This chapter provides an overview of macroeconomics, which is the study of the economy as a whole. We first discuss what macroeconomics is about. Then we describe how different types of economies (market economy, planned economy, and mixed economy) work to solve economic problems in human society. Then we discuss how economic modeling helps to understand economic phenomena. Finally, the chapter provides a brief history of macroeconomic thought.

There is a possibility that the next great military conflict could be fought over Taiwan. As we write this book, the likelihood of militarized conflict involving the United States and the PRC is higher than it has been for many decades. The sense of heightened “tensions” and looming conflict in the Taiwan Strait1 has become global news broadcasts. Some readers’ interest in Taiwan may have been prompted by news coverage of House of Representatives Speaker Nancy Pelosi's visit to Taipei in August 2022 and the People's Liberation Army's (PLA) live-fire military exercises that immediately followed it, or from commentators and some elected officials comparing the situation in Taiwan to Russia's invasion and war against Ukraine. But the situation in the Taiwan Strait is complex, nuanced and defies simple analogies. Peace in the Taiwan Strait is a product not just of Taiwan's own actions, but those of the PRC and the US. The preferences and actions of China and the US, and the conduct of relations between these two superpowers, have an inescapable impact on Taiwanese security, prosperity, and even Taiwan's continued existence as an autonomous polity and society. A militarized superpower conflict would be devastating for the people who call Taiwan home. It would destroy peace in the Asian region, fundamentally alter the global order and wreak havoc on the global economy. While the dire consequences of a hypothetical war are largely agreed on – including in the PRC – there is much more to the Taiwan story than conflict.

Taiwan is home to almost 24 million people, living in a hard-won liberal democratic society. Taiwan's diverse peoples – Indigenous Austronesian Taiwanese, transnational Hakka, immigrants from all over Southeast Asia, and different generations of Han Chinese – constitute a unique hybrid culture and society. Taiwan has been shaped by numerous colonizing powers and persevered through Kuomintang (KMT) one-party authoritarian rule to become one of the most economically vibrant and progressive societies in Asia.

It is an accepted heuristic to describe Taiwan as marginalized. That description is not entirely accurate, since it conflates several aspects of international interactions. Taiwan is marginalized in the sense that it has a mere 13 formal diplomatic allies and is barred from participation in many international organizations as a result of PRC opposition. This situation continues despite growing international support for Taiwan's participation in organizations that affect the material well-being of Taiwan's 24 million people, such as the World Health Organization (WHO), or the safety of Taiwanese and others, such as the International Civil Aviation Organization (ICAO). Since both of these examples are specialized organizations under the United Nations, the PRC's veto power means Taiwan's participation is entirely by the PRC's grace.

During the period of Ma's China-friendly policies, the PRC allowed Taiwan to participate as an observer, only to retract this favour when Tsai Ing-wen won the presidency. There are other organizations that Taiwan can participate in where statehood is not a precondition for membership. But participation is still usually contingent on doing so under a name that meets the PRC's demand that it does not hint at recognition of Taiwanese sovereignty. Taiwanese representative teams can only compete at the Olympics and other international sporting competitions under the otherwise meaningless name of “Chinese Taipei” (there is no such place or entity). Taiwan participates in the WTO as the Separate Customs Territory of Taiwan, Penghu, Kinmen and Matsu, and appears in WTO communications as Chinese Taipei. Taiwan is represented in some other organizations, but the indignities it suffers to do so are incongruous given its standing as a major global economy, technology powerhouse and successful liberal democracy. It is a loss to the international community, as demonstrated during the Covid-19 pandemic when Taiwan was excluded from receiving guidance from the WHO – and from contributing its expertise. For Taiwanese people it is also a matter of national dignity and pride. However, this does not mean that Taiwan should only be seen as marginalized.

In the summer of 2021, The Economist published a special section on Taiwan with the tagline “the most dangerous place on earth” (Economist 2021). Despite the sensational title, it provided a measured and sober account of the potential for militarized superpower conflict in the Taiwan Strait. It was a reasonable line to take, prompted by increasingly fractious Sino-US relations and deeply frozen cross-Strait relations. It also reflected a long history of academic and policy assessments that have dealt with the same question. Some scholarly research came to a similar conclusion that Taiwan is increasingly in danger, while other work did not and instead see Taiwan's position as still stable (Foreign Affairs 2022).

