Import Substitution and Export-Led Growth: A Study of Taiwan’s Petrochemical Industry
The question of how to explain the economic growth of Asia’s newly industrializing countries (NICs) has recently aroused much interest. The neo- classical view has been that growth can be explained chiefly by the adoption of export-promotion policies and hence by the reliance on the market mechanism. On the other hand, many others have stressed the role of the state in economic development. As early as 1962, Gerschenkron had stated that it is necessary for the state to remedy the lack of market institutions in the initial stages of development. Recently, Amsden’s (1989) work on South Korea and Wade’s (1990) on Taiwan have addressed this issue in the context of Asian NICs, both emphasizing the importance of the state’s ro1e.2 As Wade points out, however, more micro studies are needed to illustrate the state’s role at the sectoral level, i.e. to study the NICs’ industrial policy. This paper is an attempt in that direction.
Taiwan is no doubt a successful NIC in terms of its growth record in the last three decades. Among Taiwan’s industries, the petrochemical sector is not only one of the most important but also one of the most vertically integrated. If we include not only the chemical material sector but also the chemical product and plastic product sectors, in terms of value-added, their share in the manufacturing sector and the GDP rose from 5.5% and 1.1% in 1960, to 10.8% and 3.2% in 1970, and to 15.22% and 5.4% in 1989, respectively.’ (See Table 1.)
This paper looks at the growth history of this capital-intensive industry in Taiwan, focusing on the role the government played in fostering the industry’s growth. It uses this case study to test the validity of the various aforementioned views on the causes of NIC growth. We find that the government did play a leading role in bringing the petrochemical material sector into existence. The continued growth of the downstream export sectors, i.e. the plastic products and textile and apparel sectors, provide possibilities of backward linkage. The government itself, however, undertook the most upstream and capital-intensive part of the operation, i.e. naphtha cracking, at a time when private capital was still unable or unwilling to do so alone. Only the well-connected were encouraged to enter and become the next-stage processors.
The price of petrochemical materials sold by the government naphtha-cracking plant has been an important policy tool. The government set the price below-market after it changed its pricing formula in 1982, while there is evidence of subsidization before 1982. The sector’s growth rate has been impressive throughout this period, except during the second oil crisis. Increased subsidization since 1982 has had no notable impact on the sector’s growth, while the sector has enjoyed above-average profit rate. This is consistent with the observation that the state’s industrial policy lost its sense of direction as the business influence in politics increased in the 1980s.
2. A CHRONOLOGY OF DEVELOPMENT
The petrochemical sector is a very capital intensive industry. Thus, its development in the early stages of Taiwan’s industrialization requires special investigation. It would certainly be easier to explain the growth of Taiwan’s labor-intensive export sectors at that time. Moreover, the petrochemicals and vert- tally related industries form one of the few vertically integrated sectors in Taiwan. Using ethylene capacity as a guide, Taiwan’s petrochemical industry ranks 14th in the world in 1991.
Before we try to address the causes of the industry’s development, an examination of its history is presented in this section.
(a) Definition of the industry
For illustrative purposes, it is helpful to denote three vertically linked production stages (see Table 2).The first input in this chain of production, naphtha, is a byproduct of petroleum refining. The petrochemical industry is hence related to the petroleum-refining sector. The usual definition of the industry, however, includes only sectors I and II as defined in Table 2.
The focus of the paper is thus on these two sectors.
The general background of Taiwan’s development can be found elsewhere4 and will not be discussed here. The postwar history of Taiwan’s petrochemical industry can be roughly broken into five periods.
(i) The predevelopment period, 1949-57
In 1945 Japanese colonialists left Taiwan with a refinery and several small fertilizer plants among other things. The Nationalist government set up public enterprises to take over all of these colonial operations. The emphasis in this postwar recovery period of industrial development, however, was on providing fertilizers for the agricultural sector.
