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Taiwan: An Island of Stability No More?

By Bruce Einhorn During the great Asian financial crisis of 1997-98, Taiwan stood out as an island of stability. Southeast Asia collapsed, South Korea crumbled, and even Singapore and Hong Kong suffered, but Taiwan managed to sail through the crisis virtually unscathed. Yes, the island's currency weakened slightly, and growth slowed down a bit. But Taiwan did not endure recession, let alone the massive social and political headaches that its neighbors suffered. Finally, however, it seems that Taiwan's luck may be running out.

Taiwan owed its good fortune largely to its thriving information technology industry. American businesses and consumers gobbled up desktops, notebooks, and peripherals produced by Taiwanese contractors for American giants. Your computer might say Dell, Compaq, or IBM on the outside -- but chances are good that it was actually made by Quanta, Compal, or Arima, three of the biggest Taiwanese companies producing PCs on an OEM, or original equipment manufacturing, basis.

Anonymity was good for such Taiwanese companies. Sure, they didn't get their names out there for American consumers to see, but so what? The Taiwanese smartly recognized that the computer marketing business was not going to be one of their strengths, so they left that to the Americans.

MAXED-OUT FABS. The Taiwanese followed a similar strategy in the semiconductor industry. They became major players in the foundry industry -- in which companies with multibillion-dollar chip fabs produce semiconductors on a contract basis for others. Again, there's not as much glory involved, since the foundry doesn't market the chips itself. But the Taiwanese didn't need to do that to succeed.

And succeed they did: Taiwan Semiconductor Manufacturing Corp. and United Microelectronics Corp. became the world's No. 1 and No. 2 foundries, respectively. A year ago, the fabs of both companies were so busy that they were maxed out, running at 100% capacity.

But that was then. Now the economy is showing weakness, with unemployment rising, bad debts worsening, and the stock market faltering. Ironically, what was once Taiwan's greatest strength is now one of its major problems. What helped Taiwan during the crisis years -- the island's close ties to Silicon Valley and the rest of the high-tech American economy -- is now hurting, as demand in the U.S. for the island's electronics gizmos slackens.

THIN SAFETY NET. On the face of it, some of the problems don't seem that severe. Sure, unemployment is rising to record levels, but the jobless rate is still around 3%. That's the sort of unemployment problem that a lot of Western European countries would love to have. Still, Taiwan isn't France or Spain. Most Taiwanese don't have the option of spending months or years on the dole. Taiwan is used to full employment, and the country has little in the way of a social safety net to help the jobless survive the pain associated with layoffs. As a result, the current unemployment rate -- even at the present levels -- causes considerable distress to people.

Likewise, the level of bad debt doesn't seem that alarming. The official rate for nonperforming loans is around 5%. Compare that to a place like Thailand, where bad-debt levels hover in the 30% range, and that's after experiencing major improvement last year. Back in 1998, at the peak of the financial crisis, almost half of all bank loans in Thailand were duds. But most analysts believe that the official numbers in Taiwan aren't reliable, with a lot of bad debt disguised as good. The real rate of NPLs, therefore, is likely in the double digits.

Perhaps most troublesome, though, is the performance of Taiwan's electronics sector. The island's biggest computer maker, Acer Inc., had a terrible 2000, and its stock price fell 80% for the year (see BW, 1/15/01, "For Acer, a Bad Year Turns Brutal"). Other computer makers performed better but still slumped. And the near-term future doesn't look promising, as demand for PCs in the U.S. may continue to be slack.

OBSOLETE MODEL? But it's not just the threat of a recession in their main U.S. market that should worry the Taiwanese. After all, with the Fed slashing interest rates aggressively, the U.S. economy may still avoid a hard landing. And even if the U.S. falls into recession, the slowdown is unlikely to be a long one. More important for the Taiwanese economy, the island's business leaders and policymakers also have to be concerned about some long-term problems.

The real problem may be that Taiwan's business model shows signs of becoming obsolete. Producing PCs on an OEM basis worked fine in the 1990s. But what about the new decade, one in which demand for computers is faltering and may continue to fall?

Some of Taiwan's rivals in the contract manufacturing business -- companies like Flextronics and Solectron -- foresaw this possibility and diversified their product lines into non-PC business such as storage systems, servers, and networking equipment. Even with the popping of the dot-com bubble, those Internet-related sectors are still likely to grow well in the coming years. But Taiwan, while a powerhouse in the PC, is not much of a player yet in those businesses.

One thing to keep in mind: It's never a good idea to write off the Taiwanese. Having survived over five decades in the shadow of archrival China, the island's people have experience withstanding intense pressure. That's good for Taiwan, because signs are that the pressure from this latest economic storm will be intense, indeed. Einhorn covers technology from Hong Kong for Business Week. Follow his weekly Online Asia column, only on BW Online

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