The economic consequences of an attack on Taiwan
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The economic consequences of an attack on Taiwan

China’s leadership has options other than invasion to coerce Taiwan to submit to its political control. The immediate economic and financial ramifications would differ in each case. But any scenario that upset the existing cross-Strait balance would come with a high risk of further escalation that would lead to a hard decoupling of China from the West. In view of the wider interest, we are also sending this Emerging Asia Economics Focus to clients of our China Service.
  • China’s leadership has options other than invasion to coerce Taiwan to submit to its political control. The immediate economic and financial ramifications would differ in each case. But any scenario that upset the existing cross-Strait balance would come with a high risk of further escalation that would lead to a hard decoupling of China from the West.
  • One way short of invasion that China could put pressure on Taiwan would be for its military to seize one or more of the uninhabited islands in the South China Sea that Taiwan controls. Some are far from Taiwan. Beijing may calculate that their seizure would send a message of resolve without risking major diplomatic, economic or financial blowback. But if Taiwan’s military put up a (probably doomed) fight, this could still catalyse a response by Taiwan’s allies, including tighter sanctions on trade.
  • Seizure of an island in the Taiwan Strait would be much more provocative as it would weaken Taiwan’s ability to defend itself from attack. Many would see this as a pre-cursor to invasion. This would lead to redoubled efforts to develop high-end semiconductor supply chains outside Taiwan. Firms in all sectors would take steps to decouple their China-facing operations from those serving markets elsewhere. Restrictions on exports of technology to China would be tightened. Western countries may respond to China upsetting the status quo in the Strait by making more explicit their support for Taiwan.
  • Some analysts have raised the idea that China could take control of Taiwan’s borders – a “quarantine” operation. Cross-border activity would be allowed to continue but Beijing would reserve the right to decide which people, goods and data cross it. Any ships or aircraft deemed to require scrutiny could be made to transit through China. Acquiescing would require Taiwan to accept a significant loss of autonomy. More likely, it would use military escorts to break the quarantine, even at the risk of escalation.
  • A blockade has long been one of the key elements of People’s Liberation Army planning for a crisis in the Taiwan Strait. Taiwan’s key vulnerability is its dependence on imported fuel. A fuel blockade would soon cripple industry. Even a porous blockade that allowed fuel through would cause huge global economic disruption. The prospect of high-end chip supply being cut off in the near future would lead to stockpiling. In turn, Western governments would come under pressure to help break the blockade.
  • The upshot is that crisis scenarios short of full invasion all come with a high risk of escalation. It may not be possible to restore stability after a major breach in the status quo. Even if not the initial intention, these scenarios could easily spiral towards a cross-Strait war and to a hard decoupling of China from the West.
  • Analysts are divided on whether China has the capacity to pull off an invasion. But if it tried, whatever the outcome, this would likely result in asset freezes, and the severance of most economic and financial ties. If the US came to Taiwan’s aid, two superpowers would be at war.
  • Even the ideal scenario from Beijing’s perspective, of Taiwan capitulating under pressure early in a crisis, would trigger a wholesale reconfiguration of relations with the West. China would be the undisputed dominant power in Asia. If the US were unwilling to accept its own reduced position, it would attempt to shore up a global anti-China alliance and impose hard barriers on trade and financial flows.

The economic consequences of an attack on Taiwan

This Focus considers some scenarios for how China might attempt to force Taiwan to submit to its political control and gives some initial thoughts on the global economic and market consequences.

Popular discussion of China’s pursuit of unification with Taiwan often considers only the possibility of a military assault. But a crisis over Taiwan could take other forms. Our goal here is to provide a framework that allows us to think about the economic and financial consequences of plausible scenarios and how they might differ.

The scenarios we consider are:

Any of these steps would represent a significant shock to the current cross-Strait situation. We haven’t considered various other less significant “grayzone” tactics which China may use over coming years, which would not significantly shift the status quo – flights over the median line, cyber-attacks, attempts at economic coercion and so on.

