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Monkey See, Monkey Do
Peter T. Treadway

The United States has frequently criticized China for pursuing industrial policy and subsidizing its enterprises to gain advantage in international markets. Now the United States is proposing to imitate China and do exactly the same thing. The so-called Innovation and Competition Act is making its way through Congress. At this writing the bill is 2000 pages long, will total billions and is a moving target for pork and politics. According to the Wall Street Journal with this bill you can start with “$54 billion for the not-so-needy US semiconductor industry.”

The global, American dominated semiconductor industry is a free market marvel of economic efficiency and innovation. Take logic chips. The major companies, which typically occupy oligopolistic positions, make lots of money and don’t need Federal handouts. These companies for the most part design the chips. The Asian companies manufacture, test and package them. This is the fabless model. Thus American companies like Nvidia, Apple, Qualcomm and AMD design chips. Asian companies, notably Taiwan  Semiconductor and Samsung, manufacture them. The secret of the fabless design companies’ success is that they don’t have to allocate talent or capital to manufacturing. (Intel is an odd duck in this as it considers itself an Integrated Device Manufacturer and designs and manufactures chips. But Intel has stumbled lately.). Making chips is an incredibly difficult and complicated process but once again American companies like Applied Materials, KL Tencor and Lam Research (along with Tokyo Electron) are leaders in making the equipment to make the chips.

So what’s there not to like? If it ain’t broke, why are the politicians fixing it and implementing Chinese style industrial policy? In fact American politicians have found plenty not to like.  Underlying it all in my opinion is a race based – subconscious in some minds—dislike of China.

China is a major consumer of computer chips, having imported some $350 billion in 2020. The growing Chinese economy is a digital economy. Unfortunately for China, it is light years behind Taiwan Semiconductor and Samsung in manufacturing computer chips. Manufacturing computer chips is really hard and not like making sneakers. The latest state of the art semiconductor might have some 15 billion transistors on a tiny chip. Chinese fabs at present can’t do it.  The Chinese market is a huge buyer of computer chips and they have to be imported. The Chinese market is a major source of profitability for American and global companies. The American political class and the American public unfortunately could care less about semiconductor industry profits.

The Trump Administration stumbled on China’s semiconductor vulnerability and placed all kinds of embargoes on exporting semiconductors to China. It leaned on Taiwan Semiconductor and Samsung and even Dutch ASML not to manufacture for targeted Chinese firms like Huawei. In the case of ASML this is really a blow because ASML is the world’s only producer of EUV lithography equipment necessary for the production of high end chips. Theoretically, Samsung, Taiwan Semi and ASML aren’t American firms under US jurisdiction but they might as well be. Having a currency that others rely on and a military force that dwarfs all others allows the US to do all kinds of extraterritorial bullying.  It seemed former Secretary of State Pompeo’s main job in his last days in office was issuing prohibitions against semiconductor exports to China.

The Chinese consider Taiwan to be part of their country. Placing embargoes on Taiwanese semiconductor exports to China seems like a sure way to provoke a Chinese invasion of the island. China’s progress depends on advanced semis. Does the US want that invasion?

One thing for which the Biden Administration is pushing is for the global chip manufacturers to build foundries in the United States. This onshoring may not be the most efficient use of resources and will require substantial subsidies. According to Asia Times, Morris Chang, the now retired founder and former CEO of Taiwan Semiconductor, recently expressed doubts about US competence in chip manufacturing. Chang is an industry god whose opinions cannot be dismissed. Taiwan Semiconductor has been strong-armed by the US to build a foundry in Arizona. Chang said the conditions underlying Taiwan Semiconductor are not easily replicated elsewhere including the United States. He warned of challenges in constructing and operating the Arizona plant. By contrast, Intel’s new and also respected CEO, Pat Gelsinger, has announced two new foundries to be built in Arizona. Somebody’s going to be right!

I’ll put on my economist hat now. Onshoring in general is less efficient than offshoring and globalization. And this applies to all products, not just semiconductors. The Biden Administration’s obsession with onshoring translates into advocating more inflation and lower economic growth and productivity.

China cannot rely on global markets which are under the thumb of the United States. It must onshore its semiconductor industry. Even if successful, this will impose a significant cost on the Chinese economy.

The Chip Shortage Will Last for Years

I’m guessing but I think the chip shortage will persist in some form for years. There are a number factors:

First there is the virus. No question some companies underordered chips and are now catching up. The auto companies for example were inadequately familiar with their relatively recent dependence on chips. Luckily this is essentially a transitory factor.

Second, the secular demand for chips will grow exponentially in the coming years. The world is entering a new digital age and for this all kinds of chips are needed for all industries.

Third, fears of further embargoes on as yet un-embargoed Chinese firms undoubtably caused them to double order chips.

Fourth, China will become the number one location for semiconductor demand. But domestic supply will be constrained by Western embargoes on semiconductor equipment. The Chinese will take years to catch up. If the Chinese weren’t held back, they would eliminate any chip shortages. Just like they have done with so many other products. The China haters will rejoice but these restrictions will shoot the global economy in the foot with more inflation and global tensions.