(ii) The second trialperiod of development, 1957-67
The government-owned Chinese Petroleum Corporation (CPC) started producing benzene (sector I products) using its own facilities in 1959, and this was the beginning of the industry in Taiwan. In 1963, it entered a joint venture with foreign firms to produce ammonia and other products. Production of a few other sector II products, such as PVC and methanol, also began at this time, using imported inputs.
The government implements its policy change in 1960, switching from import substitution to export promotion. The export of labor-intensive manufactured goods began to grow rapidly in the latter half of the 1960s. The share of industrial goods in total exports hence increased from 46% in 1965 to 79% in 1970. The potential demand for local intermediate inputs grew accordingly. Among Taiwan’s early manufactured exports, plastic and textile products were star performers, hence the demand for their respective raw materials was high. Although this demand began to arouse some attention, the government’s plan to build the first naphtha cracker was only a testing of the water, and it had as yet no intention of treating this sector as a target industry to be promoted. The private sector’s response was also lukewarm at best, i.e. only two investors participated in this first phase of the development, and one was a foreign firm.
(iii) The third period, 1968-73
The CPC’s first naphtha-cracking plant began operation in 1968. It provided inputs to two plastic- material companies, which produced LDPE and VCM respectively, two sector II products. The two companies, which had just been set up, were private, while the sector I producer, the CPC, was public. In addition, the CPC built its first aromatics plant in 1970, and its subsidiary, CPDC, built an ethane cracker in 1973, using natural gas instead of naphtha to produce feedstocks.
The accelerating downstream growth in this period led the government to plan more naphtha crackers, and the results can be seen in the next period.
(iv) The fourth period, 1973-84
Incorporated as part of its ambitious lo-project development plan undertaken at that time, the state clearly demonstrated its resolve in building up a petro- chemical sector in Taiwan during this period. The CPC built the naphtha cracker and the government decided which private firms should set up facilities to process its flow of output.
The construction of the second naphtha-cracking plant began in 1970 and was completed in 1975.
Planning of the third and the fourth were initiated in 1973, but the ensuing oil crisis dampened the private sector’s enthusiasm and delayed the completion of the plan.” The third cracker began operation in 1978, with the fourth following in 1984.
(v) Thefifth period, 1984 to the present
Around 1980, in the midst of the recession and the second oil crisis, the government decided to postpone the construction of the fifth cracker indefinitely. It was felt that in the 1980s the petrochemical industry, being capital, energy, and pollution-intensive, was no longer a suitable target industry for Taiwan, a small island economy with few natural resources.
The direction that economic policy took was certainly affected by the political scene. Many changes took place in the latter half of the 1980s: the lifting of the marshal law and the onset of political reform; economic liberalization in the area of foreign exchange, commercial policy, and domestic financial markets, etc.
During this turmoil in 1986, the decision to post- pone the fifth cracker was reversed, but opposition from the local environmental groups delayed the construction until 1990. The fifth one is now expected to be completed by 1994. The building of the sixth cracking plant, initiated by the Formosa Plastic Group, a private conglomerate, was approved in 1990, but delayed until 1993 due to difficulty in finding an appropriate site.
Due to a lack of new facilities and the closing of the first plant, sector I’s output has declined in this period and will not grow until the fifth plant begins operation in 1994. In the meantime, sector II continues to expand its capacity, hence creating pressure on the state to build the fifth plant and more.
Table 3 lists the annual growth rates of the three sectors.’ On average, sector II of the plastics and the man-made fiber sector grew 16.8% and 29.5%, respectively each year during 1970-89. This growth rate of plastics is lower than that of its own downstream, while the growth rate of the man-made fiber is higher than that of its own downstream. Nonetheless, this growth rate by itself is quite significant even for a young industry.
After all this development, several of the vertically linked production stages were present in Taiwan, that is, from the most upstream, naphtha cracking and petrochemicals, to the most downstream, the textile and plastic products. This is not the norm in Taiwan’s highly internationalized industrial structure, where raw materials and intermediate inputs consist of over 70% of total imports in 1990. The other exception is the steel sector, where the major integrated steel plant is run by the China Steel Corporation, another public enterprise.
