The East Asian Electronics Sector: The roles of exchange rates, technology transfer, and global value chains

Framework for understanding learning and technological advancement in East Asia

Scholars have highlighted beneficial initial conditions in East Asia which helped the initial industrial takeoff of learning, technological assimilation, and technological progress. One highlighted factor is that workers’ technical competence affects their ability to absorb new technologies. Also having an open economy can be beneficial for technological advances. The discipline of competition necessitates firms to make good choices concerning technology. This is also true with importing. Furthermore, exporting in open markets led to beneficial learning by doing in Asian economies.

Scholars have broken up this technological learning into several stages. The first stage is when firms have little experience with technology and learn to implement imported technology. In the second stage, firms are seeking to compete using the technology. In the last stage, they become active competitors with the companies which had provided the technology. Entrepreneurs play a crucial role in this whole process of learning and technological assimilation by taking intelligent risks with no guarantees of return.

Within Asia, value chains have also become intricate. Multinational corporations lower costs by slicing production into fragmented blocks based on wage levels, factor endowments, physical and human infrastructure, and other factors. They fragment production when the cost saving from fragmenting exceeds the service cost of linking separated production blocks. So, the cost of linking production blocks across different regions reflects the cost of imperfect information, unstable contracts, uncredible partners, and costs due to transportation, telecommunication, and inter-firm coordination. Additionally, corruption tends to increase the service link costs, while high-quality infrastructure, highways, ports, airports, and other infrastructure reduce the cost.

Foreign direct investment (FDI) has played a large role in Asia in the electronics industry. One FDI model by Robert Mundell says that capital inflows cause capital-intensive industry to expand in the country receiving the FDI. On the other hand, Professor Kojima’s model states that capital flows tend to go to the labor-intensive industries. In Kojima’s framework, FDI is a means of transmitting capital, managerial skill, and technical knowledge.

Exchange rates throughout Asia also matter for exports when such a large portion of value addition through parts and components are coming from ASEAN countries. When China is exporting phones or computers, exchange rates throughout the Asian supply chain providing added value all matter, and not just the exchange rate of the renminbi.

Scholars have also highlighted the China shock. The U.S. imbalances with East Asia soared after China joined the World Trade Organization (WTO) in 2001. At this point, China liberalized trade. The Stolper–Samuelson theorem implies that trade liberalization should benefit capital in the United States and harm labor. What scholars have found is the amount of harm that came to manufacturing workers was much greater than anticipated. This was one of the main reasons why protectionism has become so strong in recent years in the United States.

Japan’s experience

In Japan, a few companies were very successful in electronics exporting. Tadashi Sasaki, who was the head of what became Sharp, was in the United States when Bell Labs invented transistors, and he realized the potential of this device. Japanese manufacturing at this point was restricted to consumer products, which was a very competitive market. Sasaki became convinced that he could produce a handheld calculator by adding more transistors to an integrated circuit. By 1970, Sharp introduced a battery powered calculator that weighed less than a kilogram, which sold millions. Then, Sasaki asked RCA to make LCD panels for calculators, but instead RCA licensed the technology to Sharp, which used it to make award-winning 14-inch, thin-screen TVs. That is how Sasaki and Sharp continued to innovate and succeeded in the very demanding consumer markets.

Another famous company which succeeded was Sony. In 1953, the CEO of Sony, Akio Morita, signed an agreement with Western Electric to license the technology to make transistors. Sony managed to master the technology. In 1957, they made pocket-sized transistor radios, which sold millions of units in the United States. Sony then was able to master this technology to make popular consumer items. Then in 1968, Sony began manufacturing the Trinitron TV, a color TV. Sony had patents on this, protecting them from price competition. In 1973, Sony’s Vice President pushed their engineers to study  charge couple devices. Eventually, they used this work to manufacture camcorders. Then, the Sony cofounders goaded engineers into making the Sony Walkman, which sold 400 million units. Hence, Sony used technology to gain the upper hand and to produce successful and profitable products. Japan also became a large player in semiconductors.

Japan had invested very heavily in education, which helped in adopting these new technologies. Research showed that in 1950 the average formal education of the working age population in Japan was 70% of the most advanced country at the time, which had increased to 80% by 1970. Similarly, while in 1940, 5,000 engineers would graduate per year in Japan, the number jumped to 50,000 in 1970, and until 1975, these Japanese engineers received both technical and liberal arts training. Additionally, Japanese consumers saved a large share of their income after World War II, which provided funds for investment in the electronics and semiconductor markets. The trading environment in Japan’s largest market, the U.S., was also tilted toward free trade until the 1980s.

