Why China is not sanctioning Taiwan’s key chip industry | Business and Economy

China has turned to the familiar playbook of trade restrictions following US House of Representatives Speaker Nancy Pelosi’s visit to Taiwan.

After Pelosi proceeded with her trip to the democratically-ruled island in spite of Beijing’s warnings, Chinese authorities suspended imports of Taiwanese citrus fruits and fish, and exports of sand.

State media also announced that major military drills around Taiwan would start on Thursday, framing the exercises as a “rehearse reunification operation”.

The trade moves have been widely interpreted as political actions aimed at pressuring the island, which Beijing considers a breakaway province that should be “reunified” — by force if necessary — although Chinese officials cited biosecurity and other trade-related grounds.

Beijing’s latest apparent attempt at economic coercion, however, conspicuously left Taiwan’s most valuable export of all untouched: semiconductors.

That is most likely because China depends on Taiwan’s exports of the critical components almost as much as the island does itself.

For Beijing, targeting Taiwan’s semiconductor industry would come at the cost of inflicting significant harm on itself.

How important are semiconductors to Taiwan?

Taiwan dominates the global industry for semiconductors, critical components used in everything from smartphones and medical devices to cars and fighter jets.

The self-ruled island accounts for 64 percent of semiconductor manufacturing revenue, according to TrendForce, with industry leader Taiwan Semiconductor Manufacturing Co (TSMC) alone taking up more than half of the total pie.

South Korea, the next biggest producer, controls less than one-fifth of the market.

For the most advanced semiconductors, Taiwan accounts for 92 percent of production, according to a report by Boston Consulting.

For Taipei, which is officially recognised by just 13 countries and the Vatican, the semiconductor industry’s importance to the economy and the island’s security can hardly be overstated.

After years of explosive demand, semiconductors now make up nearly 40 percent of exports and about 15 percent of gross domestic product.

“Taiwan’s semiconductor industry is critical for its economy, given that Taiwan is positioning itself to be a high-tech leader and the Fourth Industrial Revolution will rely on leading-edge semiconductors that Taiwanese companies can design and produce,” James Lee, an assistant research fellow in Academia Sinica in Taiwan, told Al Jazeera.

“The semiconductor industry is also critical for Taiwan’s security because it elevates Taiwan’s strategic importance for other countries, especially the United States and Western Europe.”

While Beijing’s targeting of citrus fruits and fish are expected to have a minimal effect on Taiwan’s economy, it could inflict far more damage by cutting off imports of the chips.

Why does China need Taiwan’s semiconductors?

As much as Taiwan depends on its semiconductor industry, China does, too.

The world’s second-largest economy accounts for 60 percent of the global demand for semiconductors, according to a 2020 Congressional Research Service report.

More than 90 percent of that demand is met by imports and foreign firms with production in the country, according to the same report.

Despite pouring billions of dollars into developing its industry, China controls less than 10 percent of the market, led by Shanghai-based SMIC.

“China is dependent on Taiwan because while Chinese companies can design semiconductors, they have only a limited capacity to manufacture them, especially at the leading edge,” Lee said.

“Recently there have been reports that SMIC has developed the ability to manufacture 7-nm chips, but this is still in the early stages and well behind TSMC and Samsung.”

While China has often been accused of using economic coercion against other countries, it has excluded certain goods that are important to its economy from sanctions in the past.

After China halted imports of Australian beef, wine and barley in 2020 following a dispute over the origins of the COVID-19 pandemic, Beijing continued importing huge quantities of iron ore to meet its ferocious appetite for steel.

Could China target semiconductors in future?

How long Taiwan’s semiconductor dominance may last is uncertain.

Chinese President Xi Jinping has described the reliance on foreign technology as the “greatest hidden danger” facing the country and pledged to increase its self-sufficiency.

Under the “Made in China” initiative, Beijing has pledged to invest $1.4 trillion between 2020 and 2025 in high-tech industries including semiconductors.

In 2020 alone, Chinese semiconductor companies were on the receiving end of 227.6 billion yuan ($33.7bn) in investment, up four-fold from the previous year, according to research by TechNode.

Last year, China’s production of integrated circuits increased to 359.4 billion units, a 33.3 percent rise from the preceding year, according to official government data.

“I think China is unlikely to use sanctions against the semiconductor industry while it is still dependent on Taiwanese companies for manufacturing,” Lee said. “This may change if Beijing develops a stronger manufacturing capacity of its own, but that is still several years away, in my view.”