Whatever your position on the US-China-Taiwan issue, one cannot disagree that further conflict between China and Taiwan would result in massive disruption to global supply chains. We have seen a recent teaser of potential disruption: China’s military exercises in response to a visit by US House Speaker Nancy Pelosi disrupted key air and sea space in the Taiwan Strait. Transport ships and aircraft were forced to find alternative routes in the region.
During Pelosi’s visit, China’s Defense Ministry warned ships and planes to stay out of six different areas while China conducted drills. Three areas in or near the Taiwan Strait were blockaded, causing ships and planes to cancel or divert transportation.
While one might think that such a narrow strait would be relatively unimportant, there is only one other waterway that ships can travel through to or from the all-important South China Sea: the Luzon Strait. This would add a few more days to the sea travel time. The Luzon Strait, however, is frequently agitated during typhoon season and therefore dangerous to travel.
Importantly, most ships end up using the Taiwan Strait on the way from China and Japan to Europe, and even from the United States to Oceania and Asian nations. Half of the world’s container fleet passed through the strait this year, making it a critical waterway for global supply chains. Taiwan itself relies on the strait for trade with China, which, along with Hong Kong, accounts for 40 percent of its exports.
A conflict between China and Taiwan would make it difficult to trade across the widely used South China Sea, as the passage to the north would be difficult to traverse. The South China Sea is a critical sea lane connecting Asia with the rest of the world. Since most trade routes are indirect (only 6 percent of trading partners are directly connected), the closure of critical waterways has strong collateral effects on world trade.
Bear with me for a short thought exercise on the cost of a conflict in the Taiwan Strait. If the conflict between China and Taiwan were to escalate into a military imbroglio, global supply chains would be disrupted both operationally and logistically. Imagine diverting half of the world’s container fleet and the costs that this would bring. If the main cause is the conflict between China and Taiwan, it is likely that much of the trade with China in particular will be seriously affected.
China accounts for 12 percent of world trade, and many of its exports represent key links in global supply chains. If 12 percent of container ships go to and from China alone and another 38 percent go to other Asian nations or the rest of the world, that 38 percent will incur additional costs, especially during the typhoon season, which lasts from July to October. Ships heading north that can use the Luzon Strait won’t incur extraordinary costs, but those that can’t will have to return via the South China Sea, skirting the Philippines and/or Indonesia, sailing around additional typhoon formations. This is likely to increase shipping rates, at least in this region, by amounts similar to the disruptions from the pandemic.
In terms of China’s role in global supply chains, its processing of materials into finished products represented 32 percent of its exports in 2018. That means other countries continue to rely on China to assemble inputs into final products. In addition, China produces inputs for production, including raw materials and intermediate goods, which included 18 percent of its exports in 2019. What that means is that about half of China’s exports represent important parts of global supply chains.
It has also been widely discussed in the media that any conflict between China and Taiwan could bring chaos to the semiconductor industry. Taiwan Semiconductor Manufacturing Co. produced 63 percent of global semiconductors in 2020 and almost all of the world’s advanced chips in 2019. The auto industry suffered greatly due to chip shortages in the past two years, and disruption in the industry there would be important effects on sales of advanced electronics. Furthermore, half of Taiwan’s exports are made up of machinery and electrical equipment, which would bring more pain to this industry.
The costs to global supply chains would be quite large, and we’re not even going to get into the potential cost of the conflict itself. Fortunately, companies don’t seem to be taking potential conflicts seriously yet. Marine insurance companies they have not raised the Taiwan Strait to the highest risk category. From his perspective, the Chinese military exercises this month appear to be planned in advance. many multinationals are including a conflict between China and Taiwan is on their list of risk scenarios, but they do not see it as likely.
If the possibility of conflict increases, we are likely to see more accurate cost estimates and a growing defection of multinationals from China and the Taiwan Strait region in general. This page has not been turned yet. If and when it is, we can expect supply chain costs to rise.