Interpreting Japan’s experience

Entrepreneurs such as Tadashi Sasaki guided companies to take intelligent risks, while the U.S. freely shared discoveries and technology with their Japanese counterparts. The Japanese workers were also well-educated and hardworking and firms tended to channel their profits into R&D. Engineers were also loyal to their companies, and Japanese firms focused on continual innovation to escape cutthroat competition. Public research institutes in Japan, such as the Electrotechnical Laboratory, also helped firms to choose and learn appropriate technologies. Japanese firms benefited from open markets in the United States to which they exported millions of radios, televisions, watches, calculators, and other electronic goods which led to huge efficiency gains and benefits from learning by doing.

Taiwan and South Korea’s experience

The Republic of China (ROC) lost the war in 1949 to the People’s Republic of China (PRC) and evacuated to Taiwan. At this point, Taiwan was very poor and economic development was essential for survival. The Taiwanese government decided to abandon an import substitution policy and focused on exports, while investing more in education than other countries of similar economic development. Taiwanese firms obtained technology and training from Japanese companies, and by 1973, Taiwan was a vibrant supplier of TVs and electronic parts and components.

Then, in 1974, Taiwan faced a major crisis. In the 1970s, Taiwan faced quotas on textile exports through the Multi-Fiber Agreement. It had to leave the United Nations after the U.S. established relations with the PRC. Also, Taiwan and Japan severed relationships in 1972 leading to loss of access to vital Japanese capital goods and technology, which was followed by the oil crisis and a 47% increase in its CPI. During this crisis environment, the Taiwanese government conferred extensively with Chinese experts from the United States, who were sympathetic with Taiwan. For instance, Wen-yuan Pan, director at RCA’s prestigious Sarnoff Laboratories in Princeton, suggested that the Taiwanese government focus on semiconductors. Pan also established a technical advisory committee of experts made up of Chinese researchers from the United States at leading firms and universities. RCA transferred technology and trained the Taiwanese engineers. By 1979, they were producing yields which surpassed those at RCA.

Then the Industrial Technology Research Institute (ITRI) spun off a private company, United Microelectronics Corporation (UMC). UMC joined a science park which was established by the government, where it received low interest loans, inexpensive land, and tax holidays. Today, UMC remains a leading semiconductor company. Then ITRI focused on very large-scale integration and spun off the Taiwan Semiconductor Manufacturing Company (TSMC). TSMC’s first chairman, Morris Chang, had previously been vice president of Texas Instruments Incorporated (TI). TSMC decided to make integrated circuits according to other firms’ specifications, but is now the world’s most advanced semiconductor manufacturer.

Korea’s case is similar to Taiwan. It was very poor in 1960 and faced a constant threat of military invasion from the North. Economic development was imperative for it to survive. President Chung-Hee Park was impressed with Japan’s export-oriented growth and so chose that as the model for Korea’s growth. The government established very strong export incentives for firms. If these large Korean firms were not successful at exporting, they lost access to credit. Additionally, Korea invested in education, progressing from 25% of average schooling years of the most advanced country in 1960 to 75% percent in 2000. In the 1960s, they imported package technologies to produce consumer goods. Japanese corporations provided parts and components and training and know-how, but by 1975, Korea began to do its own local innovation.

The most successful Korean company, Samsung, had originally partnered with Japanese firms and obtained know-how from them. It combined this with low-cost labor to produce things like black and white TVs. But Samsung also decided to try to make color TVs by taking apart foreign color TVs and finally succeeded in manufacturing its own color televisions for export. Samsung also used the example of Sony for guidance.

Then, in the 1980s the Samsung founder Byung-Chull Lee decided to focus on dynamic random-access memory chips, which are very difficult to produce. He recruited engineers from the United States and soon they produced quality chips. Byung-Chull Lee’s son later demanded improvements in product quality from the engineers and workers for all of their products, and the quality of Samsung cell phones and consumer electronics goods improved very rapidly.

