Geopolitical tensions in the Taiwan Strait have risen after US House Speaker Nancy Pelosi visited Taiwan.
It is no surprise that Beijing announced economic retaliations and military drills. The Taiwan Strait, one of the world’s most important lanes for marine shipping and air cargoes, is now a riskier place because of the ongoing live military exercises. These are bound to create bottlenecks and supply-chain disruptions, feeding inflationary pressures.
The focus of Beijing’s economic sanctions is on food, but that only affects 0.2% of Taiwan’s exports. So the import ban is very narrowly targeted, without touching the semiconductors that mainland China clearly needs. But the live military drills surrounding Taiwan are more worrisome, especially if they become regular. That could force ships and planes to reroute, detour, or even cancel their trips.
With the troubling developments in the Taiwan Strait and the low level of trust between China and the US, a mild global market reaction seems incomprehensible. The reality is that global investors are closely watching the growth prospects for the US and mainland China, and the focus is relatively limited to Taiwan.
Capital outflows have stepped up from Taiwan’s equities, but the scale is not comparable to April when the US Federal Reserve raised interest rates. In short, the market is hardly pricing in a crisis in the Taiwan Strait, certainly nothing like the Ukraine-Russia war.
Even if the world manages to avoid another military conflict, there are still important risks related to China continuing military drills, which are larger than during the 1996 Taiwan Strait crisis.
First, the economic size of mainland China and its trade flows with the world are much greater nowadays. Second, Taiwan has become a critical producer of semiconductors and ICT (information and communications technology) products, especially advanced chips.
There are two sectoral implications to the above.
A de facto blockade by China’s regular military exercises would create bottlenecks in fast-growing sectors dependent on semiconductors, such as high-performance computing, the Internet of Things, data centers and electric vehicles. Consumer electronics will also suffer, though falling demand and higher inventory levels should buffer the shock.
As well, the Taiwan Strait is an important route for energy imports by Japan and South Korea.
Therefore, a potential Taiwan Strait crisis is part of the bigger picture of the US-China strategic competition. Any further escalation could have very negative consequences for Taiwan, Asia, and the world. That includes supply-chain disruptions and renewed inflationary pressures.
Another consequence is that the ongoing supply-chain reshuffling is set to accelerate. China is bound to face more headwinds to moving up the tech ladder in key industries, especially semiconductors.
The US will put more pressure on key suppliers to ban exports to China and develop production in its own market with industrial policy tools, such as the CHIPS (Creating Helpful Incentives to Produce Semiconductors for America) Act, and a push for friend-shoring – that is, reworking critical supply chains and sourcing essential materials, goods and services among trusted partners and allies.
Alicia Garcia Herrero is chief economist for Asia-Pacific at Natixis and senior fellow at Bruegel; follow her on Twitter @Aligarciaherrer. Gary Ng is a senior economist for Asia-Pacific who covered thematic research at Natixis.