Until the 1930s, Taiwan's industrial sector consisted mainly of food processing, particularly sugar. Fertiliser, cement, paper, refineries, steel and machinery industries were then established by the Japanese to support their Pacific war effort. Taiwan was decolonized in 1945, with 1945-1952 being a period of post-war reconstruction, with policies primarily aimed at stabilising the economy.
The 1950s featured import substitution strategies with inward-orientated policies such as increased tariffs and import controls in order to protect local investment in light manufacturing and discourage the import of consumer goods. SMEs began to be established in these sectors as cottage industries to help absorb the surplus labour in the rural areas.
However, the petty producer's stage of SME development in Taiwan was relatively short. By the late 1950s, the local market was showing signs of saturation, the country still had a significant surplus labour problems and, with the US aid nearing an end, there was a need to develop new policies.
Economic reforms began in 1958 with corrections to the foreign exchanges rates, relaxation of import controls and a number of incentives including loans, tariff rebates and tax concessions provided to encourage exports.
The enactment of the investment law in 1960 authorised inflows of FDI, particularly into the export processing zones.
Taiwan's electronics industry was initiated by these inflows of FDI from the US and Japanese MNCs (Multi-National Companies) which set up wholly-owned subsidiaries and joint ventures to produce transistor radios, black and white television sets and electronics components and parts.
While only approximately 25% of the sector was based on foreign capital, this generated 60% of its exports in the 1960s. Local entrepreneurs began developing a comprehensive local component supply industry and established their own assembly lines, quickly becoming the centre of Taiwanese production.
Taiwanese SMEs rapidly developed an export orientation with their domestic sales falling from 47 percent of total sales in 1975 to 33 percent in 1980 and to 29 percent in 1985.
Thus the dependency stage of SME development in Taiwan was also relatively short and these firms moved rapidly into the internalisation stage with the rapid growth of OEM (Original Equipment Manufacturers) and later ODM (Original Design Capabilities) strategies as the dominant force in the sector.
There was also an extensive upstream supply network of component manufacturers. By the 1980s, Taiwan's leading sectors were predominantly under indigenous control and the electronics industry expanded rapidly in areas such as video games, Apple clones and IBM compatible systems.
By 1995, Taiwan contributed over half the world's supply of desktop and portable computers, monitors, motherboards, keyboards, and PC Mice and switch power supply units. 63% of its output was exported.
Taiwanese firms, supported by public research institutions, had developed a significant internal design capacity which allowed them to rapidly move into new areas such as multimedia and video products.
However, very little of this output was marketed under Taiwanese brand names, with the majority of firms relying on OEM-ODM supply contracts for international sales. Most SMEs remained financially weak, lacked any major R&D activities and rarely undertook their own marketing (Chung 1997: 181-183).
Exporters in other industries were also supported by efficient production networks which comprised of large numbers of highly specialised producers in sectors such as clothing, food processing, metal working, furniture, auto components and chemicals. Firms in these networks were generally independent and competed against each other for contracts.
However, they shared production and market information which enhanced their flexibility and capacity to respond to market changes. Again, the core firms in these sectors depended on contracts from MNCs and Japanese trading companies for international sales and technology transfer, which meant that their R&D and marketing capacities were underdeveloped.
Taiwan's export firms remained relatively small because they developed a structure of local sourcing from other SMEs rather than vertical integration. SME development was assisted by active subcontracting and satellite-core relationships as discussed above.
Why these industries developed with this structure is not easy to explain. By the 1970s, Taiwanese SMEs had proven that they could compete equally with larger firms in terms of cost and productivity.
They had advantages in having a more flexible set of technologies based on labour-intensive operations and thus were more adaptable to external market changes.
The relatively high interest rate prevailing during this time discouraged firms from investing in non-essential areas such as advertising, information collecting and additional operational units.
Markets were highly competitive and SMEs were prepared to accept low profit margins. Consequently, it appears export firms preferred to use these local supply networks which offered lower cost and greater flexibility rather than develop their own internal facilities.
In return, SMEs could use these contracts with international assemblers and trading companies to reduce their investment requirements and thus to continue to offer low cost supply.
By 1987, Taiwanese SMEs were feeling the full effects of the rising trade surplus which had exerted considerable upward pressure on the domestic currency, raising labour and land costs and increased import competition.