(c) The state’s involvement
Since the government has intervened in various ways in the development of Taiwan’s petrochemical
industry, it is necessary to list separately the history of its involvement As mentioned above, the state initiated the process of building up sectors I and II. When the government decided to build the naphtha-cracking facilities, or before it began actual construction of the plant, it gathered a group of investors/firms which would build plants (sector II) to process the petrochemical materials the government plant was to produce. The exact terms offered to induce them to do so are not clear. The success of the emerging sector II depended upon several factors, besides the usual ones consuming the overall investment climate: (a) secured local input supplies provided at favorable prices; (b) ready- made local output market; (c) availability of the necessary capital, land and managerial labor.
The government offered much help in securing these necessary ingredients of success. It built and operated the input production facilities, and supplied raw materials to sector II operators, that is, it took care of (a) directly. The price of these basic materials thus also became a policy tool. Whether, or to what extent the government distorted or replaced the market in this connection will be discussed below.
As for (b), the state used trade controls to ensurethat imports of sector II’s product would be restrictedas long as domestic prices fell within a reasonablerange, which is usually defined to be the internationalprice plus some appropriate CIF costs. At the sametime, exports of sector II’s products were not allowed unless domestic markets were first satisfied.”
The government also rendered assistance in termsof (c). It built the petrochemical industrial park andoffered firms help in financial matters. Moreover,quite a few top managers of the new sector II plantscame from the CPC. The government-owned petrochemical giant, though producing mainly oil-basedproducts other than petrochemical materials, provedto be a training ground for the human capital needed to manage sector II’s operation.9 The main source oftechnology transfer still, of course, remains foreigncompanies.‘
The state played the role of entrepreneur, investor,and organizer in the initial stage of development.Other policy tools were also used, such as trade controls, selective credit allocation, tax incentives, andland allocation. When the whole industry was almostnonexistent, when private capital was weak andunable and unwilling to undertake the project and bearthe risk, the state planned the project, built and operated the naphtha cracker itself, organized sector II’soperation, and groomed a group of private capitalinvestors for the task.
In retrospect, it can be said that, by getting private capital involved in the project, the government actually granted them a near-monopoly franchise, considering the fact that later sector II markets tendedto be rather oligopolistic in most cases or even monopolistic in some. This is so despite the fact that at thetime, they might have been reluctant to join theproject.
The government’s sectoral industrial policy, however, has been changing. In the late 1980s it approvedthe construction of the (CPC’s) fifth and the (private)sixth cracker, both of which it vetoed 10 years earlier.
The pricing formula for its sector I products was drastically altered in 1982. Trade control measures wereabolished in 1986, during the sweeping trade liberalization.
The state still offered many incentives to helpthe Formosa Plastic Group to build the plannedsixth cracker. This time, however, besides the usualtax and financing incentives, the measures included subsidies and assistance in acquiring land,reflecting the effect of rising land value in Taiwan.
This event is still unfolding” and will not be discussedhere.
3. EFFECTS OF THE STATE’S ACTION
The main question here is how this capital-intensive sector developed in Taiwan. The overall advancement of capitalism in Taiwan, of course, needs explanation, though we will not attempt any here. Itcertainly is easier, however, to explain the emergenceof the most labor-intensive type of export sectors, thanthat of the capital-intensive petrochemical sector, considering the relative scarcity of capital at the earlystage of development.
The focus here, however, will be on whether and towhat extent the state’s action has been responsible forthis sector’s development. The fact that the state hasalways been heavily involved in this industry, whatmight be termed the “input” side, we have describedabove; that is what might be called the “input” side .
How effective its involvement has been, i.e. on the“output” side, will be discussed in this section; andvarious related hypotheses will also be tested usingthis particular case study.
The government was heavily involved in establishing industrial activities during the early 1950. Afterthe export-led growth began in the 1960s its involvement in the downstream labor-intensive export sectorsbecame more general and indirect. On the other hand,the government let public enterprises undertake production in some of those capital-intensive upstreamsectors. The degree of success of these undertakingsvaries. Further studies are needed to assess its effects.