To flesh out scenarios we’ve drawn on reports from military analysts and governments. The US Defense Department’s annual China Military Power Report provides a useful overview of US views about China’s thinking and capabilities with respect to Taiwan. Greater depth can be found in Ian Easton’s “The Chinese Invasion Threat”, including material drawn from PLA training manuals. The annual Defense White Paper from Japan’s government provides another perspective. (The 2022 edition has just been published in English in summary form; the full 2021 edition is linked here.) And Taiwan’s National Defense Report gives the view from Taipei on both the nature of the threat and Taiwan’s defensive options.

There are many potential triggers for an attack. China would consider any formalisation of Taiwan’s independence (e.g. a change of name) a provocation. It could also act to forestall closer military support from the West. Crucially though, China claims the right under the Anti-Secession Law to use “non-peaceful means” simply if it no longer believes that “peaceful reunification” is possible.

Seizure of an outlying island

The Republic of China (i.e. Taiwan) controls well over a hundred islands and islets in the Taiwan Strait and South China Sea. (The People’s Republic of) China could seize one or more with relative ease.

Many of the islands have no permanent residents though they may have military installations. These include Pratas Island in the South China Sea, close to where China’s air force has repeatedly entered Taiwan’s air defence identification zone over the past year, and Taiping Island, in the Spratly Islands, 1,500km to the south west of Taiwan.

China’s goal in seizing one might simply be to assert sovereignty over territory it claims as its own, and to intimidate the people and government of Taiwan.

Chart 1: Taiwan and the Taiwan Strait

Sources: OpenStreetMap, Capital Economics

Three clusters of islands in the Taiwan Strait have sizeable populations: Matsu (population 14,000), Kinmen (140,000) and Penghu (100,000). The main islands of Matsu and Kinmen are each only about 10km from China’s mainland. (See Chart 1.) (In 1979, a young captain in Taiwan’s army, Justin Lin, defected from his post in Kinmen by swimming to the mainland holding basketballs as floats. These swashbuckling beginnings set him on a path to later becoming Chief Economist of the World Bank.)

If Taiwan ceded an outlying island without hostilities, there would be no direct economic consequences. The main industry on the inhabited islands is tourism (Kinmen has a side-line in knife-making, using artillery shell-casings left over from regular bombardment in the 1950s and 60s.)

But global financial markets would immediately take fright if the seized island was one of those in the Taiwan Strait. Even if China did not intend to follow up with further aggression, the suspicion that this was phase one of an invasion plan would take a while to dispel. Many analysts believe that a cross-Strait invasion would start with the seizure of Kinmen and other islands in the Strait that have large Taiwanese military facilities, to protect invading forces from attack from the rear. The Taiwan invasion plans that Mao directed the People’s Liberation Army (PLA) to draw up in the 1950s started with occupation of Kinmen and Matsu.

And many would question what point was served by grabbing an island if it wasn’t a precursor to invasion. On its own, loss of these islands wouldn’t force Taiwan to surrender and it wouldn’t bring unification with Taiwan materially closer. But it would change the cross-Strait status quo. Many of Taiwan’s allies don’t formally recognise its independence but insist that cross-Strait differences should be resolved peacefully. By forcibly changing the facts on the ground, China could open the door to more explicit support for Taiwan, including direct military support.

For that reason, it would be reasonable for financial market participants to assume that the seizure of an island in the Taiwan Strait would be followed by further steps by China to increase pressure on Taiwan, and that the crisis probably wouldn’t stop there. Taiwan’s allies would very likely respond with tighter sanctions on technology exports to China. Firms and governments would step up preparations for the contingency that a full-blown invasion might follow. For many firms this would probably involve trying to separate supply chains serving Chinese markets from those elsewhere.

If the island seized were in the South China Sea, uninhabited and far from Taiwan, global markets might be reassured that this did not make subsequent invasion more likely. But much would depend on whether Taiwan put up a fight. It has reportedly stationed troops on Pratas Island recently. A strong, if doomed, defence and casualties among Taiwanese soldiers could catalyse a shift in global support for Taiwan and ramp up US-China tension. Again, this would lead to sanctions on technology and a step-change in efforts to decouple supply chains.

“Quarantine” of Taiwan’s borders

As the authors of a Council on Foreign Relations report put it, “In a quarantine scenario, the Chinese government would effectively take control of the air and sea borders of Taiwan.” This would not be a blockade; most cross-border activity could continue. But Beijing would claim a right to decide which people, goods, ships and aircraft crossed the border. Any craft deemed to require scrutiny could be made to transit through China. China could keep military supplies out and control who was allowed to arrive and leave. The broader goal would be to force Taiwan to accept a significant loss of autonomy.

