Politics

The Future of Taiwan: Semiconductors Alone Make the Island’s Continued Freedom Crucial to the U.S.

Taiwan plays a vital role in bolstering America’s economic and national security

Image Credit: Mari Fouz

Despite being a tiny, 14,000-square-mile island of 23.5 million citizens, Taiwan plays an outsize role when it comes to America’s economic and national security interests. Taiwan is a key strategic ally, a fellow techno-democracy committed to the principles of free markets and free societies, and a critical economic partner whose technology companies play an important role in enabling U.S. competitiveness in advanced-technology industries.

This is particularly true for the semiconductor sector. Many U.S. companies depend upon Taiwanese enterprises to produce the semiconductors designed in the U.S. As such, U.S. policymakers must recognize the pivotal role Taiwan plays in America’s East Asian security framework, and pursue a range of policies designed to deepen the economic, innovation, trade and security linkages between the two allies.

The economic relationship between Taiwan and the United States is tremendously important. The statistics bear this out: Taiwan is America’s 10th-largest goods trading partner and 13th-largest goods export destination, with U.S. goods-and-services trade with Taiwan totaling $103.9 billion in 2019. Conversely, the U.S. is Taiwan’s second-largest trading partner, accounting for 13.2% of Taiwan’s total trade and receiving about one-third of Taiwan’s exports of information and communications technology (ICT) goods. Foreign direct investment (FDI) also represents an important facet of the relationship, with the U.S. FDI stock in Taiwan reaching $17.4 billion in 2019, and Taiwan’s in the U.S. totaling $11.1 billion in 2019, up 5.6% from 2018.

However, as the Congressional Research Service has written, “U.S. data on trade with Taiwan may understate the importance of Taiwan to the U.S. economy because of the role of global supply chains.” For instance, 86% of Taiwan’s exports to the U.S. comprise intermediate goods, such as semi-finished products, parts and capital goods, that U.S. companies use to make final products. Indeed, Taiwanese inputs play a critical role in U.S.-manufactured final products in a wide range of industries, and not just for ICT goods but also others including medical devices and pharmaceuticals, automobiles (especially electric vehicles), heavy machinery and transportation equipment. In fact, the United States has deeper inter-industry trade linkages with Taiwan than with almost any other East Asian trade partner: The percentage of Taiwan’s exports feeding into the U.S. global supply chain is greater than that of Indonesia, the Philippines and Thailand combined.

But there’s one industry where U.S.-Taiwan economic and trade ties are more important than any other: semiconductors. Semiconductors represent the lifeblood of the modern digital economy, powering everything from automobiles and smartphones to satellites and medical devices. Taiwan now accounts for 20% of global semiconductor wafer production capacity. That figure alone might not catch the eye, but the nation now accounts for 92% of all semiconductor production at process nodes less than 10 nm—that is, the world’s most sophisticated and most important chips. The U.S. and Taiwan have for years been moving in opposite directions in terms of semiconductor fabrication capacity: In 1990, the United States held a 37% share of global semiconductor manufacturing and Taiwan but a few percent, but by 2020 America’s share had fallen to 12%.

TSMC’s Revolutionary Business Model

Taiwan’s great semiconductor success story is in part a result of effective government planning, but most of the credit goes to Morris Chang, founder of the Taiwan Semiconductor Manufacturing Co. TSMC pioneered the foundry business model, concentrating on contract manufacturing for other “fabless” semiconductor companies (those without semiconductor fabrication factories of their own). These fabless companies focus on research and design; examples include AMD (chips for AI, HPC and graphics), NVIDIA (graphics chips), and Qualcomm (5G and other wireless chips).

A Taiwan Semiconductor Manufacturing Company (TSMC) chip fabrication plant in Taichung, Taiwan. TSMC is the largest contract maker of semiconductors in the world, with clients including Qualcomm, Apple and NVIDIA. Image Credit: Sam Yeh/Getty Images

Such has been TSMC’s success that it now accounts for over half the world’s market for made-to-order chips, commands 90% of global market share for the most advanced semiconductors (sub 7 nm) in production, and will soon open the most advanced (3 nm) semiconductor fab in the world. It also arguably now leads the world in private-sector capital expenditures, announcing in April 2021 that it would invest $100 billion over the next three years to help meet growing global semiconductor demand.

Not only are TSMC and other Taiwanese foundry players key suppliers to many U.S. enterprises, but in many cases the business models of many American chipmakers would be fundamentally impossible without these Taiwanese suppliers. In fact, U.S. companies—whether fabless players such as AMD, NVIDIA or Qualcomm, or manufacturers of consumer electronics goods such as Apple—account for 65% of global demand for fabless semiconductor manufacturing. In turn, Taiwanese companies now account for 78% of value-added output (in terms of revenues generated) from the global foundry-based semiconductor sector. Apple alone accounts for one-quarter of TSMC’s revenues.

