Taiwan's economy is breaking away from China's

Taiwan has been an essential part of the US's geopolitical and economic strategy in the Asia-Pacific since the Cold War era. The island was especially important in integrating China into the global economy after Washington's political reconciliation with Beijing in the 1970s. In recent years, however, the US's policy has switched from "integrating China into the global economy" to "confronting the China threat".

Now, there are signs that the economic ties between Taiwan and China have started to decouple.

According to Taiwan's Investment Commission, Taiwanese realised investment in China has plummeted, from US$9 billion in 2017 to just US$1.7 billion in 2022. As a consequence, China's importance in Taiwan's total outward foreign direct investment has diminished whereas other countries' weight has increased.

The officially recorded investment data shows that China accounted for 34% of Taiwanese firms' worldwide investment in 2022, followed by 31% of Southeast Asia and India, and 13% of the US and Europe. This is in sharp contrast to a decade ago, when China accounted for over two-thirds of Taiwan's global outward investment.

Taiwan's official survey report in 2022 explained that the growing competition from local producers, rising labour costs, and difficulty in developing China's domestic market are the main obstacles for Taiwanese firms doing business in China. While very real, these problems alone are insufficient to explain the extent and speed of the decline in Taiwanese investment in mainland China.

Taiwanese investment in China fell by over 50% from 2018 to 2019 alone. The timing strongly indicates that changing US trade policies toward China played a significant role. The post-2019 investment cut was far greater than the investment declines of a decade ago that resulted from China's wage hikes.

Washington delivered four rounds of higher tariffs on Chinese goods between July 2018 and May 2019. To avoid being affected by the higher tariffs against imports from China, China-based Taiwanese firms, especially those in the information and communication technology industry, shifted some production and export capacity from China to Taiwan and other developing countries, notably Vietnam.

Data from the US's International Trade Administration show that American imports of computers and electronic products from Taiwan and Vietnam doubled from 2019 to 2022, whereas imports of the same products from China increased by only 10% during that period.

Taiwanese firms also largely echoed President Trump's push to invest in the American manufacturing industry. In 2020, their investments in the US rose by 650% to US$4.2 billion. The investments continued to grow, amounting to US$11 billion in 2022 and making the US Taiwan's third largest outward investment destination, after China and Singapore, according to Taiwan's Investment Commission.

US sanctions on exporting advanced semiconductor chips and equipment to China, including Taiwanese companies' exports, have further weakened cross-strait trade relations.

The growth rate of Taiwanese exports of electronic products, including semiconductor chips, to China and Hong Kong, has decelerated from 24% in 2020 and 2021 to 11% in 2022. In comparison, the growth rates of Taiwan's exports of electronic products to Southeast Asia and India accelerated greatly - by 21% and 72%, respectively - according to Taiwan's Ministry of Finance.

Taiwan's exports of semiconductor chips to India for the final assembly could grow further after Apple's decision to shift iPhone production to India. Apple is a main contributor to Taiwan's exports of semiconductor chips to assemble devices in a third country. India is expected to account for 50% of iPhone production by 2027, up from 5% at present.

China's exports would suffer from the loss of its "global factory" status. Chinese firms' particularly strong reliance on importing Taiwanese semiconductor chips will make them vulnerable during the decoupling of the cross-strait production network. With China's domestic economy suffering from a stagnant real estate market and weak private consumption, dwindling exports will only add hail to the snowstorm.

On the other hand, Taiwan has shown greater trade resilience than China during the early stage of the cross-strait economic decoupling. Taiwan's overall trade posted positive growth in 2022, while China's exports and imports declined by 10% and 8% respectively.

China might want to retaliate against Taiwan through the termination of the Economic Cooperation Framework Agreement (ECFA), a bilateral trade agreement, implemented since 2011. However, Taiwan's merchandise exports to China, which benefited from the lower tariffs in ECFA, accounted for only 5% of Taiwan's total exports. As such, the impact of ending ECFA on Taiwan's economy might be restrained.

Indeed, Taiwan's quick growth in exporting semiconductor chips to China over the past decade has diluted the importance of ECFA goods in bilateral trade relations. Taiwan and China have enjoyed zero or low tariffs for trading information technology products, including semiconductor chips, thanks to their memberships, under the Information Technology Agreement, in the World Trade Organization.

Taiwan's public opinion in favour of the "status-quo" across the strait demonstrated that China did not succeed in bringing Taiwan politically closer to China through greater economic integration between the two economies. Instead, the greater impact on China's external trade from the US's policy change showed that the Chinese leadership has overestimated its economic leverage over Taiwan. Beijing's incessant and provocative military actions around the island of Taiwan show that China is greatly concerned that its economic coercion strategy has failed to persuade the Taiwanese people to support cross-strait unification.

Overall, China's economy has benefited from the smooth integration into the global economy - and Taiwanese firms have played a key role in that process. The sustainability of the cross-strait production network has relied on, and will continue to rely largely on, global demand, especially private consumption in the US.

The partnership with East Asian countries gives the US flexibility to adjust its economic policy to the evolving geopolitical environment. Like chess players, it has the option to move its policy pieces to maintain a posture that best defends and advances its interests.

Unlike the US, China has limited allies and a heavy dependence on the Western market and technology. This prevents it from being a dominant player and limits its ability to take effective countermeasures.

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