Taiwan: Trade Deal with U.S. and China Grey Warfare

 Taiwan’s overall country risk score of medium-low reflects economic strength and only ongoing, rather than escalating tensions with China over reunification. Taiwan has finalized an agreement on a trade framework deal with the U.S. that reduces tariffs to 15% (the same as Japan and S Korea) and provides exemptions for certain goods. In exchange, Taiwanese companies have recommitted to large existing plans to build advanced semiconductor plants in the U.S. Additionally, the U.S. and Taiwan are negotiating a 2nd set of military purchase on top of the USD11bln agreed in December, though Taiwan parliament is deadlocked on funding for defense due to opposition concerns over scale and allocation of the budget. Meanwhile, China has maintained the intermittent large scale military exercises around Taiwan as part of China’s gray-zone warfare. It remains unclear whether President Trump is fully committed to keeping the strategic ambiguity policy, and the proposed Trump/Xi meeting in April needs to be watched closely to see whether China secures any concessions from Trump. On balance the strategic ambiguity policy, likely to be maintained by the U.S., suggests that any future China invasion would have a high risk of failure if the U.S. became involved. Thus, China will likely continue to pressure Taiwan but stop short of major escalation, see below. Elsewhere, structural economic indicators remain strong, helped by a well-balanced economy, controlled inflation and a huge current account surplus. 

Figure 1: Taiwan Scenario 2027   

Source: Continuum Economics

President Xi could ask U.S. President Trump for an understanding that reunification will eventually happen and that other countries should not be involved if China takes action over reunification.  Xi could fold this into a U.S./China trade deal. Trump is provisionally scheduled to visit China in April and Xi to visit the U.S. in the fall of 2026. However, the Trump administration is likely to counter that reunification should not occur via military methods and that the strategic ambiguity policy remains in place.  Trump’s tech friends will warn him that a China takeover of Taiwan could curtail or stop advanced semiconductor exports to the U.S. and derail U.S. leadership in AI.  Many in Washington also remain biased to strategic restraint toward China, beyond Trump’s desire for a trade deal.  Trump’s focus on the Americas does not mean that the U.S. is abandoning its sphere of influence in Asia.

For President Xi, this makes an invasion (Figure 1) too high risk, as war game analysis suggests that China could lose if the U.S. become militarily involved (here). Defeat would be destabilizing for Xi and the Communist Party and Xi is not a gambler.  It is worth remembering that Xi wants China ready for the option of a regional war by 2027, but full military capability by 2035. 2049 is also the 100th anniversary for the communist party and is seen to be a date to achieve reunification. A blockade is also very high risk, as it could spiral into a China/U.S. military clash.  The U.S. may not break a blockade by force or counterattack China’s armed forces in the invasion scenario, but Xi cannot be confident about the Trump administration not reacting without a formal understanding.  The U.S. has a crucial advantage in advanced submarines, which could seriously hurt China’s navy.  Even a quick successful China invasion would still have severe adverse consequences on China economy, currency and financial markets, as Russia found out with the invasion of Ukraine. Additionally, though opinion polls in Taiwan show voters oppose invasion and would prefer the status quo, they do signal a majority of voters expect reunification at some stage. This gives China the opportunity to encourage pro-China and reunification factions within Taiwan. January 2028 is a pivotal date with parliamentary and presidential elections. 

Our baseline (Figure 1) for 2026 and 2027 remains that China maintains the existing air and naval grey zone warfare, which is low risk for China.  We have the probability of an invasion or full blockade in 2027 at 10%, but have the temporary China Coast Guard quarantine option at 10-20% -- this could be Taiwan as a whole or one of its islands, as occurred in the 1950s.  The probabilities are likely lower in 2026, as Xi could try to convince Trump a couple of times in 2026 to weaken the strategic ambiguity policy.