Quotes of the Day

Morris Chang is living proof of Taiwan's ability to transform its economy. In 1985, the China-born Chang, once a long-serving executive at Texas Instruments in the U.S., was lured to Taiwan by the government as part of its effort to develop a high-tech industry. He was hired to manage a state-funded research institute, but shortly after his arrival, an influential technocrat, Li Kuo-ting, called Chang to his office and told him: "Think about how you want to start a company." The conversation led Chang, backed by state funding, to found Taiwan Semiconductor Manufacturing Co. (TSMC), now the world's largest chip foundry and one of Taiwan's most prominent firms. That was just one part of the island's big push. Other electronics manufacturers — makers of notebook PCs, memory chips, LCD panels and other essential components — also set up shop, establishing Taiwan as a force in the global IT industry.

Taiwan's success in electronics is a prime example of economic policies that lifted the island from poorhouse to powerhouse in a generation. But these days, the model that Taiwan has followed since the 1960s — concentrating heavily on building industries that could export to the wealthy West — has been exposed as dangerously flawed. Amid the global recession, electronics exports plunged 28% in the first half of 2009 compared to a year earlier, contributing to a 10.2% contraction of Taiwan's first-quarter GDP, the worst quarterly performance in the island's history. The government forecasts the economy will shrink by 4.25% in 2009. Even before the downturn, Taiwan's tech-dependent, export-dependent model was struggling. Between 2000 and 2007, Taiwan's GDP grew on average 4.1% a year, down sharply from the average annual rate of 6.5% from 1990 to 1999.

Nowadays, Chang says Taiwan must transform itself again to ensure its future growth — and he's leading the charge. In June, he reclaimed TSMC's CEO post four years after relinquishing the job — even though he is 78 years old — with the goal of taking the firm into new industries, possibly solar panels and energy-saving LED lighting. "The next transformation is going to be something that requires ideas, innovation," Chang says. "My basic concern with Taiwan is that the country needs a lot of reforms."

That's a common conclusion, echoed in the lunchrooms at the Hsinchu Science and Industrial Park, home to Taiwan's tech industry, and in the office of President Ma Ying-jeou. Government and business leaders believe Taiwan needs to become more diversified and integrated into the regional economy, which is increasingly dominated by China. "The main lesson we learned in the financial tsunami is that we are only dependent on our export industry, in particular IT," says San Gee, deputy minister of Taiwan's Council for Economic Planning and Development. The idea is to "transform our overall economy to a different stage."

Welcome to Chaiwan
"What do you think of Chaiwan?" Christine Chen, an anchor on Taiwan's ETTV news network, asked me during a June visit to Taipei. The term Chaiwan, she said, was the talk of Taipei. Turns out that the word, meant to connote the growing economic ties between China and Taiwan, was supposedly coined by the South Korean press. The Seoul Economic Daily, a Korean business newspaper, recently ran a series of articles under the banner: "The Chaiwan Storm Is Coming." One noted that "the combination of China's capital and Taiwan's high technology ... warns us of a powerful fusion of forces that cannot but present a threat to Korean industries."

The Koreans may have reason to fret. A key plank of President Ma's economic platform is to capitalize on an expanding China to propel Taiwan's own growth. Though Taiwan firms have already shifted much low-end manufacturing to China, they have been operating under severe restrictions, such as a ban on direct travel between China and Taiwan, and limitations on investment, which put Taiwan at a disadvantage versus other economies in Asia that enjoyed greater access to the mainland. The regulations were a result of the tense political relationship between Taipei and China's leaders in Beijing, who consider Taiwan a breakaway province.

Since taking office in 2008, Ma has been clearing these hurdles away. The two sides have opened the "three links" — direct air, sea and mail connections — while Ma's administration in June permitted Chinese firms to invest in a wide range of Taiwan industries for the first time. Now Ma wants to forge a "comprehensive economic framework" with Beijing that would give Taiwan companies easier access to the China market. San, the deputy minister, believes Taiwan's shared culture and language give its businessmen an advantage in China that could make a partnership between the two especially powerful. Taiwan "has a unique relationship with China that is totally different from other countries in Asia," San says. "Our policy is to allow our firms to fully explore such advantages. There is a very good chance that both sides can work together to make the pie bigger."

One important piece of that pie is the increasingly large Chinese domestic market. Traditionally, Taiwan firms have exported electronic components to China, which were assembled in mainland factories and re-exported to customers in the West. But now Taiwan companies are looking to redirect their products toward China's wealthier consumers, thereby decreasing Taiwan's dependence on the U.S. Flat-screen-display maker AmTRAN Technology, based near Taipei, operates factories in China that export primarily to North America, but the company is tying up this year with a Chinese electronics brand to sell TVs inside China as well. "This year, we're putting a lot into China," AmTRAN president Frank Wu says.