The key question in this scenario is how Taiwan and its allies would respond. Countering a quarantine may require Taiwan to provide military escorts for ships and planes, which would create a severe risk of escalation.

Taiwan’s government would very likely take that risk. After all, if China took control of Taiwan’s borders, it would be able to throttle Taiwan’s autonomy – this scenario would come to resemble the capitulation scenario discussed below. One difference is that capitulation is only likely as the culmination of a crisis and, in the meantime, many people could leave. The imposition of quarantine measures early in a crisis would enable China to restrict emigration much sooner. Controls on emigration may make it harder for the likes of TSMC to build more chipmaking capacity outside Taiwan. But this may only temporarily sustain the Taiwan-based operations of TSMC: US sanctions on access to key inputs would soon hobble them even if key staff remained in place.

In addition, escalation may be the only way for Taiwan to pull in support from its allies. A quarantine operation by China would pose a dilemma for them. Few recognize Taiwan as independent. China could argue that it was simply asserting sovereignty over its borders and that little had changed about the status quo. Airlines and shipping firms may feel they had no choice but to go along with China’s requirements. If Beijing could maintain the quarantine without the use of violence, there would be no flashpoint that would justify Taiwan’s allies stepping in on its side. They may impose sanctions (technology again) as a protest, but may baulk at using military options to confront China.

In other words, a quarantine would either give way to capitulation or to escalation. In the latter case, the most likely next step from China would be a militarily-enforced blockade.

Blockade of trade, people and data

Taiwan’s dependence on imports is a key vulnerability. According to the US Defense Department, “PLA writings describe a Joint Blockade Campaign in which the PRC would employ kinetic blockades of maritime and air traffic, including a cut-off of Taiwan’s vital imports, to force Taiwan’s capitulation.” In its 2021 Defense Report, Taiwan’s Ministry of National Defense writes that “the PLA is capable of performing local joint blockade against our critical harbors, airports, and outbound flight routes, to cut off our air and sea lines of communication and impact the flow of our military supplies and logistic resources.” A blockade could encompass data too.

A blockade could be intended to force Taiwan to surrender without a fight. Testimony delivered to the U.S.-China Economic and Security Review Commission last year also argued that China would impose a blockade as a fallback if an invasion attempt failed. (See also this piece by Tanner Greer.)

Food and fuel are the critical chokepoints. Taiwan’s government publishes estimates of food self-sufficiency. The headline series shows that Taiwan produces only a third of the calories that its people consume. That share has been stable for 15 years. (See Chart 2.) For some popular foodstuffs, nearly all domestic consumption is dependent on imports. In 2020, Taiwan produced only 0.1% of the wheat and 4.3% of the beef that went into the national favourite niuroumian (beef noodle soup). 99.9% of the tapioca in the balls in bubble milk tea comes from overseas.

Chart 2: Taiwan’s Food Self-Sufficiency Ratio (%)

Sources: Council of Agriculture, Capital Economics

But Taiwan is more self-sufficient in food than these figures might suggest. Niuroumian and bubble tea would be off the menu, but Taiwan is close to self-sufficient in many staples – including rice, pork, fruit and vegetables. (See Chart 3.)

Chart 3: Import Share of Taiwan’s Food Supply
(%, 2020, calculated by food value not calories)

Sources: Council of Agriculture, Capital Economics

There are stockpiles too. The government maintains minimum rice stocks equivalent to three months’ consumption, and stocks are typically much higher than the mandated minimum. A Council of Agriculture survey conducted last year to counter concerns about food shortages during the pandemic found that public and private rice stocks could meet Taiwan’s needs for the next 18 months. Fruit and vegetable stocks and harvests were also found to be sufficient to last for several months. Taiwan’s people could hold out against a blockade for several months, albeit with a less varied diet.

