The Economic Risk of Taiwan

In This Issue:

• Taiwan is indispensable to the technology sector given its leadership in semiconductors
• China’s intentions towards independence of Taiwan raise economic risks
• US, Europe and Japan focused on rebuilding domestic semiconductor capacity

The key forces propelling the economy forward are innovation and advances in technology which compound upon one another. While the United States is without a doubt the economic engine of the world, it is the island nation of Taiwan that punches far above its weight and has become the centerpiece of the global technology sector. However, it has not fully escaped the forces that helped bring about its creation.

After World War II, a defeated Japan returned Taiwan to China. At that time, China was still embroiled in a periodic civil war that first began in 1927. The Communist forces led by Mao and the ruling Kuomintang party (KMT) battled for control of China’s future. By 1949, the communists defeated the KMT and the KMT’s leadership along with their supporters left China for the nearby island of Taiwan—only 90 miles off China’s coast. The KMT established one-party rule to govern the island from 1949 to 1987 – after which, other political parties were allowed to be established. The KMT finally lost power following the 2000 election.

Under the KMT, Taiwan saw its economy transform from an agricultural base to become an integral player in the modern technology and manufacturing sectors. Taiwan established itself as the world’s clear leader in the manufacturing of semiconductors (sometimes referred to as “computer chips”). This dominance is largely powered by its leading corporate titan – Taiwan Semiconductor Manufacturing Company (TSMC).

TSMC Is Indispensable

Much like oil powered the economies and war machines of the 20^th century, today’s modern economy is powered by semiconductors – making them a strategic asset for many nations.  Semiconductors power everything from cars, telecommunications, banking, energy transmission systems, satellites and military equipment. In May 2023, US director of National Intelligence, Avril Haines, told the Senate Armed Services Committee that TSMC’s chips are used in 90 percent of “almost every category of electronic device around the world.” More recently, the world is now seeing the role of TSMC in the advancement of Artificial Intelligence. While there are many companies in the semiconductor sector that are pivotal to powering the modern world, none is likely more indispensable than TSMC.

TSMC is the world’s largest semiconductor foundry (manufacturer of computer chips for other companies). While Intel and Samsung also provide foundry services to various companies, these companies also design computer chips. TSMC is solely a foundry only business and its advanced manufacturing capabilities have made it the foundry of choice. TSMC’s semiconductors are used by the world’s leading technology companies such as Apple, Nvidia and AMD. Nvidia’s founder, Jensen Huang, has stated that Nvidia would not exist without TSMC. These three companies account for 40% of TSMC’s revenues as of mid-2024. In turn, these companies are central to the US economy and to advances in Artificial Intelligence. Through TSMC, a clear nexus can be seen between Taiwan’s economy and that of the US and the modern global economy

TSMC has used this focus on manufacturing to establish a competitive superiority that has allowed it to dominate the global semiconductor industry. The majority of the most complex computer chips are produced by TSMC. The company’s ability to produce transistors at sizes too small to be seen by the naked eye means an every increasing number of transistors can be added onto a single computer chip, thus increasing computing power speed and energy efficiency. Intel has unsuccessfully attempted to compete with TSMC at being able to provide the smallest transistor scale but has come up short. Samsung is likely the next closest industry competitor to achieving this level of scale.  Chips that are increasingly smaller means they are more energy efficient and faster. The increasingly more powerful computer chips are a necessity for advancing technology to meet the needs of the future.

China’s Eyes Are On Taiwan

With the end of the Cold War, the consensus assumed that tensions amongst world powers were going to be a thing of the past. The Soviet Union had ceased to exist, Eastern Europe was free of Communism and China was transitioning towards a capitalist economy. Only things did not unfold as they were expected, to unfold and China and the US have emerged as fierce become competitors for the mantle of global leader.

For a number of years, various committees in the US Congress have sounded the alarm bells regarding the dependence of the US economy on Taiwan. There has been a push for the US to be able to become self-sufficient in the production of computer chips so that the US economy cannot be held hostage should China decide to take military action to bring Taiwan back under its formal authority.

China has long viewed Taiwan as a “breakaway province” while Taiwan sees itself as a unique nation with its own customs, constitution and democracy. Despite these sharp differences, China is Taiwan’s largest trading partner as China and Hong Kong accounted for almost 35% of its exports while exports to the US and Europe accounted for about 18 percent and 10 percent of exports respectively.

Unfortunately for US policymakers, the economic relationship between China and Taiwan is not enough to provide certainty that the two nations will avoid future potential for conflict. In fact, it is this trading relationship that worries them. TSMC sold over $54 billion of semiconductors to China and despite this – China has been ratcheting up military tactics aimed at destabilizing Taiwan.

China’s President, Xi Jinping, stated in his New Year’s address this year that “reunification” with Taiwan is inevitable. Xi stated that since Taiwan is its “sacred territory…the reunification of the motherland is a historic inevitability. China will surely be reunified.” To back up his words, China has been trying to keep Taiwan off balance with various military drills and incursions into Taiwanese airspace and waterways

This month, China conducted military drills around Taiwan code named “Joint Sword-2024B” – the largest   since similar drills in May of this year. While China has conducted numerous small sized incursions for years, it has tended to reserve the largest military exercises in response to major speeches by Taiwanese leaders that express a wish to remain free of China or when it feels other nations are not respecting its wishes on Taiwan.

While Taiwan could not win a military fight against China’s much larger forces, an invasion of Taiwan is not necessarily easy for China. In fact, China has stated a preference for unification with Taiwan through peaceful methods – but it has not renounced the use of force.

