Tensions Across the Taiwan Strait Part II: Economic Implications of the Cross-Strait Conflict for Companies and Countries
Differences regarding Taiwan’s status have elevated tensions between Taiwan and China, raising concerns of a conflict that would likely involve the United States. China’s government views Taiwan as a breakaway province that is a part of its territory - and therefore aspires to reunite Taiwan with mainland China - despite the fact that Taiwan has been governed independently of China since 1949. Tensions escalated in August 2022 after United States House of Representatives Speaker Nancy Pelosi flew to Taiwan as the highest-ranking American politician to visit in more than 25 years. Her visit with Taiwanese lawmakers and President Tsai Ing-wen, which was intended to demonstrate the United States’ support for Taiwan, prompted China to stage live-fire military exercises and surround the island with warships in what has since been described as a dry-run for a military blockade and potential invasion. Then, on February 4, 2023, the United States Department of Defense shot down a Chinese high-altitude balloon near Myrtle Beach, South Carolina, that it claims China was using to spy on key military sites and assets across the United States. While China asserts that the use of military force to attack their “civilian unmanned airship” was an “obvious overreaction,” relations between China and the United States have been exacerbated by the incident as the Pentagon has described it as an “unacceptable violation” of the United States’ sovereignty.
Although it is impossible to precisely predict how the geopolitical conflict between Taiwan, China, and the United States might unfold, the scale of economic activity at risk of disruption is immense, largely because a full-blow cross-strait conflict has the potential to sever Taiwan’s trade with the rest of the world. This would disrupt the complex and highly integrated semiconductor supply chains that contemporary economies depend on, posing a significant threat to the economic and national security of the United States, China, and Taiwan. Considering the importance of the conflict across the Taiwan Strait with respect to the semiconductor sector, the following article will explore the economic integration between China, the United States, and Taiwan, as well as the ways in which the contemporary geopolitical conflict has affected these countries' economic policies. Importantly, “Taiwan” will be used throughout the article for the purposes of clarity, although the country is officially known as the Republic of China (ROC).
Economic Implications of a Cross-Strait Conflict
Every analysis of the economic implications associated with a military clash between the United States and China over Taiwan is complicated by the fact that economic models are not calibrated for the current scenario, and there are few, if any, historical examples to serve as comparisons to the contemporary conflict. Potential scenarios are complex and require numerous assumptions about the type of military operation China might attempt, the number of countries that would become involved, the conflict's duration, and the magnitude of escalation. A 2016 study by RAND, for example, estimated that a year-long war would reduce China’s GDP by 25% to 35% and the United States’ GDP by 5% to 10%, although the study did not analyze the associated implications for supply chains or estimate the effects of sanctions, cyberattacks, or infrastructural damages. Moreover, a complete disruption of China’s trade might reduce global trade – measured in value added – by US$2.6 trillion (3% of GDP), but this figure is based on peacetime valuations of global supply chains, and therefore only captures first-order effects, meaning the economic disruptions could be significantly worse.
In a blockade scenario, the most significant disruptions to global economic activity would likely occur because of a complete disruption of Taiwan’s trade with the rest of the world. Taiwan is the 16th largest trading economy, and the world’s leading producer of advanced semiconductors, accounting for more than 60% of the global contract manufacture of microchips, and 92% of advanced logic chip production (South Korea produces the remaining 8%), which are those chips with node sizes that are less than 10 nanometers. This is largely due to the Taiwan Semiconductor Manufacturing Company’s (TSMC) disproportionate dominance in the semiconductor fabrication industry, as the firm accounted for approximately 55% of global foundry revenue in 2020. As such, rough estimates of global dependence on Taiwan suggest that companies and industries could be forced to forgo as much as US$1.6 trillion in annual revenue in the event of a complete blockade, although the global economy would also face significant second-order impacts that would likely increase the magnitude of such measures.
