Taiwan is a potential flashpoint in the ongoing tensions between the US and China and it remains a source of potential instability in the changing world order. The outcome of the January 2024 Taiwan general election could end up being destabilising to the global economy and financial markets.
Domestic identity in a geopolitically-contested territory can trigger blow-ups between superpowers. In Ukraine, for example, voting often went along identity lines, with those who considered themselves more pro-Russian voting one way and those who considered themselves Ukrainian (and pro-European) voting another. In 2010, the pro-Russia opposition leader Viktor Yanukovych beat the incumbent Yulia Tymoshenko. The pro-Russia (often Russian speaking) areas in the South and the East swung the vote for Yanukovych, while Tymoshenko won in the Ukrainian-speaking North and West. This linguistic divide is a source of the division between those who identify as Ukrainian or Russian in Ukraine.
Growing national identity
Taiwan also has an identity issue. Taiwan’s relationship with China has been held together by the 1922 Consensus, an agreement forged between the Kuomintang party (KMT) and the Chinese government. Simply put this adopted a ‘one China, different interpretations’ policy. This is considered by China as the basis for relations between the two countries.
In recent years, however, the details of the 1992 Consensus have become widely disputed. Increasingly, the Taiwanese have developed a sovereign identity. Surveys show that most of the population now identify as solely Taiwanese, as against being in the minority in the early 1990s (chart). This has influenced their politics, with the Democratic Progressive Party (DPP) – which disputes the 1992 consensus – in power since 2016 and the frontrunner in the upcoming election, while the more pro-China KMT has weakened.
It is becoming clear that the fragile truce created by the 1992 consensus may not hold. Given its strategic importance to China, Taiwan’s growing national identity is a concern – and may prompt more extreme action by Beijing to bring it back under China’s influence.
Moreover, Taiwan is in a strategic hot spot. It is located where the East and South China Seas meet off the coast of China with Japan, and the Philippines to the North and South respectively. It therefore sits in the middle of major international trade routes. The US is keen that the Chinese do not extend their reach into the Pacific. The US wants the democracies of Japan, South Korea and the Philippines to push back, while China wants to extend its influence. The clash is ideological, and the pressure point for the geopolitical tensions between China and the United States.
The Taiwanese election
The 2024 general election in Taiwan could be a flashpoint. Incumbent President Tsai Ing-wen of the DPP is ineligible to seek a third term, leaving four hopefuls to fight it out. The more pro-independence DPP currently leads the polls, but the outcome is not clear-cut. William Lai is the current vice president and the party’s hopeful. He recently said Taiwan’s sovereignty was a ‘fact’¹. Unsurprisingly, Beijing mistrusts him.
The other three opposition candidates split the vote three ways, increasing the likelihood of a DPP victory. Of these, former trauma surgeon and New Taipei City mayor Ko Wen-je may be the most interesting: he has had an ambiguous stance towards the 1992 consensus, but is more pro than anti- China. Terry Gou, the billionaire founder of Foxconn is also doing well in the opinion polls. He could be seen as Taiwan’s Donald Trump – and equally disruptive. Hou Yu-ih is the candidate for the KMT and, while supportive of reintegration with China, he has avoided expressing strong views on the topic.
What is the most likely scenario?
If the DPP win, as expected by opinion polls, it could mean greater geopolitical uncertainty given their stance on independence. If one of the other parties were to win, it may lower tensions because they would likely seek closer relations with China.
Our central case sees the DPP win the election. In this event, there are three possible scenarios over the medium-term, which vary in likelihood. The first sees tensions remaining elevated after the election and there is an ongoing risk premium applied to Chinese and Taiwanese assets. In other words, investors will demand higher returns to invest in these assets. In our view, this is the most likely outcome given the massive risks associated with the other options available to China.
There is, however, a possibility that China employs more aggressive means to shape the future of Taiwan. A second scenario could see China using hybrid military tactics, including – potentially – a blockade to bring the island under Chinese control. Our third scenario sees China mount a full-scale invasion. We assign lower probabilities to scenarios 2 and 3, but unfortunately, they can’t be ruled out.
In these latter two scenarios, the US response is another unpredictable factor. It is possible that the US could put sanctions in place, which would provide a major shock to the global economy and markets, with impacts for global supply chains. If the US responds with military force, the shock would be even more severe.
Historically, the US has followed a policy of ‘strategic ambiguity’ over whether it will defend Taiwan in the event of an attack, while also recognising Taiwan as a part of China. But President Biden has repeatedly contradicted this stance, saying he will protect Taiwan’s integrity. Recent polls suggest that the Taiwanese public are not confident the US will send their troops to defend Taiwan against China.
A Chinese military invasion or blockade of Taiwan pose the greatest risks to investors. This would have significant repercussions, particularly for the technology sector where it would be hugely damaging for the supply chain. Taiwan is the world’s largest supplier of high-spec semiconductors. Supply would be massively disrupted at a time when demand is growing significantly from the increasing adoption of Artificial Intelligence (AI). Many of the world’s largest technology companies could be exposed.
To counter this risk, countries have tried to build semiconductor independence. The US and Europe are throwing money at their semiconductor sectors through the Chips and Science Act and Chips Act respectively. However, it will take years to build a semi-conductor sector of the size and sophistication of Taiwan’s. The election in Taiwan may have been overlooked by many investors but it could be a flashpoint for markets in 2024.
Whilst considerable care has been taken to ensure the information contained within this document is accurate and up to date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.