Assessing China’s Threat

Experts are undecided if China does make an advance on Taiwan, would it decide to invade militarily or put an economic blockade on Taiwan with its navy and air power – by which, it could wear down Taiwan into submission—or risk a military fight. Despite its overwhelming strength, there has been considerable debate about how easily China could win a military victory. Though China has the world’s second largest defence budget, its military is untested and invading Taiwan would not be an easy exercise. It would have to be able to synchronize air, land and naval forces while using electronic and cyber warfare. So far, only the US has successfully done so in actual combat.

In addition, a naval invasion would not be an easy feat due to the volatile weather and choppiness of the Taiwan Strait that lies between China and Taiwan. This leaves China a limited time window each year to mount an invasion. Taiwan is also assisted by its shallow water coastline which leaves few places for an invading naval force to land its forces. The shallow waters would require Chinese transport ships to anchor a mile away from shore – making them vulnerable to counterattack.

Military experts believe that a naval invasion would require over 1000 ships and several weeks to move the necessary military personnel across the Taiwan Strait – giving Taiwan ample time to mount a defense and perhaps call on the US, Europe and Japan for help.

From a historical perspective, the largest amphibious invasion in history was the D-Day operation of WWII. To cross approximately 100 miles of the English Channel, the Allied nations landed 850,000 troops on the beaches of France. It is estimated that a successful  invasion of Taiwan would need to be larger than D-Day.

In May of this year, China reacted to the inauguration of Taiwan’s new president, Lai Ching-te, with another series of military exercises that lasted for two days.  The US Navy observed the exercises and shared its observations with Taiwan. Admiral Samuel Paparo, the commander of US Indo-Pacific Command stated that the exercises “looked like a rehearsal” for an invasion. “We watched it, We took note. We learned from it. And they helped us prepare for the future.”

Diversifying Taiwan Risks 

In 1990, the US accounted for 37% of global semiconductor manufacturing capacity. By 2022, the US only accounted for 12% according to the Semiconductor Industry Association, as Taiwan, South Korea and China have taken the market share away from the US. Asia controls 80% of global manufacturing capacity with TSMC alone controlling over 60% of the capacity.

One of the main factors for propelling Asian semiconductor manufacturing to surpass the US industry is the cost structure advantages of Asian companies. The Semiconductor Industry Association has stated that it costs about 30-50% more to build a semiconductor fabrication plant in the US than in Asia while also possessing an operating cost that is 25-50% higher.

In order to compete with Asia and to hedge against the risks of Taiwan’s semiconductor industry being impacted by a conflict with China, the US has taken steps to rebuild its domestic semiconductor manufacturing capacity (see figure above). In 2022, the US passed the CHIPS and Science Act. The legislation provided $52 billion in subsidies and incentives for semiconductor manufacturing and development in the US. The act will also aim to support quantum computing, artificial intelligence (AI) and advanced telecommunications such as 5G and 6G. All of these will require continued advancements in semiconductor technology.

Semiconductor Renaissance

The CHIPS Act has led to a surge in investment aimed at investing in not only new chip plants but also to the retooling and expansion of existing plants. Five of the leading semiconductor manufacturing companies have announced an investment for new plants. Earlier this summer, US Commerce Secretary, Gina Raimondo, told reporters that along with TSMC – Intel, Samsung, Micron and SK Hynix – have all committed to investing in new plants in the US. As the chart on shows above, the CHIPS Act has begun the revival of the US semiconductor industry. Raimondo highlighted the investment by SK Hynix was a “huge deal” because it would allow the US to “have the most secure and diverse supply chain in the world for the advanced semiconductors that power artificial intelligence.” The Semiconductor Industry Association has estimated that the new investments will help the United States triple its domestic chip manufacturing capacity by 2032.

Competitive Race With China Is On

China unveiled a comprehensive national security strategy in 2014. One of the principles of this strategy was for China to cement itself as the world’s leading science and technology superpower. For China, the road to achieving this is difficult because it is starting well behind the US.

For its part, the US has taken measures to maintain its technology lead in semiconductors and Artificial Intelligence (AI). The US has imposed rules on both US and international companies that will penalize them for selling advanced semiconductors and semiconductor manufacturing equipment to China. The rules restricting sales to China are administered by the US Commerce Department and it has stated earlier this year “it plans to continue updating its restrictions on technology shipments to China as it seeks to bolster and fine-tune the measures.” China has fired back through its Ministry of Foreign Affairs by stating that it wanted “the US to immediately corrects its wrongdoings and stop its illegal unilateral sanctions and long-arm jurisdiction against Chinese companies.”

Europe and Japan have also tightened export controls to China. Semiconductor manufacturing equipment exported by the Netherlands is a particular focus of US policy towards China. The US has worked with the Netherlands to ensure Dutch based ASML does not export  to China its most advanced machines —which sell for as much as $400 million each. While the Netherlands has agreed to restrict the export to China of the newest generation of ASML’s equipment, it is permitted to continue to sell its older generation of machines. The advanced equipment is used to produce semiconductors for Artificial Intelligence that have consumer, industrial and military applications.

Semiconductors are as pivotal a resource to economic  advancement today as oil was in the 20th century. The US, Europe and Japan recognize the risk to their economies of relying on Taiwan’s superior semiconductor industry since it lies less than 100 miles off the coast of China. They are now racing to reduce this risk while constraining China’s access to semiconductors. The potential threats to Taiwan have created an urgency for the West to  bring the semiconductor supply chain closer to home.