Global Technology Decoupling and Taiwan’s Conundrum

This article was originally published by Global Taiwan Institute in its weekly newsletter, The Global Taiwan Brief, Vol. 9, Issue 12. Used with permission. To get the Global Taiwan Brief in your inbox every week, subscribe at globaltaiwan.org/subscribe. Megha Shrivastava is a Doctoral Candidate and Dr. TMA Pai Fellow at the Department of Geopolitics and International Relations at the Manipal Academy of Higher Education.

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The ongoing tech fight between the United States and China—characterized by US-led export control measures, alliance politics, and domestic industrial subsidies—has the potential to lay the groundwork for a new configuration in the future of the global semiconductor landscape. The semiconductor chip value chain, historically concentrated in the East Asian region, is now looking to diversify horizontally—i.e., through more fragmentation, deconcentration, distributed specialization, and diversification towards lower geographical and geopolitical risk areas. The extraterritorial nature of the US sanctions directed against China has furthered the crisis. Under the US Foreign Direct Product Rules, the other key players in the value chain are restricted from supplying chip-related technologies to Chinese vendors. Additionally, provisions in the United States CHIPS and Science Act that call for “national security guardrails” prohibit funding recipients from engaging in “significant transactions” with China for ten years from the award date. This requires countries to rethink their chip business models.

Is Taiwan in a Distinctive Position?

East Asian countries like Japan, Taiwan, South Korea, Malaysia, and Singapore all hold a strong position in the chip global supply chain. While Japan holds a near monopoly position in the supply of key materials, chemicals, and gases, South Korea’s success with the Integrated Device Manufacturing model also sets an example that could not have been replicated elsewhere.

Taiwan stands as a stronger player in the chip global supply chain. Decades ago, when the industry was on the lookout for a destination with comparative and strategic advantages in the chip manufacturing process, Taiwan emerged as the most feasible option offering huge state subsidies, skilled talent, superior work culture, and cheaper lands. Today, Taiwan hosts the world’s most advanced fabrication facilities—besides hosting some well-known design and assembly, test, and packaging (ATP) facilities as well. However, a notable dimension that adds complexity to Taiwan’s position in the global value chain (GVC) is its reliance on the United States for the upstream of the value chain, as well as its reliance on China for its vast market potential.

In the wake of growing tendencies towards “technological decoupling” and “technology bifurcation”—trends that degrade the innovation systems of trading states—the global semiconductor industry faces a combination of geopolitical and market dilemmas. Both South Korea and Japan derive huge profits from the Chinese market. South Korea directs approximately 60 percent of its chip exports to China: for instance, Samsung’s production base in Xian contributes 40 percent of its global output of NAND chips. Additionally, Japan’s Tokyo Electron derives approximately one-quarter of its revenue from sales to Chinese companies, including those affected by the US export controls and other sanctions.

Taiwan’s greater reliance on China, compared to its East Asian peers, is of notable importance. While both South Korea and Japan are closely tied to the Chinese chip market for their commercial interests, Taiwan’s technology sector is more intricately linked to the Chinese in terms of technology, talent, and market. Through Taiwan’s contract manufacturing model, several Taiwanese firms act as the backbone of Chinese chip factories and design firms. Of particular relevance is China’s dependence on Taiwanese talent and a more skilled workforce in the chip segment. Despite a decline in Taiwan’s chip exports to China, China has remained in its top position as Taiwan’s largest buyer, accounting for nearly 54 percent of Taiwan’s exports in May 2023.

The anti-China chip bans have severely harmed the interests of chipmakers across the supply chain. Let’s first talk about numbers. Considering the immediate impact of the chip ban, facilities that dealt with older-generation chips seem to remain unaffected. Additionally, the one-year waiver given to several firms to continue to use American semiconductor manufacturing equipment (SME) in their production facilities in China saved the pockets of certain companies in the short run. Despite that, the ban has largely resulted in declining revenues.

Taiwan Semiconductor Manufacturing Company (TSMC, 台灣積體電路製造股份有限公司) reportedly cancelled orders from Chinese companies. Consequently, the annual revenue of TSMC has suffered a 5.96 percent decline in 2023 as compared to its revenue in 2022. While Samsung’s annual revenue spiked in 2022, it declined from USD $234 billion in 2022 to USD $194 billion in 2023. Japan’s Tokyo Electron recently revised its earnings forecast, reducing it by 8 percent following the October 2022 restrictions. Overall, the bans have pressured firms to reduce their dependence on the Chinese market, and several market leaders are expected to offshore their facilities away from China in the coming years. For instance, following the announcement of the US export restrictions, SK Hynix indicated that it might contemplate selling its Chinese operations.

