Rethinking Import-

substituting
Industrialization
Development Strategies and Institutions
in Taiwan and China

By : Tianbiao Zhu
UNU World Institute for Development Economics Research
(UNU-WIDER) | July 2006
 ABSTRACT
• The paper explains Taiwan and China’s economic success based in the shift
from an import-substituting industrialization (ISI) strategy to an export-
oriented industrialization (EOI) strategy.
• This paper argues that the development strategies in Taiwan and China have
always been a combination of ISI and EOI strategies during their entire
miracle-creating period.
• Export promotion was used in both cases to sustain ISI, which has always
been the central focus of development.
• Key institutions played a central role in both Taiwan and China in supporting
ISI, in particular, the government, the bank sector, public enterprises, and
their relationship.
 INTRODUCTION
(ISI) & (EOI) as the deriving forces for economic miracles
• Economic miracles created by Taiwan in the 1960s and 1970s and China in the
1980s and 1990s are debatable.
• One of the central arguments on how the miracles were created has been the shift
from import-substituting industrialization (ISI) strategy to export-oriented
industrialization (EOI) strategy in both Taiwan and China.
• (ISI) emphasizes infant industry protection, aiming to replace imports with
domestic products, while (EOI) stresses exports and upgrading one’s industrial
structure from labor-intensive to capital-intensive industries gradually as exports
make the initial success.
 INTRODUCTION
Differences and similarities between Taiwan & China
• Differences between Taiwan and China are represented in the fact that China has a
much larger internal market. China is also a regional power if not a world power,
while Taiwan is small and without much political and military power.
• However, the two cases share some similarities. Taiwan of the 1960s and 1970s was
firmly ruled by a radical and leftist party. socialism thought was prevailing. Taiwan
had one of the largest public sectors in the noncommunist world.
• Therefore, Taiwan and China have a compatible political and economic foundation,
especially in the two miracle-creating periods, that is, Taiwan of the 1960s and
1970s and China of the 1980s and 1990s.
 INTRODUCTION
Differences imply different capabilities
• The differences make Taiwan a hard case to study. When market size is small,
import-substituting industries can quickly fill the market with their products,
and further expansion of such industries is therefore limited.
• A large country has a large domestic market, so it is relatively easy for such a
country to engage in ISI. China is not only a large country but also a regional
power. There was an emphasis on the development of heavy industry since
1949 and continued even after China opened to the world in the early 1980s.
• Taiwan has a small market; it is therefore hard to sustain ISI, so it needs an
extra push to combine ISI and EOI strategies.
 ISI in Taiwan’s policy transition
1.The conventional view 2. Explaining policy
and its problems change and continuity
 ISI in Taiwan’s policy transition
1.The conventional view and its problems
Four Phases for industrialization
• Taiwan’s post-1949 industrialization is often divided into four phases:
• (1949 - late 1950s): Taiwan engaged in primary ISI, shifting from imports to the local manufacture
of basic consumer goods (textile, food, and other labor-intensive industries).
• (1950s - late 1960s): was an era of EOI focusing on labour-intensive products. In this period,
Taiwan’s economy began to take off, and rapid industrial growth was maintained for more than two
decades.
• (early 1970s - early 1980s): Exports continued to be promoted and began to move from labor-
intensive products to higher value-added and skill-intensive ones. At the same time, Taiwan engaged
in so-called secondary ISI, using domestic production to substitute for imports of a variety of
capital-intensive manufactures (intermediate goods and capital goods).
• (early 1980s onwards): involved major government focus on the development of technology-
intensive products.
 ISI in Taiwan’s policy transition
1.The conventional view and its problems
Shifting from ISI to EOI
• From the 1950s to 1960s, Taiwan sharply shifted from ISI to EOI. Export promotion was a major feature
of Taiwan’s economic policy and made a great contribution to rapid economic growth. This policy break as
the key to Taiwan’s economic success.
• This policy shift was attributed to two factors. The first involves economic needs. The Taiwanese local
market is small with weak ability to fully absorb domestically produced goods. Thus, it became necessary
to develop the export market. The second is the American influence. The US government began to
encourage Taiwan to develop through economic liberalization to reduce economic aid.
• In fact, Taiwan did not dramatically reduce its import controls from the early 1960s, they rather became
highly selective. The ISI strategy as a whole was pursued in parallel to the EOI strategy from the early
1960s, and export promotion was essentially supplementary to ISI .