Those with an interest in international relations (IR) theory might be familiar with seeing Taiwan portrayed using different analytical lenses. For example, scholars working within the neorealist approach to IR, which foregrounds power, self-interest and maximization, have tended to see the Taiwan issue as a likely if not inevitable casus belli between the US and China. Neorealists explain the absence, to date, of such a confrontation by invoking deterrence. In the case of Taiwan, deterrence has come primarily in the form of American strategic ambiguity backed by the US’ superior military capabilities.

Scholars in the neoliberal tradition have been more sanguine about the likelihood of conflict. These scholars foreground trilateral economic interactions and emphasize the stability conferred by the economic institutions and policy architecture constitutive of both US–China and cross-Strait relations. The high costs and disruption that would result from militarized conflict are so daunting that all sides are compelled to avoid actions that would lead to confrontation. These scholars point to the intensification of market connections among the three sides and the economic complementarities that benefit each actor and conclude that there is too much to lose by engaging in war.

Constructivist scholars, with their focus on identity and values, veer between optimistic arguments about common ethnic and cultural bonds on either side of the Strait, and pessimistic observations of the rise of nationalism, competing identities, and values supercharged by diverging national and cultural identities in Taiwan and China.

There is no single grand history of Taiwan. Instead, there are many histories involving multiple peoples, civilizations and empires that have all at different times lived, thrived, or struggled on the islands of Taiwan. These histories are imperative to understanding contemporary Taiwan, but even scholars often lament the difficulty of succinctly retelling them. Taiwan has been ruled by the Portuguese, Dutch, Ming dynasty, Qing dynasty and the Japanese. From 1945 to the present day, it has existed as the Republic of China (ROC), which was founded in China in 1912 and existed there until 1949. For thousands of years before that, Taiwan was home to Indigenous peoples of Austronesian heritage, who are culturally and linguistically related to other Pacific Island cultures. Traders and pirates once made Taiwan one of the most important and diverse centres of commerce, and in the last 400 years people from all over Southeast and Northeast Asia – and periodically, Europeans – have called Taiwan home. Today, Taiwan’s population is predominantly Han Chinese (over 95 per cent). But to describe Taiwan as a Han Chinese society would be to erase the multicultural melange that has defined so much of Taiwan’s history. The goal of this chapter is to explore some of this historical diversity, showing how various settlers, colonizers, and empires have shaped Taiwan, and how these forces are manifest today.

PREMODERN TAIWAN

Any history of Taiwan must begin by recognizing that Indigenous peoples lived and thrived on these islands long before any Chinese or western powers brought Taiwan into the world of modern geopolitics. At the same time, perhaps no other group has suffered more throughout each era of Taiwanese history than Indigenous peoples. Today, Indigenous Taiwanese make up a small percentage of the total population (around 2.5 per cent) due to centuries of colonialism, imperialism, and systemic oppression. But they continue to survive as complex contemporary peoples, and their relevance to Taiwan’s history and politics today should not be understated.

Indigenous Taiwanese likely arrived in Taiwan over 4,000 years ago. By contrast, Han Chinese only began living in Taiwan around 400 years ago. Indigenous languages are Austronesian, unlike Sinitic Chinese languages, and based on linguistic clues anthropologists suspect that from Taiwan Austronesian peoples migrated as far as Hawaii and Madagascar (Ko et al. 2014).

In the decades following the Second World War Taiwan transitioned to a newly industrialized country (NIC) and became one of four “Asian Tigers” with Singapore, South Korea and Hong Kong. The rapid and sustained growth experienced by these economies has been the subject of decades of political economy research. The puzzle has been to explain how they successfully transitioned from low-performing economies to integral parts of the global economic order, unlike many developing economies. One of the development strategies used to achieve this result was export-oriented industrialization. Prior to the Asian Tigers’ success, economists were sceptical of export-oriented industrialization. Yet, Taiwan made it work.

The conditions for rapid development were not immediately favourable. Taiwan in the early 1950s was in a chaotic state. The KMT was engaged in a brutal crackdown on local Taiwanese through the White Terror and martial law. Chiang Kai-shek was preoccupied with the prospect of war with the PRC, leading to disproportionate spending on the military and defence. Hyperinflation and instability were rampant, and the KMT desperately needed to stabilize the economy and find an economic plan that would lead to growth. Economic reform was needed, but priorities were unfocused. The KMT leadership was made up of officials with backgrounds in the military or engineering, most of whom had minimal economic policy experience. The authoritarian KMT was amenable to a strong interventionist state with the government operating state-owned enterprises (SOEs), but was largely uninterested in developing the private sector. The ROC was also heavily reliant on US aid, which was largely keeping Taiwan's economy afloat.

