The Race for Semiconductor Supremacy
What Could United States and China Do Next?
The Wall Street Journal aptly headlined their article “Chips are the New Oil”. The global superpowers are rushing towards establishing their supremacy in the semiconductor supply chain. Chips have become critical for geopolitical strategic interests and similar to the 1970s when securing oil became critical for United States (US) and China’s ambitions, both countries are using industrial policy to safeguard their place in the global semiconductor supply chain. In this essay, I will first explore what the US can do to improve its chances of a successful, homegrown, and ally-hosted semiconductor industry in the aftermath of the CHIPS Act. Then, I will delve into what China can do to blunt the impact of US export controls and decoupling in general.
What Could the United States Do?
The landmark legislation “The CHIPS and Science Act” passed as a federal law in August 2022 is the primary initiative by the US government under President Joe Biden. The Act authorizes roughly $280 billion in new funding and incentives for companies to boost research and manufacturing of semiconductors within the US. This bipartisan industrial policy action was widely regarded as the successful first step in restoring the US leadership in the high-end chip manufacturing and reducing US’s reliance on Taiwan. However, the reality so far has lagged expectations, as the CHIPS Act so far has only disbursed two grants to subsidize the expansion of legacy chip facilities. Perhaps the best example of the challenges that US faces is that the Arizona semiconductor plant proposed by TSMC that is aims to be a new manufacturing hub for high end chips, was supposed to be operational by 2024, has not been delayed until 2025 due to labour shortages and other infrastructure challenges. So, what can the US do?
In order to understand what can make the US industrial policy successful, I will use the “Determinants of National Competitive Advantage” framework by Porter. Porter identifies four attributes of a nation that determine national competitiveness. They are:
1. Factor Conditions. The nation’s position in factors of production, such as skilled labor or infrastructure, is necessary to compete in a given industry.
2. Demand Conditions. The nature of home-market demand for the industry’s product or service.
3. Related and Supporting Industries. The presence or absence in the nation of supplier industries and other related industries that are internationally competitive.
4. Firm Strategy, Structure, and Rivalry. The conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry.
This framework applied to the US:
1. Factor conditions: The US lags significantly in factor conditions. Firstly, while the US leads in research universities, it has not invested significantly in vocational and skilled trades training aimed at producing skilled workers that can work in semiconductor manufacturing. More critically, labor in the US is significantly more expensive than China and elsewhere in Asia. Secondly, the US also doesn’t have the critical raw materials needed to manufacture chips and is highly import dependent. China is the main source country for many required critical minerals including REEs, Gallium, Germanium, Arsenic, and Copper. With regards to the positives, the US does have a strong legal infrastructure to safeguard IP rights, and largest venture capital market that can incentivize risky but high yielding research and investment in semiconductor innovation.
2. Demand Conditions: The US has a comparatively wealthier, sophisticated and large domestic consumer market. While consumers do not buy chips directly, every electronic appliance, mobile phones and electric vehicles have chips in them, and hence, the US has strong domestic demand.
3. Related and Supporting Industries: For boosting the chips manufacturing industry, the US needs to have related and supporting industries and institutions that support the chips manufacturing. This is often done via “cluster” of companies and institutions, with the best-known example being Silicon Valley for the technology industry in the US. The US has several such potential clusters for the semiconductor industry, in states like Arizona, California and Texas, which have highly reputable engaged universities, major existing research facilities supported by existing industry partners, and a committed state government with major resources at its disposition. However, the US needs to invest and build to fulfill the potential. The CHIPS Act is the right step in that direction.
4. Firm Strategy, Structure and Rivalry: The US has a concentrated market with large corporations named Intel and Nvidia dominating the high-end chip manufacturing and designing industries. Despite the large concentration of companies, global competition forces these companies to research and innovate. However, due to the availability of cheap and skilled labor outside the US, many of these companies no longer manufacture chips within the US. For inducing greater competition within US, the government must not just provide financial incentives to the already established companies, rather also provide incentives to start-ups to experiment and innovate. The large venture capital market is also a strength for the US in this regard.