• During the 1960s, Taiwan paid an intensive attention to heavy industries as they produce capital goods,
thus, supporting the long-term steady growth of the economy.
 ISI in Taiwan’s policy transition
1.The conventional view and its problems

Secondary ISI (heavy and chemical industries)

• Actual growth trend and figures of heavy and
chemical industries in the 1960s reflect both
the continuation of ISI and further switch to a
secondary ISI.
• growth rate of heavy and chemical industries
increased in the period from 1961 to 1968
(the highest from 1950 to 1985).
• the transformation from developing domestic
markets to exploring external markets took
place in parallel to the transformation from
developing light industries to assisting heavy
and chemical industries.
 ISI in Taiwan’s policy transition
1.The conventional view and its problems
Adapting Secondary ISI in line with EOI
• Both ISI and EOI strategies laid a solid foundation for further industrial growth in Taiwan as
the development of heavy and chemical industries took place at the same time.
• The two explanations of the policy shift of the 1960s (economic necessity and American
influence) is problematic.
• The argument that there was an excess supply of domestic goods is often overstated. prices of
most domestic products did not sufficiently fall.
• The argument of American influence also weakens under close examination. The key piece
of evidence for American influence is Haraldson’s eight-point program of 1959. However,
none of them emphasized export promotion. In addition, many of them have still not been
effectively carried out.
 ISI in Taiwan’s policy transition
2. Explaining policy change and continuity
Reasons behind the policy change
• An explanation of both change and continuity in Taiwan’s economic policy begins with the basic need of ISI. In
order to substitute imports with domestic products, ISI requires foreign exchange to buy technology and
equipment (i.e. intermediate and capital goods).
• In the 1950s, the Taiwan government relied heavily on US aid to finance ISI (40%t of its total investment). Even
with massive aid, the Taiwan government was running budget and balance of payments deficits. The termination
of the aid would make the situation much worse.
• the real direct reason for the policy change (in the early 1960s) is that the Taiwan government anticipated a
possible reduction in US aid and therefore a possible increase in balance of payment pressure.
• Another reason for keeping ISI and EOI together came from Taiwan’s security concern. Facing a consistent
military threat from China, the government had to build an economy capable of sustaining a strong and
autonomous defence industry.
• Thus, from the early 1960s, the plan for economic independence called for independence from US aid and kept
the focus on heavy and chemical industrialization.
 ISI in Taiwan’s policy transition
2. Explaining policy change and continuity
Economic independence required both ISI & EOI
• Although export promotion gradually replaced US aid as a source of foreign exchange,
such EOI could not support economic independence. Independence required ISI. The
precise course the Taiwan government was a focus on secondary ISI promoting heavy
and chemical industrialization.
• In fact, EOI and ISI strategies worked hand in hand in the 1960s and 1970s. While
exports provided foreign exchange to import-substituting industries, those industries
developed Taiwan’s economic independence.
• In response to the changing security environment, investment resources were allocated to
the development of defense industries formed a central part of overall industrial strategy.
The development of both infrastructural facilities and of heavy and chemical industries
were promoted.
 ISI in Taiwan’s policy transition
2. Explaining policy change and continuity
Public sector as a key institution supporting ISI
• The government, banking sector and public enterprises were the key institutions supporting
Taiwan’s ISI. Taiwan has one of the largest public sectors in the noncommunist world. During
Taiwan’s high growth period (in the 1960s and 1970s), the growth of public enterprises
exceeded that of the whole economy.
• The importance of state capital was not only a matter of size. The state also controlled the vital
parts of Taiwan’s economy. State capital monopolized the electricity, gas, water, railway and
telephone utilities. in addition to strategic or ‘upstream’ industries (petroleum refining,
petrochemicals, steel and other basic metals, shipbuilding, heavy machinery, transport
equipment and fertilizer).
• Private business and especially the small and medium enterprises tended to be located in
downstream industries. Taiwan, thus, had a distinct industrial structure in which public
enterprises dominates
 ISI in Taiwan’s policy transition
2. Explaining policy change and continuity
Banking sector and pilot agency
• The banking sector in Taiwan was under double control – by the government and by the ruling party.
Industrial policies in Taiwan were carried out through the allocation of financial resources by the
government and credit was allocated on public enterprises.