Energy supply would be less resilient. Only 12% of Taiwan’s energy comes from domestically-produced fuels, renewable sources or nuclear power. For vehicle fuels, stockpiles provide a reasonable buffer. By law, Taiwan’s government is required to hold 30 days’ supply of oil while refiners and importers are required to maintain stocks of an additional 90 days of oil (and 25 days of LPG). At the end of 2021, according to the Ministry of Economic Affairs, the combined oil stockpile was sufficient to last Taiwan 138 days, at the past year’s average daily rate of consumption. Rationing could stretch fuel supply longer although, in a crisis, fuel demand from Taiwan’s air force would also inevitably increase.

The key vulnerability is electricity supply. Electricity generation is heavily and increasingly dependent on imported LNG. 37% of electricity was gas-generated last year. The last operating nuclear plant in Taiwan is due to shut down in 2025 and the government has a longstanding goal of closing the gap with more gas power. Its target is to raise the share of electricity generated using natural gas to 50% by then. (See Chart 4.)

Chart 4: Power Sources for Electricity Generation

Sources: CEIC, Ministry of Economic Affairs, Capital Economics

Natural gas stockpiles are much thinner than those for oil: importers are currently required to hold a “security stockpile” of only eight days’ supply. This will rise to 14 in 2027. These storage facilities would be vulnerable to Chinese attacks, as would the country’s two LNG terminals. (Another three are planned.)

An interruption of LNG imports would therefore result in a substantial drop in power generating capacity within days. The electricity network already has little excess capacity: strong demand from industry triggered widespread blackouts in 2021. As a result, even if China were allowing goods exports to continue through the blockade, disruption to LNG imports would soon bring much of Taiwan’s industry to a halt. The priority for remaining capacity would be to supply military needs in anticipation of invasion.

China could impose a porous blockade, allowing fuel and most trade through, and blocking only military supplies. But it’s hard to imagine this would be sustainable. Taiwan would surely cut exports of technology products to China which could provoke a tightening of the blockade. Even if most trade did continue, the global economic disruption would still be huge. TSMC produces 92% of the world’s most advanced chips in Taiwan. The prospect that this supply could be disrupted or severed in the near future would trigger panic buying and stockpiling.

The global economic disruption would also create pressure for those allies to respond with more forceful measures to contain China. They may join together to break the blockade, putting them directly in confrontation with China’s military. Another option some analysts consider is a counter-blockade of sea routes to China. In either cases, there would be substantial risk of dramatic escalation of the crisis.

A blockade would either coerce Taiwan to submit, be broken with Western help or be followed by invasion. In each eventuality, economic and financial ties between China and the West would be ruptured. There would be no turning back the clock.

Capitulation without major damage

The ideal scenario from Beijing’s perspective would be for its pressure – whether from a blockade, limited missile strikes, or the amassing of an armada – to trigger capitulation by Taiwan. What consequences would there be if Taiwan gave in before significant physical damage was done and before the US or other allies got involved?

In this scenario, China would have inflicted little direct damage on Taiwan’s infrastructure and industry and the US would not have been involved. But Taiwan’s absorption into China would reconfigure the strategic balance in the Asia-Pacific with far-reaching ramifications.

Most countries in the region are today either US allies or trying to steer a middle path between the US and China. We’ve argued that this fence-sitting will be increasingly untenable as strategic competition between the US and China intensifies. If China were to take Taiwan, those waverers may shift to China’s side. In turn, the US government would come under pressure to demonstrate its commitment to allies in the region, leading to a greater military build-up.

Japan would be particularly exposed. Control of Taiwan would give China a base from which to project power beyond the first island chain into the Pacific. A handbook for Chinese air force officers quoted by Ian Easton notes that “as soon as Taiwan is reunified with Mainland China, Japan’s maritime lines of communication will fall completely within the striking ranges of China’s fighters and bombers.”

Japan’s government increasingly appears to view Taiwan as crucial for its security. According to its 2021 Defense White Paper, “it is necessary that we pay close attention to the [Taiwan] situation with a sense of crisis more than ever before.” Shinzo Abe’s view was that “a Taiwan contingency is a Japan contingency.” 

Consequently, while a largely peaceful takeover of Taiwan by China may not immediately cause a global economic shock, it would reconfigure the region. China’s position would be strengthened, Japan and the US’s weakened. The US and its allies would face a choice: Accept China’s seizure of Taiwan and the West’s weakened position and attempt to find a modus vivendi with China; or impose some form of sanctions on China which would cause economic damage to both sides.