There is some fear in Taiwan that Ma's opening to China will accelerate a hollowing out of the island's economy by encouraging companies to move there, costing jobs. Ma's policy team, though, argues closer ties will boost the economy overall because it makes it easier for executives to keep the most advanced parts of their businesses — the high-salary R&D and management divisions — at home. San says the government's vision is to turn Taiwan into an operations center for Chinese industry by supplying technical and manufacturing expertise. There are some early indications Ma's strategy might work. Sun Ta-wen, chairman of circuit-board-parts maker Taiflex Scientific in the southern city of Kaohsiung, had planned to shift more production to China to improve efficiency, despite his fear that his company's intellectual property would be stolen. But better transport links have cut shipping costs and reduced travel time, so Sun has decided to keep his advanced R&D and manufacturing operations in Taiwan and is even investing $10 million in a new factory in Taiwan, his third on the island. "We're going to make our fortune in China, but bring it back to Taiwan," Sun says.

Spreading the Workload
The offices that house the administrators of the Hsinchu Science and Industrial Park are, perhaps fittingly, dilapidated compared with the shiny high-rises and modern factories surrounding it. When the boxy building first opened in 1980, the same year as the park, its first officials were key players in developing Hsinchu into the premier center for Taiwan's electronics industry. Today, though, the idea that a bunch of bureaucrats can engineer industrial progress seems as out-of-date as the tattered furniture in the office's dark hallways.

But don't tell that to Paul Wu, the park's director of investment services. He and his colleagues are scheming to make Hsinchu as important to Taiwan's future as it has been to its past by attracting companies in cutting-edge industries such as alternative energy. Not far away, the government this year opened a new park for biotechnology and other medical-business start-ups. "This is the time for the park to transform from old-fashioned capital-intensive industries to intellectual-based ones," Wu says.

Similar efforts are being made across the island. In Kaohsiung, the government in 2008 opened a software park to spur tech start-ups alongside the city's traditional export factories. Nationally, Ma's administration has targeted six "flagship" industries for investment and development: biotech, health care, high-end agriculture, tourism, green energy, and creative and cultural businesses such as traditional arts and pop music. The government intends to support these sectors by providing financing, improving the capabilities of state research institutes and other measures. "We are keenly aware these industries in five to 10 years will be the major industries of the world," Ma recently told TIME.

Wanted: Eureka Moments
The key to the government's grand plans is fostering innovation. Though its companies and research centers have been adept in past decades at advancing manufacturing systems and paying catch-up with the West, they haven't proven as capable of breaking new ground. To remain competitive, Taiwan has to develop its own technology, not just manufacture technology products.

There are moves afoot to bring about this crucial change. Taiwan's vaunted Industrial Technology Research Institute (ITRI), a state-funded think tank housed on a landscaped campus near Hsinchu, produced many critical breakthroughs since its founding in 1973. But ITRI's future may lie within the center's Creativity Lab. At its entryway is a collection of odd video games developed at the lab, including one that allows visitors to interact with a digitally generated infant. Inside, researchers dress in blue jeans and polo shirts instead of the usual white coats, and converse in a room with movable walls. ITRI's managers encourage its Ph.D.s to spend time in the lab to help them develop new ideas. Last year, the lab launched what it calls "playful villages," discussion groups in which the researchers can meet and chat about their own special interests. "It's not that hard to get people to be more creative, given the right atmosphere," says the Creativity Lab's general director, Hsueh Wen-jean. "The idea was to create an environment without borders, to explore the love within themselves to be creative."

Whether such efforts can truly work may determine the fate of Taiwan's economy. "The old model is a top-down approach," says ITRI president Johnsee Lee. "The innovation economy has to be more bottom-up. It needs more talent." Morris Chang says Taiwan lacks that talent, because the country's education system stresses rote learning, resulting in "very little independent thinking and very little creativity." Chang also points out that Taiwan has to contend with a greatly changed international environment. "China wasn't in the picture 30 years ago, neither was India," Chang says. "You have a big competitor that can do the basic stuff at least as well as you can, but they can do it more cheaply." His conclusion: "The next transformation is going to be very hard," he says. Even with its history of beating the odds, Taiwan may be facing its stiffest challenge yet.

— with reporting by Jiyeon Lee / Seoul and Natalie Tso / Taipei

• Michael Schuman / Taipei
• Mauled by recession, Taiwan looks to diversify through innovation and greater links with China