Any Chinese curbs on Taiwan’s trade would carry big economic costs
Chinese settlers, Portuguese explorers, Japanese colonialists, the Dutch East India Company—all of them first came to Taiwan to trade. And that trade, in turn, has always vexed the Chinese authorities. Mainlanders razed the main Dutch stronghold on the island, Fort Zeelandia, in 1662 and expelled the troublesome merchants. That did not stop the British demanding that nearby Kaohsiung (pictured below) be opened to European ships some 200 years later. To this day it remains the island’s biggest port, handling 57% of Taiwan’s maritime trade. And to this day, fears endure that the Chinese authorities might once again seek to choke off international commerce.
China has a range of options to impede Taiwan’s trade, from a complete blockade to a lesser “quarantine”, which would seek to enforce China’s claim to sovereignty over Taiwan and surrounding waters in a narrower way, such as asserting the right to inspect Taiwan-bound ships or to restrict the flow of particular goods. In 2022 Rhodium Group, a research firm, estimated the direct cost of a blockade to the world economy at over $2trn, based on quite conservative assumptions. A toll that severe might generate a counterproductive backlash for China. The advantage of a quarantine, in contrast, is that it can be adjusted in scope depending on the ferocity of the international response and the severity of the economic fallout.
An obvious target is Taiwan’s exports of semiconductors. TSMC, a Taiwanese firm, produces roughly 90% of the world’s most sophisticated chips on the island. Some Taiwanese see this as a “silicon shield”, protecting them from coercion. Taiwanese chips are so essential to the world economy and to strategic IT infrastructure in particular, the thinking goes, that Taiwan’s friends would have no choice but to help it break any Chinese blockade or quarantine.
But other observers believe the opposite: precisely because Taiwan’s chips are so indispensable, the world might accede to Chinese demands, simply to ensure a steady flow of them. Just 7% of TSMC’s net sales are to Chinese firms, after all, compared with 77% to firms in North America. Western customers would start squealing at the first hint of any disruption to supply. They recall with trepidation the chip shortage of 2021, which is thought to have led to $500bn in forgone sales. China might even try to engineer a sale of TSMC to Chinese entities in return for lifting a quarantine, say analysts at the Baker Institute, an American think-tank.
Chips are not Taiwan’s only export. The island’s ports handled over $500bn of trade in 2022, including trans-shipments that use Taiwan as a way-station. A more expansive quarantine might affect shipping merely passing through the Taiwan Strait, the 180km-wide channel that separates Taiwan from China. Each year around half the world’s container fleet, and nearly all of its biggest ships, pass through it.
China would have several ways to enforce compliance short of sending maritime police to board every passing ship. Chinese ports account for around 40% of the world’s container traffic. Chinese firms also own or operate 115 ports outside the mainland. Chinese law gives the maritime-safety authority the power to punish firms whose vessels enter restricted military areas. A threat to bar non-compliant firms from Chinese-owned ports might well be enough to bring most shipping companies into line.
Shipping firms could try to divert their fleets. Indeed, in any scenario involving a blockade or quarantine, insurance premiums for the Taiwan Strait would presumably leap, creating another incentive to re-route. China’s live-fire military exercises in 2022 offer a preview. Over 200 ships had to divert to avoid six restricted zones declared by China in what would normally be considered international waters. Only a handful dared to ignore the injunction, according to Lloyd’s List, a shipping journal. Insurance premiums for the area have since risen, albeit from a low base.
There are no easy alternatives to the Taiwan Strait. One option is to sail through the Luzon Strait, between southern Taiwan and the Philippines. Shipping firms prefer the Taiwan Strait, however, as it offers some shelter from typhoons, which are especially prevalent between June and October as the rush to transport goods to America for the holidays gathers pace. Other alternatives are much more circuitous and therefore entail higher shipping costs.
Trade unpaid
A quarantine would also disrupt trade finance, a $25trn industry which helps bridge the gap between when exporters dispatch goods and importers receive and pay for them. It is a staid market, with low margins and few defaults, and so is unprepared for big disruptions. It is also largely denominated in dollars and centred on American banks, and so is vulnerable to American sanctions. It could well seize up altogether if lenders begin to anticipate a wave of defaults owing to difficulties in shipping to and from Taiwan. According to the Bank for International Settlements, a grouping of the world’s central banks, roughly a fifth of the “great trade collapse” in 2008-09, when world trade abruptly plunged by 15%, was attributable to the contraction of trade finance.
All these mechanisms to exert pressure on Taiwan and its allies would also harm China to an extent. Any trade restrictions imposed on Taiwan would not only rile markets because of their direct economic effects, but also because they would suggest an increased risk of war. That could lead to a dramatic plunge in asset prices in China and a rush by foreign firms to sell Chinese assets. Both would strain China’s tight capital controls and weigh on the yuan. Turmoil in the shipping industry could also disrupt the over $1trn of Chinese imports and exports that pass through the Taiwan Strait each year. Chinese industry might find it hard to obtain critical imports such as iron ore from Australia, for instance. For an economy already afflicted by faltering foreign investment and weak consumer confidence, the consequences could be dire.
China would know that a quarantine was coming, however, so it could prepare. And it can probably withstand economic pain better than America. Above all, the flexibility of a quarantine would allow China to start small and tighten the screws almost imperceptibly, to provoke as little pushback as possible. ■