Key Points:

• Lai Ching-te's presidency is restrained by a hung legislature.
• A pragmatic approach may ease immediate concerns of heightened cross-strait tensions.
• The fate of Taiwan's "Silicon Shield" is uncertain amid shifts in investments and U.S. restrictions.
• Short-term relief for investors is likely, but economic and geopolitical uncertainties demand vigilance.

Introduction

The dust has settled on Taiwan's 2024 presidential and legislative elections, revealing a nuanced political landscape that requires analysis of its implications for cross-Strait relations, economic policies, and the global semiconductor supply chain. President-elect Lai Ching-te's victory, the shift in legislative dynamics, and the reactions from mainland China and the US set the stage for examining the potential impact on financial markets.

Shifting Tides and the Impact of a Hung Legislature

In a closely contested election, Lai Ching-te of the Democratic Progressive Party (DPP) secured the presidency with 40.0% of the votes, defeating Hou Yu-ih of the Kuomintang (KMT) who received 33.5%, and Ko Wen-je of the Taiwan People's Party (TPP) with 26.5%. However, Lai garnered significantly fewer votes than his predecessor Tsai Ing-wen, who achieved a landslide victory with 57.1% in the previous presidential election. Furthermore, the DPP faced setbacks in the Legislative Yuan, winning only 51 seats, dropping from 62 seats and resulting in a loss of majority and control. The KMT gained ground with 52 seats, rising from 38 seats but not being able to reach a majority of 57 seats, while the TPP secured 8 seats, rising from 2 seats.

The outcome of the Legislative Yuan is a hung legislature, where no party holds a majority. This situation is likely to weaken Lai’s presidency, granting opposition parties, the KMT, and the TPP leverage in shaping the legislative agenda and blocking bill passage. They will also wield significant power in scrutinizing the Lai administration’s budgetary bills, including those related to arms purchases, foreign aid, and subsidies under the New Southbound Policy. The potential result is a series of heated negotiations and standoffs that may lead to a more centrist orientation of policies in Taiwan over the next four years, potentially having a positive impact on financial markets. Much will depend on the evolution of the policy choices of the TPP over different issues, and its positions are fluid. The loss of majority by the DPP and the rise of TPP to the position of holding decisive votes that either of the two largest parties need to command a majority reflects a dynamic shift in Taiwan's political landscape, highlighting a more pluralistic political environment.

Implications on Cross-Strait Relations

Lai Ching-te's relatively modest winning margin and the hung legislature may potentially limit his ability to pursue a more radical agenda, especially concerning the independence of Taiwan. He could end up continuing the policies set by incumbent Tsai Ing-wen, delicately balancing the rejection of the one-China framework under the 1992 Consensus without declaring outright independence. The 1992 Consensus is an agreement between the KMT and mainland Chinese authorities on the existence of only one China, but with differing interpretations.

Lai's commitment to maintaining the constitutional order and managing cross-strait affairs within established frameworks signals a pragmatic stance. Despite mainland China expressing dissatisfaction with the DPP's win, Lai's approach may alleviate the urgency for more aggressive tactics, fostering an environment that maintains the status quo and potentially supports de-escalation. U.S. President Biden's statement, reiterating non-support for Taiwan's independence, contributes to reassuring mainland China that Taiwan is unlikely to escalate efforts toward independence. The reactions from mainland China following Lai’s presidential win have, so far, been measured. The fear that Lai's election will prompt mainland China to immediately adopt a markedly more aggressive stance toward Taiwan appears misplaced. Investors this week may feel relieved, moderating their concerns about an immediate escalation of cross-strait tension.

Mutual Economic Dependence and Supply Chain Dynamics

Mainland China has pursued a gradual economic-absorption strategy towards Taiwan, as outlined in Kevin Rudd's 2022 book, "The Avoidable War." Over the years, it has evolved into Taiwan's largest export market, accounting for 39% of exports in 2022, with Mainland China and Hong Kong combined. Although mainland China's share of Taiwan's outward direct investment has decreased from 83.8% in 2010 to 31.8% in 2021, it remains the primary destination for Taiwan's outward direct investment.

Semiconductors form a critical component of this economic interdependence, constituting over 50% of Taiwan's exports to mainland China and Hong Kong. Mainland China heavily relies on these semiconductor imports to meet its chip demand, which is its largest import, amounting to USD 415 billion in 2022. Taiwanese semiconductor manufacturers, seeking cost advantages, have established factories in mainland China, creating a symbiotic relationship. Even during the presidency of the DPP’s Chen Shui-bian from 2000 to 2008, trade with and investment in mainland China rose rapidly. A global supply chain has been built around Taiwan-manufactured semiconductors exported to the mainland and the Taiwanese invested and operated production capacities of electronics products in the mainland using these advanced chips. These manufactured electronic products are then exported to the rest of the world. Some argue mainland China’s dependence on Taiwan’s semiconductors, both in the supply of advanced chips made in Taiwan and Taiwanese-owned and operated foundries in the mainland, as a Silicon Shield for Taiwan.

The mutual reliance has, however, faced challenges. Slower growth, a challenging business environment, and increased labour costs on the mainland have diminished its appeal for Taiwanese semiconductor factories. Political and security considerations further complicate the landscape. While over 80% of Taiwan's outward direct investment targeted the mainland in 2010, this figure declined to 32% in 2021. Southeast Asia saw a surge in Taiwanese investment during this period, rising from 6.3% in 2010 to 30.6% in 2021. Businesses in Taiwan have also been moving away, not only from mainland China but also from Taiwan itself to other countries, citing a decrease in confidence in Taiwan’s economic future, according to a CSIS survey. Fear of war was not statistically significant in the CSIS survey, but it may be embedded in the lack of confidence in the economic future in Taiwan.

The United States plays a significant role in this dynamic, imposing restrictions on the export of advanced semiconductors and related technology to China. Furthermore, the U.S. has actively attracted Taiwanese semiconductor manufacturers, such as TSMC, expressing concerns about mainland China acquiring critical semiconductor technology from Taiwan. Fears of potential disruption in the supply chain to the U.S. and its allies, particularly in the event of a crisis in Taiwan, underscore the geopolitical risks.

These developments raise concerns about whether Taiwan is losing its silicon shield as the mutual dependence between Taiwan and mainland China fades. As Taiwan navigates these complexities under the Lai presidency and a hung legislature, closely monitoring its policies becomes paramount for investors. In a world marked by increasing fragmentation, heightened geopolitical risks underscore the importance of vigilance in understanding the evolving dynamics.

Conclusion

The aftermath of Taiwan's 2024 presidential and legislative elections presents a multifaceted landscape, shaping cross-Strait relations, economic policies, and the global semiconductor supply chain. President-elect Lai Ching-te's triumph, coupled with a hung legislature, marks a significant turning point in Taiwan's political dynamics. However, his presidency, hindered by the absence of a majority in the Legislative Yuan, implies inherent challenges in pushing forth a definitive agenda. The intricate interplay between the Democratic Progressive Party (DPP), the Kuomintang (KMT), and the Taiwan People's Party (TPP) sets the stage for negotiations and potential standoffs, signalling a possible shift towards a more centrist political orientation.

Lai Ching-te's modest winning margin and the legislative impasse suggest limitations on pursuing radical agendas, especially regarding Taiwan's independence. A pragmatic approach may see him endeavoring to maintain the status quo and even facilitate de-escalation. While mainland China has expressed dissatisfaction, measured reactions may ease immediate concerns of heightened cross-strait tensions.

The delicate balance of Taiwan's mutual economic dependence with mainland China, particularly in the semiconductor industry, faces challenges such as slower growth and rising costs on the mainland. These factors have prompted shifts in Taiwanese investments, diversifying towards Southeast Asia. The United States, with its restrictions on semiconductor exports to China, adds another layer of complexity. The fate of Taiwan's "Silicon Shield" is uncertain as economic interdependence encounters obstacles.

The potential for a centrist policy orientation and measured cross-strait relations could provide relief to investors, moderating concerns about immediate escalations. However, uncertainties surrounding Taiwan's economic future, security, and geopolitical risks, necessitate vigilant monitoring. The impact of U.S. involvement and mainland China's leadership aspirations for national rejuvenation adds to the complexity, potentially introducing volatility to financial markets in the medium term beyond the near-term calm.