With U.S. Cooperation, a Shift in Supply Chains

Taiwan and the U.S. are seeking build alternatives to production of critical equipment in China in the wake of the global pandemic.

First came the U.S.-China “trade war,” with Washington encouraging American companies to leave China and bring manufacturing back home. Then COVID-19 struck, halting the flow of medical equipment and other goods and laying bare the world’s dependence on Chinese supply chains.

Washington has since intensified its efforts to reduce reliance on China – even if that means production goes to countries other than the U.S. Referring specifically to the shortage of critical medical equipment, Secretary of State Mike Pompeo in April said the U.S. government was holding discussions with other countries, including India and Japan, “about how we restructure these supply chains to prevent something like this from ever happening again.”

Now the U.S. is bringing Taiwan into the fold. In making Taiwan a partner in its endeavor to restructure global trade flows, Washington is actively seeking to help shift international supply chains in the island’s favor. Due to Taiwan’s manufacturing reliability and shared democratic values, both governments regard Taiwan as well-positioned to be a key global player in the information and communications technology (ICT) and other supply chains in a post-pandemic world. Major categories in the ICT arena include PCs, smartphones, switches, and routers, as well as support industries such as semiconductors.

Taiwan is already a critical part of global high-tech supply chains, particularly for semiconductors – one sector in which investment has continued to be concentrated in Taiwan rather than migrating to China. In numerous other industries, however, tens of thousands of Taiwanese companies set up manufacturing facilities in China in recent decades, with many of the operations focused on selling to the U.S. market.

As relations have soured between China and Taiwan, President Tsai Ing-wen’s government has encouraged Taiwanese companies to move their supply chains out of China, either back to Taiwan or to countries in Southeast and South Asia. Since January 2019, Taiwan has reportedly received US$33 billion in such investment, either actual or pledged. 

Now COVID-19 has caused more governments and multinationals to explore how to reduce their own economic reliance on China, and Taiwan is hoping to be a major beneficiary of that trend. In the early days of the pandemic, many countries with a heavy trade dependence on China suffered a shortage of supplies, such as ventilators and face masks, that became critical as the coronavirus spread.

Taiwan mobilized its domestic industry and for a time became the world’s largest manufacturer of surgical masks. This achievement demonstrated “Taiwan’s strength as a global supply chain leader,” David Stilwell, U.S. Assistant Secretary of State for East Asian and Pacific Affairs, said in late August at a forum at the Heritage Foundation. 

Participants in discussion before the start of the AIT-initiated Forum on Supply Chain Restructuring. Photo: Louise Watt

Soon afterward, W. Brent Christensen, director of the American Institute in Taiwan (AIT), the de facto U.S. embassy in Taipei, confirmed that the U.S. side had been discussing supply chain restructuring with the Taiwan government for the past eight months. “Supply chain resiliency is just one of the areas in which Taiwan will play a key role in the post-COVID-19 era,” he told a September 4 forum in Taipei entitled “Supply Chain Restructuring: Improving Resilience Amongst Like-minded Partners.”

Taiwanese companies helped to develop the ICT and other supply chains in China over the past 30 years, Christensen said. “However, in contrast to (Chinese) companies, Taiwan firms adhere to the rule of law and protect intellectual property,” he said.

Taiwan’s Foreign Minister, Joseph Wu, told the same forum that it was “time for a different industrial landscape.” Without mentioning China by name, he said that “the outbreak of COVID-19 has exposed the risk of overreliance on a single country or supplier for critical materials such as medical supplies or pharmaceuticals.”

Wu said that many countries have started to consider a key question: “If medical supplies could be weaponized or politicized during the pandemic, what would happen if a country’s strategic industries and key infrastructure were in the hands of another during a time of crisis? Another country that does not honor the values of the rule of law, freedom, democracy, and transparency?”

Taiwan will work with “like-minded partners to establish reciprocal industrial ties, ones that lead to joint prosperity instead of coercion, exploitation and expansionism,” Wu said.

The forum was initiated by AIT and co-hosted by Taiwan’s Ministry of Foreign Affairs, the European Union, the Japanese representative offices in Taiwan, and the Taiwan External Trade Development Council (TAITRA), a government-sponsored organization that promotes trade.

At the event, AIT and TAITRA announced plans to strengthen cooperation on supply chain restructuring and resiliency, especially in the ICT and medical sectors. They also said they would engage with “like-minded” partners with “shared values” to develop new supply chains that would be resilient in times of crisis.

Shift already occurring

China’s rising labor costs and its trade dispute with the U.S. have already pushed American, Taiwanese, and other companies to look for new suppliers elsewhere. To avoid the stiff tariffs the U.S. has slapped on goods made in China, Taiwanese companies have been moving back home or to other Asian countries. Major iPhone assemblers Foxconn, Pegatron, and Wistron have been adding manufacturing capacity in Vietnam and India.

Analysts expect the fallout from the coronavirus to accelerate this trend of diversifying away from China, particularly for products of strategic importance. Ray Yang, a technology specialist at the semi-governmental Industrial Technology Research Institute, says that COVID-19 had changed the mindset of CEOs.