The CPC also produced other petro-based products,which enjoyed monopoly status and profits. Overall,the CPC itself is doing well, but how much is due to itsinvolvement in the petrochemical sector will be discussed later in the paper.
(a) Neoclassical or Gerschenkron
In the neoclassical view, the success of Asian NICs lies in their adoption of export-promotion policies and reliance on the free market. The government’s role is minimal and, if intervention exists, it minimizes price distortion. This case study offers little support for this view. The government has played a pivotal role in the establishment of this industry, as the previous discussion has shown.
The salient feature of the development of these vertically linked sectors is that the downstream (III) sector developed first through export growth and provided occasion for backward linkages. The sequence of events is clear, that is, sector III developed first, sector I next, and sector II last.” The downstream sector provided possibilities of backward linkages to sectors I and II, while sector I provided forward linkage to sector II.
Entering sector II to produce for a captive domestic market did not seem profitable to many at the beginning, therefore when the CPC set up the first cracking plant, it found few takers of its output.” The government simply created sector I itself, and fostered sector II’s development by treating it as an infant industry.
Whether market failures were present at that time to “justify” the government’s intervention in this sector is not of concern here. It suffices to point out that the intervention indeed occurred and Taiwan began to have a thriving petrochemical sector as a result.
Some may question the wisdom of building up a capital-intensive sector in a less developed country (LDC) such as Taiwan at that time,” considering the relative scarcity of the capital input. But, as Taiwan entered into its next stage of development in the late 1980s as its labor-intensive exports began rapidly losing competitiveness, the advantage of having established the mid- and upstream beforehand clearly manifests itself.‘” This paper shows that the sectoral industrial policy helped to create Taiwan’s future competitive advantage.
Looking at it from another angle, the Gerschenkron hypothesis seems appropriate here. If we ignore the static concerns of market failure, the sectoral industrial policy certainly seems like a way of creating institutions in place of the nonexistent market in a developing country.
(b) Subsidy and pricing policy
The previous subsection is mainly concerned with the role of the government in the initial stage of the industry’s development. This subsection will discuss its other role, i.e. whether it has subsidized the day-to- day operation of sector 11 firms after the initial setting- up. Amsden (1989) argues that late learners such as South Korea and Taiwan have no technological advantage to speak of, and hence have to rely upon government subsidies in order to get any capital-intensive operation started. The validity of this hypothesis will be our concern here.
Besides one-time favors given during the setting up stage, the privilege of having easy access to subsidized loans persisted. Most importantly, however, did the government subsidize the day-to-day operation of sector II by supplying the petrochemical raw materials at below-market prices? The answer is a qualified yes.
That is, subsidization most likely existed and continues to exist, and the degree of subsidization has increased since 1982. The proof, however, may not be straightforward.
(i) Evolution of the pricing policy CPC’s pricing formula of these petrochemical materials is set by the government, and is hence a policy tool. Sector II firms, of course, have always lobbied to make the formula more favorable to them. The formula has been modified many times since the first naphtha cracker was completed in 1968.
The pricing formula was based on CPC’s cost considerations before 1982. At the beginning, prices were adjusted only when the oil prices increased significantly. After the first oil crisis, the pricing formula began to include some cost factors other than the oil prices.” The major change occurred in December 1981, when the government decided to set the feed- stock price on a par with the US contract price, the supposedly lowest contract price in the world, disregarding any cost considerations.
Table 4 shows that the price CPC charged on ethylene was higher than the US contract price before 1982 and lower than that afterward. Changes in CPC’s price, however, were almost parallel to those of the US prices even before 1982, indicating that changes in CPC’s price had followed those of the international prices though it was supposed to be cost-based changes. The fourth column of Table 4 lists PD, the difference between the CPC’s and the US ethylene prices as a ratio of the US price. It shows that the CPC’s price was in average 23% higher before 1982, and 4% lower after 1982.
(ii) Did subsidy occur?
Though the evidence is not absolutely conclusive, it can be said that there was a subsidy and the evidence is much stronger after 1982 than before.
