Taiwan – the least talked about success story

Country A vs. Country B comparisons are popular to make in comparative economics. One of the most notable examples is North Korea vs. South Korea. One of the most lurid cases of socialist failure, North Korea trails behind its southern neighbor in practically all meaningful measures – from human development down to per capita GDP. Since both countries went on distinctive economic paths after the Korean War, it has become apparent that capitalism provides the best results.

In present times, the example of Chile vs. Venezuela also comes to mind. Once one of Latin America’s richest countries, Venezuela has gone down the economic doldrums since it embraced hard socialism over the last two decades. Even with vast oil riches, Venezuela could not escape these disastrous effects. Chile, on the other hand, has become a regional and world leader in economic freedom after embracing pro-growth policies such as enterprise privatization, free trade and social security privatization.

However, these cases of comparative development do not stop there. One of the most unheralded cases of Country A vs. Country B comparisons is mainland China vs. Taiwan. Since the 1980s, Taiwan has strongly embraced free market policies that have made the country a magnet for foreign investment. And the results speak for themselves. Taiwan boasts a per capita GDP of $48,095 and is ranked as the 13th freest economy in the world according to the Heritage Foundation’s 2018 Index of Economic Freedom. The island nation also received glowing reviews from the Fraser Institute’s 2018 Human Freedom Index, which placed it in 10th position.

Understanding Taiwan’s economic history will show how it came to be one of Asia’s most successful growth stories.

Taiwan street scene at night

The origins of Taiwan

In similar circumstances to its Korean peninsula counterpart in South Korea, Taiwan was a creature of Cold War politics. Taiwan was originally part of the Chinese mainland. China’s 20th century was nothing short of a roller coaster ride. Once the Qing dynasty fell in 1912, China was under the control of warlords until nationalist leader Chiang Kai-Shek took control of the county in 1928.

Chiang’s regime was not without its opposition. With the increasing appeal of Communism, a Communist movement emerged in China led by guerilla stalwart Mao Zedong. Beginning in 1927, Communist forces clashed with Chiang Kai-Shek’s nationalist government. Although the Japanese invasion of 1937 briefly united the Communists and Nationalists in China, the Chinese Communists continued to organize and build their forces behind the scenes throughout World War II.

By the end of World War II, nationalist forces were greatly weakened by the Japanese invasion, whereas the communist rivals were able to escape most of the damage of World War II.

With the dust settled, the Communists decided it was the perfect opportunity to strike. The Chinese Communist Revolution (1945-1949) cemented the communists’ foothold over China.

The only silver lining of this conflict was that Chiang Kai-Shek was able to retreat to the island of modern-day Taiwan, and establish the de facto Republic of China. Despite the successful push to create a new nation, the Chinese mainland has not recognized the newly formed country and has treated it like a rogue province ever since.

Setting a new path

Despite its retreat from the mainland, Taiwan began carving its own path to prosperity. The early years of the Taiwanese political experiment were rocky due to Chiang Kai-Shek’s authoritarian tendencies. Apart from obvious violations of civil liberties, the Taiwanese economy was under strict economic controls. Under Chiang Kai-Shek’s authoritarian grip, the country embraced import-substituting industrialization, which emphasized protectionism and the subsidization of strategic industries.

The results were rather mixed, since this model created a system of crony capitalism and facilitated considerable graft. The only bright spot was that Taiwan at least maintained some semblance of private property rights.

After Chiang Kai-Shek’s death in 1975, Taiwan turned a new page when it finally embraced multi-party democracy. Apart from free elections and the embrace of basic civil liberties such as free speech, the Taiwanese state started to take a more hands off approach to economic policy. Taiwan cut subsidies to strategic industries, reduced tariffs, privatized industries, and gradually opened the country to free trade.

From 1952 to 1982, Taiwan boasted an average growth rate of 8.7 percent, while its gross national product grew by 360 percent from 1965 to 1986. Taiwan’s success has continued into the 21st century with its per capita GDP reaching $48,095 according to the Heritage Foundation.

China vs Taiwan graphs
Click to enlarge

Devotion to markets: Taiwan’s secret weapon

Taiwan’s continued success is by no means a coincidence. Through the 2000s, Taiwan exercised considerable fiscal restraint. Specifically, from 2001 to 2006, Taiwan implemented several spending freezes that allowed the private sector to grow faster than the government. In this period of fiscal restraint, government spending fell as a share of total GDP.

The good news for Taiwan did not stop there. The country’s spending deficits also fell as spending was contained. One of the major fiscal riddles countries are faced with is the political class’s maintenance of big spending.