Overall, the US needs to do much more on several of these fronts, most critically in factor conditions. I recommend the following actions for the US government:
1. Reform the US immigration system and attract/keep highly skilled workers. Despite having the best research universities in the world, the US often fails to keep the high skilled workers needed to employ in the high-end chips designing and manufacturing jobs, due to its lottery-based immigration system for foreign students with post-graduation employment. The US needs to create new pathways for highly skilled immigration, especially tied with the semiconductor industry to keep and attract relevant workers. Moreover, the government can also train existing workers from related industries to up-skill and have relevant skills to work in chips manufacturing. Given the lack of bipartisan agreement on immigration policy, a short-term policy to provide chips companies with fast-track access to necessary workers they need, coordinated by the Commerce Department, can be effective.
2. Extend the tax incentives for chip factory and related infrastructure investments provided via the CHIPS Act, beyond 2026. Building high-end chip manufacturing plants are resource intensive and requires high capital investments. The CHIPS Act currently provides generous tax credit for such investments and this provision ends in 2026. If this provision is extended for a longer period of time, it will provide the companies and investors with more predictability in US policy and also provide a comparative advantage to the US for companies to build manufacturing factories within the US. This is because over 70% of the costs in high-end chip making comes from chipmaking tools, which cost the same everywhere in the world. Hence, significant tax credit for such investments can save millions of dollars and can be a critical factor.
3. Fast track the permitting process for chip manufacturing plants. One of the current bottle necks for chip manufacturing in the US is the long and costly permitting process that companies have to go through. This process is especially cumbersome due to the regulations imposed by NEPA (National Environmental Policy Act). In fact, as it currently stands, it takes longer to get a permit in the US than in the EU. Given that companies like TSMC and Intel have long expertise in building such factories, and they have self-interest in ensuring the safety and security of such manufacturing plants given they are investing billions of dollars, the permitting process should be fast tracked and standardized. One way the US government can do is by putting strict time limits for NEPA to either accept or reject permitting applications.
4. Build partnerships with allies and critical suppliers of minerals countries. While the previous three recommendations aim at improving the factor conditions within the US, ultimately achieving full self-sufficiency in chip manufacturing might be a mirage and not a successful long-term strategy. Instead, a more sustainable and effective strategy will be for the US to work with its allies, not use industrial policy punitively to take away investments from allies and working together to create a resilient and dependable supply chain of chips. US already have a strong relationship with critical partners such as the Netherlands and Japan, who provide critical parts of the supply chain. But US is particularly lagging in building partnerships with countries in the African continent and other Asian countries, who provide the critical minerals and other parts of the supply chain that these countries have specialized in providing. By building partnerships and creating a strong international supply chain, the US can also ensure that it maintains its ‘soft power’ over its allies and other developing countries.
What Could China Do?
In 2022, the US imposed sweeping export controls on China, barring US companies from trading high-end chips and also diplomatically pressuring US allies to do the same. In October 2023, the Bureau of Industry and Security issued an updated set of rules, further closing loopholes and increasing the export control via growing the list of countries to which exports will now require a license, etc. As retaliation, the Chinese government recently banned Micron Technology, a US company that makes memory chips, from selling its chips to companies in China. In order to explore what else China can do to retaliate, but also to achieve its goal of becoming self-sufficient in producing cutting edge chips, let’s apply Porter’s framework:
1. Factor Conditions: China’s primary competitive advantage lies in its factor conditions, as it has abundance of skilled and cheap labour, it has all the critical minerals required to manufacture chips, and the Chinese government invests highly in education and academic specialization. China accounts for 79% of global raw silicon and 70% of global silicon production, which provides it with a huge advantage. However, one negative for China is the legal uncertainty of IP rights within China, although this has steadily improved. Finally, despite favorable factor conditions, China still depends on exporting cutting edge chips as the technology is highly guarded in the manufacturing countries like Taiwan. Although Chinese companies are catching up, it is still behind in producing the high-end chips.
