War between America, China over Taiwan’s future: Economic impacts, deterrents

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The Economist recently opined that Taiwan is the most dangerous in the world. When viewed through the lens of superpower politics, this description is apt because of four interrelated reasons. 

First, with the passage of time, more residents of Taiwan identify as Taiwanese and not Chinese and, as a result, the opportunities for a peaceful reunification of democratic Taiwan with China are diminishing. Second, President Xi Jinping of China has said clearly that complete reunification of Taiwan with China is of the utmost importance and that he is prepared to use force, if necessary, to accomplish this objective. Third, over the last 25 years, the Chinese government has invested significant resources to expand and modernize its military capabilities. As a result, the Chinese People’s Liberation Army (PLA) is now a formidable foe, particularly in the East and South China Seas. Finally, the United States now recognizes that China is a formidable foe and hence it is beginning to doubt whether it can militarily defend Taiwan if it were to be attacked by the PLA.  

There will be significant political and national security implications for both the United States and China if war breaks out between them over the future of Taiwan. Consequently, a lot has now been written about this topic with many of the writings emphasizing the significant military devastation that will result from such a war.  

Much less has been written about the economic impacts of a war over the future of Taiwan and how economic deterrents might be used to ensure that no war actually breaks out. This notwithstanding, my prior research on economic issues concerning China suggests that these impacts can be just as consequential as the political and national security implications. 

Unlike the insular China that existed before Deng Xiaoping came to power in the mid-1970s, this nation, presently led by President Xi, is a veritable economic powerhouse. China is now a salient manufacturing hub, it plays a major role in the smooth functioning of global supply chains and it imports a large amount of raw materials from other nations. So, the general point is that because the Chinese economy is now so thoroughly integrated with the world economy, war over Taiwan will almost certainly lead to great disruptions to the world economy.  

To give a recent example, the economic disarray that is likely to begin soon after the fighting commences will be at least as severe as the disarray stemming from the 2008 financial crisis. In fact, because a war over Taiwan will involve the world’s first (United States) and second largest (China) economies and possibly other nations, the destruction that will arise is likely to be long-lasting and reversible only at great cost. By comparison, the damage caused to the world economy by the 2008 financial crisis will seem ephemeral and relatively insignificant.  

Stock markets hate uncertainty and a war over Taiwan will generate all manner of economic uncertainties concerning the future of global trade, investment, and commerce. Therefore, in the United States, China and Taiwan, stock markets are likely to tumble and they may keep tumbling for a while. This disruption is likely to have a negative snowballing impact on the stock markets of other nations which will, in turn, lead to the destruction of a lot of wealth.  

The Taiwanese economy will be hit hard by a war over its future and the negative impact of this state of affairs for the world economy cannot be overemphasized. Taiwan sits at the center of the world semiconductor industry. Specifically, Taiwan Semiconductor Manufacturing Company (TSMC) is the world’s most valuable chip maker, and it produces 84 percent of the most advanced chips. If war stopped chip production then the world’s electronics industry would come to a grinding halt, imposing tremendous costs on America, China and many other nations that may have little or no role to play in a conflict over Taiwan.  

Given the many and profound global economic impacts of a war over the future of Taiwan, it makes sense to look at what economic levers the United States and its allies can pull to deter China from attempting to unify Taiwan with China using force.  

Since China has frequently attempted to use economic coercion to get countries to do its bidding, it makes sense for the Biden administration and future administrations to engage in robust diplomacy with allies to credibly declare to Beijing that attacking Taiwan militarily to reunify the motherland will result in a complete economic boycott of China. What this means is that the coalition of the willing will neither buy from nor sell anything to China. As an example, a joint U.S./E.U. announcement to this effect is likely to have greater deterrence value than an  announcement, suggested by Richard Haass and David Sacks, that the U.S. will certainly come to Taiwan’s defense if attacked by China.  

A second lever that the U.S. can pull to deter Chinese military aggression is to declare publicly that if China attacks Taiwan then it will exercise the “nuclear option,” i.e., kick China out of the global dollar-based payments system. Since the U.S. dollar is the world’s reserve currency that is used routinely to settle all manner of cross-border financial transactions, getting kicked out of this system will marginalize China and make it difficult for this nation to access convertible currency. If this action by the U.S. is coordinated with the E.U. so that China is effectively kept out of the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, then this will make President Xi’s vision — of China becoming the world’s dominant power in 30 years — virtually unattainable.  

The success of the above economic levers in deterring China depends fundamentally on the credibility of the two declarations. These declarations will only be credible if a large number of nations are parties to them. This is why robust diplomacy by the U.S. is essential to get many nations on board. Only then will President Xi believe that the rest or at least most of the rest of the world will not stand for his “might makes right” approach to international affairs.  

Batabyal is the Arthur J. Gosnell professor of economics at the Rochester Institute of Technology but these views are his own.