One lasting effect of the pandemic’s disruption of global supply chains has been a shortage of chips. This is not primarily a shortage of the advanced semiconductors which some industry leaders have increasingly favored because of their higher margins; rather, it’s the commoditized, workhorse chips that are now essential components of consumer goods from cars to home appliances and simple consumer electronics — especially power management and microcontrollers.
Of course these chips are also present in our ubiquitous telecom devices such as smart phones, tools, and AI speakers; the advanced chips get the news coverage, but low-cost chips are just as critical to functionality. Carmakers have been especially hard-hit, with many manufacturers forced to idle production lines, and consumers scouring empty lots for new cars and trucks. It is a particularly intense manifestation of the effects of the unprecedented pandemic start/stop and the rapid post-pandemic global economic acceleration, and of the fragility of a just-in-time inventory and logistics system. (Some observers are saying that “just in time” is giving way to its opposite — “just in case” — resulting in an even sharper uptick in double ordering, restocking, and inventory building.)
That brings us to Taiwan, and to the high-wire balancing act that U.S./China relations have become. How did this small, earthquake-prone island become so important on the global stage?
Although there are global semi manufacturers in many countries, particularly in east Asia and the United States, 63% of global semi manufacturing capacity is located in Taiwan — 54% of that capacity from Taiwan Semiconductor Manufacturing Company [TSMC]. It is not an exaggeration to say that Taiwan is the Saudi Arabia of semiconductors — in fact, the concentration is far greater than the concentration of oil production. The U.S.-based GlobalFoundries, a privately owned U.S. semiconductor manufacturer, claims only 7%.
With all the recent talk about the pandemic-driven acceleration of the decarbonized, digital global economy, perhaps the saying that “copper is the new oil” should be revised to say that “semiconductors are the new oil.” The difference between copper and semis of course is that new semi capacity can be built. But it is not a trivial affair. The Semiconductor Industry Association estimates that making the U.S. self-sufficient in semi capacity would take a $1.4 trillion investment over a decade. That leaves aside the intensely cyclical and risky nature of semi demand, which makes sinking such capital into expansion a fraught and difficult decision. Even now, semi manufacturers are wrestling with the problem of how enduring the current demand spike will be, before they make existentially risky capital allocation decisions to ramp capacity. (First, they’re trying to squeeze every drop of capacity they can out of existing facilities.)
Neither the semi manufacturing dominance of Taiwan, nor the critical importance of semis in the global economy, are likely to change quickly.
This reality puts U.S./China relations in a new light. Taiwan, the island to which the defeated Chinese nationalists fled after the Communist victory on the mainland, has long been a thorn in the side of the People’s Republic, which continues to believe that Taiwan is an integral part of its territory, and which engages in sometimes ludicrous acrobatic diplomacy to punish anyone who even refers to Taiwan as “a country.” Students of history familiar with Taiwan are likely to question the rationale or validation of China’s claims, but the vigor with which China pursues them is more important than their validity. Taiwan’s dominance in producing a commodity which the People’s Republic desperately needs to further its own economic growth (and therefore, political stability) makes it even more of a desired prize for China to reclaim.
The embarrassing Alaska meeting between U.S. and Chinese officials earlier this year highlighted a shift that has been in the making during most of Chinese President Xi Jinping’s tenure. Deng Xioaping, who led China out of the Maoist era and into the embrace of an authoritarian form of capitalism, counseled the Chinese to lie low and bide their time; and for many years, China did not want to upset the status quo with the United States, which Chinese officials often ruefully referred to as lao da, “the big boss.” It is increasingly apparent that Xi and his confreres believe that the time has come for China to assert itself as the equal of the U.S. in technology, military power, and global influence.
The Taiwanese and U.S. militaries are keenly aware of this shift. Several years ago, Taiwan, under domestic political pressure, radically scaled back its mandatory military service; its military has shrunk from 275,000 members to 165,000 over the course of three years. Taiwanese leaders are ramping military spending, and a recent U.S. military study concluded that China might feel sufficiently emboldened to attempt to retake Taiwan some time in the next decade. Of course, China has non-military means to undermine U.S./Taiwanese relations, for example by playing up anti-Asian sentiment in the U.S. to a Taiwanese media audience.
The current U.S. administration has been uncertain in its posture towards China. In some respects, the rhetoric of Secretary of State Antony Blinken has been quite sharp, and he has made moves to rally global democracies against the common threat of rising illiberal regimes, including both Russia and China. They have sanctioned Chinese officials for China’s genocidal campaign against the Uighurs in Xinjiang. Blinken has continued to refer to Taiwan as a “country,” angering his Chinese counterparts. But at the same time, the administration has made critical changes of tone in its communications — emphasizing that the U.S. relationship with China is not a confrontation, but a “competition.”
One aspect of the previous administration’s China policy that has fallen by the wayside is the emphasis on China’s theft of intellectual property and general disregard for intellectual property rights. Another is the attention given to the various means by which the Chinese government attempts to infiltrate and influence U.S. institutions and lawmakers — including the Confucius Institutes.
Perhaps most troubling is the press to waive patent protections on U.S. vaccine technologies. With biotechnology as one of the focus areas of China’s “Made In China 2025” initiative, it is unlikely that the technology transferred with the data on mRNA vaccines would be applied only to vaccine manufacture and distribution.
Thus, tough rhetoric is being accompanied by a softening of the U.S. stance underneath. It is early innings in the new U.S. administration’s efforts to keep U.S./China relations on a steady path. Taiwan is a critical place to watch.
Investment implications: We believe it is unlikely that China’s designs on Taiwan will occasion a hot war in the near future. China certainly has every reason to avoid a military conflict that would cripple the island’s crown jewel — its semi manufacturing capacity. The U.S. also has every reason to avoid this eventuality. Still, the current trajectory of Chinese ambition, and the growing geopolitical importance of Taiwan as a semi manufacturing hub, indicates that U.S. and Taiwanese caution and preparation is warranted. The tension may also ultimately benefit U.S. semi manufacturers, if tensions are prolonged and result in an enduring rise of global “semiconductor nationalism.”
