China, Taiwan, and Semiconductor Risks – Part 2

As I alluded to in an earlier post, the scenario of China invading Taiwan, and halting all semiconductor production is highly unlikely, for a number of reasons.

First, the Taiwanese are a very nationalistic and patriotic group of people.  If China went into Taiwan and said “We are taking over,” the workforce would simply not support it!  You cannot make technical personnel work to build semiconductors, and there are countless ways they could sabotage production.  As I noted earlier, semiconductor manufacturing requires very specialized knowledge, and Taiwan engineers possess the “secret sauce” of knowledge.

Second, invading Taiwan would have a devastating impact on the Chinese themselves.  Even if China had an agreement to build an identical factory, and followed the recipe, it would likely fail.  As noted earlier, the likelihood of a failure in even one of the 600-700 processes required to build a wafer will produce a very low yield or a poor yield, and the customer will refuse to purchase it.  As noted, Chinas has already tried to hunt talent from TSMC to build up an identical capability, and also purchased agreements for materials from key TSMC suppliers.  However, an entire team is needed, and because manufacturing processes are so integrated, missing even one part of the “secret sauce” means you won’t be able to make it.  Not surprisingly, China’s attempts to replicate semiconductor manufacturing at home have not been successful.

Third, the US-led boycott of China’s semiconductor industries (e.g. Huawei) is making the situation worse for China than they have let on.  The design software and raw materials required for production of semiconductors is controlled by Japan, and China cannot get access to these goods if they are boycotted.  For example, the grain of the wafer is very different for a 45 nm wafer than a 28 nm wafer – and it would be very challenging for China to attempt to produce these raw materials on their own.

To summarize, China would be “killing the golden goose” if they invaded Taiwan.  A lot of people have speculated what would happen, but in reality, it is not likely to occur.

Are there other threats to Taiwan?

One likelihood that is often not considered is the probability that Taiwan will be shut down by China in a cyberattack.  Many executives surveyed believe there is a 30-40% probability of this occurring in the next five years.

Despite the increasing concern of a cyberattack or an armed forces attack, the reality is that this is not a very likely event.  One geopolitical expert in China creates indices used by insurance companies to estimate risk probabilities used in creating industrial insurance policies.  His estimate of the probability of invasion before the Russian attack was 2%.  After the invasion, the probably had increased only to 3%.  One caveat added was that no one ever thought Putin was going to invade the Ukraine.  However, the stakes for China are much greater in this case, so the probability is less than 5%, even after the Pelosi visit.

In addition, there are some other significant economic reasons behind why it is unlikely that China will invade Taiwan.  China has been observing (and learning) how the West responded to the Russian invasion of the Ukraine, and do not wish to have a boycott of the West imposed on them.  Because almost 70% of global semiconductor production for all industries comes from Taiwan, the impact on the global economy of an invasion would be disastrous.  A majority of Chinese government leaders have a lot of money invested in mutual funds on Wall Street, and the Chinese government owns billions in US Treasure bonds.   A Taiwan invasion would likely cause a significant crash in the Chinese economy, which is already very fragile. For these reasons, an invasion is very unlikely, as too many peoples’ money in China is involved.

There are also significant issues regarding the balance of power – between the economic powers and ideological powers in countries like Russia and China.  In Russia, the invasion of the Ukraine has led to many oligarchs losing a lot of money, and Russia’s choice in retrospect is looking very foolish.  It seems that Putin was persuaded by ideological hardliners, not the oligarchs.  A similar struggle exists in China.  President Xi has been leaning towards the ideological viewpoint for some time. (Consider how the Zero COVID policy is considered completely irrational from an economic standpoint.)  For this reason it is important to look at how influencers work and follow the money!  Today, about 44% of Taiwan’s economy is based on trade with China.  There are some very strong economic interests at play, and it is in the state’s economic interest to let Taiwan maintain their current status.   Xi will have to look at the wealth of the Chinese economy, not just the wealth of a few individuals.  But in Taiwan, the ideological interests are paramount, much more so than the economy.  Individuals there are passionate about their independence from China and will not easily collaborate with them if invaded.

Summary

China also has a “CHIPS” Act of their own – but it is unlikely they will become independent from Taiwan.  They can spend significant volumes, but there is a major barrier they will never overcome.  They simply don’t have the know-how to do what Taiwan and TSMC are able to do.  Even if Xi decides for ideological reasons that he needs to invade, there are a lot of people that would stop him.  The Communist Party’s primary foundation rests upon a strong economy, and this would not be possible if Taiwan’s industry were disrupted.