The Russia sanctions provide a model for the sort of steps the West could take. Many Russian firms and banks have had their access to Western markets and financial systems severed. Public and privately-owned foreign assets have been frozen. Technology exports have been severely restricted. Many foreign firms have unilaterally ceased operations in Russia even when not required to by sanctions.

But it would be hard to win popular backing in the West to impose similar sanctions across the board on China or to maintain them indefinitely in a scenario in which Taiwan had already surrendered. There would be no plausible near-term goal akin to Russian withdrawal; the message instead would presumably be that the sanctions would remain indefinitely. And their immediate impact on Western economies could be huge if they were applied widely. China supplies 15% of the world’s goods exports, six times as much as Russia. (See Chart 5.)

Chart 5: Share of World Goods Exports (%, dollar value)

Source: IMF DOTS

That said, the exclusion of Russian energy from sanctions is an example of Western willingness to shape sanctions to limit domestic damage. In a bloodless takeover of Taiwan, similar exclusions could allow significant trade to continue between China and the West. In this scenario, sanctions may be focused narrowly on areas deemed of particular strategic importance.

But this could still entail significant disruption to global supply chains. The US is currently tightening restrictions on exports to China of technology and machines needed to make advanced semiconductors. Most of these are currently made in Taiwan. Accordingly, if Taiwan were part of China, it would lose access to inputs needed to keep producing cutting edge chips.

In practice, key personnel would probably be encouraged to emigrate before the takeover. Advanced facilities could be sabotaged or destroyed. Even if advanced manufacturing facilities were not damaged, production would be affected. TSMC, for example, operates in close partnership with ASML, the Dutch firm whose lithography machines it uses to make sub-10nm chips. Around of tenth of ASML’s staff work in Taiwan operating and maintaining those machines. Without that support, production would be affected. And without support from ASML, TSMC would be unable to increase capacity of advanced chips or create next generation chips.

For this reason, it makes no sense to argue, as some do, that China would invade Taiwan in order to gain control of TSMC production lines. It is more likely that invasion would result in China losing access to the most advanced chips by degrading TSMC’s capabilities or by triggering a ban by Western powers on exports of chipmaking equipment. China is almost entirely dependent in this area on the US and its allies. (See Chart 6.) (To be clear, we doubt that this fact would on its own be sufficient to deter an invasion either.)

Chart 6: Sources of Chipmaking Equipment Imported by China ($, 2016-2020)

Sources: UN Comtrade, Capital Economics

Building a TSMC-in-exile outside Taiwan would be a lengthy and vastly expensive process. Even a bloodless takeover of Taiwan which left most trade relations unaffected would therefore still deliver a major shock to chip production, and through it to large swathes of manufacturing.

Invasion – the US doesn’t defend Taiwan

Military experts differ on whether China yet has the capacity to carry out a successful invasion. In its 2021 China Military Power Report, Taiwan’s Ministry of National Defense concluded that China stills lacks the logistics capability and landing craft it would need. Those who believe China does have the capability concede that it would be extremely difficult to pull off (“by far the largest amphibious landing any military force has contemplated”).

Taiwan’s geography favours the defence. China’s troops would have to be brought across the Taiwan Strait, which is 130 kilometres wide at its narrowest and prone to typhoons and fog for much of the year. They would have to land on one of the handful of beaches and harbours suitable for bringing large numbers of troops and equipment ashore. Taiwan’s east coast is predominantly cliffs, its west coast mostly mudflats. Taiwan and its allies would have time to prepare their defences of these landing spots as an invasion armada assembled – PLA writings suggest that an amphibious landing would happen several months into a campaign, after the seizure of outlying islands and missile attacks. If a beachhead were established, troops would then have to fight their way inland. Much of Taiwan is mountains and forest, with a dense urban strip along the west coast. (See Chart 1 again.) The US abandoned its plan to invade Taiwan in the Second World War, Operation Causeway, because it estimated that, even with control of the air, half a million troops would be needed to defeat a far smaller Japanese force.

Chart 7: Size of Taiwan’s Military Forces Relative to China’s (China = 100)

Sources: US Defense Department China Power Report 2021, Cap. Econ.