Evidence 1: From data provided by the CPC itself, the company sustained losses in this part of its operation, i.e. petrochemical material production, during 1980-88. The accumulated losses amounted to NT$24 billion in total for that period of time (see Table 5). The share of the petrochemical materials in CPC’s total operating cost has been consistently greater than its share in CPC’s total revenue. CPC’s other products are mostly oil-related products which enjoy monopoly status in the domestic market. Thus, at least from these data, cross-subsidization is evident, that is, monopoly profits from other products help to cover losses from providing petrochemical materials to sector II firms.
Continuously lobbying for lower material prices, the local sector II firms have long disputed these data, arguing that CPC’s joint production costs have not been properly calculated and distributed between the two operations, and that CPC’s efficiency is also questionable. It is not possible for this study to verify these two issues. Properly assigning joint costs is always a thorny issue. Given the same method of calculation, however, the fact that CPC’s profits in this part of its operation turned negative in 1980 and did not improve until 1989 at least confirms the increase in the degree of subsidy during the 1980s.
Evidence 2: After 1982, the price the CPC charged is the US contract price, but this does not include transportation costs, or tariffs, or any other CIF type of costs, that is, it is FOB pricing. The price that sector II firms charge the downstream firm for the materials, however, are CIF-based plus taxes, etc.”
The policy objective is supposedly to maintain international competitiveness of Taiwan’s exports, and to maximize the value-added in those exports. Until the late 1980s the exporting sectors were the downstream sector III. Thus, protecting competitive- ness directly concerns the input prices this sector faces. If to be charged CIF prices does not hurt sector III’s competitiveness, then why should sector II face FOB prices?
Since charging international CIF prices is the accepted market practice, the government is indeed
subsidizing sector II by charging below-market prices.*l At the same time, it does not require sector II firms to pass on this “benefit” to the exporting sector III, that is, it does not intend to subsidize the latter.
The government seems more concerned with the second objective than the first. It is hard to verify whether or to what extent subsidization occurred in the period before 1982.22 In terms of Evidence 1, the CPC’s profits began to decline significantly in 1979 and turned negative in 1980-81 (see Table 5). The government obviously was trying to shelter sector II from the impact of the second oil crisis.
Judging from the growth record of sector II, it is difficult to believe that they suffered much injustice in terms of input costs before 1979. Between the two oil crises, 1975-80, the average annual growth rate of output was 26% and 59% for the plastic materials and man-made fiber materials respectively. These are rather high levels of growth for “infant industries.”
Moreover, they were target industries promoted by the government, and hence unlikely to be treated unfavorably. The price difference ratio in Table 4, showing the CPC’s price as higher than in the United States in 1975-80, is not necessarily a good indicator of how the CPC’s prices deviated from the international price anyway, for reasons discussed above. Though it is not easy to verify if subsidization occurred before 1979, it certainly seems likely that it did. Thus, to conclude, subsidization did occur after 1982, and probably occurred before 1982 as well, and the degree of subsidization increased after 1982.
(iii) Did subsidization work?
The price of the petrochemical materials, no doubt, has been an important policy tool for the government.
The previous discussion leads us to believe that subsidization did occur. The overall effect of subsidy on growth is difficult to assess, though the growth record of the target industry is quite good. The change, however, in the pricing formula in 1982, i.e. an increase in the degree of subsidization, is a noticeable event. As the policy change purported to promote sector II’s growth, the growth records of the two periods, before and after 1982, should differ.
The regression method is employed to evaluate the effects of the change in subsidy on sector II’s growth. The price difference variable (PD), as defined in Table 4, is used as a proxy for the degree of subsidization. The results, however, did not turn out as expected. Sector II includes mainly the plastic material, the man-made fiber material, and the synthetic rubber material subsectors. The synthetic rubber subsector is the least important and is therefore left out.
