China's military drills have clear ramifications for the global economy

China's military drills have clear ramifications for the global economy

The U.S. House Speaker Nancy Pelosi visited Taipei after China's latest military exercises encircling Taiwan have clear ramifications for the global economy.

Gareth Leather, Senior Economist at Capital Economics, wrote in a note that Taiwan matters more to the world economy than its 1% share of global GDP.

The military exercises included live-fire drills and missile launches, restricting access to ships and aircraft in the area. More than 40 vessels have passed through the drill zones south of Taiwan's main port, according to the data compiled by Bloomberg.

Further escalation in cross-strait tensions that cut Taiwan's exports from the rest of the world would lead to renewed shortages in the automotive and electronics sectors and cause further upward pressure on inflation, Leather wrote.

He stated that Taiwan is the world's largest producer of processor chips that are increasingly ubiquitous in new products, having twice the market share of the next biggest producer.

Leather added that 92% of the most advanced semiconductors are made by TSMC in Taiwan, making its dominance even greater at the high end. If Taiwanese semiconductor supply was disrupted for a long time, electronics and automotive manufacturers would struggle to find alternative suppliers.

Taiwan's autonomy has become a key geopolitical interest for the U.S. due to the island's dominance in the global market for microchips. Semiconductors, which are used in everything from smartphones to cars, have become an integral part of our daily lives.

In a 2021 report from the Biden Administration, it was stated that the United States is heavily dependent on a single company TSMC for producing its leading edge chips. The lack of domestic production capability puts at risk the ability to provide current and future national security and critical infrastructure needs, as well as the lack of domestic production capability, according to the report. The Chips and Science Act passed the Chips and Science Act last week, providing $52 billion in subsidies for America's semiconductor sector, while Washington and Beijing are locked in a race to become the world leader in high-tech industries.

This would shore up our chip industry, with around $39 billion being allocated for building new chip manufacturing plants on U.S. soil. The global production of goods would only be vulnerable if a bottleneck was added.

The stakes are very high if production facilities are damaged, as it takes two to three years to build a semiconductor plant from scratch, according to Leather. The implications would be extremely expensive replacing lost manufacturing capacity and it wouldn't be possible to re-establish TSMC's most advanced facilities without its personnel and intellectual property. An electronic shortage would lead to an increase in prices, adding more pressure to global inflation.

Leather warns that if Taiwanese semiconductor supply was disrupted for a prolonged period, electronics and automotive manufacturers would struggle to find alternative suppliers. Many firms would have to halt production because of this.

Electronic goods make up a relatively small share of the CPI baskets, but widespread chip shortages would affect the output of a wider range of consumer goods and even digital services, according to Leather. A major escalation over Taiwan would result in another supply shock, keeping inflation high for even longer.