War for Taiwan: What If China Wins? The Economic and Political Consequences
“Think of the global economy having a heart attack.”
The immense economic fallout that would materialize even before an invasion of Taiwan;
How the world may (or may not) respond to a Chinese invasion, militarily and economically;
The delicate balancing act of signaling credible deterrence.
ChinaTalk is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.
The Price of Contemplating an Invasion
Jordan Schneider: Recently, you two wrote a paper exploring the economic, political, and geopolitical consequences of China prevailing in a conflict where they take over Taiwan.
What happens, diplomatically and economically, when war is imminent?
Jude Blanchette: One point that is worth making: in the analysis we tried to say, “What could a clean, low-cost success for China to look like?” You can imagine a world — although I think it’s a low probability one — where China is able to go in quick and fast, without a real significant observable buildup, decapitate the Taipei leadership, face minimal to zero resistance on-island resistance — and then, critically, have the whole world shrug, so that there’s no after-invasion backlash from the global community.
Another possible scenario here is that China is able to create a scenario where its action on Taiwan is understood by a significant enough number of the international community to be defensive. That could be that they claim that there was an attack on a PLAN destroyer by the Taiwanese and that they had no choice.
So it’s worth highlighting those scenarios because our analysis critically assumes: one, there is an observable buildup and that, even if China tries to control the messaging such that it is on the defensive, realistically it will be seen (at least by advanced economies) as an offensive, aggressive move; and two, it is going to be facing some non-trivial amount of resistance on the island, such that it isn’t a clean, day-one victory.
Jordan Schneider: So now let’s say China ultimately prevails, and it’s not a third-standard deviation positive outcome for them. What happens, and what are the diplomatic and economic implications?
Gerard DiPippo: In phase one — the lead-up to a Chinese attack — it’s very important to keep in mind that the world doesn’t exactly know what’s going to happen. We are assuming, I think reasonably, that the US and others would detect some signs; the US might be warning the world and its allies about Chinese intentions, similar to what happened with Russia. But US allies and certainly other countries may not believe or may not want to fully internalize the implications of that buildup.
That’s also true for multinational firms and investors. If you assume the really bad outcome is going to happen, that entails a whole set of aggressive actions like divestment that a lot of companies are not going to want to do; there would be a lot of wishing that it’s going to pass. So you would see things like stock markets and commodity markets responding — portfolio investors would be the first to respond.
But direct investors in China are probably going to be more in “wait and see” mode — because what we would be talking about here is something that hasn’t happened; nothing like this has happened in modern history.
Jude Blanchette: You can imagine liquid capital moving pretty quickly. If we think about operational MNCs or direct investors, I think a lot of this would depend on the credibility of China’s “we’re not going to invade” messaging or obfuscation — and conversely, the credibility of the US’s warnings about an invasion.
If you have something similar to what the US was doing during Russia’s buildup to the Ukraine invasion — and now in a post-Russian invasion of Ukraine, where the US intelligence community and the senior leadership have a lot of credibility built up — especially if boards of MNCs are reading on the front page of the Financial Times what looks like credible evidence that this time is different and China is actually mobilizing for an attack, even in that pending phase you might get more drastic behavior changes from MNCs than we might expect.
Jordan Schneider: That’s an interesting tension you bring up: on the one hand, China would want to obfuscate and not tell folks; but also, they would prefer capital controls and nationalization to all of this money just falling out of the country, which is about to be subject to an enormous GDP hit.
Gerard DiPippo: And Chinese leaders would know that this would be an incredibly risky act — so they would need to prepare their own population with propaganda, prepare the diplomatic space, mobilize military forces, and put in some economic measures to get the economy ready, including capital control.
Jude Blanchette: There’s probably an entire project here on all of the ways China would launch an attack in defensive terms. I always think about the 1931 Mukden Incident, where the Japanese blamed a railway explosion in Manchuria as the proximate cause for sending troops into China. We had the Gulf of Tonkin incident. We have to be conceptualizing ways in which China would want to be able to credibly claim in diplomatic channels, “We were not the aggressor here — we were forced to.”
I don’t know if China would be able to have that space if it was, for example, a constitutional referendum in Taipei. I think in China’s head that would be a provocation — but I’m not sure if the rest of the world would necessarily agree, even if they understood that for China that was a red line.
Jordan Schneider: We’ve been dancing around it — we should get to the meat. Once the conflict really kicks off, why is this so bad for China?