Out of control spending and deficits go hand in hand. As debt accumulates, future generations will be stuck with a hefty tax bill. Not only that, but big spending crowds out private-sector investment, thus creating a capital-deprived economy for future generations. In such cases of fiscal irresponsibility, governments are either forced to raise taxes at astronomical levels or turn to the printing presses to inflate themselves out of their fiscal quagmire. Not exactly a winning formula for attracting foreign investment.

Unlike other countries, Taiwan has doubled down on its market reforms. Chris Edwards notes that Taiwan in 2010 cut its corporate taxes from 20 percent down to 17 percent. This current rate is among the lowest corporate tax rates of developed countries. A favorable corporate income tax environment is a key ingredient for economic growth.

Countries do not live in an institutional vacuum these days. Their citizens respond to tax incentives the same way they do with prices. Countries with high corporate taxes, like the U.S. before 2017 tax reforms, face numerous challenges in attaining foreign investment. Due to increased tax competition between nations, multinational corporations will opt to set up their headquarters in low-tax jurisdictions and invest abroad.

Thankfully, Taiwan has not fallen for this trap and has become a regional leader alongside Hong Kong and Singapore as far as corporate tax policy goes.

On the other hand, its Chinese neighbor in the mainland can learn a thing or two from the island nation.

How Taiwan beats China

Taiwan’s more consistent devotion to market-based reforms has made it one of the biggest economic success stories in the past 50 years. But in some regards, Taiwan’s success tends to be overlooked by many commentators. In fact, its northern neighbor in China receives more praise for its recent shift toward embracing markets.

To some extent, some of this praise is warranted. Under the iron-fisted rule of Mao Zedong, China’s Great Leap Forward experiment was an unmitigated disaster. The Great Leap forward was a full-blown attempt to collectivize the Chinese economy and give total central planning power to the Chinese state. Private property and voluntary price signaling in the market place went out the window.

Not only did the Great Leap Forward destroy China’s productive sector, it left millions starving thanks to the central planning schemes that wrecked China’s agricultural sector. Mao Zedong’s reputation took a hit after this failed socialist experiment but it did not deter him from pursuing other means of social engineering.

The Cultural Revolution of 1966 to 1976 was Mao’s final attempt to impose the top-down vision of socialism on the Chinese populace. Like the Great Leap Forward, the Cultural Revolution was not conducive for economic growth and saw the civil liberties of millions of people trampled on. Thankfully, cooler heads started to prevail in China once a new leader in Deng Xiaoping emerged. Deng Xiaoping acknowledged that Maoism brought China tremendous harm and a new path was needed to bring the country back to its feet.

Deng introduced a series of economic reforms such as land privatization and the introduction of special economic zones to make China more competitive on the global market. Albeit limited in scope, China’s reforms had an immediate impact. Certain reports pin China’s annual GDP growth rate somewhere in between 9.5 to 11.5 percent from 1978 to 2013. From the start of Deng’s market-oriented reforms, China’s GDP increased tenfold. Consequently, millions of Chinese have been lifted out of extreme poverty.

That being said, China still has work to do and must continue to liberalize its economy. In fact, Taiwan’s steady dedication to liberalization, has allowed the country to easily stay ahead of China in both economic freedom and performance.

China is only ranked 110th on the Heritage Foundation’s Index of Economic Freedom, whereas Taiwan finds itself in an envious 13th place. The Fraser Institute’s Human Freedom Index likewise gives China questionable marks, placing it in 135th place. In contrast, Taiwan finds itself in 10th place. China’s per capita GDP is a middling $15,399. On the other hand, Taiwan’s per capita GDP is $48,095, which places it among the wealthiest countries in the world.

China still relies on state-owned enterprises as its flagship economic actors. Plus, the Chinese Communist Party continues to maintain an unhealthy relationship with the Chinese private sector. Since Xi Jinping took power in 2013, China has taken a more authoritarian turn in political affairs and this has permeated down to its economic policies.

China’s unsustainable Keynesian programs and cronyist relations raise many concerns on its long-term viability as an economic player. Taiwan has at least shown fiscal maturity by implementing spending freezes. It seems, however, that Beijing is content with its status quo of state capitalism.

Taiwan is a firm reminder that sometimes big things come in small packages. It also lends credence to Hayek’s assertion that smaller political units are more conducive to freedom.

In the Road to Serfdom, Hayek praised states like Switzerland and the Netherlands for maintaining smaller political units: “I believe that here the experience of the small countries like Holland and Switzerland contains much from which even the most fortunate larger countries like Great Britain can learn. We shall all be the gainers if we can create a world fit for small states to live in.”

Maybe it’s time economists give Taiwan its due as a viable model for economic growth.