From 1957, when the US began cutting back its aid to Taiwan, the KMT realized that reform was urgently needed. It pushed the KMT to prioritize economic and party reform in order to reduce its dependency on the US. Economists and bureaucratic planners would have a bigger say in how to grow Taiwan's economy. A combination of Taiwanese bureaucrats from the KMT and the International Monetary Fund (IMF) began collaborating on ideas to overcome Taiwan's economic problems. They agreed that Taiwan's reliance on the American foreign exchange was its biggest problem, and that it was not taking full advantage of its potential to export.

Macroeconomic data is important both for macroeconomic research and for the functioning of the economy itself. In this chapter, we discuss the principles and practices of macroeconomic data construction. Emphasis is on measures of output or income (e.g., GDP), price and inflation (e.g., CPI), employment and labor participation (e.g., unemployment rate), and money supply.

This chapter studies short-term economic fluctuations or business cycles. We first introduce the Keynesian Cross model which, in contrast to classical models, allows the equilibrium output to deviate from the potential level of output. Next, we introduce the celebrated IS-LM model, which is the leading interpretation of the Keynesian theory. We also modified the IS-LM model to study interest rate policy, the small open economy with floating exchange rate, the small open economy with a fixed exchange rate, and the large open economy. Next, we derive aggregate demand (AD) from the IS-LM model and introduce the Keynesian AD-AS model. Then we introduce dynamic modeling and study two dynamic AD-AS models. Finally, we discuss two verbal theories, Keynes’ theory of employment and investment and Minsky’s financial cycles.

This chapter studies economic growth. We first introduce two versions of the Solow model. The first is without technological progress. We show that there would be no sustained growth in per capita terms in a steady state. The second Solow model assumes exogenous technological progress, which makes sustained growth possible in a steady state. Next, we introduce an endogenous growth model that produces sustained growth without assuming exogenous technological progress. We then study how to account for the contribution of factor accumulation and technological progress to growth. Finally, we introduce two verbal theories. The first is Schumpeter’s creative destruction. The second is the Lewis model of economic development.

This chapter deals with long-run equilibrium analysis. We first introduce a classical AD-AS model to analyze how the total output is determined in equilibrium under classical assumptions. Next, to analyze frictional unemployment, we discuss a model of the natural rate of unemployment. Then we introduce a representative-firm model to analyze real factor prices and income distribution. Then we introduce a classical model of real interest rate and discuss how the model may be employed to explain economic phenomena and conduct virtual experiments. Next, we introduce the quantity theory of money. We provide a case study of China’s hyperinflation in the 1940s. Finally, we introduce open-economy models to analyze the long-run equilibrium of exchange rates.

There has never been greater international interest in Taiwan, nor such widespread concern. This moment is long overdue. For decades, Taiwanese people have hoped that their achievements in economic transformation and democratic transition would be recognized, and that Taiwan could participate and contribute to international society on its own merits. For political reasons discussed throughout this book, that has not happened. Taiwan's desire to be seen as a respected player on the global stage has generally been frustrated. It is ironic that it took the intensification of PRC threats to alert global audiences to Taiwan's many achievements, and to inculcate feelings of solidarity for Taiwan's struggle. To meaningfully care about what happens in Taiwan, however, requires an understanding of what makes Taiwan special, why it matters and what can be done to keep Taiwan peaceful.

This book is pitched at readers who are new to Taiwan and want to learn more about it. We hope to introduce the complexities of Taiwan and “the Taiwan issue” in a clear and accessible way. We cannot speak on behalf of Taiwanese people or articulate what it means to be Taiwanese, but we can speak to the process of learning about Taiwan. Our research and experiences as academics can help connect those who want to know more about Taiwan. We anticipate that this group will include policymakers, journalists, businesspeople, students and concerned citizens around the world. Both authors have worked extensively with such stakeholders and have identified a need and appetite for this kind of publication. In this book, we aim to provide a comprehensive and balanced discussion of “where are we at?”, an explanation of “how did we get here?”, and informed speculation about “where are things heading?”

