China's most significant foreign policy goal is the control of Taiwan. This goal could embroil China and the West in a diplomatic and military showdown, while providing significant sales opportunities for arms manufacturers and exporters and threatening high-tech manufacturers with operations in Taiwan. A Western arms embargo against China has been ignored, in part, by profit-seeking European companies. Thus, an arms race in the Taiwan Straits could be a reality.
The China-Taiwan relationship offers great political and investment drama. Taiwanese companies are some of the largest overseas Direct Investors in mainland China and hostility between the two territories might cause a hiccup in China's economic growth. Potential retaliation, such as sanctions, from other Western countries would also impact China-related investments significantly. At the same time, tech investors might not sufficiently appreciate their exposure to trouble in the Taiwan Straits -- for the lion's share of all Apple's iPods are made in Taiwan.
China considers Taiwan (aka the Republic of China or ROC) to be a renegade province. Meanwhile many in Taiwan consider their island to be an independent country. And Westerners regard Taiwan as the first Chinese democracy in the World.
When the Nationalists under Chiang Kai-Shek fled from China to Taiwan after World War Two, the U.S. recognized Taiwan as the legitimate government of China. This changed under the Presidency of Richard Nixon. In 1971, the U.S. supported the seating of China's representative in the United Nations Security Council and in 1973, China and the United States opened "liaison offices" in each other's capital. Normalization ultimately concluded in 1979, with the establishment of a U.S. Embassy in Beijing and the shuttering of the U.S. Embassy in Taipei.
Nixon’s diplomatic efforts did not abate the American people’s fears about Communism, as manifested in China. Thus, while the U.S. formally ended its diplomatic recognition of Taiwan and normalized relations with China in 1979, Congress passed the Taiwan Relations Act at the same time. The Act pledges that the U.S. will assist Taiwan to “resist any resort to force or other forms of coercion that would jeopardize the security, or the social or economic system, of the people on Taiwan,” and approved the continued sale of U.S. arms to Taiwan.
As part of its One China policy, the United States formally considers Taiwan to be a subcomponent of the People’s Republic of China and has limited official engagement with Taiwan’s leaders. The United States has no Embassy or Consulate in Taiwan, however it maintains a pseudo-embassy called the American Institute in Taiwan, which employs U.S. foreign service officers who resign from the service during their tour in Taiwan and then are reinstated upon their return. Likewise, any U.S. visas issued to Taiwanese are officially from the U.S. Consulate in Hong Kong.
Actions by the United States, Taiwan, or China can have a dramatic impact on a military build-up in the Taiwan Strait. China often conducts wargames in the Strait as a means of warning Taiwanese politicians not to become too independent. Meanwhile Taiwan conducts military exercises with missile-tipped fighter planes to warn China that an invasion would be costly. And the U.S. sometimes conducts its own naval exercises nearby, given the importance of free passage of the Taiwan Straits for the shipment of oil from the Middle East to U.S. ally Japan.
A 2005 report by Japan’s Office of Net Assessment warned that China's need for oil, gas and other energy resources is driving the country toward becoming an expansionist power. It noted that China "is looking not only to build a blue-water navy to control the sea lanes [from the Middle East], but also to develop undersea mines and missile capabilities to deter the potential disruption of its energy supplies from potential threats,including the U.S. Navy, especially in the case of a conflict with Taiwan." The most recent example of this triangular balance of power was the Third Taiwan Strait Crisis in 1995-1996, wherein China conducted a series of missile tests in the waters surrounding Taiwan including the Strait, from July 21, 1995 to March 23, 1996. Rhetoric at the time suggested that the missiles were to scare both Lee Teng-hui, Taiwan’s then-President, and the Taiwanese populace to not move the country away from from the One-China Policy. The U.S. responded by sending the USS Nimitz, an enormous nuclear powered aircraft carrier, through the Taiwan Strait in December 1995, just a few months after China’s missile tests. This was followed by the March 8, 2006 deployment of the USS Independence carrier battle group to international waters near Taiwan and the March 11, 2006 re-deployment of the Nimitz from the Persian Gulf back to the area near Taiwan. News reports suggest that China has subsequently focused its military buildup on higher-tech missiles and other means to block future U.S. involvement in the area.