One crucial consideration is the economic integration between Taiwan and China. Taiwan’s imports from China have increased by 87% during the last five years – relative to a 44% increase in imports from the United States over the same period – which represents an average annual growth rate of 13.3% – a faster rate than most measures of bilateral trade anywhere else in the world. China has also become increasingly reliant on Taiwanese products, as China’s imports from Taiwan increased by approximately 71% between 2016 and 2021, representing an average annual growth rate of 11.3%. Crucially, electrical technology products – the majority of which are semiconductors or semiconductor components – represent approximately 70% of China’s total imports from Taiwan. While China’s government has persistently attempted to develop a domestic semiconductor industry through the provision of billions of dollars in subsidies, grants, and contracts to large domestic firms, China’s large-scale state-owned semiconductor fabrication companies – most notably the Semiconductor Manufacturing International Corporation (SMIC) – currently lack the capacity to meet China’s semiconductor needs and can only produce lower-end chips for consumer electronics. In fact, Chinese semiconductor companies can only produce about 6% of the chips needed to satisfy its world-leading consumer electronics industry, meaning China depends on TSMC to make up more than 70% of the deficit. This is largely because of China’s unbalanced development experience since its market reforms in 1978, but also because of the inherent inefficiencies associated with its state-dominated industrial sector.
Like China, the United States also depends on TSMC, but the nature of its dependency is far different. Semiconductor companies that are headquartered in the United States– such as Apple, Google, Intel, AMD, Qualcomm, and Nvidia – dominate the design of the most advanced chips, and collectively account for approximately 47% of global semiconductor and integrated circuit (IC) revenue, although they lack fabrication capabilities, and are therefore reliant on TSMC’s manufacturing expertise. As many of TSMC’s fabrication facilities are located on the west coast of Taiwan, where they are perilously exposed to a Chinese invasion, the United States is especially vulnerable to supply-chain disruptions associated with a cross-strait conflict.
As a result, the United States passed the Creating Helpful Incentives to Produce Semiconductors and Science Act (CHIPS ACT) on August 9, 2022, to enhance domestic competitiveness, innovation, and national security. The act authorized US$280 billion in total spending over the next ten years, with US$200 billion devoted to scientific R&D and commercialization; $52.7 billion towards semiconductor manufacturing, R&D, and workforce development; US$24 billion worth of tax credits and subsidies for chip production; and the remaining US$3 billion for programs aimed at developing “cutting-edge technology,” and wireless supply chains. The act has already attracted more than US$200 billion in investment commitments, most notably from TSMC, which has agreed to invest US$40 billion in order to build two fabrication facilities in Arizona. The company is expected to begin producing four-nanometer chips in 2023 – the most advanced ever made in the United States. – before developing more advanced chips in 2026.
Just months later in October 2022, the United States Department of Commerce disclosed an unprecedented list of new export controls that target China’s semiconductor and supercomputing industries by restricting China’s ability to access certain semiconductor chips produced by foreign firms using United States inputs. The new controls are based on the broadening of the Foreign Direct Product Rule (FDPR), and impose stringent licensing requirements on the sale of advanced chips, chip-design software, and semiconductor manufacturing equipment (SEM) to firm’s based in China, but also to prevent United States’ citizens and residents from working for Chinese semiconductor companies. Such measures are expected to cripple China’s ability to access advanced semiconductors or produce them domestically in the short term, although China will likely be able to access alternative supplies of crucial components within four to ten years as other international companies remove the inputs and components that are subject to export controls imposed by the United States from their engineering processes.
Despite such measures, factories in the United States would still be unable to independently manufacture many of the final goods such semiconductors go into. This is largely because China is the world’s leading manufacturer, meaning Chinese factories assemble many of the products that are exported to the United States, especially electronic consumer goods. As a result, substantial economic disruptions between China and the United States poses a serious threat to the United States in the medium term. In fact, a recent report from the Boston Consulting Group (BCG) suggests that semiconductor companies based in the United States could lose as much as 18% of their global market share, and 37% of their revenue - which would lead to the loss of between 15,000 and 40,000 high-skilled domestic jobs - if the United States completely prohibited United States companies from selling to their Chinese clients. The United States is unlikely to pursue such a strategy in the short term, and the aforementioned legislation will undoubtedly help mitigate risk, although recent reports suggest that the United States continues to lack the institutional capacity and political will required to implement industrial policies that are large enough to substantially mitigate supply-chain exposure to China.
As tensions in the Taiwan Strait continue to escalate, the challenge for the United States will be to simultaneously compete and cooperate with China. Confrontational policies that heighten the risk of outright war should be scrupulously avoided, although it is important to consider that both countries bear the responsibility of preventing a complete conflict. Regardless, decoupling the world’s two largest economies is bound to adversely affect both China and the United States. While it is true that nations go to war and engage in military actions despite obvious economic disadvantages, the economic importance of Taiwan must be considered in both countries’ geopolitical choices.