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7. Price Level Considerations
After showing that and how Taiwan’s price level decoupled from the international one and looking into the balance of payments to assess why the New Taiwan Dollar’s valuation is weak, it is time to mention some more, though harder to quantify theories on why Taiwan’s prices are low. Those are related to Taiwan’s and China’s special relationship or Taiwan’s traditional business structure and focus.
7.1 China’s Influence
The flow of funds from Taiwan to China indicates strong competition between the two countries for those funds - and for the associated jobs. This results in strong
downwards pressure on wages, as otherwise many firms can choose to outsource an increasing share of their business. In general, this applies to many countries today, but due to geographic, historic, linguistic, cultural and racial proximity, Taiwan is an especially severe case.
Furthermore, western practises remain branded as foreign in China and hence are clearly definable from local practises. Foreign Asian practises are at first sight more similar - for instance with an emphasise on authority and hierarchy - but they are nevertheless alien, as for instance Japanese business culture turns out to be much more tacit and group-centered than Chinese business culture (Li & Putterill (2007)).
Taiwanese culture on the other hand not only is significantly closer in its roots, but it is also perceived as very similar, also due to the influence of China’s government on the mindset of its people and its persistence on the One China principle. Learning from Taiwanese businessmen, who have a longer history of capitalist private business management and undeniably a more productive background - as still today Taiwanese nominal per capita GDP is about twice as high as the Chinese counterpart - is not as disloyal towards Chinese culture and values as adapting Western, Japanese or Korean management style and best practises. In return, due to accepted economic dependence, Taiwanese employees are more likely to accept Chinese practises that are found to be beneficial by Taiwanese businessmen abroad. Assuming that culture specific
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accumulation of best practises defines a unique production function for each cultural unit, this concludes that a part of Taiwan’s and China’s comparative advantage is moving closer together.
The direct investment flow from Taiwan to China is supporting this argument, as it leads to comparable clusters in Taiwan and China. “Clusters are more likely to span political borders where there is a common language, short physical distances (e.g., 200 miles or less between business locations), similar legal systems and other institutions, and minimal trade or investment barriers” (Porter (2008)).
According to the 2006 Report on Foreign Investment Strategies of the
Manufactures, the primary factor that motivates Taiwanese firms to invest in China in 2005 has been great local market potential (62.45%). With the Chinese market not only being large, but being 40-times larger by population than the Taiwanese one, many companies might seek their primary profit in China, rather than in Taiwan. With this in mind, their pricing strategy is likely to focus on maximising penetration of the Chinese market. A separate pricing strategy for Taiwan might be dropped as the high amount of Taiwanese Import-export businesses will quickly discover the arbitrage opportunity, a different strategy has high initial sunken costs and increases overhead, Taiwanese market has an insignificant relative size, and Taiwanese low nominal income implies a relatively small spread in the optimal Mainland and the optimal Taiwan price. With the rise of Taobao, it became effortless for Taiwanese consumers to compare local prices to the ones found in China, and in case of appreciable spreads, directly order from the Mainland.
It can therefore be argued, that the Chinese price level has a significant impact on the Taiwanese price level. 30
7.2 Competition and Efficiency Focus
Unfortunately, China’s price level is difficult to assess. Not only does its size imply
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that many goods consumed do not have a counterpart abroad, which means they are ignored in PPP calculations, but also is the original data prone to manipulation.
Furthermore, the last change in methodology for PPP has had significant impact, and capital controls distort the nominal exchange rate. Ratio according to IMF:
2000 2005 2010 2013
3.02 2.47 2.03 1.71
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Efficient markets have always been driven by competition. Monopolies and
monopsonies levy their market power to increase profits - by increasing prices over production costs. The more participants in the market, the more competitive pressure arises and hence the smaller the spread between prices and production costs, ceteris paribus.
While South Korea is traditionally dominated by Chaebols, large, often family-controlled conglomerates, Taiwan’s business landscape is fractured into many small and medium enterprises. Unfortunately, Taiwan does not follow OECD’s practice of publishing the share of employees engaged at enterprises by size of employment. It does however publish the amount of enterprises by size of employment - though in slightly different categories than the OECD.
Comparing these numbers for Taiwan, South Korea, Israel (the second least integrated country in the sample) and Germany (well-known for its small and medium sized companies or ‘Mittelstand’), shows Taiwan’s large share of very small (1-9
Figure 7.2 Firm Size Comparison
20%
40%
60%
80%
100%
1-9 Employees 10-19 Employees 20-49 Employees 50+ Employees
Taiwan Germany Israel Korea
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employees) companies (Figure 7.2) . This presentation however understates the 31 magnitude of the difference, as the category 50+ employees is very wide and a larger share of big enterprises has an over proportional effect on their share of employees.
Another traditionally anchored aspect of Taiwanese business culture is its lack of marketing focus. As Liu and Shih (2013) state, in the past, many of Taiwan’s businesses focused on volume and later cost cutting, rather then enhancing product value-added. This in combination with Becherer, Halstead and Haynes’ (2003) finding, that SMEs exhibit less marketing orientation then larger companies, explains a relatively low price level due to only limited differentiation in the eyes of
costumers. This is supported by Horng and Chen (1998), who find a “lack of
professional and talented marketing managers’ for Taiwanese manufacturing SMEs.
Liu and Shih hence recommend “Taiwanese industry needs to move away from being production-oriented (focusing on reducing production costs) towards being market-oriented (emphasising value creation and service provision)”. This might not be an easy task however, according to Jamie Lin, founder of appWorks, an incubator for start ups in Taipei. According to BBC, his experience shows that Taiwanese enterprises are innovative, but they are not catering to the market and instead are following the same management practises they did in the 1980’s. This fits well to OEM production, but it is not creating a position, that allows the exertion of monopolistic power, hence the low profit margins (and prices).
Unfortunately Taiwan groups its enterprises into different categories as OECD does,
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so a lot of information gets lost forming a comparison. Please see the appendix for more detailed data.