policy to help re-inflate the economy. Deflation is a dangerous state for the economy and monetary policy is one tool that can be used to help avoid a it. The biggest problem with this type of policy is that it may instead create bubbles in asset values, such as houses, bonds, and stock. When asset prices rise, people may still choose to save rather than spend. Printing lots of money may cause asset inflation rather than goods and services inflation. When asset inflation occurs, people may decide to hold off on their spending and buy stocks and bonds now. Goods and services inflation may not rise even with a faster growth in money! This is one reason Taipei housing is so expensive, even though there has been little increase in the real economy or in inflation.

  1. Growth in Productivity

The third challenge Taiwan faces is finding ways to maintain its growth in labor productivity. Productivity growth is perhaps the most important variable in economics since it decides our standard of living and typically determines how quickly our real wages can rise. Higher productivity means that we are producing more per labor hour than before. A country which is accumulating more physical capital and is experiencing improvements in its technology will naturally show higher productivity growth. Also, a country that is recovering from a recession will show string growth in productivity.

Since 2009 all three indicators of labor performance have been sick. This is an alarming trend and deserves special consideration. The recession in 2009 made growth in earnings, hours worked, and productivity very unstable. Compare this trend to what went before during the 1980s and 1990s. Manufacturing workers can no longer look to an ever

increasing standard of living as productivity has been low or falling.Some people have claimed that rising productivity leads to greater unemployment. They feel that labor has modern machinery which it can use today, meaning that business can do more using less labor. Each labor hour can produce more output. Other economists claim that higher productivity makes labor more attractive as a factor of production and this raises its demand. What seems clear is that education plays an important part in raising productivity and this education makes labor much moreattractive, raising its demand considerably. Education has become more important in Taiwan and this is one of the reasons that expenditure on education has risen in household budgets. The same is true in other countries, as well. An important misconception in Taiwan is that some businesses complain that Taiwan workers are too expensive, while other countries’ workers (e.g. mainland China) are very cheap. The same businesses complain that the

government must do something to help increase theproductivity of Taiwan’s workers. However, increased productivity, coupled with competitive markets, nearly always leads to higher wages being paid. You can’t have rising productivity without rising wages. This is true in the US and is true in Taiwan. High wages simply reflect the high productivity of Taiwan workers. If some companies wish to move to Mainland China they will find that workers there are not as productive as Taiwan workers—even if they have the same machinery! Perhaps this is one reason why that many firms have in fact lost money on their Mainland investments. Finally, Taiwan must carefully consider the

effect itsregulation of industry and energy policies have on labor productivity. Efforts to improve the environment and reduce pollution may have the perverse effect of lowering labor productivity, since money will be spent on equipment that does not increase production and the most efficient methods of production may not be the cleanest. A tradeoff exists between a cleaner environment and productivity. The people of Taiwan deserve to be told clearly the nature of this tradeoff.

IV. Government Budget Deficits

The last big challenge which Taiwan faces is its large government budget deficits. There is nothing wrong with a government which borrows part of its revenue to finance its expenditure. Every government in the world engages in borrowing. Even rich countries such as the US and Japan borrow large sums of money each year. This borrowing can be divided into domestic borrowing and international borrowing. Countries which borrow internationally must be prepared to pay out large sums of foreign exchange (e.g. US dollars). If they cannot pay these dollars back they either find alternative lenders, such as the IMF, to help them, or they face a possible depreciation of their own currencies. Taiwan borrows almost all of its funds domestically—despite the fact that it has massive amounts of foreign exchange reserves and could easily accommodate a sudden outflow of foreign money from the island. Borrowing domestically can become a problem if such borrowing raises interest rates so much that it “crowds out” private investment and private consumption expenditure. The government is borrowing a large part of domestic saving and private interests find it prohibitively expensive to borrow.

The Ministry of Finance in Taiwan provides some data on government revenues and expenditures (as well as the deficit) which after dividing by the GDP gives us an idea of the magnitude of the problem in Taiwan. Unfortunately, many of the data sets show different results. The graph below shows the most recent data on revenues and expenditures in Taiwan.

Another problem is that if government borrows too much and interest rates rise too high, this can attract foreign capital flows and raise the domestic currency. Such a fall in the foreign exchange rate (or rise in the domestic currency) can reduce exports. This is sometimes called “international crowding out”. The US has had considerable trouble with international crowding out. Taiwan does not appear to be having trouble with this. It has been aggressively pursuing expansionary fiscal policy, running big deficits and undertaking large scale spending projects. However, there has not been a significant increase in interest rates. Taiwan is using traditional Keynesian fiscal policy to fight its economic doldrums. When investment and consumption are lackluster, it is best for the government to borrow the saving of the public and spend it on important public infrastructural works. Economists typically feel that the government budget deficit, as a percentage of GDP, should not rise above 5% and is best kept below 3%. As we have noted, things will improve naturally as the economy improves. Nevertheless, it is important for people in Taiwan to be careful how this money is spent, so that wasteful and inequitable spending does not occur.

Debt to GDP is another important statistic that is closely watched. Generally, economists tend to think that debt to GDP should be kept below 60%. Taiwan is currently slightly 40%. This is a strength and a good sign. It gives Taiwan policymakers more flexibility in deciding their spending policies.

Discussion Questions:

#1. What are four major economic challenges which Taiwan faces?

#2. Why is high unemployment undesirable?

#3. What are some reasons Taiwan has been suffering higher unemployment?

#4. Why is high inflation undesirable?

#5. Has Taiwan had inflation recently? What has been happening?

#6. Why is productivity growth so important? Is Taiwan’s productivity growing?

#7. Are budget deficits undesirable? Why or why not?

#8. What has been Taiwan’s recent experience in government budget deficits and debts?