The global semiconductor industry is interconnected, like it or not

Business & Technology

The global production of semiconductors will be interdependent for at least the next decade. China and the U.S. may want chip self-sufficiency, but neither will be able to achieve that anytime soon.

Illustration for The China Project by Derek Zheng

You would be hard-pressed to name a modern digital device that does not contain a semiconductor. Found in smartphones, medical devices, and military systems, semiconductors are the lifeblood of the digital economy, and of equivalent importance to the 21st century as oil was to the 20th.

There is currently a global semiconductor shortage, brought on by COVID-related factory shutdowns in early 2020 and exacerbated by chip stockpiling and unpredictable demand. As a result, the semiconductor industry has become a battleground for geopolitical rivals, and yet it remains characterized by significant international interdependence. China has declared its wish to be self-sufficient in semiconductor production, while President Joe Biden has prioritized U.S. domestic semiconductor manufacturing and R&D since taking office, but neither side will be able to achieve what they want without the other.

What do the two sides want? Chinese semiconductor policy

The State Council, China’s central administrative organ, began its current semiconductor policy with the establishment of the National Integrated Circuit Industry Investment Fund in 2014. The fund, capitalized at 98.7 billion yuan ($15 billion), is a “government guidance fund” with a Limited Partnership structure typical of equity finance, but overseen by government ministries that influence investment decisions.

China’s most recent Five Year Plan, published in March 2021, emphasized self-reliance in science and technology, and for the first time treated semiconductors as an independent category, one of seven technologies selected for prioritized investment. So keen is the Chinese government to accelerate the development of its semiconductor capabilities that it has launched a campaign to galvanize public interest in the sector, in an effort to attract tech talent to the country. This campaign even includes a new Chinese TV drama called The Silicon Waves (纵横芯海 zònghéng xīnhǎi), which will be produced by a subsidiary of the state-owned Shanghai Media Group. It tells the story of two Chinese entrepreneurs based overseas who return to China, enticed by Beijing’s preferential policies to develop the sector. After contributing to the independent development of Chinese chips, the pair retire and dedicate their time to supporting young people in China to advance the domestic chips industry.

A promotional poster for “The Silicon Waves,” a 40-episode TV series about two Chinese semiconductor entrepreneurs.

U.S. semiconductor initiatives

In the U.S., initiatives to strengthen domestic semiconductor security include Biden’s national supply chain executive order of February 2021. While Biden cited the global shortage as a key motivation for investing in chip production, he also made clear that he views the sector as a key area of strategic competition with Beijing, saying, “China is doing everything it can to take over the [computer chip] global market so they can try to outcompete the rest of us.”

Biden’s executive order included the commissioning of a report to identify risks in the semiconductor manufacturing and advanced packaging supply chains, as well as policy recommendations “to address these risks.”

In June 2021, the Senate adopted the United States Innovation and Competition Act, a $250 billion bill designed in part to boost U.S. semiconductor production in response to China’s advancements. The bill includes $52 billion for the CHIPS for America Act, which seeks to catalyze more private-sector investments. Such efforts have already borne fruit: In January 2022, Intel announced a $20 billion commitment to build two semiconductor factories in Ohio.

Global supply chains and interconnectedness

Despite significant government-led efforts to achieve greater self-sufficiency, this sector is one of the most globalized: A semiconductor could be designed in the U.S., manufactured in Taiwan using chemicals from Japan and Germany and equipment from the Netherlands, and assembled and packaged in China. As one analyst told the Financial Times, “Self-sufficiency in semiconductors is a fantasy for anyone — from the chemicals, to the production tools, to the software, to the chips themselves, they cannot [all] be monopolized by any one country.”

A report on China’s semiconductor ecosystem, published in June 2021 by two German think tanks, assessed the likelihood of China’s semiconductor industry catching up with global market leaders within a decade. The report broke down production into eight steps and concluded that in five out of eight categories, China is unlikely to be able to compete with global leaders within the next decade.