Interpreting Taiwan and Korea’s experiences

Japanese firms provided know-how, technology, and training to both Taiwan and Korea. This is consistent with Professor Kojima’s FDI model that says FDI can also impart skills and training. Also, local engineers were well-educated, adept at assimilating technologies, reverse-engineering products, and innovating. Institutions like ITRI promoted semiconductors by identifying and absorbing new technologies, training researchers, and spinning off companies. This happened as Taiwan faced a major crisis, and so at this point, the government focused on development to survive.

Political scientists say that when national security concerns are paramount, the political environment reacts as a unified actor. At other times, interest group competition, rent-seeking, and distributional struggles can predominate. The incentives for government officials at this time were to help their country survive. For this to happen, government officials might not have the requisite knowledge, but Taiwan solved that by accessing knowledge from sympathetic members of the Chinese diaspora.

Korea promoted semiconductors by using a carrot and stick approach. Korean workers were patriotic and determined for Korea to succeed economically. In this crisis environment, in both the cases of Korea and Taiwan, the idea that the country was working together for survival is a good description.

Thailand and Malaysia’s experience

In the late 1980s, ASEAN countries like Japan, Korea, Taiwan, and Singapore experienced large appreciations, which caused them to lose price competitiveness. There was a large cost saving if they could transfer factories to lower wage locations. The hard disk drive industry moved to Thailand, and an intricate network developed where they were sourcing parts and components from local firms. These firms in the supply chain worked closely together. Upgradation occurred within these value chains as foreign engineers trained Thai engineers and Thai engineers in turn trained other Thai engineers.

On the other hand, Malaysia tried to upgrade its semiconductor industry but never succeeded. The Malaysian government saw how Taiwan and South Korea had been successful in integrated circuits. However, politics in Malaysia was dominated by trying to help local Malay populations as opposed to ethnic Chinese and Indian Malaysians. The government focused more on redistributing wealth. This shows when firms are making decisions based on redistributive questions rather than choosing the most qualified candidate, they often fail. Malaysia failed to develop a cutting-edge IC industry whereas Taiwan and South Korea succeeded.

China’s experience

China originally developed Special Economic Zones in the Pearl and Yangtze Rivers with superb networks of highways, ports, and infrastructures. It then joined the WTO, which provided confidence to investors that China would follow the rule of law. At this point, the electronics industry in China took off, and it became successful at attracting FDI from Taiwan. For instance, the Taiwanese notebook PC industry was established in the Yangtze River delta and intricate clusters developed there.

China’s exchange rates show that the renminbi appreciated very rapidly, but exchange rates in upstream countries did not. Therefore, the products that China was exporting remained price competitive, largely because the semiconductors, the image sensors, and the other inputs from upstream Asian countries were produced in countries with weak exchange rates.

Lessons for the U.S.

There are several lessons to be learned by countries like the United States, who is eager to strengthen its semiconductor manufacturing, from the successes seen in East Asian countries.

The first lesson is that the East Asian countries invested heavily in education and learning. In the rankings of the 2018 Program for International Student Assessment test the U.S. ranked 25th. Therefore, the U.S. should start investing in education and in human capital beginning at an early age. In this digital economy, education should impart advanced cognitive skills such as complex problem-solving, social skills such as teamwork, and adaptive skills such as reasoning and self-efficacy. The U.S. should also seek to recruit engineers and scientists from Asia with tacit experience.

The second lesson is to practice fiscal discipline. When electronics moved to Asia, Asian countries had high national savings rates, which provided funds for capital formation. On the contrary, the U.S. runs large budget deficits every year, which reduces national savings. It also contributes to large U.S. trade deficits. To strengthen its manufacturing sector, the U.S. should reduce its budget deficit.

The third lesson for the U.S. is that harnessing incentives are important. Asian entrepreneurs were not guaranteed success. Even though U.S. researchers invented many of the new technologies in electronics, it was usually Asian firms that profited from them. Asian firms had to compete in demanding consumer markets. Hufbauer and Jung emphasized that competition is necessary for U.S. firms to succeed.

The fourth lesson is to encourage entrepreneurship. Entrepreneurs such as Akio Morita at Sony, Tadashi Sasaki at Sharp, Byung-Chul Lee at Samsung were vital in Asia’s success. When the U.S. is seeking to promote the semiconductor industry, it should put entrepreneurs in the best position possible, and they should be allowed to take risks and to fail. Appropriate incentives should involve market competition instead of lobbying for government largesse.

