A chip war has brewed quietly between the US and China for several years. Both are the largest semiconductor markets, each accounting for nearly 25% of global consumption. The US has long been trying to deny China access to latest technology, but recently several happenings one after the other suggest this chip war is getting turbulent, and the US is trying to cut China out of the global semiconductor supply chain.
US House Speaker Nancy Pelosi’s defiant trip to Taiwan that angered China had an important sideshow. Pelosi met top executives of Taiwan Semiconductor Manufacturing Company Limited (TSMC), the world’s biggest contract manufacturer of chips. Pelosi’s meeting comes after the US taking several steps recently to foil China’s semiconductor ambitions—and reports that China has crossed an important barrier in manufacturing advanced chips on its own.
America’s all-out push against China
Last month, the US government reportedly asked the Netherlands to stop Dutch semiconductor manufacturing equipment provider ASML Holding NV to stop selling equipment to Chinese companies. ASML is the sole supplier of lithography machines used to make advanced chips. Chinese companies were earlier banned from buying the cutting-edge technology used to make lower-capacity chips. Now it seems the US wants to prevent Chinese companies from buying even the older ASML technology.
Early this month, Bloomberg and Reuters reported that the US was planning new curbs on chip makers in China. The US is considering limiting shipments of American chip-making equipment to producers in China. The curbs will also impact South Korean giants Samsung Electronics and SK Hynix from shipping new equipment to the factories they operate in China, which means they will not be able to upgrade their factories.
The US had banned the sale of most gear that can fabricate chips of 10 nanometre or better to Chinese firm Semiconductor Manufacturing International Corp (SMIC) without a licence. Bloomberg reported that now the barrier has been extended to equipment that can make anything more advanced than 14 nm. The moratorium likely extends beyond SMIC and includes other fabrication plants run by contract chip-makers in China including TSMC.
These measures to contain China’s chip makers come just when the US Congress has passed the CHIPS and Science Act which will offer a $52 billion package to semiconductor manufacturing companies in the US. The money will come with a clause—recipient companies can’t increase production of advanced chips in their factories located in China. The US is also promoting the so-called “Chip 4 Alliance" with South Korea, Japan and Taiwan excluding China.
US President Joe Biden said while commenting on the CHIPS and Science Act, “America invented the semiconductor. It’s time to bring it home." It isn’t as simple as he made it sound. The semiconductor supply chain has spread over to other parts of the world not without a reason—fabrication is more cost-effective in Asian countries. If US tries to gain self-sufficiency in chips, its products will be very expensive. It seems the US government’s plan to fund chip-making within the country is simply to gain some degree of control over supply of advanced chips for critical uses.
The global semiconductor supply chain
The US is the birthplace of semiconductors (the Silicon Valley got its name because chips are made from silicon wafers). It outsourced chip manufacturing, like so many other things, to Asia. Today, the US along with the Netherlands dominates the upstream of the semiconductor value chain while Taiwan, South Korea and China own the downstream. The upstream constitutes the technology, design and equipment required to manufacture chips while downstream constitutes fabrication of chips and their assembly, packaging and testing.
In the global supply chain of chips, countries are interdependent as goods and technology flow to the places where they can be optimally used. That means fabrication and packaging are located chiefly in Asian countries due to advantages of cost and trained labour while technology, design and research are centred in the US and Europe.
Global supply chain with a division of labour is considered a better alternative to integrated device manufacturers (IDMs), the companies that design, manufacture and also sell chips. But geopolitical concerns now seek to alter the supply chain as both the US and China, distrustful of each other, aim to achieve some degree of self-sufficiency.
While the US has near-total control over equipment and technology used to design advanced chips, Chinese companies—kept away from cutting-edge technology by the US—focus on memory chips and logic chips that lag a few generations.
Who does what
The term ‘node’ describes the power of chips which have been evolving very fast. It is measured in nanometres (nm)—the lower the level of nanometres, the more powerful and efficient the chip. Only 2% of the global chip manufacturing capacity is below 10 nm nodes. Nodes go back to 180 nm which are used for discrete and analog semiconductors. Samsung has started manufacturing 3 nm chips, which are considered the most advanced.
Semiconductor manufacturing capacity in nodes below 10 nm is currently located only in Taiwan and South Korea. Chinese companies, or foreign companies manufacturing in China, make chips that are in upper ranges which go several generations back. According to a BCG report, China manufactures only 3% of 10-22 nm logic chips but 19% of 28-45 nm chips. It makes 23% of logic chips in the category above 45 nm.
