Taiwan arms sales—the term evokes images of the US selling advanced missiles, helicopters, fighter aircraft, military components and other defense articles to Taiwan in accordance with the Taiwan Relations Act. Soon, it will mean something completely different, as Taiwan plans to develop its own indigenous defense industry, which would involve selling military equipment abroad to other countries as a boost to its domestic economy and in order to to create jobs. In doing so, Taipei should explore a range of different defense-industrial business models across a variety of countries, and develop a system that best fits the unique characteristics of Taiwan’s domestic economy.
Taiwan is prioritizing development of its defense industry as part of its new economic strategy. On October 10, President Tsai re-emphasized her plan to revitalize Taiwan’s economy through five innovative industries in her Taiwan National Day speech. These five industries are: biotechnology, green technology, smart machinery, the internet of things, and national defense.
The defense export industry represents an enormous business opportunity, and Taiwan is following a strong regional precedent in making this decision. Taiwan is the last of its fellow “Asian Tigers”—South Korea, Singapore, and Japan—to move in this direction. For instance, South Korea’s defense exports totaled over US $3 billion in 2015. Although US $3 billion is only 0.2 percent of Korea’s economy, if Taiwan can gain US $3 billion in annual revenue from arms sales it would comprise nearly 1 percent of Taiwan’s entire GDP. Even Singapore exports around $80 million a year in military equipment, such as armored personnel carriers to Afghanistan and Thailand, making it the world’s 20th largest arms exporter in 2013. With this in mind, in 2014 Japan began reforms to its Three Principles on Arms Exports policy, replacing it with the Three Principles on Transfer of Defense Equipment and Technology, in order to allow arms sales under certain conditions. In addition, major powers such as the United States, Russia, and China rely on arms sales as a significant source of revenue.
The politically safest way to grow Taiwan’s high-tech defense industry is to supply key components to platforms manufactured by the United States and NATO+4 countries (NATO European members plus Japan, South Korea, Australia and New Zealand). Platforms differ from components since platforms are standalone systems that are made up of components. Taiwan already provides components for foreign military platforms, for example Taiwan’s Hung Shen Propeller Company manufactures propellers for British minesweepers. However, for Taiwan’s other industries, such as its electronics industry, to become part of the US and other countries’ weapons platforms, these companies need to join the DoD Trusted Foundry program, which is a grouping of 52 trusted suppliers to the US military and government. Supplying parts to a foreign military platform allows Taiwan to lower its international exposure to public opinion, since its name is not branded on the weapon system, and therefore to distance itself from the possible international repercussions of arms exports.
If Taiwan decides to manufacture entire military platforms for export, such as tanks and naval vessels, the best model for Taiwan to follow is the prime contractor or subcontractor model. Taiwan will need to carefully calculate and account for the reaction of China and its other neighbors in the region; it should also consult with the United States as it moves forward, because the geopolitical implications of arms sales are serious. The prime contractor/subcontractor model best takes into account how Taiwan’s economy and business environment are mainly composed of small and middle sized companies. In this model, the government can award a contract for a weapon system to one company as prime contractor, and that company would line up other companies as subcontractors to manufacture components that are then assembled into a complete system, resulting in a division of labor, tasks and items. These same complete platforms (containing only Taiwan’s own intellectual property) could be exported to other countries for profit. This is how the major US defense companies such as Lockheed Martin, Raytheon, Northrop Grumman, and others operate, and it fits with Taiwan’s business landscape, which is different from that of Korea or Japan, both of which feature large business conglomerates with many international enterprises.
The drawback of following the prime contractor/subcontractor model is the possibility of soaring costs. When one company relies on other companies to piece together complex weapons systems, each side will build profits into their calculations, which could drastically raise the total price. This does not happen when a company enjoys a vertical monopoly over an entire manufacturing process. In addition, a subcontractor might not provide its items on time, which could delay the overall program. Engineers, fabrication teams, and assembly teams will still be paid for the longer time that passes before the weapon platform is completely assembled. However, Taiwan could keep prices of weapons platforms low if it implemented tight government oversight over the prime contractor, and close prime contractor oversight over subcontractors, to ensure there are as little extraneous labor hours or materials as necessary.
Another consideration in the prime contractor/subcontractor model is the need for a new information infrastructure for sharing classified information. Prime contractors would need to share sensitive and classified military equipment designs with subcontractors. These designs are by nature sensitive, because an adversary could learn about a system’s vulnerabilities if it had access to its designs. Protecting this information would involve setting up an air gapped network, completely separated from the public internet, similar to the SIPRnet system used by the US government and shared with US defense companies and defense think tanks.
Furthermore, there are some items that do not make sense for Taiwan to manufacture on its own. The technology may be too advanced and therefore out of reach of Taiwan’s current technological capabilities, or because, while Taiwan is technologically capable of producing them, it may be cheaper to buy these items commercially, off-the-shelf. For the advanced items, one approach would be for Taiwan to partner with foreign defense companies to integrate foreign, pre-existing technology into Taiwan’s platforms;or, as mentioned earlier, Taiwan’s companies could become a subcontractor and integrate Taiwan’s unique technologies into foreign platforms. Taiwan would economically benefit either way.
The prospects are bright for Taiwan to grow its defense industry and improve its economy through arms sales, just like its neighbors South Korea, Japan, Singapore and others have done. This is a pivotal moment for the Tsai Administration to do so, as it moves forward with its new economic plans. In this article, I have proposed a defense-industrial model that fits with Taiwan’s economy, but further analysis will be needed on exactly which defense items Taiwan is able to export now, and what new defense equipment and technologies is Taiwan well positioned to produce in the future? Who will be Taiwan’s buyers, and what are the geopolitics that Taiwan will have to navigate? These are the questions to be explored in future articles.
The main point: As Taiwan develops its arms export industry, it should consider a variety of business models, but my findings indicate that the prime contractor/subcontractor model fits Taiwan’s arms industry since it takes advantage of small and medium sized businesses that make up Taiwan’s business landscape.