Another lesson is that Asia created a positive research environment when it was most successful. A lot of times, innovative breakthroughs come when researchers are free to come up with new ideas and new ways of doing things. In the United States, lobbying and rent-seeking are endemic. In this environment, industrial policy is likely to fail. Also, expenditure-switching policies can be helpful. Tariffs are very problematic. The exchange rate might be a better tool. However, the presence of weak exchange rates in Japan, Korea, Taiwan, and other Asian supply chain countries is going to make it hard for the U.S. to compete. In Asia industrial clusters were beneficial as well, so the U.S would want to develop industrial clusters.

Comment

Guanie LIM:
This is a strong summary by Thorbecke-sensei of how the electronics sector grew over the last 50 or 60 odd years in various East Asian economics. The focus here is on real-world and policy implications for other developing or developed economies.

The first theme that emerges is that the East Asian supply chain is quite successful. A good proxy would be comparing today’s cell phones versus the ones in the late 1990s or early 2000s. Today’s cell phones are successful, but this “success” comes at a price. It is so driven by cost/efficiency concerns that it has becoming vulnerable to shocks such as COVID and trade wars.

The second point is the issue of finding solutions to these issues. Recently “friendshoring” has been forwarded as one such solution. Friendshoring is a new word, but the meaning is clear. Defining countries as a “friend,” a “rival,” or a “frenemy” is difficult, because countries can be friends on one issue but compete on other issues. There is also a cost-related concern of whether a “friendly” country is fundamentally a competitive ally or lacks competitiveness. This was one concern raised by the International Monetary Fund report recently.

The last theme is that industrial policy has only become acceptable outside Asia recently, and despite its recent acceptance, there is heterogeneity in terms of different strategies by countries as well as by industries. Upper middle-income economies such as Malaysia and Thailand cannot push policies that bigger and richer economies can push and have been targeting. Therefore, it is more pragmatic to improve the business environment than to go for grand plans. They need to target more “horizontal” industry policies rather than “vertical” ones. Another concern is how to finance such industrial policies. Countries like Malaysia and Thailand cannot finance R&D and other necessary policies to the degree that even a single one of these large multinationals from a richer economy can..

Q&A

Moderator:
Dr. Lim raised three important issues: first, cost efficiency and vulnerability; second, how to determine friends, enemies, and frenemies; and third, how to finalize such industrial policies.

Willem THORBECKE:
The comment about horizontal industrial policy rather than vertical ones seems wise. Malaysia and Thailand are facing serious challenges with industrial policy, but these countries’ policymakers have been adept and skilled. I am confident that you will be able to come up with some good strategies for your countries.

Moderator:
I have three questions from the audience.

Q:
Does yuan depreciation mean that the Chinese government has fixed the exchange rate that way? What advice can be given regarding Japanese industrial policy from this research? Today, the U.S. is trying to decouple its economy and technology from China, especially in the advanced semiconductor field. Will China succeed in acquiring advanced technology without U.S. inputs?

Willem THORBECKE:
China had a fixed exchange rate against the U.S. dollar up until July 2005. At that time, China was focusing on having an undervalued exchange rate, and selling products cheaply to the West, and it was not beneficial for Chinese consumers. Many Asian scholars said it was detrimental for China, which China listened to. So, starting in 2005, it allowed its currency to appreciate, which produced a better allocation of resources in China.

On the question of giving advice regarding Japanese industrial policy from this research, Japan at its most successful time had amazing entrepreneurs—Matsushita-san, Morita-san, and Sasaki-san—who took risks and had vision. If Japan could somehow give prominent position to its entrepreneurs again, that might be beneficial.

On whether China will succeed in establishing its own technology, especially in semiconductors, the Chinese are very intelligent and hardworking. They have a good chance of developing semiconductor technology, although without a lot of the advanced capital goods from the West, it is going to be much harder.

Guanie LIM:
People tend to forget that Japan is the “mother” or the “father” of Asia-style industrial policy. People also tend to take things for granted. There are certain things that are impossible to replicate such as finding another Murata. It is very difficult to find very high-tech parts and services and different institutions are required for that. Those institutions are not that easily forged by other economies. That is a niche by itself. However, that could be something which could be extrapolated.

Regarding America reducing the possibilities of tech transfer to the Chinese economy, the other side might still acquire it, but the question is at what price. The history of capitalism is full of examples like that. The understanding is the other side will always create new institutions to forge these efforts at catching up.