• The most important bodies of the government involved in industrial policy-making had little contact
with the private sector.
• Although the key economic institution or often called the ‘pilot agency’, which makes and
implements economic decisions, took various names and even forms over the years, the KMT leaders
also made the pilot agency independent from the rest of the bureaucracy, and its power of policy
making and implementing was therefore enhanced.
• Regarding the linkages between the government, public enterprises and the banking sector, the
government was at the center. public enterprises were the key instruments of government’s industrial
policy dominated the upstream of the production process, and supported by a conservative banking
sector.
 ISI in China’s policy transition
1.The origin of the combined 2. New challenge and
strategy of ISI and EOI institutional change
 ISI in China’s policy transition
1.The origin of the combined strategy of ISI and EOI
Extreme ISI & domestic finance
• China is seen following the footsteps of Taiwan – between the 1950s and 1970s China was engaged in ISI
(just like Taiwan in the 1950s), and from the early 1980s China’s development strategy changed to EOI
(just like Taiwan from the early 1960s).
• China’s open-door policy was induced by international markets forces. within the crisis in ISI, the
solution was not to give up ISI strategy but to combine it with an EOI strategy.
• The problem began with China’s adoption of extreme ISI strategy in the 1950s. Unlike Taiwan, in China
ISI was the key part of central planning system copied from the Soviet model, which makes normal ISI
measures all become extreme – instead of infant industry protection, it protects all industries; instead of
putting tariffs on the imports similar to what the infant industries produce, it puts tariffs on all imports.
• The key difference concerns how the ISI is financed. The extreme ISI aims at achieving the goal of rapid
industrial growth by mobilizing all domestic resources rather than relying on foreign assistance.
 ISI in China’s policy transition
1.The origin of the combined strategy of ISI and EOI
Extreme ISI & export promotion
• Although the extreme ISI created an industrial foundation for China’s modernization, it alone clearly had
its limitations. First, China seriously lacked modern technology and equipment making ISI ineffective
simply because there was no hard currency to buy the goods which were so urgently needed by China to
produce import products. Second, in order to mobilize all available resources, the extreme ISI had to
suppress domestic consumption, which in the long run damaged people’s incentive to work.
• Solution to these two problems was promoting exports. Foreign exchange can be earned to pay for the
imported technology and equipment, and at the same time the suppression over domestic consumption
can be lifted (at least to certain extend) which would provide people with more incentive to work.
• However, the extreme ISI had been on-going in China for three decades, becoming a way of life. Thus, it
is difficult to change without a major crisis which could make people open to alternative thinking.
 ISI in China’s policy transition
1.The origin of the combined strategy of ISI and EOI
The motivating crisis
• For China, the crisis was the campaign of so-called ‘leap forward by foreign means’. In 1976 Mao
passed away and the new political change temporarily pushed up economic growth, in 1977 and 1978
total output of agricultural and industrial production grew at 11.5% annually, investment in basic
construction grew at 50% in 1978 and number of heavy truck imported also at 50%.
• With those large investments and imports, finance became a key problem. Oil sale was the main way
for China to earn foreign exchange in the 1970s. However, towards the late 1970s new oil fields were
hardly found, and worse, a rapid expansion of petroleum output even damaged the long-term
productivity of the existing fields.
• Thus, the government had to borrow large amount of foreign debt. The direct result was the largest
balance of payment deficit since the People’s Republic of China was founded. Large investment also
crossed out domestic consumption and therefore delayed people’s welfare improvement. As a result, by
1980, the government had to put the whole plan on hold.
 ISI in China’s policy transition
1.The origin of the combined strategy of ISI and EOI
The motivating crisis
• The economic crisis created an opportunity to change economic strategy, which led to the open-door
policy in the early 1980s. However, it is wrong to assume that EOI replaced ISI. The open-door policy
was born at a particular point of time to deal with the problem of extreme ISI and financing ISI with
foreign exchange. The solution was promoting exports in order to continue ISI.
• China is much closer to integration of the two strategies.
• Although exports and light industry as the main parts of EOI have been the target for government
support since the early 1980s, the government continued to promote ISI by maintaining and even
raising tariffs and by supporting heavy industry.
• Moreover, EOI has become a key means for China to solve the main problems of ISI, that is, exports
to earn foreign exchange and to free up ISI suppression of domestic consumption and light industry to
produce consumer goods.