2. Demand Conditions: The Chinese domestic market has expanded in its wealth and sophistication, dramatically over the past two decades. It is also large in terms of population and consequent consumer demand and the technological know-how of the people is increasing.
3. Related and Supporting Industries: China has a strong manufacturing and related industries domestically, that can support the chip industry. Firstly, China has a huge supply of the rare earth minerals and metals necessary for chip manufacturing. Secondly, the Chinese government provides huge financial support to specific local companies to scale up and experiment. Finally, initiatives like the Belt and Road Initiative (BRI) and other foreign investments, especially in the African continent, has helped China build relationships with many foreign governments, who also have critical minerals and other parts of the supply chain.
4. Firm Strategy, Structure and Rivalry: Chinese government prefers picking national champions and often supports specific companies via massive subsidies. While this strategy has worked in the recent past, arguably this also lessens the domestic rivalry and thus stimies competition and innovation. It is unlikely that China will allow full market competition under President Xi.
Given these attributes, following are my recommendations with regards to what China can do to blunt the impact of US export controls and accelerate decoupling in general:
1. Weaponize raw materials as part of tit-for-tat strategy. China’s strongest comparative advantage in the current chips manufacturing supply chain lies in its dominance of producing critical rare earth minerals and metals, necessary for chips production. As a ‘tit-for-tat’ strategy, China can put on export controls on the US and any other country, that imposes export controls on China. This will at least create a short-term shortage of such critical raw materials and force the US and its allies to re-evaluate its export controls strategy vis-à-vis China.
2. Focus investments to be self-reliant on below the cutting-edge chips making. While it is much harder for China to become a producer of cutting-edge chips, it can easily become self-reliant for below the cutting-edge chips and scale up its domestic chip making strategy. Banning micron, the US company, is a step in that direction. With targeted investments by the Chinese government, domestic companies such as the state backed Semiconductor Manufacturing International Corporation (SMIC) can produce more chips and invest in R&D. Billions of dollars in investment recently provides evidence that China is already working on this.
3. Attract High-Skilled Workers: A pivotal step for China lies in attracting high-skilled workers. The United States, with its diverse and innovative ecosystem, has long been a magnet for the world’s top talents in semiconductor technology. China, on the other hand, while having a large pool of skilled labor, often lags in attracting international experts crucial for breakthroughs in chip technology. To compete, China must bolster its appeal to these high-skilled professionals. This entails not only competitive financial incentives but also fostering an environment of intellectual freedom and innovation, where the experts can innovate without being critical of the Chinese government.
4. Establish a High-Tech Manufacturing Hub: The ambition to build a high-tech manufacturing center for advanced chip-making equipment is daunting yet possible in the long run. Current global leaders in this space, such as ASML, have taken decades to refine their technologies. China’s approach must be multi-faceted: investing heavily in R&D, forming partnerships with domestic universities and research institutions, and perhaps most critically, engaging in international collaboration for technology transfer and skill development. China can especially court countries like South Korea, which are willing to talk to Chinese diplomats and want to keep friendly relations with its Asian neighbor in China.
5. Continue Political Persuasion Campaign in Taiwan: China claims Taiwan is a part of China and must return under its control. Taiwan is perhaps the most important player in the semiconductor supply chain, particularly through TSMC, which holds significant strategic importance as the manufacturer of over 70% of the global cutting-edge chips. China must continue its efforts to sway the “hearts and minds” of the Taiwanese towards reunification, and influencing the domestic politics, similar to what the Chinese succeeded to do in Hong Kong. Arguably, such a campaign will be much harder in Taiwan, but if China succeeds in reunifying Taiwan without using military force, it won’t just gain back the island, it will also gain the largest manufacturer of high-end chips.
Reflections on this Exercise
The benefit of thinking through what the key stakeholders or the superpower countries could do is that it helps us to foresee (possibly) what are the potential future scenarios that we may face.
The most likely scenario is a bifurcation of the semiconductor supply chain. While the “semiconductor cold war” is likely to continue between the US and China, by leveraging their current strengths, strategically investing in key areas, and fostering international alliances, both countries will focus on ensuring their own control over semiconductors.
