The Economic Effects of a Potential Armed Conflict Over Taiwan

Abstract

This article examines the likely economic effects of a Chinese invasion or blockade of Taiwan for the U.S. and the world by considering historical precedents. Such a conflict would likely produce a flight-to-safety in the asset market, huge disruptions in international trade, and banking problems, and it would greatly exacerbate existing fiscal pressures. The authorities of the People’s Republic of China would probably try to sell U.S. and other western securities prior to a conflict to avoid sanctions on those assets. Such sales would be temporarily disruptive but would likely have only marginal effects on yields in the longer term. Long-term effects would include disrupted trade, higher price levels, higher levels of nominal debt, and higher taxes.

Introduction

The 2022 Russian invasion of Ukraine provides a recent example of the use of violence to change the status quo. It has distressed the world economy through its effect on commodity prices. This episode has rekindled speculation that the People’s Republic of China (PRC) might invade or blockade Taiwan, bringing on an armed conflict with much greater global economic repercussions. The U.S. Department of Defense (2023) warns that the PRC uses the People’s Liberation Army (PLA) as “an instrument of statecraft” that has “adopted more coercive actions” and is strengthening its ability to “fight and win wars against a strong enemy.”

The PRC and the island of Taiwan have been separately governed since the Chinese Nationalist forces retreated to Taiwan, while the Chinese Communist forces gained control of the mainland at the end of the Chinese civil war in 1949. PRC leaders have repeatedly asserted that Taiwan is an integral part of China (PRC, 2022). The government of Taiwan has also historically insisted that China and Taiwan are one nation, although popular sentiment on the island increasingly views the Taiwanese as a distinct nationality (BBC, 2024a).

Since the 1970s, the U.S. position has been described as a “one-China” policy: This position recognizes that the PRC is the government of China and that Taiwan is part of China. The U.S. has formal diplomatic relations with the PRC but only unofficial relations with Taiwan (Green and Glaser, 2017). Despite this, the U.S. has opposed the forceful reunification of the mainland and Taiwan and has adopted a policy of strategic ambiguity when dealing with the PRC’s attempts to forcefully reunite the mainland and Taiwan (Liu, 2023; Lawrence, 2023). Strategic ambiguity means that the U.S. has not committed to how it would react to an attempt at forceful reunification. Likewise, it is uncertain how other countries in the region would react. Lawrence (2023) describes this policy as follows: “[T]he United States does not support Taiwan independence, opposes unilateral changes to the cross-Strait status quo, is committed to meeting its TRA [Taiwan Relations Act of 1979] obligations to support Taiwan’s self-defense, and has an abiding interest in peace and stability in the Taiwan Strait.”

Despite this policy of strategic ambiguity, many observers have long believed that the U.S. would likely assist Taiwan if the PRC blockaded or invaded Taiwan without provocation (Cancian, Cancian, and Heginbotham, 2023). President Biden made public statements that the U.S. would assist Taiwan in the event of an attack, although the White House later withdrew these statements (Sevastopulo, Inagaki, and Hille, 2022). In addition, many analysts believe that Australia and Japan would assist the U.S. in coming to Taiwan’s defense but that South Korea would be unlikely to join the coalition (Cancian, Cancian, and Heginbotham, 2023).

Such an armed conflict between the PRC and the U.S., Australia, Japan, and Taiwan would produce both great human costs and very significant, negative economic effects. The intensity and scale of such a conflict would dwarf those of any sea-air conflict since World War II. In particular, the economic effects would probably be more serious than any conflict in which the U.S. has been engaged in recent decades.