Until 1993, cross-straits discussions were targeted towards an eventual reunification under a one country-two systems understanding. However, after 1993 and the election of Chen Shui-bian and the Democratic Progressive Party into power, the Taiwanese government’s rhetoric changed to a proposed special “State-to-State relationship.” Not surprisingly, this provoked a heated reaction from China, which viewed this as a move towards eventual independence, rather than reunification.
Not long after, in 1997, China resumed control of Hong Kong. The people of Hong Kong were promised that they could retain their own system of governance and education for fifty years after the reunification with the Mainland (represented by the catchy Chinese phrase “Wu Shi Nian Bu Bian”). Since 1997, all Taiwanese eyes have been on China’s conduct in Hong Kong to see whether China honors its promise of two systems.
In early 2005, China passed an “anti-secession” law, in an effort to create a legal basis for Chinese leaders to conduct a military attack on Taiwan. Nonetheless, with the 2008 Beijing Olympics just around the corner, China is at the center of the market for Western companies by requiring its suitors to ignore Taiwan, a clearly less attractive market -- only the world’s 14th largest economy. It seems to be the hope of the Chinese government that a more isolated Taiwan will:
To enhance its own military capabilities in the Taiwan Straits, China’s Premier has actively lobbied the European Union to lift its arms embargo of China by dangling a $100 billion war chest for the purchase of technology, dual-use products, and military goods. The EU stated its desire to lift the embargo upon China improving its respect for human rights, such as the ratification of the United Nations Covenant on Civil and Political Rights, the release of the prisoners from Tiananmen Square, and the abolishment of the extra-legal penal system of education through labour. Meanwhile, Russia, building one of its few strengths from the Soviet-era, has willingly sold military hardware to China as part of its military cooperation and effort to diversify the Russian economy away from its heavy dependence on fuel sales.
The Chinese Military Build-up has raised alarms in Washington. The US had to scramble to block the sale of advanced radar system to China from the Czech Republic in 2004. Combined with China's oil demand leading to agreements with Iran and Sudan, the US has become increasingly concerned about China’s intentions and capabilities.
Taiwan’s large foreign currency reserves, totaling over $100 billion, pale compared to China’s $1 trillion, but are still an attractive target for defense contractors. In 1992, for example, France’s Dassault was willing to brave China’s economic wrath in exchange for the sale of 60 Mirage fighters to Taiwan for $2.5 billion. The French deal was a lifesaver for Dassault Aviation, the economically troubled supplier of the French Air Force, and was concluded in spite of China’s threat to retaliate by canceling orders for 12 airliners from Airbus Industrie, owned in part by France and Germany.
Nonetheless, the embargo's major limitation is that it is too weak to stem military trade with China. Some EU member states have interpreted the embargo to only cover "major weapons platforms" such as aircraft or naval vessels and "lethal items" such as machine guns and missiles -- not weapons subsystems or militarily relevant dual-use items such as advanced machine tools.
As a result, several EU member-states have sold militarily significant goods to the Chinese military already. The engines for China's new Song-class diesel submarine are reportedly German and the engines for China's newest 054-class frigates are likely French. In the late 1990s, the United Kingdom sold China sets of naval aviation radars and France sold Crotale ship-to-air missiles and launchers. EU members have also supplied China's defense industry with advanced production equipment.
The United States formally views Taiwan to be a part of China and has supported the one country-two systems stance. Although any reunification must be peaceful. The US has sold military weapons systems to Taiwan including ballistic missiles, destroyers, missiles and a ‘Pave Paws’ long range radar system. The Taiwan Security Enhancement Act of 1999 was a congressional mandate for Taiwan to have sufficient self-defense capability. Future arms sales could benefit defense contractors such as Lockheed Martin, Northrop Grumman, and Raytheon.
While all parties involved tout peaceful reunification, the unlikely event of a military intervention by China could have drastic economic impact. Taiwan’s economy is heavily technology dependent – Taiwan is amongst the world’s largest producers of flat panels, customized semiconductor chips, notebook computers, etc. Companies with high exposure include Taiwan Semiconductor TSMC and United Microelectronics UHC. However, companies that rely upon Taiwan’s components would also be impacted. Fab-less customers of TSMC include ATI, Broadcom, and Conexant – all of whom would need to rapidly identify other production capacity. Dell Computers, Intel, Apple, and other PC and peripheral manufacturers would likewise need to scramble to identify a new production base for their higher-end products. For example, Taiwan-based Inventec, produces all of Apple’s iPods -- any disruption in its production would have a direct impact back in Silicon Valley.