Taiwan’s China Dependency Is a Double-Edged Sword

Taiwan’s China Dependency Is a Double-Edged Sword
Photo Credit: CNA

What you need to know

As a major hub in global supply chains, Taiwan’s trade relationship with China depends on U.S. policy towards China and supply chain reform.

Taiwan’s remarkable economic performance in 2020 is something to celebrate given most countries globally plunged into recession because of the Covid-19 pandemic. Taiwan’s GDP increased by 3.11% in 2020 compared to the global average of negative 4.5%. It is the first time in three decades that Taiwan has achieved a growth rate greater than China’s.

But political debate broke out over one key element that enabled this achievement. Taiwan’s GDP growth in 2020 was mainly underpinned by an increased trade surplus and domestic investment. Exports increased by a record-breaking 4.9% in 2020, with China (Hong Kong included) receiving close to 44% of Taiwan’s exports, a 12% increase from 2019. This makes China Taiwan’s single most important trading partner and a key source of trade surplus.

Many in Taiwan argue that trade dependence on China indicates that the current Democratic Progressive Party (DPP) government’s approach — keeping China at arms length while pursuing a closer alliance with the United States — is just political rhetoric. Taiwan, after all, needs China for economic prosperity.

There are calls to address this high export concentration issue based on economic security concerns. One key risk is that this structure may increase China’s ability to coerce Taiwan for political benefit. China’s decisions in January and April 2021 to block Taiwan’s pork and pineapple imports based on arbitrary quarantine reasons are recent examples that support this argument.

The key question is whether trade concentration represents low resilience levels, over-dependence, and other economic security risks that Taiwan faces, or to the contrary, is an indication of China’s “supplier dependency” on Taiwan.

The top five export product categories from Taiwan to China measured in export value are electrical machinery and equipment and parts; machinery, mechanical appliances, and computers; optical and other precision instruments and accessories; plastics and articles; and organic chemicals. Together, they accounted for 86.3% of Taiwan’s exports to China in 2020.

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Photo Credit: Reuters / TPG Images
People ride a motorcycle while a container ship passes by at Keelung port in northern Taiwan, July 20, 2010.

Cross-strait trade is predominately electrical machinery trade — it accounts for 64% of total exports. Semiconductors are the most important product item under the electrical machinery category, accounting for 78% of electrical machinery exports. As such, the 27% increase in semiconductor exports to China in 2020 was the main factor underpinning the overall increase in exports.

Chinese demand for semiconductors surged in 2020 because of the growing demand for electronic consumer products due to the worldwide proliferation of working from home and home-schooling. The stockpiling strategy of Chinese tech firms, including Huawei and SMIC, in light of potential U.S. export controls contributed to the surge of demand as well.

As far as the danger of economic coercion is concerned, the risk for Taiwan is at this stage limited. Taking semiconductor trade as an example, China’s current domestic capacity can only supply somewhere between 15 to 20% of semiconductor demand. Semiconductors from Taiwan and South Korea are the main sources of supply underpinning China’s position as the global manufacturing powerhouse for semiconductor-enabled electronic products.

This “reverse” dependency structure means that if Beijing were to weaponize semiconductor trade to coerce Taiwan, it could potentially harm China’s own economic growth much more than Taiwan’s. The “reverse” dependency structure is one of China’s primary strategic concerns and was a key driver of China’s semiconductor import substitution policy created more than 20 years ago.

Taiwan’s current trade structure suggests that the threat of economic coercion is small. As a major hub in global supply chains, the future orientation of Taiwan’s trade relationship with China depends more on other external factors, like the direction of U.S. policy towards China and supply chain reform.

As reflected in its Interim National Security Strategic Guidance, the Biden administration has formally initiated “strategic competition” with China. On the supply chain restructuring front, the continuing trade war suggests the pressure for U.S.-based suppliers in China to relocate will remain.

The draft “Strategic Competition Act of 2021” passed by the U.S. Senate’s Foreign Relations Committee in April (which was integrated as part of the U.S. Innovation and Competition Act in June 2021) intends to further accelerate the process by requesting that U.S. overseas missions facilitate U.S. companies embedded in global supply chains to relocate outside of China. The Critical Supply Chain Review ordered by U.S. President Joe Biden aims to reduce dependency on China and foreign-supplied critical products, in particular semiconductors, by way of re-establishing U.S.-based production capacity.

For Taiwan, there are several key implications of this situation.

First, pressure to diversify supply chains will likely increase for those companies that are currently located in China with majority U.S. clients. In the long run, both investment and investment-led trade between Taiwan and China will likely decline. Taiwan may be able to leverage this situation to secure its position in the new supply chain.

Second, as all major economies are pursuing similar “import substitution” policies on semiconductors, Taiwan’s semiconductor-led exports to China and elsewhere will likely decline as well. Foundries such as the Taiwan Semiconductor Manufacturing Company can mitigate these challenges by diversifying production facilities globally, but the impact on Taiwan’s trade surplus and GDP growth will be significant.

Instead of worrying about trade concentration, Taiwan should concentrate on defining strategies for and finding solutions to these structural changes that are unfolding rapidly.

Roy C Lee is Deputy Executive Director at the Taiwan WTO and RTA Center, Chung-Hua Institution for Economic Research.

The News Lens has been authorized to republish this article from East Asia Forum. East Asia Forum is a platform for analysis and research on politics, economics, business, law, security, international relations and society relevant to public policy, centered on the Asia Pacific region.

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