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Supply Chain Security, From Taipei to Brussels

ARTICLES - 18 May 2021

Most industrialized nations have launched policy reviews to reduce critical supply chain vulnerabilities, in particular those linked to overdependence on China. Taiwan’s stakes are higher. In 2019, cross-strait trade was US$150 billion, and the stock of Taiwanese investment in Mainland China US$186.5 billion. This represents more than 40% of Taiwan’s foreign trade, its largest source of trade surplus and more than 55% of Taiwan’s Foreign Direct Investment. This deep economic interdependence is a source of prosperity but also a strategic vulnerability given China’s intentions to impose political unification to Taiwan, with non-peaceful means if necessary. Since the beginning of the liberalization of cross-strait economic exchanges at the end of the 1980s, all Taiwanese governments have tried to reverse the trend of increasing reliance on China as a production base and as a market. All have failed. 

But the terms of the equation are finally changing because of rising production costs in China, the US-China tech and trade war, and the Covid-19 supply chain disruptions. Between 2010 and 2018, the annual average of incoming Taiwanese investment in China was US$11.06 billion, according to the Taiwanese Ministry of Economic Affairs. In 2019, it was only US$4.17 billion. This sudden sharp decline was confirmed in 2020: during the first seven months of the year, the amount was US$3.54 billion.

While Taiwanese investment continues to accumulate in China, albeit at a far slower pace, the simultaneous trend towards reshoring and diversification is significant enough to relativize the Chinese narrative that China emerges from the Covid-19 crisis as the "promised land" (应许之地) for foreign investment. Taiwan’s focus is on the United States and on some countries in South and Southeast Asia - India has finally emerged in the Taiwanese business mental map. For the Taiwanese government and many firms, the global trend towards supply chain restructuring is an opportunity that should not be missed. Does this make any difference for Europe? The European Union also seeks to better manage supply chain disruption risks. In theory, Taiwan and the EU should be natural partners. In reality, despite some initial political push, much still needs to be done if the two sides are to provide practical solutions to each other’s China problem. 

Taiwan’s policy framework and strategic positioning

In any state undergoing a policy debate regarding strategic vulnerabilities, resilience and economic relations with China, national and corporate interests do not necessarily align. In general, public administrations and companies conduct distinct critical supply chain risk reviews. Companies can act on their own to reorganize their network of suppliers and mitigate risks, but public/private coordinated action stands a better chance to succeed. 

Covid-19 only had an accelerating effect on this preexisting trend - Taiwan’s incentive policies and shifts in corporate attitude predate the pandemic outbreak in Wuhan.

In Taiwan, an issue of business optimization and risk management for Taiwanese firms is an issue of national survival for the government. And their priorities have diverged for more than two decades. Indeed, this is everything but a new question. As early as 1994, President Lee Teng-hui launched a "Go South" policy to divert Taiwanese investment to ASEAN, away from Mainland China. But all attempts failed - China’s attractiveness was just too strong for Taiwanese businesses. That all polls have long underlined an overwhelming rejection of unification with China in Taiwan has had only a marginal restraining effect on the process of cross-strait economic integration. 

The real turning point for Taiwan came with the US-China conflict. Covid-19 only had an accelerating effect on this preexisting trend - Taiwan’s incentive policies and shifts in corporate attitude predate the pandemic outbreak in Wuhan. Several Taiwanese Original Equipment Manufacturers (OEMs) and Original Design Manufacturers (ODMs), including the largest, Foxconn, were already engaged in diversifying production away from China. Such companies usually operate with a low-profit margin and were thus extremely reactive to changes or anticipated changes in the US import tax burden.

In July 2019, the Taiwanese government launched its "Action Plan for Welcoming Overseas Taiwanese Businesses to Return to Invest in Taiwan" (known as the "Welcome Back Action Plan"). As of April 2021, 213 projects had been approved, for a total investment value of NT$ 799.7 billion (US$28.6 billion). The government provides preferential loans, tax incentives, assistance in land acquisition, stable and cheap supplies of water and electricity, and preferential labor regulations for the hiring of foreign nationals.

The program targets Taiwanese companies affected by the US-China conflict that have been operating in China for at least two years. It specifically targets sectors defined as strategic: those that belong to Taiwan’s 5+2 Industrial Innovation Program (intelligent machinery, Asia Silicon Valley, green energy, biomedicine, national defense and aerospace, new agriculture and the circular economy), or those that play a critical role in international supply chains.

Taiwan’s eyes on the United States

Supply chain vulnerabilities have become a new driver for the deepening of US-Taiwan relations. The mutual attraction is magnetic. Taiwan can provide solutions to an acute American problem - the need to reduce the China risk in America’s supply chains. And seen from Taipei, anything that tightens links with the US is beneficial to Taiwan’s strategic position. In addition, the interests and the respective strengths of the US and Taiwan are a match in the semiconductor industry, often called the steam machine of the digital revolution, and the best industrial battleground to take on China, given its relative weakness.

