Taiwan and Textbook Economics

Taiwan is paying farmers to not farm rice. And while these type of policies are usually distortionary, this one is just intro economics. Literally, just intro economics.

I’ll cover the intro economics, then I’ll look at two cases in the US that show how hard it is to get these policies to succeed.

Taiwan on the Frontier

Taiwan produces many things. But they produce one thing best of all.

Microchips.

Taiwan produces at least 60% of the world’s semiconductors, and over 90% of the most advanced ones. And these chips are the brains of nearly every electronic you use on a daily basis. For example, when microchips were harder to get after COVID, it caused a huge problem for the global auto industry, making it nearly impossible to get a new car. Taiwan’s dominance in microchips and its vulnerability to China are one of the top global security issues right now.

But Taiwan also produces other stuff. Most importantly for today’s discussion, Taiwan produces rice. And even though there are lots of other things that Taiwan produces, we can imagine an economy where it only produces microchips and rice. In that world, we could draw the Taiwanese economy in one graph like this.

This is a production possibilities frontier, or PPF. The blue line describes the combinations of microchips and rice that are possible. This is taught in the first week of an intro econ class because it demonstrates one of the core principles in economics. You can see it in the slope of the line. If you are on the line, then to get more microchips you want to go up. But to go up, also have to go left. That is, to get more microchips, you have to sacrifice some rice. The PPF demonstrates the fundamental principles of trade-offs and opportunity costs.

But it’s important to review why there are trade-offs at all. Why do I have to give up rice to get more microchips? Under the hood, there are the resources we use to produce each. Maybe you need more land for microchip factories, so you have to build over land that used to be cultivated for rice. Maybe the people you need to run the factories are coming out of the rice fields, so there are fewer people to farm. Or, in the case of Taiwan today, both factories and farms need water, so if you run more factories, you have less water for farms.

There’s another reason we use this graph, but let me get to the issue first.

Draught of chips

I was recently pointed to an article about a policy experiment in Taiwan. Last year, Taiwan was facing a terrible drought. Water was scarce. And water is needed for both microchips and rice.

Taiwan solved the problem using what some people see as a counterintuitive policy: it started paying farmers to not farm rice.

But this wasn’t counterintuitive. It was a return to intro econ.

The second reason we like this graph is because it shows the gains from trade. According to comparative advantage, Taiwan should not try to produce both microchips and rice. Instead, it should stick to its comparative advantage, which is clearly microchips. It should max-out production here, then it should sell the extra microchips and import rice with them.

I added two dots to demonstrate this. One shows where Taiwan should produce, at max chips and zero rice. The other dot shows where it can consume. Note that this is a place beyond anything on its frontier. If Taiwan acted alone, it can only achieve what’s on the blue line. But by trading, it can get more rice than it could produce on its own and it still gets microchips.

But one concern that arises in trade discussions like this is that the rice farmers can’t all go work in the microchip factories. The manufacturing process is so complex that untrained farm laborers cannot immediately get jobs there. The factory needs their water, not their labor. So sure, the factories make a lot of money, but the farmers are now poor.

That’s why the gains of trade are so amazing. Frequently, the gains from trade are large enough that we can compensate the people displaced by trade. Amazingly, Taiwan is doing that.

They could have just forbidden farmers from using water, but instead they’re paying them. I don’t know the full policy, but if you’re being paid, that means you have a choice. So if you can make more money farming, you choose to not take the payment and you work your rice fields. Who takes the money? The least-productive farmers who know they won’t make more than the government payment. That’s amazing! That means the water is receding from the least productive farms and flowing to the most-productive factories.

The Microchip Shock

Taiwan’s experience reminds me of a similar story in the US, but with a different outcome.

In 2001, China join the World Trade Organization. As a result, it became much cheaper to manufacture goods there. So cheap, in fact, that US companies started sending their manufacturing jobs to China.

This was our Taiwan moment. China’s comparative advantage was manufacturing. One of our comparative advantages was software. Think of the unicorns that started to spring up around this same time (e.g. Amazon, Google, Facebook).

But as we leaned into our comparative advantage, the people who worked in manufacturing started to get left behind. Their factories closed but they weren’t trained to take the jobs in Silicon Valley. While we theoretically could have compensated them like in Taiwan, we didn’t.

And now there’s basically a whole field of economics looking at the effects of this shock. You can find a collection of papers here. The effects include higher unemployment, lower marriage rates, and higher out-of-wedlock births. In many ways, China is how we got Trump-Vance 2024. Not only did the loss of manufacturing jobs lead to greater political polarization and cause increases in support for Trump in 2016, JD Vance’s rise to fame and power began with his memoir Hillbillly Elegy, which discussed the effects the decline in manufacturing has had on the Appalachia area.

This leads me to a big question about Taiwan. How did they have the political economy to compensate the farmers? Does the US need to learn something from their political situation? Will Taiwan avoid the political troubles that come from macroeconomic changes? Or will we see similar struggles from the farmers and their families?