Semiconductors and the U.S.-China Innovation Race (Foreign Policy)

 

Semiconductors and the U.S.-China Innovation Race

Geopolitics of the supply chain and the central role of Taiwan

A SPECIAL REPORT BY FP ANALYTICS  |  PUBLISHED: FEBRUARY 16, 2021

Semiconductors, otherwise known as “chips,” are an ­­essential component at the heart of economic growth, security, and technological innovation. Smaller than the size of a postage stamp, thinner than a human hair, and made of nearly 40 billion components, the impact that semiconductors are having on world development exceeds that of the Industrial Revolution. From smartphones, PCs, pacemakers to the internet, electronic vehicles, aircrafts, and hypersonic weaponry, semiconductors are ubiquitous in electrical devices and the digitization of goods and services such as global e-commerce. And demand is skyrocketing, with the industry facing numerous challenges and opportunities as emerging technologies such as artificial intelligence (AI), quantum computing, Internet of Things (IoT), and advanced wireless communications, notably 5G, all requiring cutting-edge semiconductor-enabled devices. But the COVID-19 pandemic and international trade disputes are straining the industry’s supply and value chains while the battle between the United States and China over tech supremacy risks splintering the supply chain further, contributing to technological fragmentation and significant disruption in international commerce.

For decades, the U.S. has been a leader in the semiconductor industry, controlling 48 percent (or $193 billion) of the market share in terms of revenue as of 2020. According to IC Insights, eight of the 15 largest semiconductor firms in the world are in the U.S., with Intel ranking first in terms of sales. China is a net importer of semiconductors, heavily relying on foreign manufacturers—notably those in the U.S.—to enable most of its technology. China imported $350 billion worth of chips in 2020, an increase of 14.6 percent from 2019. Through its Made in China 2025 initiative and Guidelines to Promote National Integrated Circuit Industry Development, over the past six years, China has been ramping up its efforts using financial incentives, intellectual property (IP) and antitrust standards to accelerate the development of its domestic semiconductor industry, diminish its reliance on the U.S., and establish itself as a global tech leader. As U.S.-China competition has intensified, notably under the former Trump administration, the U.S. has been tightening semiconductor export controls with stricter licensing policies, particularly toward Chinese entities. Concerns continue regarding China’s acquisition of American technology through civilian supply chains and integration with Chinese military and surveillance capabilities.

Caught between these global superpowers is the Taiwan Semiconductor Manufacturing Corporation (TSMC), a leading manufacturer in the industry, owning 51.5 percent of the foundry market and producing the most advanced chips in the world (10 nanometers or smaller). TSMC supports both American and Chinese firms such as Apple, Qualcomm, Broadcom, and Xilinx. Until recently, the firm also supplied Huawei but severed ties with the Chinese giant in May 2020 because of U.S. Department of Commerce restrictions on Huawei suppliers over security concerns.

Taiwan has also become a geopolitical focal point because the Trump administration’s moves to strengthen American-Taiwanese relations heightened tensions in the Taiwan Strait and increased China’s military activity in the region, testing the Biden administration’s resolve. Together, these factors present significant risks to a critical manufacturing node for the global semiconductor industry. Taiwan represents one part of the industry’s complex ecosystem and shows more broadly the increasing difficulty for companies and countries to remain insulated from geopolitics—particularly amid pressures contributing to U.S. and China decoupling. As geopolitical, trade, and technology disputes mount and the COVID-19 pandemic continues to harm the supply and value chains, semiconductor firms are trying to secure their manufacturing processes by stockpiling supplies or relocating production facilities—disrupting the industry at large.

With semiconductors at the heart of U.S.-China strategic and technological competition, the industry continues to experience a range of protective tariff and non-tariff measures that threaten production and competitiveness of the industry. This FP Insider Report analyzes the evolving strategic economic relationship among China, Taiwan, and the United States as it pertains to semiconductors, examines the growing economic and security challenges that key private and public sector actors within the industry face, and pinpoints opportunities for the Biden administration as it seeks to bolster U.S. competitiveness while containing China’s technological ambitions. In particular, this report finds:

1.     Semiconductors represent the linchpin for U.S. and China’s mutually dependent technological ambitions. Semiconductors are a critical technological vulnerability for both China and the United States, which rely on each other as well as Taiwan for cutting-edge semiconductor devices.

2.    Despite massive investment, China is highly unlikely to achieve independent semiconductor manufacturing capabilities in the next five to 10 years. Chinese companies are unable to compete against top-tier firms because of limited access to semiconductor manufacturing equipment (SME) and software, and their overall lack of industry knowledge hinders the development of a self-sufficient supply chain.

3.    Taiwan is set to become the center of U.S.-China tensions. Given the country’s central role in semiconductor manufacturing and technology supply chains, China will likely leverage its economic influence through trade restrictions, talent recruitment, and cyber to attack key companies in order to obtain core semiconductor intellectual property (IP) needed to bolster its domestic industry.

4.    Unilateral restrictions fostering distrust among companies and country governments risk economic decoupling. Unilateral economic measures imposed by the United States on segments of the supply chain, notably manufacturers such as TSMC, have fostered concern among private and public actors on the impact of action by U.S. leaders on global supply chains and corporate competitiveness. Recognizing critical bottlenecks and vulnerabilities, some companies are evaluating new production models, diversifying investments and suppliers to circumvent American economic policies, which could undermine U.S. primacy in the industry.

5.    Collaboration between the Biden administration and American corporations will be key to balancing national security and commercial interests. Given that multilateral frameworks on semiconductor regulation do not include Taiwan or China, the Biden administration could bolster existing forums for enhanced American-Taiwanese economic relations through the Economic Prosperity Partnership Dialogue (EPP) and Sino-American relations through the Strategic Economic Dialogue. Evaluation of current tax codes and permitting processes under the Federal Clean Air Act, which now disincentivizes companies from investing in U.S.-based fabrication plants, will also be important to attracting investment and strengthening U.S. competitiveness in the sector.