In the early 1980s, the industrial economy of Taiwan was mostly in the area of labour-centric export-oriented manufacturing, import substitution, and processing of locally available farming outputs like sugarcane. Notable firms in different industrial sectors of Taiwan were barely profitable. The best performing ones were reporting three to five per cent net profit. However, over a span of 40 years, there has been a significant shift. Visible change has been in sharp rise of both gross and net profit margin. For many firms, gross profit has climbed to above 50 per cent, resulting in reporting more than 25 per cent net profit a common scenario. For example, net profit margin of Taiwan Semiconductor Manufacturing has grown from 30 per cent in 2010 to over 43 per cent in 2023. Similarly, from reporting almost loss in early 1990s, Largan's net profit margin has steadily grown to as high has 43 per cent. How have Taiwanese firms uplifted their financial performance? Is there a seed of remedy for less developed countries to end industry subsidies?
Like Taiwan, most of the less developed countries started the industrial economy for the purpose of commercialisation of labour and locally available natural resources or farming outputs. Hence, Taiwan also suffered from low margin and need for incentives for expanding the industrial economy. However, unlike most less developed countries, Taiwan focused on increasing value addition. How did Taiwanese firms succeed to increase net profit margin through increasing value addition is a subject of learning for other less developed countries, suffering from weak health of industrial economy and needing incentives for remaining afloat.
In addition to drawing lesson from other countries, less developed countries may also find solution from the operation of multinational companies in their economies. In most cases, MNCs like Unilever, Bata, Linde, Berger, and many others report very high earning per share (EPS). On the other hand, their local companies operating in the same industries report very low EPS, as low as five times less. However, let us discuss commonly cited recommendations for increasing the health and reducing dependence on incentives of industrial economy of less developed countries.
DEALING WITH VISIBLE IMPEDIMENTS: Often, industry leaders talk about (i) reducing cost of doing business, (ii) improving ease of doing business, (iii) enhancing regulatory efficiency, (iv) developing appropriate infrastructure, (v) ensuring energy security, (vi) improving logistics and (vii) facilitating access to finance for the private sector for improving the financial performance of firms. Of course, these issues need to be addressed. In global ranking in these indicators, most less developed countries are at the bottom. However, if these indicators are improved and taken at par of advanced countries, will the financial indicators of firms less developed countries also proportionately improve? Besides, upon facing the same impediments, why are MNCs operating in less developed countries far more profitable than their local counter parts?
VERTICAL OR BACKWARD LINKAGE: One of the commonly cited recommendations of improving the profitability of firms has been to increase the backward linkage. From logistic cost point of view, it may make sense. But what the about of economies of specialisation and scale? In many industries, local production of certain components may lead to cost escalation and quality erosion. Hence, global success stores have been surfacing from leveraging disintegration. For example, American Intel, IBM, and Texas Instruments are vertically integrated device makers (IDMs). On the other hand, MediaTek, and TSMC of Taiwan serve only one link of the value chain of the global semiconductor value chain. On the back drop of eroding profit and slow grow of IDMs, why have been Taiwan's specific firms have been increasing the volume and profit? It seems that integration has become a barrier to increasing profit, as link specific firms are leveraging grater advantage from economies of specialization and scale. Besides, iconic success stories like Apple have been leveraging specialissation and economies of scale of their global component suppliers. Despite the examples and theoretical merits, why are less developed countries after backward linkage to find the remedy of necessity of incentives?
GETTING INTO HIGH-TECH: There has been a common belief that getting into high-tech industry would drive economic growth of less developed countries. Hence, they have been after establishing high-tech parks, expanding education science, technology, and engineering, and giving incentives. However, they have been still relying on selling working hours or time of their people whether we call them labor or knowledge workers. Hence, despite some success made in label, there has not been any success of creating local firm with high-profit margin. On the other hand, MNCs operating in manufacturing or assembling high-tech products in these countries are offering very low salary, not sufficient to reach high-income status. Alarmingly, to make an entry and expanding the high-tech footprint, the incentives have reached a new height. In addition to offering well developed infrastructure, some less developed countries have started offering as high as 75 per cent subsidies to capital expenditure. On top of it, as high as 6 per cent production linked cash incentives are being offered. Ironically, wages earned by local people working in all these high-tech ventures in most less developed countries do not add up to given incentives.
DIVERSIFICATION: For strengthening industrial economy, experts suggest diversification to less developed countries. It refers to increasing the number of products. Due to belief in diversification, some of the firms in less developed countries have produces as high as 5,000 products, from biscuits to plastic chairs. However, despite such wide diversification, these companies suffer from very low net margin. Often, such diversification is primarily to get benefit from incentives, including concessional loans. On the other hand, global success stories have been from specialisation in a few selected areas, instead of diversification. For example, Taiwan's success has distilled from semiconductor manufacturing service. On the other hand, Apple generates almost $400 billion revenue and $100 billion net profit only from less than a dozen products. If diversification were the solution for increasing profit and getting rid of incentives, what is the lesson from Taiwan and Apple?
Most of the less developed countries have colonial history. Right after independence, they embarked on industrialisation for the purpose of import substitutions. Hence, they geared up all kinds of incentives, policies and regulation for ensuring profit from replication and imitation of imported foreign products. In the beginning, labour-based value addition was high and wage differential was significant. Hence, import substitution emerged as a profitable means of industrialisation. For the same reason, export-oriented manufacturing started gaining momentum in the 1970s. However, there has been a steady erosion of labour content in industrial products and wage differential. Hence, profitability in the industrial economy of less developed countries has been continuously falling. To offset it, less developed countries have been offering growing incentives, even as cash subsidies. How to reverse it is a daunting challenge. It's time for rethinking about the means of adding value and how to reduce the labour content. Unless less developed countries draw lesson, question their beliefs, and embark on the path of changing the orbit of value addition, the liability of industrial incentives in less developed countries has only one direction-getting worse.
M. Rokonuzzaman, PhD is an academic and researcher on technology, innovation and policy. [email protected]
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