By: Aarav Mahendru and Tyler Horvath

Background

Since 1979, the US government has strategically adopted a “One-China” policy to maintain diplomatic ties with both Taiwan and China. This policy of “strategic ambiguity” has allowed economic growth in all three countries to continue largely uncontested. The Taiwan Relations Act reinforces this ambiguity by not specifying whether the US would actually defend Taiwan from an invasion. Most recently, when President Trump was asked about his position on Taiwan in February, he responded, “I never comment on that.” This approach allows the US to maintain a defense posture in the South China Sea while continuing business ventures in both countries.

The US has brought Taiwan onto the global stage, with investments now totaling nearly $20 billion. During former President Biden’s administration, we saw a direct effort to strengthen ties with Taiwan through the CHIPS and Science Act, which allocated billions of dollars to Taiwan Semiconductor Manufacturing Company (TSMC). Defense spending also increased, though with less direct impact on the economy. However, Trump recently imposed import tariffs on Taiwan. These contrasting approaches—expanding manufacturing and R&D while simultaneously restricting imports—risk undermining growth. Given today’s geopolitical uncertainty, clarity is needed, especially for Taiwan. The US seeks to reduce dependence on China to bolster national security, and Congress has increasingly called for official recognition. This paper will analyze the short- and long-term economic effects of officially recognizing Taiwan. It will also consider China’s likely response and possible alternatives. Finally, we will evaluate whether the US should pursue this course of action given the consequences.

We will examine the opportunity costs of officially recognizing Taiwan versus maintaining strategic ambiguity, independent of potential military intervention. This approach is based on two assumptions: From a liberalist perspective, China would avoid military action to preserve economic stability. In the absence of recent emboldening measures, China is unlikely to act militarily in the short term. This paper offers a surface-level assessment of a hypothetical policy shift. More detailed economic research is needed on specific products and industries. The aim here is to familiarize readers with the current situation and the potential benefits and drawbacks of US recognition of Taiwan.

Policy Potentials

If the US government were to officially recognize Taiwan as a sovereign nation, it could proceed in several ways. Current US President Donald Trump could begin by issuing a formal declaration recognizing Taiwan as separate from China. While not a congressional action, such a move would represent a drastic foreign policy shift and likely provoke international backlash, particularly from China. If Congress were to follow suit by passing legislation recognizing Taiwan as independent, it would also need to repeal or amend the long-standing “One-China Policy.” In addition, Congress would have to reconsider the Taiwan Relations Act, the Three Joint Communiqués with China, and the Six Assurances. Recognition would entail closing the American Institute in Taiwan—the de facto US embassy in Taipei—and replacing it with an official US embassy. These measures would strengthen US-Taiwan relations but almost certainly provoke persistent backlash from China and other nations.

Short-Term Impacts

Officially recognizing Taiwan would severely damage current US-China relations by undermining China’s strategic interests. Other US partners might also view the move as a breach of trust. Such a shift could unravel established agreements, sowing distrust among US allies. Countries might be forced to choose sides, causing major disruptions to the international economy. China and other negatively affected nations would likely retaliate by imposing barriers to trade—tariffs, embargoes, or restrictions on American production. These measures would disrupt the flow of goods, given the US’s reliance on Chinese manufacturing. The result would be sharp price increases and a reduced level of short-run aggregate supply, putting significant pressure on both businesses and consumers. This downturn could spiral into stagflation, with slowed growth and rising inflation. Corporations would face declining profits, leading to layoffs and reduced investment. Although recognition may seem a purely diplomatic act, its short-term economic consequences would be both regional and global.

If the US maintains its current policy, it would avoid many of these short-term disruptions but risk alienating Taiwan. Conversely, official recognition would strengthen ties with Taiwan but almost certainly provoke retaliation from China, harming the broader economy.

Long-Term Impacts

Long-term effects are difficult to predict given today’s volatile geopolitical environment. Taiwan controls 60–80 percent of global semiconductor manufacturing. Recognition would likely give the US more secure diplomatic access to this supply, supporting growth in technological sectors. Companies like NVIDIA, AMD, Intel, and TSMC could form a trusted technology bloc, hardening supply chains and reducing shocks. This would incentivize investment in US infrastructure and foster deeper integration of Taiwan into the US economy. The US would also encourage technological manufacturing in Taiwan as part of a broader “friend-shoring” strategy—shifting production from unstable or rival regions to allied partners. This could bolster Japan and South Korea, especially if the US subsidized firms like TSMC, Samsung, and Intel. Such efforts would reduce overstocking, lower shipping insurance premiums, and stabilize supply chains. Other areas of cooperation could include rare earth materials, energy transition, and regional policy alignment.

However, recognition would come with steep costs. China would almost certainly restrict US companies from its market. American firms like Apple, Tesla, and Starbucks derive 15–20 percent of their profits from China, and losing access would mean hundreds of billions in lost revenue over decades.

Without China’s cost-efficient manufacturing, the US would need alternatives. Apple has already shifted some operations to India, and other firms have begun similar moves. While this transition might resemble the corporate exit from Russia after its invasion of Ukraine, the financial stakes in China are far greater. China could also respond by forming a counter-bloc with Russia, Iran, North Korea, and Belt and Road partners, leading to market fragmentation and resource competition. US firms would suffer as investments dried up. Furthermore, China’s history of resourcefulness suggests it could accelerate its R&D in response, much like its development of DeepSeek in retaliation to US AI advances. In this sense, economic interdependence with China can promote “dual growth,” where both economies benefit despite tensions.

Conclusion

Recognizing Taiwan as an independent nation would require major reforms to existing agreements such as the “One-China Policy.” Though the move may appear diplomatic, it would trigger significant economic consequences. In the short term, the US would face global disruptions: higher unemployment, rising inflation, and lower investment. In the long term, recognition could enable the US to decouple from China, bolster technological leadership, and strengthen supply chains. However, the loss of access to China’s massive consumer market would be a major drawback. If the US prioritizes long-term security and technological dominance, recognition may be the right path. If short- to medium-term growth and corporate profits take precedence, recognition could prove too costly. A phased approach—gradually strengthening ties with Taiwan while reducing reliance on China—may be the most pragmatic course.

Thus, the most logical policy would be for the US to develop a 5–7 year plan to formally recognize Taiwan while phasing out dependence on China. This approach would give the US, Taiwan, and China time to adapt to a shifting geopolitical and economic climate.