As soon as the US regulators released their export bans, the US government pressured industry leaders like Taiwan, The Netherlands, South Korea, Germany, and Japan to get on board with their anti-China chip sanctions. Disagreements among allies over the sale of SME have emerged discreetly in diplomatic channels. Although Japan banned the export of 23 kinds of etching equipment without naming China, Japan’s trade and industry minister mentioned that Japan’s moves were not meant to follow the lead of the United States. Rather Japan’s initiatives were linked to de-risking the supply chain due to concerns about Chinese economic coercion. Regardless, Tokyo remains worried that targeting China will provoke damaging retaliations, such as a ban on Japanese electric cars. The Japanese government has maintained a restrained public stance, but Tokyo Electron reportedly opposed the US curbs. Similarly, South Korea, though prepared to “partially” comply with US sanctions, is worried about the already existing gap with competitors in the industry and future domestic competitiveness due to the loss of Chinese markets. While South Korean and Japanese responses reflect market considerations, Taiwan’s conundrum is largely attached to the evolving dimensions of regional security. In contrast to the reactions of Taiwan’s counterparts, former President Tsai Ing-Wen (蔡英文) openly expressed interest in producing “Democracy Chips” with the United States.

What Does Technology Decoupling Mean for Taiwan?

Taiwan’s dilemma with the ongoing tussle between the superpowers is more severe. While the political leadership has taken the ongoing changes as an opportunity for diversification, these changes still hold wider implications for Taiwan’s critical position in the global value chain—which is ultimately linked to Taiwan’s future security and defense.

First, both US and Taiwanese companies are working to move their chip manufacturing away from China. The “China plus one” strategy—a strategy led by the United States and its allies that avoids investing only in China and promotes diversification—complements Taiwan’s New Southbound Policy. Taiwan’s diversification efforts may be more successful amid these US-led decoupling efforts. However, Washington’s recent strategies, including domestic industrial subsidies and external outreach, indicate a concerted effort not only to shift away from China but also to reduce reliance on Taiwan due to geopolitical tensions with China. The CHIPS and Science Act of 2022 encourages other chipmakers to establish facilities in the United States while also expanding chip investments in alternatives like India and Vietnam. In short, the United States believes that a chip value chain that reduces the concentration of both Chinese and Taiwanese companies would be in its best interest. This “Taiwan plus” approach suggests a growing disinterest in Taiwan’s security, which could weaken Taiwan’s deterrence against China.

Second, the anticipated shift in the global supply chain does not guarantee Taiwan’s current position in the GVC. According to industry predictions, countries like Malaysia and Vietnam are expected to make significant progress in ATP, achieving a 10 percent global share by 2027. Conversely, Taiwan’s share is anticipated to decline from 51 percent in 2022 to 47 percent in 2027. Moreover, Taiwan is under pressure to offshore investments and transfer its technology and IP now more than ever.

Despite severe historical animosity and contemporary geopolitical contestations, China’s promising market potential has kept both South Korea and Japan tied to the Chinese economy for decades. When the United States pressured them to de-Sinicize chip supply chains, both countries’ panic centered around losing the lucrative Chinese market. In contrast, Taiwan has a stronger geopolitical incentive to side with the United States. Taiwan is more concerned with evolving geopolitical dynamics that also loom large over its future security and its position in the chip supply chain.

Towards an Uncanny Future

Experts often state that it is an opportune moment for Taiwan to address uncertainties within the semiconductor industry and its fear of Chinese invasion. Recent developments demonstrate the rapidly growing importance of South and Southeast Asia for prospective chipmaking hubs. Though American industrial policies offer investment avenues to Taiwanese chipmakers, they also offer prospects for expanding the role of countries like India and Vietnam in the chip supply chain. Though future diversification away from China remains central to Taiwan’s current semiconductor policies as well, it is important to consider what this might look like for Taiwan. We need to consider whether horizontal diversification actually expands the current opportunities for Taiwan—or if it puts greater pressure to export talent, and endangers crucial trade secrets. We also need to consider whether it actually strengthens Taiwan’s “Silicon Shield” against a Chinese invasion. An additional question that may prove to be decisive in this context is: Are the alternatives to China better than China itself? Can newcomers like India and Vietnam match China’s decades-long industrial and manufacturing experience, and its so-far unmatched competitive advantage? Moreover, considering the nature of the industry, can the current diversification plan of the chip industry be successful?

The main point: Though the ongoing process of chip supply chain diversification seems more like an opportunity than a challenge, it is crucial to Taiwan’s technological edge—which is linked to its future security against the PRC—in contrast to the economic and market-related concerns of peers. Taiwan should be more concerned about how a “Taiwan Plus” approach will affect its position in the global value chain.

(Featured photo from Taiwan Semiconductor Manufacturing Company)