Taiwan: Economic implications of cross-strait tensions
- Taiwan is vulnerable to supply chain disruption risks; …
- … a disruption in its semiconductor supply chain could have notable impact on the global economy
- Taiwan is susceptible to trade and investment curbs imposed by China; …
- … Beijing may need to tread carefully in the electronics sector
- To hedge risks, Taiwanese firms will likely further diversify towards Southeast/South Asia
Following US House Speaker Nancy Pelosi’s visit to Taipei on 2-3 August, China conducted its largest-ever military exercises including missel tests around Taiwan over the past one week. On 10 August, the Eastern Theatre Command of the People's Liberation Army said that it has “successfully completed various tasks”, but would continue to “organize regular patrols in the direction of the Taiwan Strait”.
On the economic front, Beijing announced an import ban on Taiwanese citrus and certain types of frozen fish, a ban on exporting natural sand to Taiwan, as well as sanctions on two Taiwanese NGOs and four Taiwanese firms that donate to them. It was also reported that Beijing has suspended the imports from more than 100 Taiwanese food producers.
Supply chain risks
The military drills near Taiwan over the past one week forced many international flights and vessels to cancel or reroute their journeys. News reports suggest that air and shipping traffic is returning to normal this week. But uncertainties remain in place. The upcoming political calendar in China, Taiwan and the US is busy – China’s 20th Party Congress (Oct/Nov), Taiwan’s local elections (26 Nov), and the US’s midterm elections (8 Nov). Geopolitical tensions and military activities, if happen again in the coming months, could cause renewed delays in shipments and deliveries.
Taiwan is a trade dependent economy and is vulnerable to the risk of supply chain disruptions. The island’s monthly trade value amounts to USD78bn, equivalent to the size of some small economies like Sri Lanka. Exports are a key growth pillar for the economy, accounting for 70% of GDP. Meanwhile, coal, petroleum and natural gas are almost entirely imported, accounting for 90% of total energy supply. During the outbreak of the Ukraine crisis in February, the Ministry of Economic Affairs said that domestic reserves of coal, petroleum and natural gas could cover 36 days, 148 days, and 10 days demand, respectively.
From a global perspective, a disruption in Taiwan’s supply chain could have notable knock-on impact, especially in the semiconductor sector. Taiwan is the world’s 21st largest economy, 17th largest exporter, and 18th largest importer. Kaohsiung port ranked as the world’s 15th busiest container port in 2020, posting a volume of 9.6mn TEU, according to the World Shipping Council.
Furthermore, the Taiwan Strait is a primary route for vessels carrying goods from China, Japan, South Korea and Taiwan, to Europe, US and other major markets. Data compiled by Bloomberg showed that almost half the global container ships passed through the Taiwan Strait in the first seven months of this year.
And importantly, Taiwan plays a critical role in global semiconductor supply. According to TrendForce, Taiwan maintained the No.1 position in the world’s chip foundry market in 4Q21, accounting for a dominant share of 63%. TSMC alone accounted for 52%, including a 90% share in the advanced 5nm chip market.
Trade and investment curbs
The economic restriction measures Beijing announced over the past week mainly hit Taiwanese farmers and food exporters. Going forward, it remains possible for Beijing to roll out further measures, such as imposing import bans on a wider range of Taiwanese products, and increasing the investment barriers for the Taiwanese companies operating on the mainland. Meanwhile, Chinese consumers could voluntarily boycott the Taiwan branded products/companies, similar as during the China-South Korea tensions in 2016-17 and the China-Japan tensions in 2012.
Taiwan is susceptible to trade and investment curbs imposed by China. China is Taiwan’s largest export market, largest import source, and largest source of trade surplus. In 2021, Taiwan exported USD125.9bn to the mainland (28% of total exports), imported USD82.5bn from the mainland (22%), running a large trade surplus of USD43.4bn (67%). Its export dependence on China is high across a wide range of products, from agricultural, food, to manufacturing goods like chemicals, plastics & rubber, machinery & electrical equipment, and optical & precision instruments. Import dependence on China is also high across various manufacturing goods, from textiles, footwear & headgear, to machinery & electrical equipment.
Meanwhile, China is also Taiwan’s largest outward FDI destination. About USD5.9bn of Taiwan’s approved outward FDI went to the mainland market in 2021 (32% of the total).
That said, Beijing may need to tread carefully on trade and investment curbs in the electronics sector. As a whole, China doesn’t rely very much on Taiwan for exports (2%) or imports (9%). But it heavily depends on Taiwan for the imports of tech goods, i.e., machinery & electrical equipment and optical & precision instruments. Suspending the imports of the Taiwan-made chips and other electronic components could also seriously disrupt the supply chain on the mainland and result in unwanted losses for the Chinese economy.
Likewise, on the investment front, Taiwan is not a top source for China’s overall FDI, but it is a primary investor in the electronics sector. Among China’s top 10 exporters in 2020, six were the Taiwanese invested electronics firms that manufacture and export computers, mobile phones and other consumer electronics products. Foxconn, alone, employs around 1mn workers on the mainland. Restricting the business of these electronics firms on the mainland could also result in notable losses in China’s export revenues and employment.
To hedge the risks from cross-strait tensions, the private and public sectors in Taiwan will likely adjust their business strategies and policy plans in the coming years. These may include:
1) Taiwanese companies will likely further diversify supply chains towards Southeast and South Asia, to offset losses from their China business. Taiwanese manufacturers have started to diversify towards ASEAN and India since the outbreak of the China-US trade war in 2018. The share of China in Taiwan’s outward FDI declined to 32% in 2021 from 44% in 2017, while that of ASEAN-6 countries and India increased to 31% from 14% during the same period. This change was largely driven by electronics manufacturers. For instance, Foxconn invested USD270mn in Vietnam in 2020 to produce tablets and laptops, and expanded its investment by USD80mn in 2021. The company also spent USD350mn in the Indian subsidiary in 2021 to produce iPhones. Meanwhile, Pegatron invested USD150mn in Vietnam in 2020 to establish a subsidiary and manufacture consumer electronics products.
2) The Taiwanese government will likely attempt to expand the free trade networks, to reduce the reliance on the Chinese market. It submitted applications to join the CPTPP last September, a multilateral free trade agreement that involves 11 members including Japan and Australia. It also launched the Initiative on 21st-Century Trade with the US in June, establishing the framework for negotiating a bilateral FTA.
3) Taiwan may move to strengthen the security of energy supply, such as increasing oil and gas imports to build more safety reserves, and developing domestic alternative energy sources such as wind, solar and other renewables.
4) Taiwan may also require its government agencies, financial institutions and companies to reduce the use of China-made telecom equipment and software, to enhance cybersecurity and prevent cyberattacks.
In addition, the world’s major economies will likely continue to push for semiconductor investment in their home markets, to prevent the risk of chip supply shortage from Taiwan. The US successfully lobbied TSMC to build a 5nm chip factory in Arizona in 2020. Japan also convinced TSMC to construct a fabrication plant in Kumamoto last year. More recently, the US Congress passed the CHIPS and Science Act in July, providing USD52.7bn funds for the American semiconductor R&D, manufacturing and workforce development. Meanwhile, the US is pushing for the so-called Chip 4 alliance with Japan, South Korea, and Taiwan to enhance the cooperation on semiconductor design and production. A global race for semiconductor investment could induce additional chip production costs and aggravate the risk of overcapacity in the longer term.
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