Taiwan's China dependency is a double-edged sword

Roy C Lee, Chung-Hua Institution for Economic Research

2021-07-06

ASIA

TRADE AND ECONOMICS

This article first appeared on the East Asia Forum

Taiwan
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 per cent in 2020 compared to the global average of negative 4.5 per cent. It is the first time in three decades that Taiwan has achieved a growth rate greater than China’s.

Taiwanese President and chairwoman of the DPP Tsai Ing-Wen, seen pointing at a pineapple during a press conference at the Democratic Progressive Party (DPP) office. In response to China's ban on exports of Taiwan-grown pineapples, the Taiwan government has been promoting local products based on home grown pineapples, Taipei, Taiwan, 3 March 2021 (Photo: Reuters).
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 to a record-breaking 4.9 per cent in 2020, with China (Hong Kong included) receiving close to 44 per cent of Taiwan’s exports, a 12 per cent 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 per cent of Taiwan’s exports to China in 2020.

Cross-strait trade is predominately electrical machinery trade — it accounts for 64 percent of total exports. Semiconductors are the most important product item under the electrical machinery category, accounting for 78 per cent of electrical machinery exports. As such, the 27 per cent 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 US 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 per cent 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 weaponise 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 US 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 US-based suppliers in China to relocate will remain.

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

Original article here

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