These factors initiated a division of labour within Taiwanese firm's mature technology, labour-intensive operations moving to Southeast Asia and China while more advanced firms were encouraged to develop high technology and higher value added products locally.
SMEs account for varying proportions of Taiwan's high technology industries ranging from 100 percent of firms in medical instruments and equipment and other precision equipment, 97 percent of pharmaceutical manufacturing, to 80% of the aircraft and component parts industry.
SMEs spend slightly less on R&D and are only slightly less technology intensive than larger firms in these industries.
Thus some, particularly medium-sized firms which produced a range of related products, were able to develop new markets by upgrading their Taiwanese operations introducing greater automation, improved product quality and focusing on the higher value added end of their product range.
These firms have been able to develop an independent international market presence based on their OEM-ODM capacities, competing for MNC subcontracts as these become more open.
The government required such firms to commit to continued investment projects in Taiwan before approving of offshore operations for their labour-intensive activities (Chung 1997:89-90).
Thus a significant component of the SME sector in Taiwan has been able to operate and benefit from the new market opportunities arising from the externalisation of Japanese operations, with some growing to become larger international enterprises.
However, another common response by Taiwanese SMEs to these cost pressures was to move production offshore in search of lower labour and land cost. Cultural factors have particularly led small firms to invest in mainland China, as well as Malaysia and Thailand.
SMEs in labour intensive sectors such as apparel, leather and fur product, wood and bamboo products, toys, sporting goods, plastic products, metal products, electrical goods and electronic components moved production out of Taiwan between 1987 and 1991. Accelerating outwards, FDI caused upstream producers and suppliers to follow.
At first, Taiwanese overseas subsidiaries attempted to duplicate the network structures developed around these industries at home and otherwise relied on the head office to supply the raw materials, components, parts and semi-finished products.
Production technologies were transferred overseas intact, although new technologies, product design and innovation predominantly remained in Taiwan.
However, by the mid 1990s, FDI was more often motivated by attempts to capture the local (host) market rather than cost cutting. The proportion of sales into market was quicker than that of larger firms.
They could exploit these local markets, which they found less competitive than international markets offering higher profit margins. Local sourcing also increased rapidly, at the expense of sourcing from Taiwan.
Subsidiaries of Taiwanese SMEs were quickly absorbed into the local supply networks as the transactions costs involved in maintaining Taiwanese supply relationships became too high.
Their competitive edge over indigenous firms also quickly dissipated as they were too small set up their own subcontracting and suppliers networks and had to adapt to products supplied by local firms.
Taiwanese SMEs had often used personal contacts to help their entry into foreign markets and these same contacts resulted in their absorption into local networks Thus Taiwanese SME foreign investment rapidly became a localisation strategy, with product increasingly focused towards foreign host markets and local supply networks established involving some transplants but increasingly local firms.
These firms have remained relatively small in size and their local orientation has helped their evolution and integration into global networks.
Taiwan's few large scale, multi-products manufactures are beginning to develop integrated production and marketing strategies among their international subsidiaries, including alliances and joint ventures with overseas firms to set up high technology manufacturing in Taiwan.
However, SMEs are yet to develop integrated networking structures. Their original Taiwanese networks were a major source of competitive advantage with OEM-ODM supplies, and provided logistical support, market information and technological assistance when FDI first occurred.
However, these overseas operations have not been integrated into a global strategy. Rather, as discussed above, they are developing as national networks in host markets.
Thus the network strategies of Taiwanese SMEs involve strong external network linkages but weak internal linkages between subsidiary operations. Strategic network linkage, involving business alliances pooling firm-specific capabilities and complementaries occurs predominantly between large firms in high technology industries.
However, some smaller firms with technological expertise or market power in niche markets also utilise this approach. Nevertheless, Taiwanese investments in Southeast Asia and China are mainly based on relational networks or personal contacts which rely on trust as the basis of inter-firm co-operation.
Such networks, however, tend to be location specific and hence are less useful as a means of expanding international activities and thus more often lead to embedded localisation rather than globalisation.
SOUTH KOREA FOLLOWING JAPANESE MODEL: The Korean economy experienced severe disruption in the immediate post-war period which badly affected its industrial base. A truce in the Korean War was declared in July 1953.