However, it should be noted that Taiwan accounts for 45% of U.S. exports of semiconductor manufacturing equipment (i.e., the tools that run the fabs). Further, the importance of this relationship doesn’t pertain solely to ICT goods. Semiconductors represent an increasingly important input to cars—with the average vehicle requiring anywhere from 50 to 150 semiconductors and the newest electric vehicles using as many as 3,000. Accordingly, the ongoing global semiconductor shortage has exerted a tremendous impact on the industry, resulting in as many as 672,000 fewer cars being manufactured in the first quarter of 2021, compared with automakers’ anticipated production going into the quarter.

Bolstering the U.S.-Taiwan Relationship

Given Taiwan’s importance to the U.S., policymakers in Washington should be seeking to strengthen the relationship. One place they can start is trade. First, the U.S. should move beyond the existing Trade and Investment Framework Agreement between the U.S. and Taiwan (which provides a strategic framework and principles for dialogue on trade and investment issues) and pursue negotiation of a bilateral U.S.-Taiwan free trade agreement, which would further enhance trade linkages between, and improve the competitiveness of, both nations. A U.S.-Taiwan FTA would help ensure that Taiwan has stable access to the U.S. market, promote political stability in the country, and increase growth and employment in both nations.

Specifically, analysts estimate that a U.S.-Taiwan FTA would increase U.S. GDP by $3.5 billion, decrease the U.S. trade deficit with Taiwan by 75%, and generate an additional 27,000 U.S. jobs. Another step is for the U.S. to join the Comprehensive and Progressive Trans-Pacific Partnership and bring Taiwan in with it. The U.S. can also champion Taiwanese participation in international fora—which China often seeks to block—such as the International Civil Aviation Organization, Interpol and the World Health Organization.

The U.S. can also collaborate more closely with Taiwan to promote innovation, both in semiconductors and across other fields. For instance, in 2018 Taiwan announced a new “Five Plus Two” innovation strategy, which aims to expand industries and projects related to the internet of things, biotechnology, green energy, smart technology and defense (“Five”) while also promoting agricultural efficiency and a circular economy—that is, economic systems that are more sustainable in terms of environment and resiliency concerns (“Plus Two”).

Here, the recently created U.S.-Taiwan Economic Prosperity Partnership Dialogue represents an important start, but it could go further by setting up an Innovation Experts Working Group that would act as an integrated platform for collaboration and cooperation in the development of new technologies and industries. One focus could be integrating U.S. strength in software with Taiwanese strength in hardware. As the Carnegie Endowment for International Peace’s Evan Feigenbaum writes, “Taiwan has yet to transition from a hardware-dominant ecosystem to greater emphasis not just on software but especially on hardware-software integration.” And Stanford University’s Alexa Lee notes that another area ripe for cooperation would be cybersecurity.

Semiconductors should of course be a focus of U.S.-Taiwan innovation collaboration, which is already occurring, as evidenced by TSMC’s collaboration with Purdue University to open the Center for Secure Microelectronics Ecosystem. This center aims to ensure a secure supply of semiconductor chips and related tools from one end of the supply chain to the other, with a goal of developing advanced chips that could be detected or traced if security concerns arise. Programs envisioned in the Creating Helpful Incentives to Produce Semiconductors for America (CHIPS) Act—for which the Biden administration has sought $50 billion as part of its $2 trillion infrastructure plan—would introduce additional opportunities for collaboration, including a $750 million multilateral security fund to support development and adoption of secure microelectronics and microelectronics supply chains, as well as incentive packages that TSMC will likely avail itself of as it invests $35 billion in a new 5 nm fab in Arizona.

Finally, the Biden administration needs to articulate a new security framework with Taiwan. In particular, it is past time the U.S. abandon its policy of “strategic ambiguity” vis-à-vis Taiwan and clarify that it would come to the island’s defense if attacked. The policy of strategic ambiguity has been attributed to Joseph Nye, assistant secretary of state in the Clinton administration, who, when asked in 1995 by Chinese officials how the U.S. would react to an attack on the island, responded, “We don’t know and you don’t know. It would depend on the circumstances.”

The U.S. should make absolutely clear that it will not permit what happened to Hong Kong to happen to Taiwan, and that Taiwan’s status as a free society is inviolable. To this end, the U.S. should commit to bolstering Taiwanese security by consistently selling it more-advanced weapons systems, including the newest fighter aircraft, missiles and tanks, as the head of U.S. Indo-Pacific Command, Adm. Philip Davidson, has advised.

From both an economic and a geostrategic perspective, Taiwan has become crucial to U.S. national security. A new study estimates that a hypothetical one-year disruption of the Taiwanese semiconductor supply (whether due to natural disasters or geopolitical conflict) would cost global fabless companies $80 billion in revenues and electronic device manufacturers $500 billion. If such complete disruption were to become permanent, it could take a minimum of three years and $350 billion of investment to rebuild enough capacity in the rest of the world to replace the Taiwanese foundries. It is imperative that the U.S. help Taiwan remain a free, democratic, market-based society.

This is the third article in a series titled “The Future of Taiwan.” The first article focuses on steps the U.S. can take at home and abroad to prevent a Chinese invasion of Taiwan. The second article discusses the obstacles facing a Chinese military conquest of Taiwan. In the fourth article, a Taipei  journalist recounts the years of living with cross-Strait tensions.  

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