“It made all the major Fortune 500 companies really start to think about how to reduce the risk so that the supply chain is smooth, agile, and flexible,” he says. “But when you start to think about how to mitigate the risk, it will incur some costs. The key is how to share the cost between the brand company and the supply chain — and the supply chain is very long, with many, many players, so it is a bargaining process.”

China accounted for more than a quarter of global manufacturing output in 2018, according to U.N. data. In the key manufacturing industries of textiles, high-tech goods, chemical products, and machinery components, China accounts for roughly 40-50% of global production, according to market research provider Euromonitor International.

As supply chain lines are redrawn, lower value-added and labor-intensive manufacturing, such as textiles production and electronics assembly, is likely to go to Asian countries with lower labor costs. “Taiwan, on the other hand, can compete in attracting investments into higher value-added fields, such as semiconductors, batteries, machinery or automotive parts,” says Justinas Liuima, a senior consultant at Euromonitor. “These sectors require specific skills and know-how, which Taiwan has, and are less sensitive to higher labor costs.”

U.S. supply chains are already seeing a shift away from China, particularly in the computer and electronics sector, with Vietnam, Mexico, and Taiwan the main beneficiaries, according to a July research note by Netherlands-based RaboResearch. It said that last year, U.S. manufacturing imports from China dropped by 17% or US$88 billion. Of this, 20% went to Vietnam, 16% to Mexico, and 10% to Taiwan.

The benefit to Taiwan came mainly from a shift in printed circuit assembly supply chains, a semiconductor subsector, said RaboResearch economist Michiel van der Veen, as Taiwanese firms relocated parts of their supply chains back to Taiwan, largely because of the trade war. The RaboResearch report also suggests some production is moving back to the U.S.

 Looking ahead, U.S. imports of semiconductors can be expected to drop further when Taiwan’s largest chip maker, Taiwan Semiconductor Manufacturing Co. (TSMC), begins operating a planned US$12 billion chip factory in Arizona. The fab is scheduled to come online in 2024.

The shifting of supply chains away from China is a process that U.S. companies must initiate, says Yang of ITRI. “The decision maker or the major driving force is not AIT or the Taiwan government, although they can assist and facilitate,” he says. Rather, it is U.S. companies that will have to give “advice or instructions” to their Taiwanese partners to shift production away from China – either to continue to make products for them in a third country such as Vietnam, India, or Mexico, or to make specific priority products or components with possibly “sensitive or very high-value technologies” in Taiwan, said Yang.

This process will lead to the creation of brand-new supply chains with new facilities, equipment, and workers. Companies that remain in China will be focused on its massive domestic market only. “Those old supply chains won’t be manufacturing for the world, but only for China,” says Yang.

Taiwan’s government can help by setting up more training programs to increase the supply of high-level engineers and scientists, including electrical engineers and computer scientists, Yang says. It can also create more clusters, similar to the Hsinchu Science Park, “for AI and 5G or even 6G,” to facilitate collaboration among companies. Boosting this kind of infrastructure will encourage U.S. companies to locate R&D in Taiwan, not just production, Yang says.

Promoting Taiwan as a business alternative to China is Washington’s latest pillar of support for Taipei, which faces increasing military, economic and diplomatic pressure from Beijing. In late August, the U.S. said it was establishing a new bilateral economic dialogue with Taiwan to strengthen ties in the face of Beijing’s pressure. The annual talks were described as covering semiconductors, healthcare, energy, and more, “with technology at the core,” Assistant Secretary Stilwell said in an August announcement.

The dialogue follows President Tsai’s announcement that Taiwan will ease its restrictions on U.S. pork and beef, a sticking point between the two sides for more than a decade. Taiwan’s ultimate goal is to conclude a bilateral trade agreement with the U.S.

In August, Secretary of Health and Human Services Alex Azar became the highest-ranking U.S. cabinet member to visit Taiwan since 1979. His visit was followed last month by that of Under Secretary of State for Economic Affairs Keith Krach, who attended a memorial service for former President Lee Teng-hui and held informal talks with Taiwanese economic officials on supply chain restructuring and other issues. 

Some companies that want to diversify away from China are currently focused on surviving the economic fall-out from the pandemic, coping with declines in demand, supply chain hold-ups, and cash-flow problems. When they are ready to explore new options, it will take time to build relationships with potential suppliers. Restructuring supply chains will incur significant costs, and companies will want to negotiate with governments over financial assistance, which could be a lengthy process.

“We foresee that it will take around two to three years until we see final results, as it will take time to find alternative suppliers, regroup transportation networks, and adjust physical factories,” says Liuima of Euromonitor. In the meantime, Taiwanese companies face disadvantages in the competition for new investment.

They have “quite limited positions in the global supply chain,” and most of their manufacturing activities are within Asia, which limits the possibilities for global expansion, says Liuima. Geopolitics may also get in the way. “Potential political tensions with China might also limit Taiwan’s attractiveness to foreign players,” Liuima notes.

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