This was followed by a period of stabilisation and import substitution policies. As occurred in Taiwan, export-oriented policies were introduced in the early 1960s and SME production and exports grew quickly, particularly in the textiles and apparel sectors.
However, unlike Taiwan, the South Korean government then instituted a policy of industrial intervention which particularly favoured large assembly and later heavy industrial firms. Thus, in the 1970s, both the absolute numbers and the relative position of SMEs declined.
Korea's large firms initially adopted a strong vertical integration strategy. However, in the 1980s, government polices promoted parts and component production, particularly from SMEs, as a means of import substitution to offset the large trade deficit.
Large businesses faced labour shortages and rising wages at this time which increased their subcontracting to SMEs.
The proportion of manufacturing SMEs which are involved in subcontracting arrangements increased from 36.7% in 1981 to 48.5% in 1987. However, the Korean subcontracting structure was weakly developed compared to that in Japan, consisting of only one or two tiers.
Korean's SMEs were enmeshed in highly dependent relationships not only with Korean assemblers in the automobile and electronics industries for contracts but also with their Japanese suppliers for essential parts, machinery and technical advice.
Consequently, they had very limited product development and local product design capacities. Other difficulties which arose from this dependency included substandard quality of parts produced in Korea, poor access to appropriate production equipment, inability to provide appropriate support to other firms in the production chain and difficulties in accumulating soft skills due to shortages of trained labour.
Korea's dependency on Japanese parts, intermediate products and know-how increased rapidly as it moved into higher value products in the late 1980s.
However, many Korean SMEs are still located in the rural regions in traditional sectors such as textile production.
These firms operate predominantly on orders from agents in virtual subcontracting relationships involving an 'advance order' or 'putting out' system either from large wholesalers or exporters in the cities or large local textile factories.
These traditional SMEs are operated by single entrepreneurs and can be a significant source of indirect exports.
However, this process acts as a barrier between the small firms and international market pressure, inhibiting their development of independent marketing or technical capacities.
While South Korea has developed extensive programs of assistance for SMEs since the promulgation of the 'Small and Medium Industry Basic Law' in 1966, most of this was aimed at protecting the SMEs subcontracting system.
Large firms were able to deliver substantial economic growth and were the focus of industry policy until after the July 1997 crisis. Subsequently, the government has looked to small firms as a new source of growth but this has been hampered by the lack of technical and marketing skills in the SME sector.
The Korean government provides SMEs with financial support, fiscal and tax incentives and technical guidance to encourage technology development. Financial support comes from sector-specific promotion funds and for specific R & D projects. 50% of these program funds must be allocated to SMEs.
One of the most serious bottlenecks inhibiting technological development in SMEs in Korea was a shortage of technical personnel. A number of institutions have been established to provide skilled personnel and information to SMEs on technology development, including Regional Industrial Technology Institutions which utilise a network of technical experts who can be assigned to SMEs to provide long term assistance.
The extent to which Korean SMEs have been able to develop new or original products varies with sectors. It is quite limited in sectors such as textiles, electronic parts and components and automobile parts, where however firms are now attempting to upgrade their technical capacities after a long period of dependence on Japanese suppliers.
By contrast, the factory automation sector has successfully developed new products using a variety of relationships with public R&D institutions, universities and international agents.
Localisation is not prevalent among Korean SMEs, very few of which have undertaken FDI. Rather, the government encouraged localisation within Korea by assisting SMEs to strengthen their capacities to operate as more independent OEM and ODM suppliers.
Since the 1990s, large Korean firms have been restructuring their production organisation into a global model. This restructuring has involved inter-firm externalisation and specialisation whereby they devolve production of certain lines to new subsidiary firms, spin-off divisions or subcontracts to small firms.
This process required the creation of more stable linkages between the firms involved. The density of these subcontracting networks has increased with small firms producing 70-80% of their output through subcontracting arrangements with other firms in 1990-91, twice the proportion of the mid-1980s.
In Korea, government regulations stipulate conditions for transferring business from large to small firms and control relations between large and small firms in these networks. In effect, this process involves assisting subcontracting firms to evolve relationships with their parent firms.
However, this approach was severely disrupted by the financial failure of many of the chaebol companies after the 1997 crisis.
The government encouraged technology and knowledge-based small firms to emerge as the next wave of global competitors. As a vast range of programs was instigated to foster the growth of 'promising' and 'technically advancing' SMEs.
