Lessons from Ukraine

How Businesses Can Prepare their Supply Chains for a Taiwan Crisis

Russia’s invasion of Ukraine has disrupted global supply chains, spiking inflation across the world. With the benefit of hindsight, investors now see the warning signs that led to the conflict: the 2014 annexation of Crimea, Russian denunciations of Ukrainian sovereignty, military action in the Donbas region, and the recognition of two independent republics in Eastern Ukraine in early 2022.

As global attention shifts to Ukraine, investors may overlook signs of another possible conflict that could severely impact supply chains: between China and the disputed island of Taiwan, which China claims as ancestral territory.

Prospects of a conflict between China and Taiwan by 2027

Just as Russia’s invasion of Ukraine was predictable with hindsight, there are signs that tensions between China and Taiwan are rising, and may reach a tipping point by 2027. This date is the centenary of the foundation of China’s armed forces, the People’s Liberation Army (PLA). According to state legend, the PLA originated from the Nanchang Uprising, a clash in August 1927 between the Chinese Communists and the dominant political party at the time, the Kuomintang, triggering the Chinese Civil War.

The Kuomintang and their armed forces eventually lost their struggle with the Communists and fled mainland China for the island of Taiwan in 1949, where they continued their rule in exile and claimed to represent a rival sovereign Chinese state. This sparked a long-held desire in mainland China to take Taiwan back through peaceful or military means.

Furthermore, 2027 is not just a centenary for the PLA; it is also an important waypoint in Vision 2035, the Chinese government’s national modernisation plan. A key objective of this plan is the enhancement of the PLA’s capabilities by 2027 in order to achieve strategic and military parity with the US.

These historical grievances and policy decisions mean Xi Jinping’s administration will be under pressure to mount a public demonstration of the PLA’s capabilities by 2027 – which may end up being an attempt to resolve the Taiwan question. Signalling this, Chinese official rhetoric about unification with Taiwan has escalated sharply since 2012. Moreover, China has been flexing its muscles in the region recently; a record-breaking 149 Chinese aircraft entered Taiwan’s air defence zone over four days in October 2021. China followed this by sending 39 warplanes into Taiwan in January 2022, and nine further military jets on the day that Russia announced the invasion of Ukraine in February 2022.

The impact of a conflict on global business

How would a conflict between China and Taiwan impact investors and supply chains?

First, Asia-Pacific supply chains would enter a period of intense disruption and reconfiguration. Although there are numerous scenarios for the conflict, many of them involve an economic and military blockade of Taiwan or its outlying islands. As a result, the island may lose access to sea freight supply routes through the Strait of Malacca, a trade chokepoint between the Malay Peninsula and Sumatra, or the Luzon Strait south of Taiwan’s main island of Formosa.

Blocking the Strait of Malacca would slash the volume of exports to the US and Europe in market-leading Taiwanese industries like semiconductor products and sporting goods. Similarly, conflict in the Luzon Strait could result in the blockage or destruction of subsea fibreoptic connections between Asia and the US, resulting in disruption to telecommunications and financial services. In addition to real-world obstruction, China would likely conduct denial-of-service cyberattacks on critical Taiwanese infrastructure as part of a hybrid warfare strategy, possibly compounding logistical difficulties for investors.

Second, the US, EU and UK would likely impose sanctions on the Chinese government and state-owned entities. The complex and pervasive interconnections between the Chinese government and all Chinese businesses of any significance, whether state-owned or private, would complicate the implementation and enforcement of any sanctions regime. Similarly, it is likely any new sanctions regime will require businesses to commit more resources to identifying, and divesting from, Chinese entities in their supply chain linked to forced labour, war crimes and human rights abuses

How should businesses prepare?

To hedge against the risk of an invasion, investors should conduct stress tests to measure their exposure to conflict scenarios. Businesses should also seek to diversify their supply chains before 2027 to include production and export through alternative jurisdictions, such as manufacturing centres in India or Vietnam. Decision-makers should also factor in medium-term volatility, work with specialist due diligence firms to analyse sanctions risk, and consider the realistic possibility that divestment orders and stringent dollar-denominated reporting standards will form part of their Taiwan operating costs.