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How Does China's Economy Affect The World – The recent tensions in the Taiwan Strait have raised fears of a conflict between China and Taiwan, and raised questions about the consequences of such a scenario for the global economy. It is impossible to predict how the conflict might develop, which further complicates any assessment of its economic and trade consequences. However, the risks of a crisis over Taiwan have risen, making these questions more important than ever for policymakers and business leaders.
Throughout 2022, with the war in Ukraine highlighting geopolitical risks, Rhodium Group examined the potential global economic disruptions resulting from a hypothetical conflict between China and Taiwan. Our work is based on research dating back to 2004 examining Taiwan’s global economic relations. Unsurprisingly, the amount of economic activity at risk of being disrupted by conflict in the Taiwan Strait is enormous: more than $2 trillion in a blockade scenario, even before taking into account international responses or second-order effects. Disturbances will be felt immediately and will be difficult to reverse. It would affect trade and investment on a global scale, affecting only a few countries. Such disturbances can occur even if the conflict does not become kinetic.
How Does China's Economy Affect The World
Estimating the economic consequences of a Taiwan-centered conflict is difficult. Such a conflict can take many forms, varying in duration and size and in terms of the parties involved. Crucial data, especially related to semiconductor supply chain activity, is not publicly available. Important aspects of disruption scenarios cannot be easily measured, and are often left out of models of trade shocks, including impacts on cross-border flows of people and ideas. It is also difficult to estimate the ripple effects of trade and supply chain disruptions.
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With these challenges in mind, our analysis adopts a necessarily simplistic and partial approach to estimate the scope and nature of economic activities at risk of disruption in the Taiwan-China conflict. We define the conflict – for the purposes of our hypothetical assessment – as a blockade imposed by China on Taiwan that halts all trade between Taiwan and the rest of the world. Based on these criteria, we identify the main channels of economic disruption and, where possible, provide an estimate of the lower bound of the range of economic activity at risk. We do this by using conservative assumptions throughout our analysis and by focusing our attention on the most serious areas of economic disruption.
We do not claim to estimate GDP losses or other measures of foregone economic well-being. Instead, we provide a snapshot of the activity at risk at the start of a siege, if it occurred today, without making any predictions or assumptions about how such a crisis might develop. When we provide estimates of economic flows at risk, they are annual figures. We discuss potential long-term risks qualitatively throughout this note, but our quantitative estimates do not take into account second-order effects. Importantly, our analysis does not attempt to estimate the costs associated with additional disruptions caused by military escalation or the imposition of international sanctions. As such, our analysis should be considered
In a blockade scenario, the most significant disruption to global economic activity would come from the cessation of Taiwan’s trade with the world, especially in semiconductors. Disruptions to global supply chains – especially in key chip-consuming sectors such as electronics, automobiles, and computing – would have serious repercussions for the global economy. Global trade with China will also decline due to a contraction in global trade financing, which will cause a shock to the global economy and potentially lead to debt crises among China’s more fragile trading partners.
The largest trading economy, it imported and exported $922 billion worth of goods and services in 2021. Almost all of this trade would be severely disrupted if a blockade was imposed. Regardless of the value of eventual re-exports and ICT-related trade we cover below, approximately $565 billion of Taiwanese value-added trade would be at high risk of disruption due to the blockade.
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While the absolute commercial values at risk are high, the most serious economic impact will come from disruptions to semiconductor supply chains and associated manufacturing industries. Taiwan produces 92% of the world’s most advanced logic chips (with node sizes below 10 nm), as well as one-third to one-half of global production of less advanced but nonetheless critical chips. By some estimates, Taiwan’s leading chip foundry TSMC produces 35% of the world’s automotive microcontrollers and 70% of the world’s smartphone chips. It also dominates the production of chips for high-end graphics processing units in computers and servers. A conservative rough estimate of reliance on Taiwanese chips suggests that companies in these industries may have to give up as much as $1.6 trillion in revenue annually in the event of a blockade.