More broadly, the February 2021 Executive Order on America’s Supply Chains has set in motion a 100-day risk review for semiconductors, high-capacity batteries, critical minerals, and active pharmaceutical ingredients. Reducing supply chains vulnerabilities is about strategic competition with China, but also part of a domestic agenda seeking to "rebuild domestic manufacturing capacity, maintain America’s competitive edge in research and development, and create well-paying jobs".

Taiwan can provide solutions to an acute American problem - the need to reduce the China risk in America’s supply chains. 

This further enlarges the space already opened by the Trump administration for deeper US-Taiwan industrial ties. Supply chains are on the "top of the list" of the new high-level bilateral dialogue instituted by the two sides. In early September, the American Institute in Taiwan (AIT) and the Taiwan External Trade Development Council (TAITRA) signed a joint statement on securing supply chains, with a priority placed on the Information and communications technology (ICT) and medical sectors. The aim is to build supply chains that are immune to political coercion, and that ideally could reflect "shared values, standards and best practices".

This political involvement in global value chains has already produced results in the semiconductor industry. In May 2018, TSMC announced that it would build an advanced semiconductor foundry in Phoenix, Arizona. The decision is not only significant for US-Taiwan relations, it also does have implications for the whole semiconductor value chain. This will be the first time that Taiwan TSMC’s leading 5-nanometer technology for semiconductor wafer fabrication is used outside Taiwan. The announced US$12 billion investment has been facilitated by an undisclosed package of subsidies provided by the federal and the Arizona governments. According to TSMC Chairman Mark Liu, subsidies are "a key factor in TSMC’s decision to set up a fab in the US...Our request is that the state and federal governments together make up for the cost gap between the US and Taiwan". By how much? Estimates vary but the production cost in the US is estimated to exceed Taiwan’s by at least 20%. Back in June 2020, the State of Arizona rejected a freedom of information request on the incentives it was agreeing to provide, and that were reportedly meant to ensure the conclusion of the deal. The most recent reports show that the US government and TSMC are considering further expansion - larger facilities, and a move to 3 nanometer technology, which would mean doubling the cost of the fab, and another round of subsidies from the Biden administration’s new infrastructure investment package.

TSMC’s most advanced technology stays in Taiwan, but the Arizona fab will process orders from specific US high-tech industries, such as integrated circuits for the defense and the space industry. It will also become a major hub for integrated circuits linked to the applications of the new 5G infrastructure - new generations of smartphones, medical equipment, self-driving vehicles, smart factories… This is made possible by TSMC’s contract foundry model, which specializes in customized orders: the company manufactures 10,000 products for more than 480 customers. This will entrench TSMC as a key supplier to the US arms industry. Having integrated circuits that go in US weapons systems produced in the United States has been a constant goal of the Trump administration when pushing for the fab deal with TSMC.

TSMC no longer sells to Huawei and makes a clear choice to support the US plans for digital transformation, ambitions for arms industry innovation and policies to create high-skilled industry jobs. But this does not mean that TSMC entirely turns its back on China. On the contrary, TSMC plans a major expansion of its Nanjing fab to produce less advanced semiconductor technology (28 nm), with an investment announced at US$ 2,87 billion. The fab expansion responds to the massive needs of the world’s - and China’s booming - automotive industry that have been underlined by the shortages the sector has faced since late 2020. High-end production in Taiwan and in the US, mature technology on mass production in China: this is TSMC’s balancing act, and it has provoked the ire of Chinese netizens, angry that a company now considered by many hostile to Chinese interests continues to draw huge profits from China. 

Contract electronic manufacturers looking South and Southeast 

Supply chains are a priority of Taiwan’s 2016 "New Southbound policy", which seeks to deepen Taiwan’s links with ASEAN, South Asia, New Zealand and Australia. While the focus of the 2016 policy echoes Lee Teng-hui’s 1994 "Go South" policy, the Taiwanese government strategizes in a changing Asian business environment when it comes to supply chains. Taiwan’s electronic contract manufacturers are crucial consumer electronics assemblers in the supply chains of all the world’s most successful brands, including Apple, Dell, Toshiba and Hewlett-Packard (HP). While Taiwan’s electronic contract manufacturers have massive operations in China, a diversification process is underway. Taiwan-based Market Intelligence & Consulting Institute expects a continuous shift of computer assembly away from China to Southeast Asia and India, with component makers gradually following the assemblers.

Taiwan’s electronic contract manufacturers are crucial consumer electronics assemblers in the supply chains of all the world’s most successful brands.

This is the result of business optimization strategies rather than government incentives. Commenting on Pegatron’s decision to move production of contract manufacturing away from China to Vietnam and Indonesia, its chairman Tung Hsu-chien explains that China "has not been an optimum manufacturing location since more than five years ago". He adds that "when U.S. President Donald Trump threw a stone, diversification of production began like tumbling building blocks."