Gerard DiPippo: It’s bad for China and the world — and the main reason is that it would be beyond disruptive to the global economy, far beyond the 2008 global financial crisis. We’re not just talking about financial reactions in the commodity market. It would be a conflict zone covering the most vital shipping lane in the world. It would also be within range of China’s major ports — and China’s the world’s factory; it’s the number-one manufacturing exporter.
In comparison, Russia’s economy was one-tenth the size of China’s. But the bigger thing was that Russia’s main avenues of trade were not disrupted physically. In this case, though, China’s would be, and a lot of Asian trade is providing inputs that then go into Chinese factories and then make goods that go elsewhere. So it would be disruptive to the whole world — but China in particular, because their export sector would be completely hammered.
It’s hard to know just how disruptive, but it’s safe to assume it would be incredibly severe. No one has really done a good job of estimating this in GDP terms, and I think part of the reason is that this kind of scenario is well beyond the historical sample set that you use for econometric modeling. There was a RAND paper from 2016 called “Thinking Through the Unthinkable” that attempted something like this, but it wasn’t really econometric, and it also used data that now is almost a decade old. But with that caveat given, the RAND paper had China’s GDP declining by twenty-five to thirty-five percent in a year-long conflict, and the US’s GDP declining by five or ten percent. I suspect now, because of China’s larger relative size, the pain is going to be a little more balanced, but it would still be more on the Chinese side.
China’s key coastal provinces are going to be well within the range of aircraft and missiles. Something that I’ve seen others assert is, “How much can commercial shipping go around this? You could, say, escort ships.”
The reality is, if there are naval ships blowing up and missiles flying, commercial traffic is not going through the straits and are not going to go into ports that are in the war zone. Think of the global economy having a heart attack.
Jude Blanchette: I think that some of the specific calculations of the costs would partly depend on the conflict radius. Even if you’re using a relatively conservative conflict radius, you’re implicating four or five of China’s largest ports. The provinces which are directly abutting Taiwan account for about twenty percent of China’s overall GDP.
And then if you start imagining what onshore activity is looking like: first of all, China A-shares are going to tank immediately. Part of this is going to be flight from risk; part of this is going to be investors who are dumping equities on US markets of Chinese companies. If a war is starting to break out, Alibaba, Tencent, or any US-listed equity is going to be seen as toxic, probably because you’re expecting future sanctions by the US.
I was in Beijing in 2015 to 2016, after the stock market crashed in China: foreign MNCs were having a hell of a time getting capital out. And there was clear window guidance from SAFE and PBOC to all the major state banks saying, first of all, “Triage” — and in the triage, foreigners are last, rich Chinese are second-to-last. You can imagine a scenario like that, where all the windows at the state banks are overflowing with companies trying to repatriate capital. You’re also going to imagine an extraordinary amount of psychological volatility for MNCs, as they’re thinking about personnel safety and as they’re trying to find ways to get employees out, especially senior expat employees.
So you’re going to have a massive level of volatility in business sentiment where, even if the conflict ends within twenty-four hours, the now-associated risk and toxicity of the Chinese market lingers for an enduring amount of time. Even companies that aren’t able to repatriate capital or that aren’t able to get employees out — then it’s just a matter of time and finding windows to where they can.
You’ll have phases of the economic cost: first is the immediate one, when there’s actual conflict and all the attendant, immediate responses from investors and FIEs. And then you’ll have the long-term phase where no marginal unit of capital is being invested in China by a foreign company, certainly a G7-economy company.
Jordan Schneider: How long does shipping need to be disrupted before you start thinking about famine?
Gerard DiPippo: China is a net importer of food. Supply-chain analysis is a blossoming industry but still in its infancy — so it’s hard to know how all this stuff works. China does make inputs, like certain types of agricultural products or machinery that are necessary for production elsewhere. But from a raw-commodities perspective, China would be the one that’s getting the bad end of it because they’re a net importer — whereas the US, and certainly North America, is a net exporter of food.
In terms of whether there will be famine — I’ll use this opportunity to make a broader point. When you’re talking about big shocks, part of why it’s so hard to model them, even just qualitatively, is that you have to get out of the mindset of thinking things will continue to operate the way they did in peacetime — or to be a little wonkier, assuming that prices are fixed. People might say, “China needs x million tons of soybeans, which then go in to feed its pork — and the Chinese population loves eating pork.” But in a wartime situation, there will probably be massive spikes in pricing and rationing, and I think the Chinese citizenry — and those elsewhere — will just have to adjust.