The regression equation to be estimated is as follows:
PLAQ and MMFQ are the output level of the six major plastic materials, and the four major man-made fiber materials, both measured in metric tons. Down - Q, and Up - Q, are the downstream and the upstream production indexes for the PLA and MMF sectors. The latter two are used to test the effects of the backward and forward linkage. The data used are annual figures for 1976-90.22
The regression results, as listed in Table 6, show that the PD variable is not significant in most cases, while the other two are much more significant. The Up - Q variable better explains the MMF material production, while the Down - Q variable interprets the PLA material production better.2’ It would require further studies to ascertain why the effects of the for- ward and the backward linkage differ in the two sectors.**
Other formulations have also been tried, and the results are consistent with our findings, that is, that the PD variable is not an important explanatory variable with regard to sector II’s growth.26 There are, of course, other factors which may influence sector II’s production level. The observation period, however, is too short for us to investigate all of their possible effects.
The result hence indicates that the change of the pricing policy and the CPC’s deviations from the US prices did not matter much in sector II’s growth. A reasonable interpretation is that the expansion of this sector, in between the upstream and the downstream, really depends upon the growth of the other two vert- tally linked sectors. For various reasons, the export ratios of this sector are quite 10w.*~
As discussed above, sector II’s healthy growth in the pre-1982 period demonstrated that it was not hampered in any way by the CPC’s selling prices. The lowering of the CPC’s prices after 1982, though initially helping to cushion the blow of the recession at that time, simply gave sector II firms nice bonuses rather than indispensable incentives to expand and
Table 7 lists the average rate of return on assets of various sectors. The chemical material sector enjoyed rates of return higher than average in all years except in 1981-83. This finding, that extra subsidies after 1982 contributed mainly to sector II firms’ extra profits and not to their growth, begs the question of why the subsidy took place, which will be discussed next.
(iv) Reasons for changing the formula
The reason often mentioned as to why the pricing formula was changed in 1982 was that it was necessary to rescue the sector from the oil crisis. At that particular moment, right after the second oil crisis, the petrochemical sector was depressed, and several foreign joint-venture partners concurrently decided to pull out. This is also the only period in which sector II had below-average profit rates (see Table 7). This sector, however, is known worldwide to have large swings in its business cycles, due to its capital-intensive nature.
Whether sector II firms would have survived the crisis without the policy shift is not possible to ascertain, but the change in pricing formula had long been advocated by those with vested interests. The crisis atmosphere certainly helped to realize this policy shift.
This sector had been a target industry ever since its birth, so it is not surprising that it should receive special help during a crisis. Nonetheless, rescue operations by definition should be short-term or temporary.
The government did not reverse the policy after therecession/crisis was over. This suggests the reasonsfor the policy shift are not limited to the crisis.
The reasons for the shift have to do with concentrated market power and its political implications inthis particular sector and in the overall economy. Themarket structure of sector II had been rather oligopolistic, with only one or two firms in each of the product markets. In an economy where small and medium sized firms dominate, the sector II firms are relativelylarge and well-connected and hence can easily beheard. Moreover, their absolute size and relative sharein the economy, in total and individually, have continued to grow, hence their political influence.”
Similar changes have also occurred in the overalleconomy. The increase of the capitalist influence inthe political sphere during the 1980s is striking, compared to the postwar era in which the governmentplayed a leading role. Further mixing politics withbusiness, from the late 1970s on, the financial interests of Taiwan’s ruling political party, the KMTbegan to enter into sector II, among other sectors, byholding minority interests in some eight companies.”
The supposedly short-term rescue operation, i.e.changing the pricing formula, thus turned out to be a rather permanent one. The formula was changed once again at the end of 1989, to take average of the US and the European prices. The change, heavily lobbied by the producers, occurred only because the European prices became cheaper than the US ones at that time.?”
The fact that the increased subsidy did not seem to have affected sector II’s growth, and, from previous discussions, that the government was not concerned whether the benefits of subsidy trickled down to the exporting sector III, and that the government reversed its decision made in 1980 to limit the further development of this industry, is also consistent with our discussion here. The objective of industrial policy hadbecome blurred.
(c)Export promotion vs. import substitution
Many have used the growth record of Asian NICs to conclude that export promotion is superior to import substitution as a development strategy.
Taiwan’s overall outward orientation is beyond doubt, but this case study indicates that the government has been pursuing secondary import substitution to maximize domestic value-added per exported product. The extent of the state’s involvement was much greater than merely providing the “right” incentives; it played the role of entrepreneur. Other policy tools were also used.
The evidence goes beyond this industry, of course, though its full extent cannot be dealt with here. The state has consistently pushed local content requirements” and helped to foster backward linkages wherever possible. South Korea is very similar in this respect, the extent of its involvement perhaps even greater. Both Taiwan and South Korea have been used as strong cases supporting the correlation between outward orientation and growth, but the complementary role of import substitution has not been fully appreciated and hence has been under evaluated. It would thus be misleading to derive any policy implications from the growth record of Asian NICs without recognizing this fact.
If the down stream’s final output is meant for the domestic market, then government protection can easily do the work, i.e. the consumer would be forced to bear the cost. But here the final product is headed for the export market. Since the goods have to be sold at competitive international market prices, the down- stream obviously cannot afford to subsidize the local intermediate input producers. Thus, outright protection with no strings attached simply would not work in this case. This is one area where there are two types of import substitution: one is purely inward oriented and the other is complementary to export promotion.
Some would no doubt treat the NICs’ venture into capital-intensive sectors as mistakes, which are either to be ignored” or viewed as waste or inefficiency.” An infant industry will show static inefficiency during its infancy, but it will improve if learning does take place.
Failure results when learning does not occur and protection entails industries’ staying moribund. The merit of industrial promotion lies in stimulating dynamic growth, and should be judged from this perspective.
More importantly, what is needed is a longer term evaluation of the state’s effort in maximizing domestic value-added and secondary import substitution.
Questions such as the following should be investigated in the future: how valuable is the presence of the upstream to the growth of the downstream; whether the promotion of the upstream exactly precedes its later full-blown development; how important is the nurtured growth of a national bourgeoisie to future development, etc.
(d) “Leading” or “following” the market?
Stressing the role of the state, as opposed to relying upon the “free market” in explaining the emergence of Asian NICs, Wade (1990) introduces a distinction between the government “leading” and “following” the market. The criterion used to distinguish between these two types seems to consist of the intention of the firms involved and whether the project was ahead of its time.34 The latter refers to, in particular, phenomenon such as “fast growth occurred before changes in comparative advantage” and “resulted from the state acting in anticipation of changes in comparative advantage.“”
Judging from the fact that the state played an active role as the entrepreneur/organizer in promoting the petrochemical industry, the only way to refute the importance of the developmental state in this case is to assume that whatever the state has done here was either to simulate the market and/or to replace the private enterprises instead of promoting them. The simulation theory is hard to prove or disprove completely, though its explanatory value seems rather small.
Economic development has to be an historical process, not only for the whole economy, but also for the individual capitalist. When the level of capitalist development is still low, the individual capitalist remains small, and the amount of capital he can raise in the “free” market without government help is likewise small. Thus, at this level of development, it is unlikely to have the “free market” to generate capital intensive investment.”
If we look at the economic environment during the time when the petrochemical sector was being promoted, it would be hard to find a substitute in the private sector to play the role actually undertaken by the state then. For private capital at that time was either too small or unwilling to bear that kind of risk. When the state was organizing and setting up sector II, even though the overall risk should have been reduced by the state’s show of commitment, many of the private firms contacted were reluctant to join, a far cry from the current situation. Thus, the state had difficulties in arranging to have all the feedstocks processed by sector II firms. The capital-labor ratio of sector I and II was also considerably above the industry average then and now. Thus, it seems fair to conclude that the state action was ahead of its time.
Does it then make sense to say the state was “leading the market” in this case? The answer would be yes in the sense that the private sector would not have done the same thing without state interference. It should not imply, however, that there is a “market” which objectively determines in which industries a particular economy could specialize, and that the state was able to anticipate the market.
