international analysis and commentary

The US-China-Taiwan: a sticky economic triangle

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The reelection of Taiwan’s ruling party, the Democratic People’s Party, to the presidency – in the person of William Lai Ching-te, former Vice-President – will not fundamentally change the complicated economic dynamics of the US-China-Taiwan relationship, especially in the established economic dimension.

 

The obvious need of Xi Jinping to continue his efforts to regularize the PRC’s political and economic relations with the receptive Biden administration, due to China’s dependence on manufactured exports, investment and technology (including from US-supported Taiwan), is one reason for the PRC not to escalate threats on the neighboring island and thus provoke the Americans. Xi’s purge of top military leadership continues unabated and undermines any ability to mount the complex military operations involved in taking over an increasingly democratic oriented industrial nation which can count on aid from the US, Australia and Japan.

Also working against any radical change in the triangular relationship are a nexus of economic and technological ties which would be difficult and damaging to unwind in the short term. Both China and the US are dependent on each other for crucial inputs to their modern economies. Thus the stated desire of each side to achieve more self-sufficiency will require considerable time to accomplish.

Taiwan remains at the center of the advanced semiconductor network at the global level. Along with South Korea, it dominates the production of the 7 nanometer (NM) or smaller segment of the market. The US, Europe and Japan remain in strong supplier relationships with the leading producers and fabricate smaller amounts of finished products. Advanced chips are the key to critical sectors of the modern economy such as smartphones, computers, AI, Cloud computing and the huge gaming industry. China itself must rely on Taiwanese-made chips, software and design, and even high-grade sand to produce pure silicon from the US. The PRC also relies on European production equipment and specialized chemicals from Japan to make chips.

On the other hand, the US and its allies are increasingly reliant on so-called “legacy chips” at the 28 NM and above level made in China. These are the workhorses of the modern auto, appliance, internet of things, electronics, commodity cell phone industries, and even of advanced weapons systems. Electronic vehicles (EVs) use three times more legacy chips than the gas powered automobile. As much as 70 to 80% of foundry capacity for these chips is located in China and Taiwan. The PRC has plans to invest as much as $150 billion in new foundries over the next decade.

The US and its allies are investing heavily in both advanced and legacy chip production, with the US leading the way with its $50 billion plus CHIPS Act and new research funding. Washington’s sanctions, largely supported by America’s allies, have kept China 4-5 years behind the West and Taiwan for advanced chips. But China is now a major exporter of legacy chips, with around $50 billion in exports to the US alone in recent years. Even with initiatives such as the CHIPS Act of August 2022, new production capacity in the US will not be seen for two to five years.

 

Read also: The US-China economic link: high level diplomacy and structural problems

 

Apple still relies on Taiwanese-made chips for its iPhones and Mac computers, and on China for the assembly of these products. 95% of the main Apple products are assembled in China. 23% of Apple smartphones are sold in the PRC, just above the 22% sold in the US.

The US also remains dependent on Beijing for  increasingly important and economically significant solar and wind products, on rare earths for making these and other products, on batteries for EV and electricity storage markets. China is now the world’s largest exporter of automobiles, albeit with much of these from foreign firms such as Tesla and Mercedes operating in the PRC. 8% of the EU market for EVs is now controlled by China, and it is expected to rise to 15% by 2025.

Chinese firm BYD, backed by Warren Buffet, is now the world’s largest producer of EVS. BYD and other Chinese EV makers are able to produce at prices even the 25% tariffs and massive new subsidies in the US under the so-called Inflation Reduction Act (IRA, also approved in  August 2022) cannot make US firms competitive. Ford and GM have both reduced plans to build new EV plants in the US in the last six months.[i]

One almost inevitable result of Chinese dominance in the renewables and EV industries will be even more US (and probably EU and Japanese) trade restrictions, and more aggressive scrutiny of both inward and outward investments involving Chinese producers. The European Commission is now following this path as Chinese exports to the EU market are growing rapidly. Because Western auto firms, especially Tesla and the German auto giants remain major players in the Chinese market, these key companies are potentially the targets of PRC retaliation against restrictions on its exports.

As explored in my recent research[ii], China remains vulnerable to US restrictions on its exports and sanctions on technology transfers. Additionally, due to the highly indebted and fragile domestic financial system which has been weakened by the crash of its property market and endemically weak consumer spending, China remains highly dependent on investments and capital flows from the West.

Despite these implacable realities, both Xi Jinping’s inner circle and the Biden administration, with bipartisan support in Congress, remain committed to building resilience through more self sufficiency and moving supply chains away from the countries of their adversaries. In the US case, resilience is associated with enhanced cooperation with its democratic allies, while the PRC is trying to build its own economic sphere with programs such as the BRICS and the Belt and Road Initiative (BRI).

 

Read also: A dangerous deadlock over Taiwan

 

In the short to medium term, however, such efforts will have only limited success as the difficulty of reconfiguring supply chains and building new capacity requires time and considerable investment. The US will have to work diligently with partners to win cooperation on a partial disengagement from China. China will have difficulty replacing the huge and lucrative US, EU and Pacific Rim markets with weak economies such as Russia, Brazil and South Africa and with an ambivalent India. The US and its allies are in a stronger position as they have better tools to affect the Chinese economy, and the Chinese reliance on weaker economies contrasts with the more dynamic and larger democratic economic sphere.

While this great power maneuvering evolves, Taiwanese technology is vitally important to both the US and China, making the price of military confrontation prohibitive to both sides.

 

 


[i] See Thomas Duesterberg, “Il Revival Hamiltoniano,”  Aspenia, 4/2023, December 2023. Title of the issue is “La Debolezza della Potenza.”

[ii] See Thomas J. Duesterberg, “China’s Economic Weakness and Challenge to the Bretton Woods System: How Sould the US Respond?” Washington, Hudson Institute, November 2023. https://www.hudson.org/foreign-policy/chinas-economic-weakness-challenge-bretton-woods-system-how-should-us-respond-thomas-duesterberg