Taiwan and China Are Locked in Economic Co-Dependence

Both sides have leverage but have been reluctant to use it.

By Bonnie Glaser and Jeremy Mark, a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center.
A factory of Taiwanese semiconductor manufacturer TSMC
A factory of Taiwanese semiconductor manufacturer TSMC at Central Taiwan Science Park in Taichung on March 25. Sam Yeh/AFP via Getty Images

Beijing grabbed headlines in March when it banned imports of Taiwanese pineapples, alleging a pest infestation. The action fit a pattern of China’s weaponization of trade for political purposes elsewhere in the world through informal actions, rather than explicit trade barriers.

The ban ultimately proved fruitless as the 40,000 tons of pineapples originally destined for mainland Chinese tables were snapped up by other buyers. But the incident was a reminder of how deep the trade and investment ties are between Taiwan and China—and how, for the most part, they’ve remained surprisingly insulated from increasingly fraught cross-strait politics.

Cross-strait trade hit a record last year, including indirect trade through Hong Kong and Macao, with Taiwan’s exports representing some 70 percent of the total. Much of the increase was due to strong global demand for made-in-China goods in response to the COVID-19 pandemic. It also helped give a lift to Taiwan’s economy, as did its successful and rapid control of the pandemic, causing growth to exceed China’s—2.98 percent versus 2.3 percent—for the first time since 1990.

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While the increasing flow of trade—and more than $188 billion of Taiwanese investment into China since 1991—serves Beijing’s long-standing goal of integrating Taiwan’s economy with its own, the situation isn’t as favorable to China as it might seem. The two sides of the strait are locked in a state of economic co-dependence, with China increasingly reliant on Taiwan for technology. The largest proportion of Taiwanese exports is sophisticated electronics, especially cutting-edge semiconductors that China lacks the ability to produce. And with the United States imposing restrictions on sales to China of both semiconductors and the technology to make them, Beijing is facing vulnerabilities that make economic relations with Taiwan even more important.

Over the years of deepening trade and investment ties, Chinese punitive economic actions against Taiwan have been limited, the notable exception being a sharp reduction in Chinese tourism after the inauguration of Taiwanese President Tsai Ing-wen in May 2016. The continuing emphasis on cross-strait economic integration as a means of political reunification was underscored last month during a visit by Chinese President Xi Jinping to Fujian province—the closest part of China to Taiwan—during which he urged Fujianese to “be bold in exploring new paths for integrated cross-strait development.”

Beijing’s reluctance to punish Taiwan economically stands in sharp contrast to hard-line Chinese diplomatic and military actions toward the island in response to Taiwanese policies that Beijing finds objectionable. During Tsai’s first four-year term, Beijing poached seven of Taipei’s diplomatic allies. Despite the pandemic, it has blocked Taiwan from participating in the World Health Assembly, the decision-making body of the World Health Organization. Since March 2019, Chinese jets regularly trespass into Taiwan’s air defense identification zone and frequently cross the centerline of the Taiwan Strait, which the People’s Liberation Army Air Force had tacitly respected for 20 years. And threats of a Chinese invasion of Taiwan often appear in China’s state media. Some observers view China’s growing pressure as a sign that Beijing is no longer confident that time is on its side and that Chinese patience for reunification may be growing thin.

In this context, the pineapple ban was a shot across Taipei’s bow—a warning that the cross-strait relationship is not immune from the same retribution that countries that have angered Beijing of late have faced. For example, Australia was hit last year with restrictions on exports to China of beef, barley, wine, and other products in response to Canberra’s insistence on an international inquiry into China’s handling of the COVID-19 outbreak, among other perceived slights. But exports of Australian natural resources, such as iron ore and liquefied natural gas, that are important to the Chinese economy have remained largely untouched.

Taiwan’s government has attempted to reduce dependence on the Chinese economy by encouraging market diversification and by enticing Taiwanese businesses to shift investments back from China. The centerpiece of the diversification strategy has been the New Southbound Policy, which promotes the expansion of trade, investment, culture, and educational ties with other Indo-Pacific countries. That policy saw some success before COVID-19, but trade and investment flows were disrupted during the pandemic.

Incentives to Taiwanese businesses to return from China, put in place two years ago, have attracted at least $38 billion in commitments to invest in factories in Taiwan—many of them high-tech. Nonetheless, Taiwanese companies remain deeply embedded in the Chinese economy. The Foxconn Technology Group has more than 1 million employees in China assembling Apple iPhones and other name-brand electronics.

There is also a push factor for Taiwanese companies that have found China less hospitable to their bottom lines as labor costs rise, Chinese environmental regulations become stricter, and U.S.-China trade tensions disrupt supply chains. Companies—many of which once left Taiwan for China—now are shifting factories to Southeast and South Asia, and elsewhere, with an eye to producing in China only for the domestic market.

Nonetheless, China’s share (including Hong Kong and Macao) of all Taiwanese exports reached nearly 44 percent in 2020, a record high. What is uncertain is whether the rebound in cross-strait trade in response to coronavirus-related demand will last once the global economy recovers from the pandemic.

Strong demand for electronics—and especially semiconductors—is expected to continue for the next few years. But that needs to be balanced against expectations of continued U.S.-China trade tensions centered on technology sales. Those tensions affected several Taiwanese companies in 2020, when the United States imposed a ban on exports of high-end semiconductors to Huawei and restricted commercial transactions with China’s largest chipmaker, Semiconductor Manufacturing International Corp. A portion of Taiwan’s increased exports to China in 2020 came as a result of Huawei’s effort to stock up on chips before the ban went into effect.

China focused its anger over the restrictions on the United States, but a key question going forward is whether it will be prepared to take major coercive economic actions against Taiwan should Washington continue to tighten controls on technology sales—or in response to developments in U.S.-Taiwan relations or Taiwanese politics. For now, China’s economic dependence on Taiwan and the Chinese leadership’s goal of integrating the two economies point to the likelihood of more responses along the lines of the pineapple ban. Taiwanese exports to China that can be replaced by other suppliers will be vulnerable, and companies in those sectors should diversify their markets.

However, punitive actions directed at Taiwan that damage core Chinese interests—certainly including Beijing’s goal of developing high-tech industries—are less likely, and imports of semiconductors and other electronics components will remain prioritized. Should Beijing choose, it has the ability to exert pressure on Taiwanese businesses that have a major presence in China by disrupting their operations But that probably would occur only if China gave up entirely on its strategy of promoting reunification through economic integration combined with various forms of military, diplomatic, and economic pressure.

China-Taiwan economic interdependence is likely to continue because of their geographical and cultural proximity and the complementarity of the two economies, as reflected in their intertwined supply chains. Beijing may target the likes of pineapples, but it is not going to upset the apple cart.

Bonnie S. Glaser is senior advisor for Asia and director of the China Power Project at the Center for Strategic and International Studies (CSIS).

Jeremy Mark is a nonresident senior fellow at the Atlantic Council’s GeoEconomics Center.