The state, in this case, may have been simply trying to foster the upstream sectors of established down- stream export industries for maximizing local value- added of exported products. The latter has been the state’s unwavering goal for the past three decades in Taiwan. On the other hand, it is widely accepted that growth usually means climbing up the ladder of the international division of labor, i.e. the relative capital and technology intensity of the exported products would increase with development. It requires no sophisticated studies for the state to understand that it should move in this general direction.
Moreover, although the general direction may be clear, what might become the next set of sunrise industries is not clear. The action of the state itself, along with the condition of the economy and the changing international competitive situation, would together determine which industries would succeed in the next round. To assume that there is a set of events predetermined by the “market” and which could be anticipated by the state seems counterfactual.
Rather than using the phrase, “leading the market,” we suggest that replacing the word “market” with “development” would be helpful. What the state did in the early stage was actually to ignore the short-run static market concerns, and instead, to focus on long term dynamic considerations. In other words, it was leading the development process and ignoring the “market.” As discussed above, the state did not “follow the market” in the later period either. Instead, it followed the guide of vested interests rather than that of overall developmental goals. Market concerns are short run in nature, thus “leading or following the market” may not be such a useful distinction after all, especially when dynamic growth or development is in question.
This paper examines the role of the state in the development of the petrochemical sector in Taiwan in the last two decades. It is found that, contrary to the neoclassical view, the government played a crucial role in the initial stage, i.e. taking on the role of entrepreneur, investor, and organizer all at the same time while private capital was unable and unwilling to undertake such a project. When grooming private capital for the task, the government granted private capital many favors.
As for day-to-day operations, however, the state/CPC had been subsidizing sector II by providing feedstocks at below-market prices after the pricing formula change in 1982. Subsidization probably also occurred before 1982, though to a lesser extent, but this part is more difficult to prove. This confirms Amsden’s (1989) hypothesis regarding the necessity of this type of subsidy. It is somewhat ironic, however, for subsidies, if needed at all, should be provided in the early stage of the development to assist learning, rather than in the later stage after a successful start has already occurred.
This trend reflects the fact that the private sector has grown stronger relative to the state as a by-product of Taiwan’s economic growth, and that the state’s autonomy has declined as a result. The state may have been “leading the development” in the early stages of Taiwan’s development in the sense that its role then could not have a substitute in the private sector. It has become the one led in the later period, however, and led moreover by some vested interests.
One main reason the state succeeded in fostering the development of the petrochemical sector was the continued presence of the thriving downstream export sectors. Certainly, the requirement that the down- stream sector has to maintain its international competitiveness imposes strict discipline on its upstream suppliers.
This case study supports the view that the NICs’ success cannot be explained simply by the use of the market mechanism. It was not “a simple choice between market mechanism and state intervention”“; nor was it between export-promotion or import-substitution policy. Actually, the import-substitution promoted by the state, reflecting its develop mentalism, not only was complementary to the overall exportpromotion strategy, but also was used to sustain the long-term success of export-led growth. Thus to base the superiority of export-promotion on the NICs’ record is misleading.
The state has obviously helped to foster the growth of the capital-intensive upstream, but its effect on the economy’s long-term growth needs to be explored further. The welfare implications also have to be investigated in the future, especially because the environmental impact of this highly polluting industj has been ignored until recently. This paper has focused on growth per se.
What then are the policy implications from this case study? The role of the state in substituting the market mechanism in late-comers has been emphasized by many, such as Gerschenkron (1962). This study supports this general approach, in viewing the role of the state as a necessary condition. It lends only partial support to Wade’s “governing the market” the sis though,j8 for it shows a state leading the development process in the early stages out of necessity, not one leading it because of being able to “anticipate the market.” The fact that the state’s goal and behavior would change over time indicates that the nature of the state cannot be taken for granted, even for NICs, and should be examined along with its social background.
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Import Substitution and Export-Led Growth: A Study of Taiwan’s Petrochemical Industry
Import Substitution and Export-Led Growth: A Study of Taiwan’s Petrochemical Industry