MALAYSIA - APPLYING THE JAPANESE MODEL: Malaysia achieved independence in 1957. At that time, the Chinese ethnic group dominated small scale manufacturing as well as mining and the wholesale and retail trades.
Malaysian SME policy between 1957 and 1985 was predominantly aimed at encouraging Bumiputera (ethnic Malay) enterprise. SMEs, regardless of ethnic ownership, had an inward, domestic market orientation with low product quality and technological capacity.
In the meantime, the Malaysian Government had adopted a relatively open policy to foreign investment which saw the economy move away from resource-based industries (rubber and palm oil plantations and tin mining) in the 1970s towards electronics and electrical equipment, giving it a manufacturing export orientation.
In the 1980s, textiles and clothing also became export orientated. These sectors provided two-thirds of manufacturing value added, 40 percent of manufacturing employment and 80 percent of exports.
Malaysia offered foreign investors incentives including tax holidays, investment tax credits, accelerated depreciation, export incentives and location incentives.
Exporting firms tended to be large scale, foreign owned enclaves and relatively capital and import intensive.
They had few local economic linkages with little subcontracting or technology transfer with local enterprises. In 1983, the Malaysian domestic automobile industry was established on a large scale with Proton developed as a joint venture between local and foreign shareholders including Mitsubishi of Japan. The relative significance's of SMEs declined during this period.
Although they increased in absolute numbers and employment, larger enterprises expanded even more rapidly.
After 1986, government policy towards SMEs, regardless of ethnic ownership, changes to recognise their having an essential role within the industrialisation process. Part of the new policy involved fostering strategic linkages between the export industries and local SMEs.
Foreign firms were encouraged to develop subcontracting relationships, particularly as they introduced a more automated process into their Malaysian operations.
These buyer firms initiated the subcontracting process by establishing supplier partnership programs to develop long term relationships with suppliers, encouraged their engineers to set-up their own subcontracting business and transferred managerial and technical know-how.
Proton also established a local vendor program to increase its local content providing local subcontractors with technological support. The Malaysian system involved two subcontracting tiers.
The parents have targeted a few reliable first tiers, medium-sized suppliers, and helped them upgrade their product quality to international standards. The second tier involves small firms which provide engineering services.
In addition, two trading companies in furniture and food products have been established to improve the marketing and productive capacity of other SMEs, resulting in increased domestic sales against imports, government procurement contracts and some export of these products.
As already indicated. Smaller Taiwanese firms moved to countries such as Malaysia in search of lower labour and loss costs, and have often become embedded in the local economy. 52 percent of Taiwanese FDI projects in Malaysia were small-scale, manufacturing electronics, basic metals and metal products, chemicals and textiles. Larger projects have a clearer export orientation while smaller projects have targeted the local market.
A number of Taiwanese SMEs entered Malaysia as satellite suppliers producing components and parts which were sold to larger assembly firms for eventual export to Taiwan and third countries.
These firms source around 40 percent of their inputs from Taiwan, although this proportion is declining as they have become more embedded in local networks.
Due to the nature of export industries in Malaysia, a few SMEs had the capacity to develop as OEM-ODM enterprises. The post-1986 policies aimed not only at expanding the number of SMEs by encouraging subcontracting and franchising but also at modernising SME operations by providing financial assistance and promoting training, export and research and development activities.
The proportion of local sourcing increased significantly in the late 1980s, although this represented an increase in internal integration as well as subcontracting.
Some examples of SMEs evolving through this process, establishing their own subcontracting networks, developing independent technical and design capabilities and gaining substantial world-wide export sales can be cited.
However, for the majority of SMEs, poor product quality and lack of financial resources remain fundamental problems, despite an extensive array of Government assistance programs being available.
It can thus be concluded that Malaysian SMEs, after a long period as domestically orientated petty producers, are now entering the second stage as subcontractors to large foreign and domestic assemblers in the electronics and automobile industries, and to government inspired marketing intermediaries in other sectors.
However, because these parent firms operate in competitive international markets, this subcontracting process must involve suppliers with world standard product quality and production costs.
A limited number of first tier subcontractors, with technical and managerial assistance from their clients are now evolving through the OEM-ODM to become global niche producers.
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