The U.S., too, has a long way to go, currently accounting for just 12% of global semiconductor manufacturing. The significant costs involved would likely make U.S. efforts to compete with established industry leaders, who have invested billions in R&D over decades, unsustainable. As one analyst commented:

“I think what folks don’t realize is that this is not a one-time fix. If you want [to produce] 3-nanometer [chips], that is going to cost you $15 billion, and then two years later, you are going to have to spend another $18 billion, and after that, another $20 billion. The numbers are massive, and it is an ongoing investment to stay at the leading edge.”

The sector is currently highly oligopolistic, with certain regions and companies dominating sections of the value chain. For instance, Intel and British company ARM dominate the microprocessor sector, and South Korea’s Samsung dominates the production of dynamic random access memory, a type of semiconductor memory. U.S. companies, including Qualcomm, Broadcom, and Nvidia, dominate chip design, while the majority of chip production occurs in Taiwan, with Taiwanese semiconductor giant TSMC accounting for 40% to 65% of revenues in the less advanced 28- to 65-nm chip category, and producing 90% of the global market’s most advanced chips. China is also a core part of the supply chain; first, as a global leader in outsourced assembly, packaging, and testing (“OSAT”), representing 38% of the total OSAT market in 2020; and second, as a front-end wafer manufacturer, with 23% of global market capacity located in China, of which 30% is owned by multinational firms largely from other East Asian nations.

In addition to new players facing high market-entry barriers, the consequences of cutting out companies at the end of the supply chain further demonstrates why the industry is so internationally interdependent. China is the largest global consumer of chips: In 2020, it imported $378 billion in semiconductors and assembled 35% of the world’s electronic devices. China is also, after the U.S., the second-largest final consumption market for semiconductor-enabled devices. One can therefore understand why, when Huawei was sanctioned by the U.S. in 2019, the U.S. semiconductor lobby was one of the staunchest opponents of the sanctions, given its dependence on the Chinese market. Indeed, Qualcomm and Intel later received licenses to sell chips to Huawei in 2020.

Geopolitical tensions and sanctions

Taiwan’s advanced semiconductor capabilities have placed the island and its leading tech companies at the center of a U.S.-China technological battle, in addition to its position as a point of focus for military rivalry in the region. The Taiwanese government has passed increasingly tough laws in recent years in an effort to protect its semiconductor industry, with new offenses for “economic espionage” under its national security law recently proposed, including punishment of up to 12 years in prison for those who leak core technologies to “foreign enemy forces.”

Taiwan is not the only government using legislation to try and safeguard domestic semiconductor capabilities. The UK government announced last month that the takeover in 2021 of the UK’s largest semiconductor foundry, Newport Wafer Fab, by Nexperia — a Dutch subsidiary of Chinese company Wingtech — would face a review under the new National Security and Investment Act, which came into force in January this year.

The political sensitivities surrounding the sector pose risks for businesses as well as governments. These include U.S. sanctions risks, national security reviews of mergers and acquisitions, and political exposure in a sector receiving significant government attention, including state connections in China. An example of the potential effect of U.S. sanctions on a European company occurred in 2020 when, after the U.S. banned sales to Huawei, British chip designer ARM, which had U.S.-based engineers, was forced to declare that its technology was of UK origin and therefore not subject to export controls. Further examples of national security reviews of foreign takeovers include the Italian government’s prevention in 2021 of a Chinese company from buying a controlling stake in LPE, a Milan-based firm producing semiconductor equipment, and the failed takeover of German chip supplier Siltronic by GlobalWafers of Taiwan earlier this year following a protracted review by German regulators.

The speed at which countries sanctioned Russia after its invasion of Ukraine has made people think about a similar future scenario involving China. But for all the predictions of a decoupling between the American and Chinese economies, the semiconductor sector represents a good example of global reliance that cannot be undone overnight — nor, it would seem, within the next two decades.