This article was originally published in The Diplomat and is republished here with the permission of the author.
Huawei and the threat it poses to security may grab more headlines, but the semiconductor industry that underwrites the much-debated 5G transition — and nearly every technological advancement we see ahead of us — is an issue of even more vital importance. Both the United States and China recognize this.
China’s designs on self-sufficiency explicitly include not only self-sufficiency, but a pre-eminent role in semiconductor technology. Indeed, its controversial “Made in China 2025” push included a goal to domestically produce 70 percent of the chips demanded by domestic firms. Such a drastic shift would certainly ripple through global markets, but progress toward that lofty goal has proven elusive despite the billions poured into the industry. In fact, only 6 percent of semiconductors used in 2020 by Chinese firms were made in China.
Meanwhile, the United States has increasingly employed every incentive it can in order to bring semiconductor manufacturers to U.S. soil to avoid disruption to the industry amid supply chain shocks. Further, Senate majority leader Chuck Schumer has explicitly stated that semiconductors are an industry in which the U.S. must “out-compete China.” Overall, this suggests that the dynamics of Sino-American competition have not, in fact, been augmented significantly by the change in Oval Office occupant.
At the heart of the China-U.S. tug of war in tech is the island of Taiwan. This is especially so in the semiconductor industry as Taiwan’s largest company, Taiwan Semiconductor Company (TSMC), is perhaps the most critical firm in the entire industry. As such, aspects of political and economic concentration risk have come to overlap and perhaps make microchips the catalyst for macro problems on the horizon between the world’s great powers.
Small Chips, Big Impact
First, it is important to stress the importance of semiconductors to the global economy. In this regard, one can consider these chips as the oil upon which the economy of the future runs.
Beyond the existing demand for chips to power computers, data centers that undergird modern cloud computing, and the rapidly expanding gaming industry, the future of self-driving vehicles, artificial intelligence, and Internet of Things (IoT) advancements all rely on the promise of how much these small chips can do. Almost anything that has technological capability relies in some way on semiconductors, as reflected in the doubling of the overall industry’s revenue since 2009.
This dynamic is, of course, only amplified by ongoing transitions to 5G networks and many of the advancements in technology already noted express an ever-greater demand for semiconductors. Adding to the impact on supply and demand is the fallout from the COVID-19 pandemic, which has hurt global supply chain dynamics while also ramping up demand to accommodate an increasingly online economy.
As a result, semiconductors are in short supply at a time when they are demanded most and by nations racing frantically for supremacy in the modern tech-defined economy.
Washington Weighs Its Options
The latest executive to open an examination of the issue as it reaches a crescendo is newly minted President Joe Biden. In a statement from the White House this week, semiconductors figured into the categories most needing strategic review to prevent significant economic disruption as the U.S. continues in its post-COVID-19 recovery.
“The United States is the birthplace of this technology, and has always been a leader in semiconductor development,” the statement read. “However, over the years we have underinvested in production—hurting our innovative edge—while other countries have learned from our example and increased their investments in the industry.”
The situation for semiconductors that the administration is likely to find does reflect underinvestment and a loss of first-mover advantage. The shift is based upon the failure of U.S. titans in the industry and years of outsourcing-based “fabless” business models, which has wrought an overwhelming reliance on East Asian firms. In fact, according to the Semiconductor Industry Association, the U.S. share of global semiconductor manufacturing has steadily declined from 37 percent in 1990 to just 12 percent in February 2021.
The waning importance of U.S. manufacturers is partly a result of strategy, wherein major semiconductor players like Qualcomm and Nvidia pursued the “fabless” model of manufacturing wherein only design aspects of chips are handled in-house and manufacturing is outsourced. As a result, the manufacturers, or foundries, arose as a crucial part of the industry as it become unmoored from prior vertical integration. Perhaps the greatest winner in this dynamic was TSMC, which quickly filled the market gap for foundries.
Accelerating its rise to the top was also the floundering of U.S. tech titan Intel, whose delays in manufacturing of both 10 nanometer and 7 nm chips has left it well behind its Taiwanese competitor in manufacturing, to the point of considering ceding the business itself to TSMC.
In order to assuage concerns on this front, the Trump administration had fostered a stronger relationship with TSMC as part of its somewhat scattershot efforts in the China-U.S. trade war, most notably an agreement to establish a $12 billion foundry in Arizona. In short, much of the problems that arose in offshoring and losing an initial lead in the industry are now being remedied by luring international companies, namely TSMC and Samsung, to U.S. soil.
China’s Big Chase
China, on the other hand, has the arguably more arduous task of playing catch-up in an incredibly dynamic industry.
China’s national champion foundry, Semiconductor Manufacturing International Corporation (SMIC), remains years behind its competitors in South Korea, the United States, and, of course, Taiwan. For reference, SMIC has been unable to complete manufacture of 10 nm chips, largely due to U.S. sanctions on specialized equipment export to the company. By comparison, TSMC is already manufacturing 5 nm chips, leading the bleeding edge of technological advancement, perhaps a decade ahead of China’s best foundry.
The laggard nature of China’s semiconductor manufacturing is not for lack of effort either, as investment in the industry from the government has been enormous. Additionally, the concern over pilfering of intellectual property has been rampant, not least with TSMC. In fact, SMIC was charged with stealing trade secrets from TSMC at various times for the better part of a decade prior to the institution of certain equipment bans amidst Trump’s trade war.
Indeed, the trade war had choked off critical components to China’s nascent semiconductor fabrication industry as key technology imports from the Netherlands-based ASML Holdings were cut off and, crucially, fabrication from TSMC was blocked for key firms such as Huawei and its HiSilicon fabless semiconductor subsidiary.
As shortages begin to significantly impact the industry, the embargo on TSMC technology at the behest of U.S. sanctions is likely to exacerbate existing issues for Chinese firms amid the supply and demand dynamics. Likewise, the United States is not likely to rescind such practices as the curb on Huawei’s hulking demand for chips helps alleviate the issue for U.S. and European firms by freeing capacity at firms like TSMC.
Trade War Grows Tenser
The issue that arises from this dynamic is, rather distressingly, one that could easily move from macroeconomic to geostrategic rather quickly.
China’s exercises in the South China Sea and subsequent scrambling of jets from Taipei are by no means a novel action. The frequency with which tensions escalate is adding to concerns that the situation may soon move beyond mere saber-rattling. At the very least, it appears an option that Xi Jinping is not willing to rule out in pursuit of China’s foundational One China principle.
Of course, it is not to say that the impetus behind increasing belligerence is semiconductors; rather the sector would be a high-profile casualty should such conflict occur. The expensive establishment of a $12 billion TSMC fab in Arizona and the EU’s mulling of a similar deal with TSMC, at least in part motivated by politics, suggests some are hedging against such risk.
Meanwhile, in more likely scenarios, Western firms will need to be vigilant against intellectual property theft, joint ventures, and other dubious trade tactics that will attempt to shore up China’s particularly precarious position in the economy amidst the technology equivalent of an oil shock. If anything, there cannot be any complacency on the lead that yet remains for firms that remain outside of Beijing’s grip. There is certainly no complacency in the skyscrapers that dot Shenzhen, nor indeed in the halls of Zhongnanhai itself.