This is also true of Apple’s supply chain, which has brought so many benefits to the Taiwanese industry. It is only after TSMC joined Apple’s supply chain in 2014, producing the A8 CPU for the iPhone 6, that it gradually ate away the market share of Samsung, its main competitor for high-end microprocessors. Given Apple’s importance for Taiwanese electronic contract manufacturers, it is not surprising that Apple’s strategy to divide its supply chain into a part for the Chinese market and another part for the rest of the world has had an impact on many of these. The most obvious effect is to put India on Taiwan’s map. In 2018, Taiwan’s Foreign Direct Investment in India was only US$20 million. The expansion since 2020 by Foxconn of an existing facility in Tamil Nadu to assemble state-of-the-art iPhones is such a large scale investment (valued at US$1 billion) that by itself changes the big picture of Taiwan-India business ties. Two other Taiwanese iPhone assemblers, Wistron and Pegatron, are either expanding or building facilities in India. What initially appeared to be part of Apple’s strategy towards the Indian market is clearly also increasingly targeting export markets in third countries and to lessen dependence on China.

Europe and Taiwan as each other’s respective blind spot

The EU has also recently conducted an in-depth analysis of Europe’s strategic dependencies, as part of the Commission’s update to the 2020 EU’s industrial strategy. The review proposes measures such as "diversifying production and supply chains, ensuring strategic stockpiling, as well as fostering production and investment in Europe". The aim is to reduce the EU’s dependencies in six critical sectors: raw materials, active pharmaceutical ingredients, Li-ion batteries, hydrogen, semiconductors, cloud and edge computing.

Supply chain dialogues have taken place between Taiwan and Europe, most recently with President Tsai Ing-wen underlining the importance of cooperation to build "more robust supply chains". But some differences of priorities are hard to bridge. The Taiwanese side tends to see the issue as an opportunity to make the point for greater European investment in Taiwan. The EU thinks that the investment relationship is asymmetric and wants to attract Taiwanese investment in Europe. With a FDI stock of €21.9 billion in Taiwan in 2019, the EU is Taiwan’s largest source of foreign investment. By comparison, Taiwan’s investment in the EU is low, at €2.5 billion in 2019, less than 2% of Taiwan’s global FDI stocks. The factors that help deepen Taiwan’s ties with the United States, India and Vietnam are not at play in the Europe-Taiwan relationship. Taiwan does not see Europe as a security provider in the Strait, and European costs are too high for Taiwan’s contract electronic manufacturers optimizing their global operations.

For a deepening of ties with Taiwan, semiconductors are the most promising area of the six European priorities. The other five are not entirely absent from the EU-Taiwan trade and investment agenda, but the case for a supply chain security approach may be difficult to make convincingly. For example, Taiwan can’t solve the EU’s problem of access to active pharmaceutical ingredients, as it is not a major producer. This is not contradictory with the fact that the rapid growth of the Taiwanese biotech ecosystem can create opportunities for Europe’s biotech players - but not really from the angle of supply chain security.

In the semiconductor industry, where Taiwan leads in contract foundry but has also impressive strengths in IC design and OSAT (Outsourced Semiconductor Assembly and Test), there could in theory be complementarity. After all, Europe’s key strengths are innovative research, equipment, critical tools such as lithography, design for the automotive and aeronautic industries. 

The Taiwanese side tends to see the issue as an opportunity to make the point for greater European investment in Taiwan.

The complementarity already exists - innovative European companies that design integrated circuits needing manufacturing capacity below the 22 nm node have no choice but to turn to TSMC, while the success of TSMC has relied on the R&D capacities of Interuniversity Microelectronics Centre (IMEC) in Belgium, and on imports of ASML’s lithography machines.

But what can be built on that basis, in the context of the two sides rethinking the security of their supply chains, and especially at a time when the European Commission sees manufacturing of advanced semiconductors in Europe as a priority? The Taiwanese semiconductor association suggests R&D cooperation as the key building block, because the European R&D establishment produces innovation that the Taiwanese industry needs, in terms of precision engineering for example. This would be consistent with TSMC’s approach to Japan, where the company recently announced an investment in a R&D facility in the Tokyo area. This could be part of an incremental approach paving the way to a larger TSMC footprint in Japan, and culminating in an investment in a fab. This was not the Japanese government’s first choice: it is now clear that the Japanese government tried and so far failed to convince TSMC to invest in an advanced fab on Japanese soil.

In the current phase of its expansion, TSMC’s focus is on Taiwan for innovation, on the US for internationalization of its manufacturing capacity, and on China for the earlier generations of semiconductors needed by the automotive industry. Even if the sufficient incentives were put together by the Commission and Member States to make up for the cost difference of operating a fab in Europe, TSMC may still have its hands full with its current growth plan. Nevertheless, Europe should explore as precisely as possible what would be the cost of a package of measures that would make a TSMC fab investment on European soil a profitable endeavor for all parties.

In sum, Taiwanese companies have been active and agile players in the global supply chain discussion prompted by US-China competition. The ongoing European efforts to reduce critical supply chain vulnerabilities have not induced a change of perspective that could affect their calculations regarding our continent so far. Europe remains on Taiwanese companies’ mental map as an export market, rather than an investment destination. This situation has costs for both parties. For Taiwan, this weakens the case for a bilateral investment agreement with Europe to be taken as a priority issue by the EU. For Europe, this underlines the limits of political narratives stressing common values when they are not backed by a solid commitment to Taiwan’s future: the other side sees the relationship in terms of business and profits. 

 

 

Copyright: SAM YEH / AFP

 

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