That said, China has massive material superiority over Taiwan. (See Chart 7.) China’s economy is twenty times as big as Taiwan’s. Its published military budget exceeds Taiwan’s by a similar magnitude ($209bn vs $13bn) and probably understates actual spending. In manpower, China’s military outnumbers Taiwan’s twelve-to-one. If the PLA were able to establish a beachhead and China’s leaders were willing to tolerate huge losses, China would prevail, unless Taiwan’s allies stepped in.

In some scenarios, they would not have the opportunity to. Some analysts argue that China could stage a surprise attack comprising a combined missile strike and airborne assault. (The need to assemble a fleet means that a surprise attack isn’t possible by sea.) The initial goal might be to disable Taiwan’s ability to defend itself and to kill or detain its political leaders. If airfields and air superiority could be secured quickly, troops could then be in flown in in large numbers before Taiwan’s allies had time to respond in force.

Most analysts seem to think this approach would have a low chance of succeeding. A surprise strike would by necessity not be preceded by a major build-up of troops and equipment. China would therefore relinquish its main advantage: its overwhelming superiority in resources. Failure would probably prompt a formal declaration of independence from Taiwan.

There are many other scenarios in which Taiwan’s allies do not get directly involved in a cross-Strait fight. The most plausible is that, as with the war in Ukraine, US leaders conclude that the risk of escalation and potential costs from fighting a superpower would be too high. And options to resupply Taiwan’s military during an ongoing conflict would be far more limited than in Ukraine.

While in this scenario, the US and China would not have come into direct conflict, it is hard to imagine that there would not be an almost complete rupture in relations. The geopolitical map would have been violently redrawn and US allies in the region would feel under threat. Sanctions would be wide-ranging across trade and financial ties. China’s foreign assets would be frozen. China may allow some Western firms to keep operating in China, in hope they might provide some leverage over Western government policy and as conduits for acquisition of technology. But many would face retaliatory asset seizure from China’s government and come under pressure from Western governments to pull out. High-end manufacturing facilities in Taiwan would probably be sabotaged, creating a supply shock for both sides.

The economic damage from hard decoupling would be greater for China – nearly two thirds of its exports go to the United States and its allies, compared with only 15% of exports from the US bloc to China and its allies. (See Chart 8 taken from our work Mapping Decoupling.) There is a similar disparity for imports. But the shock to economies in the West would nonetheless be severe. As Chart 8 illustrates, China is an order of magnitude more important in the global trading system than Russia.

Chart 8: Goods & Services Trade ($, 2019)

Source: IMF, WTO, Capital Economics

One question worth asking is whether the economic and financial response from the West would differ if Taiwan triggered the crisis in some way. We don’t think it would. Western powers would consider invasion a wildly disproportionate and unjustified response to any step Taiwan might take, such as a declaration of independence. While the US and its allies may not come to Taiwan’s aid in this scenario, China’s belligerence and its rewriting of the geopolitical map would still trigger a decoupling of economic and financial ties.

Invasion – the US defends Taiwan

A policy of “strategic ambiguity” leaves open the question of whether the US would come to Taiwan’s aid. But a build-up of military forces on the coast opposite Taiwan would give it – as well as Japan and other allies – time to provide support if they chose to.

Any significant support would almost certainly bring Western powers into direct conflict with China in the event of a cross-Strait war, since China would attempt to impose a blockade and air exclusion zone around Taiwan. If China’s leaders thought that the US would intervene and wanted to invade regardless, they could launch pre-emptive strikes on US forces in the region, including in Okinawa, 650km from Taipei.

In this scenario, the ensuing breakdown of economic and financial relations between the West and China may not be the main concern. But at the minimum there would be a hard decoupling of most trade, investment and financial flows between the West and China, at least as stringent as that being applied to Russia now. Foreign assets (manufacturing plants, US Treasury bills) would be seized on each side. Strategically-important parts of Taiwan’s industrial base, including semiconductors fabs, may be destroyed. Even if superpower hostilities were somehow contained to Taiwan and nearby waters, the global economic shock would be huge.


Mark Williams, Chief Asia Economist, mark.williams@capitaleconomics.com

Mark Williams Chief Asia Economist
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