Beyond the direct impact on corporate revenues from lost semiconductor production, the global economy will face significant second-order effects that will likely add trillions more in economic impact. Many industries depend on the availability of goods and equipment containing Taiwanese chips. These include e-commerce, logistics, passenger services, entertainment, and other industries that collectively employ tens of millions of people. Spare parts and components for critical public infrastructure, such as communications and medical devices, may become scarce. Ultimately, the full social and economic impacts of a chip shortage of this magnitude are incalculable, but likely catastrophic.
The conflict over Taiwan will affect not only economic activity with Taiwan, but also economic activity with China. Even assuming no sanctions or military escalation between the United States and China, trade between China and the rest of the world would be severely affected by disruptions to global trade finance.
Every year, banks provide $6.5 to $8 trillion in financing to help importers and exporters facilitate trade while goods are in transit. This short-term financing supports up to a third of trade flows. In the event of a conflict between China and Taiwan, risk-averse global investors would withdraw from lending activities, reducing the availability of trade financing and thus weakening international trade. During the global financial crisis, it was estimated that the collapse of trade finance was responsible for nearly one-fifth of the total decline in global trade. In the Taiwan conflict, the impact could be more pronounced as banks reduce their exposure to Chinese counterparties in anticipation of financial sanctions. Between the global liquidity crisis and the threat of sanctions, trade financing with China is likely to become at least as scarce as it was in the global financial crisis, with the potential disruption of more than $270 billion in trade between China and the rest of the world. – Even before any sanctions were imposed.
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Trade with China will be affected by other forces as well. Domestic economic conditions in China will deteriorate rapidly, especially due to the disruptions to the global semiconductor value chains described above. China is the world’s largest exporter of ICT goods, as well as the number one global production center for automotive goods (Figures 1 and 2). Losing access to Taiwanese semiconductors would virtually guarantee a major economic shock to China’s manufacturing sector and economy in general.
In addition, global and domestic investors would almost certainly seek to move funds out of China, which would put pressure on China’s exchange rate to such an extent that even China’s strong capital controls and intervention by the People’s Bank would not be able to China is unable to contain it completely. Against the backdrop of a faltering domestic economy, a weakening of the renminbi would reduce China’s imports from the rest of the world.
In a conflict scenario in Taiwan, foreign investors would likely divest their holdings of Chinese securities. As of June 2022, foreign investors held more than $1 trillion of onshore Chinese bonds and stocks, and as of September 2022, more than $775 billion of offshore Chinese stocks listed in the United States. In the event of a conflict, investors would dump Chinese securities to limit their exposure to potential financial sanctions and broader economic risks. Even before Western sanctions were imposed on Russia, the value of Russia-linked portfolio assets collapsed as war risks began to escalate: by February 24.
On the day Russia launched its latest invasion of Ukraine, Russia’s MOEX stock index fell nearly 30% from its peak in October 2021. The conflict could trigger a similar sell-off in Chinese assets, with hundreds of billions of dollars in investor value at risk. The sell-offs, in turn, could lead to stronger capital controls from Beijing, preventing foreign investors from moving money abroad.
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The conflict is also likely to have a far-reaching impact on Chinese overseas investment and lending activities. Amid the crisis-induced currency crunch, China is likely to halt outward direct investment, lending and new aid activities, putting about $100 billion in annual investment and lending flows at risk. Countries that have relied on renewing and refinancing Chinese loans in recent years – such as Sri Lanka, Pakistan, and Laos – will be most affected. It is possible that Beijing may decide to withdraw from debt renegotiation talks under the G20 Common Framework as well, putting other countries at risk.
Multinational companies selling their products in the Chinese market will face immediate revenue risks. The impact will come primarily from disruption to global semiconductor trade, given the concentration of foreign investment in China in the automotive, manufacturing and manufacturing sectors.