Vladimir Putin’s invasion of Ukraine has roiled energy markets and food supply chains, sending economic shockwaves around the world. This prompts an important question: What would happen to the world economy if China invaded Taiwan? Clearly, the economic impact would be much more devastating and profound than that of the Ukraine war, given the fact that Taiwan and China are both far more integrated into the global economy. Even without direct military intervention from the United States, a Taiwan-China war would devastate the global economy like a weapon of mass destruction.

The Geopolitical Roots of Taiwan-China Economic Ties  

Taiwan’s booming economy and deep economic ties with the United States and China have been a consequence of evolving geopolitical factors. Its economic development—driven by U.S. aid, investments, and exports to the American market—was inextricably linked to its role as a key anti-Communist fortress in the region early in the Cold War. Given the threat of an invasion from China, the United States considered it imperative that Taiwan prosper economically in order to support the island’s major military requirements. 

By the end of the 1970s, U.S. foreign policy shifted. Abandoning its previous antagonistic approach to China, Washington increasingly moved to open diplomatic and economic ties with Beijing, as both came to see the Soviet Union as a common enemy. The United States granted China Most Favored Nation (MFN) status in the 1980s and 1990s, allowing China to enjoy far more favorable trade terms. In 2000, Washington granted Permanent Normal Trade Relations (PNTR) status to China shortly before its admission to the World Trade Organization (WTO) in 2001. 

Apart from using China to counterbalance the Soviet Union, the United States was hoping that trade and economic engagement would help to change China. As President Bill Clinton declared in 1998: “Trade is a force for change in China, exposing China to our ideas and our ideals, and integrating China into the global economy.” 

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America’s opening to China also served as an impetus for greater cross-Strait integration between the Chinese and Taiwanese economies. Taiwanese firms that aimed to export final consumption goods to overseas markets moved their labor-intensive manufacturing to China to lower production costs. 

Today, as China grows more belligerent, it has become clear that the United States’ efforts to change China by integrating it into the global economy proved a failure. Not only is China far  from embracing American ideas of democracy, but it has become a threat to the United States in terms of military power and high-technology development. The war in Ukraine has strained bilateral tensions even further. In addition to its regular military harassment activities near Taiwan, China is distancing itself from the West through its “unlimited” partnership with—and economic support to—Russia.

De-coupling the Cross-Strait Production Network and Changing Geopolitical Contexts

For more than three decades, Taiwan has relied on exporting key components and semi-industrial goods to China for final assembly. This model is now changing. Taiwanese firms started to shift some production away from China to other developing countries more than a decade ago due to increased labor costs on the mainland. The growing United States-China rivalry has accelerated investment relocation. China’s share of Taiwan’s outbound foreign direct investment (FDI) has declined from 84 percent in 2010 to 34 percent in 2022, according to Taiwan’s Investment Commission.

One key component of China-Taiwan trade has been the semiconductor industry. However, the shift of semiconductor production away from China has become more pronounced since the outbreak of the COVID-19 pandemic. China’s share of Taiwan’s outbound investments in electronic parts, computer, and optical product manufacturing decreased from 67 percent in 2020 to 42 percent in 2022.

In 2022, China and Hong Kong remained Taiwan’s largest export destinations. However, the growth rates of its exports to China and Hong Kong have turned negative, whereas exports to other major markets (such as Southeast Asia, the United States, Japan, and Europe) have increased significantly, according to Taiwan’s Ministry of Finance (MOF, 財政部).

Demand from China-based Taiwanese businesses for capital equipment and semi-industrial goods was once the main driver of Taiwan’s exports to China. With the number of Taiwanese businesses in China decreasing, demand from Chinese companies and foreign companies located in China has become the main driver of Taiwanese exports to China. Taiwan’s supply of key components to China remains essential to Beijing’s ambitions to play a role in global supply chains. 

However, Taiwanese exports of key components to China are likely to slow even further following new U.S. restrictions on exports to China of semiconductor chips that use U.S. technology. In addition, Apple shifting a quarter of its production of iPhones from China to India could further reduce Taiwan’s exports of key components to China. While Taiwan can continue to export its chips to India for making iPhones, China might lose one of its key economic pillars: exporting final consumption goods such as the iPhone to the world market.

An Economic Evaluation of China’s Military Invasion of Taiwan

Unlike Russia’s security concerns after the collapse of the Soviet Union, China’s foreign policy has been rooted in a quest for economic modernization. [1] China’s more extensive involvement with the world economy provides multiple channels for Western countries to sanction China. However, economic interdependence is a double-edged sword: China’s greater integration with the global economy might restrain potential economic sanctions from Western countries, as it will also hurt the countries that impose sanctions.

If tensions over Taiwan continue to rise, the question is: Which side can better bear losing the benefits derived from economic interdependence? It should be easier for Western countries and companies to line up substitutes to fill China’s manufacturing role (such as India, Vietnam, and other developing countries) than it would be for China to find alternative sources of technology, and replacement markets for its exports of final consumption goods. Indeed, the Chinese Communist Party (CCP) would risk losing its political control over the whole country if it lost Western export markets and sources of advanced technology.  

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However, rationality may not be enough to deter further, and more aggressive, Chinese military activities in the Taiwan Strait. China has not ceased or slowed its provocative military actions near the island of Taiwan, even as its economy has declined over the past few years. Several prominent military analysts now predict that China is likely to invade Taiwan between 2024 and 2027. 

Conclusion

Taiwan’s economy and its relations with China have been shaped by a complex mixture of geopolitical and global economic dynamics between major powers. Both countries’ extensive trade with the rest of the world would make any war in the Taiwan Strait a catastrophe for the global economy.

The triangular relations between China, Russia, and the United States have dramatically changed since the 1990s. Before the Ukraine war, Russia’s GDP was comparable to South Korea, a middle power in the world. Russia’s economy is likely to shrink even more after the war. By contrast, China’s economic modernization has enhanced its military muscle and emboldened its ambitions to challenge the United States’ leadership role in the world. Integrating China into the global economy failed to make it a reliable partner for the United States.

In drafting any plans for military action against Taiwan, Beijing will consider how the United States and its European allies have reacted to Russia’s invasion. The eruption of the war in Ukraine is also a wake-up call for Taiwan. The ruling Democratic Progressive Party (DPP, 民進黨) government has been making efforts to strengthen Taiwan’s overall defense capabilities through the “strengthening all-people’s defense military force restructuring plan,” announced in December 2022. The Ministry of National Defense (MND, 中華民國國防部) has also proposed a 14 percent hike in defense spending in 2023 to beef up Taiwan’s defense capabilities. 

Sustaining these new military expenditures will require robust economic growth. So far, declining exports to China and the relocation of investments out of China have not had a severe impact on Taiwan’s economy. However, Taiwan will require greater political and economic engagement with a wider variety of countries in order to continue diversifying its economic ties. 

The main point: A war over Taiwan would have severe negative repercussions for the world economy. However, the potential economic and political turmoil from launching a war against Taiwan will likely not restrain China’s provocative military actions. A new China policy is imperative to prevent a conflict in the Taiwan Strait from devastating the global economy. 

[1] Jeanne L. Wilson, Strategic Partners: Russian-Chinese Relations in the Post-Soviet Era (New York: M.E. Sharpe, 2004), 199.