One of our main motivations for writing the book is to recentre Taiwan. In doing so, we want to provide an alternative to typical analyses that depict Taiwan as a passive object or define it solely as a site of potential conflict. As western academic specialists of Taiwanese politics who have spent much of our lives studying and living in Taiwan, we are keenly aware that Taiwan is frequently relegated to a “flashpoint” and a cause of nebulous “tensions”.

What is the US position with regard to Taiwan? Due to Taiwan's contested and unrecognized status, and the ambiguities that the US has deliberately cultivated, the answer is not straightforward. The Taiwan issue abounds in complications, such as the subtle difference between the US’ “One-China policy” and the PRC's “One-China principle”. In this chapter we set out the “Taiwan Relations Act”, the “Three Joint Communiques” and “Six Assurances” that have formed the US framework for handling Taiwan and China relations since the 1970s. We also discuss the US’ posture of “strategic ambiguity”, a useful position that has recently come under pressure from within the US. Demystifying these concepts and terminology is fundamental to understanding the US position. In this chapter, we explain the history of the US–Taiwan relationship, how key US–Taiwan policy was formed, and how these policies are used in practice today.

FROM ROC TO PRC: HOW THE UNITED STATES CAME TO NOT RECOGNIZE TAIWAN

During the Chinese Civil War (technically 1945–49, but fought intermittently since the 1920s), the US and most of the western world supported and backed the KMT side against the CCP. Even after the Civil War ended and the KMT fled to Taiwan, the US continued to support the KMT's claim to represent the legitimate government of China. Despite being exiled to Taiwan and possessing no authority over Chinese territory, the ROC on Taiwan was still seen as the “true” China by much of the world. At the United Nations and other international organizations the ROC was recognized as the governing body of China for several decades. The advent of the Korean War in the summer of 1950 sealed the US’ determination to support the ROC and prevent the PLA from invading and taking control of Taiwan. The US provided training for Chiang's Nationalist Army, substantial military aid and technical assistance, and ultimately signed a mutual defence treaty with the ROC in 1954.

In the same period, the PRC underwent dramatic changes. After its founding in 1949, the PRC experienced new levels of state and nation building, but also devastating events like the Great Leap Forward (1958– 60) and the Cultural Revolution (1966–76).

The seemingly facile question of what to call Taiwan is politically sensitive and hotly contested. Strictly speaking, “Taiwan” is a geographical term referring to the largest of four islands under the jurisdiction of the ROC – Taiwan, Kinmen, Penghu and Matsu.1 But where does seeing Taiwan as a geographic location and the ROC as a contested state begin to blur? What is the difference between Taiwan and the ROC? Although some observers imply that ROC is merely Taiwan's “formal name” it is more complicated than that. Indeed, Taiwan's relationship to the ROC is not straightforward. The continued existence of the ROC is crucial to understanding Taiwan's international situation, its relations with the PRC and Taiwanese domestic political competition. Empirically speaking, the ROC is a discrete, functionally autonomous, liberal democratic polity that is de facto independent. The ROC has its own distinct political system, currency and military. It raises its own taxes and conducts its own foreign policy, albeit within parameters that are affected by its disputed status. The ROC cannot participate in international organizations for which statehood is a membership criteria, and the PRC even attempts to influence what Taiwan can do informally.

THE ROC–KMT CONNECTION

The KMT has its roots in organizations formed as the Qing dynasty collapsed and revolutionaries like Sun Yat-sen put forward alternatives for China's future. The KMT evolved out of two revolutionary groups founded by Sun, the Revive China Society (Xing Zhong Hui, founded in Hawaii in 1894) and the United League (Tong Meng Hui, founded in Tokyo in 1905), as vehicles for overthrowing a Qing government besieged by imperial aggressors, domestic rebellion and internal dysfunction.

Following the conclusion of the Xinhai Revolution that ended dynastic China in 1911, Sun became the first (temporary) leader of the ROC. Sun also went on to oversee the foundation of the KMT, the Chinese Nationalist Party to give it its full name, in 1919. After Sun's death in 1925, Chiang Kai-shek assumed leadership of the KMT and reunified a country fragmented by warlordism under the leadership of his Nationalist government. The ROC and KMT have always been intimately connected, and the legacy of this connection created complexities many decades later in Taiwan.