 ISI in China’s policy transition
2. New challenge and institutional change
supporting ISI
• The situation related to ISI has become complicated since the early 1990s. China’s preparation for
World Trade Organization meant that a few traditional measures associated with ISI have to be
abandoned or reduced in significance.
• However, the Chinese government has been mobilizing various means, to protect and support the
import-substituting industries especially capital- and technology-intensive ones.
• Officially, the average tariff has been reduced from 43% to under 20% in the 1990s, but according to
some foreign exporters, the real tariff was still close to 40% since local governments could exempt
domestic products from value added tax, which was always levied on imports.
• By innovating and re-innovating domestic legal treatment of stateowned enterprises (SOEs), foreign
and domestic private firms, the government was believed to give the most favorable treatment to SOEs.
 ISI in China’s policy transition
2. New challenge and institutional change
light & heavy industries
• in the 1980s labor-intensive industry
expanded more rapidly than the capital-
intensive one, but in the 1990s, the
situation reversed, the capital-intensive
industry became faster due to large
scale investments.
• Figure 2 shows that in terms of output
growth light industry and heavy
industry were neck in neck in the 1990s
with the former slightly ahead, but the
trend after 1998 points to a stronger
growth of heavy industry.
 ISI in China’s policy transition
2. New challenge and institutional change
Institutional Support
• China’s combined strategy of ISI and EOI in the 1980s and 1990s had a strong institutional support.
The government, the banking sector and SOEs are the major institutions behind ISI in China.
• The government controls the banking sector, which provides investments to SOEs. What is different
from Taiwan is that in China SOEs plays a larger role in the economy. Between 1978 and 1992, the
state sectors received about 80% of bank credits. large SOEs dominates capital-intensive industry.
Given the dominant role of SOEs in China’s economy, the government has been engaging in enterprise
reform ever since the beginning of the reform which became more urgent when about half of SOEs
encountered the problem of non-performing loans in the 1990s.
• The solutions were privatization and corporatization with the emphasis of the latter.
• About the same time, the government organized large SOEs into large enterprise groups to enhance
their international competitiveness based on their economies of scale. “grasping the large while letting
go of the small”.
 ISI in China’s policy transition
2. New challenge and institutional change
Support SOEs
• government’s measures to support key state enterprises and enterprise groups are described as following:
“extensive support from the banking sector; shelter from international competition behind a wall of protective
tariff and non-tariff barriers; an independent accounting system, which removed the barriers between different
sectors, departments and regions; permission for the establishment of internal group finance companies; the
granting of import and export rights”
• In the 1990s, the government also engaged in internal re-organization, establishing the State Economic and
Trade Commission (SETC) and one of its objectives was to help re-organization of SOEs.
• As a result of government and SOE re-organization, SOE based enterprise groups control the upstream of
production processes, which basically consist of petrochemical and heavy industries, and the banking sector
is organized to support those groups, while in the downstream of production processes, privatized small and
medium SOEs together with other private firms.
 CONCLUSION
• ISI and EOI are both present in Taiwan and China during the eras of their economic
success. EOI in both cases began as a means to sustain ISI.
• The government, the banking sector and public enterprises are all the key institutions
supporting ISI in Taiwan and China, and even the way in which those key institutions
are linked is similar between the two cases.
• Market size is a big difference. Also, China is now facing an uncertain central-local
relation domestically and the challenge of globalization internationally, while Taiwan
had none of them 30 to 40 years ago.
• However, given those significant differences, this study still found a parallel experience
between Taiwan and China in terms of development strategy and institutions across
time.
 CONCLUSION
• EOI created the economic miracles in Taiwan and China despite a strong presence of the
ISI drive, in other words, the economic success could have been greater without the ISI
drive.
• Perhaps the difference between Taiwan and the Southeast Asian tigers can provide part
of the answer to this question. Taiwan’s economic success is not so much in selling
more goods to the world, but to build a solid industrial base for further development,
while lack of a solid industrial base was one of the key problems, which led to the fall of
Southeast Asian economies during the Asian financial crisis of 1997.
• ISI is the key to industrial upgrading as the Taiwan experience shows and which is
exactly what Southeast Asian countries have not done or not done enough. Now it is
China’s turn to show the power of combining ISI and EOI.
International Trade and Economic Development

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Alexandria University | Spring2024