Would it literally be a famine? I’m pretty doubtful. I think the Chinese would switch to grains and other things. If you look at the 14th Five-Year Plan, it has self-sufficiency targets for basic grains — but that’s assuming peacetime conditions. Elsewhere, because China is not a net exporter of food, I think in some ways it would be less disruptive than Russia and Ukraine, because those are major net exporters of grain.
Everyone in the War’s Crossfire
Jordan Schneider: I imagine one model that leaders in Beijing might be hoping for in this scenario is something akin to post-Tiananmen: you did have sanctions, but it didn’t rupture the future trajectory of China being able to engage and trade with the world. Why do you think that a scenario like this doesn’t apply here?
Jude Blanchette: As horrific as Tiananmen was, it was a purely domestic event. It’s a little bit like the international reaction to Xinjiang or even Hong Kong, which elicited a great deal of external concern and criticism — but ultimately, Hong Kong is China’s de jure territory. Taiwan is not seen as a domestic event. In China, of course, it is — but not internationally.
A second point: a counterfactual where China made an attack on Taiwan in 1999 or 2003, I think, has a different outcome than an attack in 2022 or 2023, given the state of the US bilateral relationship with China, the degree of hostility that already exists toward China now, and especially in a post-Ukraine world. I think the cost-acceptance threshold in the US has gone up appreciably vis-à-vis China just in the last couple years, and certainly over the last nine months.
But you’re asking a question that gets into the really important dynamics of, “We don’t know.” We don’t know exactly what the response would be because we don’t know exactly what the course of events would look like. So Gerard and I try to, in as many ways as we can, italicize, embolden, underline, put exclamation marks behind some comments where we are saying, “This is a stylized thought exercise, not a prediction of the future!”
I think as we’re having a discussion on ensuring that Beijing is sufficiently deterred such that it never contemplates such a risky event (even if our underlying assumption is they have some recognition of the costs): if states always internalized the full cost-equation of an invasion or war, we would have far fewer wars — meaning states are very, very bad at decision-making, and I don’t see any reason why China is necessarily immune from that.
If I can get prescriptive for one second: it is imperative that the US and G7 economies who are invested in avoiding this outcome start to build credible signals of intent of what they would be prepared to do, such that China understands that some of the dynamics we’re talking about — imposition of sanctions, ostracism of the Chinese market, MNCs and investors moving their capital to other locations — are not seen as just flippancy, but as actual credible commitments. Some of the statements you’ve seen — such as when US banks were hauled up on Capitol Hill, snapped the salute, and said, “Aye aye, captain — we’re patriotic” — that’s not a credible statement.
Gerard DiPippo: I think it’s worth pointing out three core assumptions — I think they are pretty important in shaping our analysis, and they matter more for phases two (actual war) and three (after war).
The first assumption, which we say pretty early in the paper, is that Taiwan resists at least somewhat and with some credibility. We’re not saying they win; we’re just saying that they resist.
The second is that the US has at least the governance and diplomatic acumen and intent to organize some type of coalition among its allies, even if only in the economic sense.
The third — and probably most controversial of the three — is that the US is actually engaged militarily.
Now, we’re assuming that it’s a fairly limited engagement: the US doesn’t go all in total war, and we say explicitly that we’re assuming there’s no nuclear exchange. But the third assumption is really important, in part because — at least in our view, and this is speculative — if the US is engaged, we’re actively fighting the PRC, and the US is sustaining, conservatively, thousands if not tens of thousands of casualties among sailors, airmen, and others, I think the US population is going to be losing its mind.
And this is where we get into one of the major discontinuities — people say things like, “Oh, but Americans wouldn’t be able to function without their cell phones.” I’m not so sure about that. I think once people start seeing people dying — it goes beyond the purely rational, and it certainly goes beyond the economic-balance-sheet approach that a lot of people seem to think is going to be a compelling deterrent, including for the United States — I just don’t think that’s true once the bullets start flying.
Jordan Schneider: This comes to the key question of, “How credible do you really want your deterrence to be?” Because Jude, I think you’re completely right: you can imagine a world in which a US president is staring at an instant recession and says, “You know what? Taiwan — they didn’t try that hard. They’re really far away. It’s not worth it.”
And even if you have a G7 statement and a really nice ten-point plan and a fifty-page document — “if you do this, then we’ll do that” — it’s still going to come down to leadership to pull that lever and really inflict the pain, both on China and the US, too.
You can pre-commit by putting a lot more American troops in Taiwan, but there’s a big debate: to what extent is that an important part of deterrence versus something that would just raise the chance of conflict?
Next, Jude and Gerard discuss how US allies in Asia can best shape the calculus of deterrence, and what the prospects would be for US allies joining in inflicting economic pain on China: