Despite Drills, War Over the Taiwan Strait Remains a Tail Risk

Genevieve Signoret & Delia Paredes

(Hay una versión en español de este artículo aquí.)

“War will not break out over the Taiwan Strait”, we wrote in our last edition of Quarterly Outlook in our list of assumptions underlying all three of our global macro scenarios—the exercise by which we assume away forecast tail risks[1]. Yet, on May 22, purportedly as punishment for the inaugural speech given just days earlier by recently elected Taiwanese President Lai Ching-te, China launched drills simulating a full-scale attack on Taiwan, drills some observers saw as an escalation[2] from previous ones.

In the aftermath of these drills, do we still see a war breaking out over the Taiwan Strait as highly unlikely and thus classify it as a tail risk?

Yes, for four reasons:

1. It was planned. Analysts cited by BBC note that the simulation could not have been spontaneous; it had to have been planned far in advance.
2. It was expected. The New York Times reports that “Taiwanese officials and military experts had been expecting China to make a show of military force after Mr. Lai’s inauguration.”
3. Lai represents continuity. Ryan Hass of Brookings writes that

Lai has pledged continuity of policy on cross-Strait relations with Taiwan’s outgoing president, Tsai Ing-wen. Tsai is widely credited internationally for charting a principled, steady, pragmatic course on cross-Strait relations. Indeed, these attributes were definitional to Tsai’s success in attracting greater global support for maintaining cross-Strait peace and stability.

Lai has kept nearly all of Tsai’s closest advisors on in his administration.

4. Lai is well incentivized. Lai will want to be reelected. Having won the presidency by a mere plurality, he’s rather weak. And 94% of Taiwanese voters prefer extending the status quo over right away pursuing independence from China (or reunification with China, for that matter).

We will continue to closely watch the Taiwan Strait for our clients. But for now at least, we still classify the risk of war there as a tail risk.

[1] A tail risk, recall, is one we see as highly unlikely but as fatal to our entire forecast apparatus were it to materialize—it would throw us into a whole new world.

[2] China on this occasion mentioned as targets islands off the coast of Taiwan, something it refrained from doing in its previous large-scale drill, in August 2022. Moreover, rather than simulate a mere blockade as it did in 2022, this time China simulated a full-scale attack. Finally, China launched its drills this time with no forewarning—again in contrast to 2022.