China has just 5% share in equipment part of the supply chain. Most equipment used to manufacture chips come from the US, followed by East Asian countries. In manufacturing of chips, China holds just 16% share while East Asian countries (mostly Taiwan) have 56%. However, in assembly, packaging and testing, China holds a large 38% share.
The geopolitics of chips
Since semiconductor supply chain is spread over several countries, each with its own strength, a free flow of goods and technology is essential for its smooth functioning. If these countries get locked in geopolitical struggles, high risks emerge. As the US and China vie for global supremacy, the dangers of concentration of chip manufacturing in a highly unstable region have come to fore. Most of the world’s chip manufacturing is done in Taiwan, China and South Korea, all located in a geopolitical tinderbox.
Forget war, even a storm in Taipei can disrupt global chip supply and make the world come to a grinding halt. In December 2020, a power outage affected a memory fab located in Taiwan for just one hour, impacting 10% of global DRAM supply.
In fact, it has become a truism that Taiwan is safe from Chinese attacks because China can’t afford destruction of Taiwanese chip factories since Taiwan is its major supplier; nor will the US allow China to interfere with Taiwan because the US too is dependent for its chip supply on Taiwan.
The dangers of a disruption in chip supply became evident when the pandemic affected chip factories and a restricted supply caused major problems around the world. The US inflation—especially the rise in used car prices—is being attributed to shortage of chips which are used in making new cars. Chip shortages also constrained the ability of US defence contractors to supply weapons to Ukraine. For example, every Javelin missile launching system has 250 chips or more. US Secretary of Commerce Gina Raimondo said the biggest pain point of American defence contractors seeking to supply weapons to Ukraine was chips.
Why is US wary of China’s chip power?
It is evident that whoever controls the chips, controls the world. Today, the US has total control over technology and equipment used to make chips. China is several generations behind the US, Taiwan and South Korea in technology as well as manufacturing. But China is doing everything it can to get ahead.
In 2014, China released its National IC [integrated circuits] Promotion Guidelines to set ambitious targets for chip manufacturing. China’s 'Made in China 2025 Plan' launched a year later aimed to achieve 70% self-sufficiency in chips in a decade. These aims are backed by a “Big Fund" worth $21 billion of state financing. The fund was boosted in 2019 with $35 billion more of state money.
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Throwing money at chip makers is just one of several ways China promotes manufacturing. It also encourages purchase of foreign companies and joint ventures with them. It also tries to poach talent from Taiwanese companies. Taiwan has reportedly launched probes into around 100 Chinese companies suspected of illegally poaching semiconductor engineers.
A US Congressional report says China appears to be reinforcing its statist approach to developing its semiconductor industry and is continuing to target US and foreign capabilities in semiconductors and other critical and emerging technologies.
Though China has not been able to achieve much by throwing money at its companies or trying to get access to technology through JVs with foreign companies, it is definitely making strides.
America’s Semiconductor Industry Association (SIA) says global chip sales from Chinese companies are on the rise, largely due to increasing US-China tensions and a "whole-of-nation" effort to advance China’s chip sector, including government subsidies, procurement preferences, and other preferential policies.
Just five years ago, SIA claims, China’s semiconductor device sales were $13 billion, accounting for only 3.8% of global chip sales. In 2020, however, the Chinese semiconductor industry registered an unprecedented annual growth rate of about 30% to reach nearly $40 billion in total annual sales, claims the SIA analysis. This jump in growth helped China capture 9% of the global semiconductor market in 2020, claims SIA.
SIA says across all four sub-segments of the Chinese semiconductor supply chain—fabless, IDM, foundry, and OSAT—Chinese firms recorded rapid increases in revenue in 2020, representing annual growth rates of 36%, 23%, 32%, 23%, respectively.
In contrast, SIA says, the share of modern semiconductor manufacturing capacity located in the US has decreased from 37% in 1990 to 12% today.
American dependence on foreign-manufactured chips has reached alarming levels. A report released early this year by the US Commerce Department found that the median supply of chips held by manufacturers dropped from 40 days’ worth in 2019 to less than five days’ worth in late 2021.
Even before China becomes a chip manufacturing power, it has a chokehold over global chip supply—simply because most of the manufacturing is located in Taiwan which China can forcibly take over.
China’s leapfrog to banned technology
Foreign companies do not share latest chip technology with China so Chinese companies stay several generations behind. China is supposed to have no production capability below 10 nm chips. The reason is American, European, Taiwanese and South Korean companies refusing to share such technology with Chinese companies. Chinese companies also do not have access to equipment used to create advanced chips, which are sold mostly by American and Dutch firms.
However, a recent news shocked the world. A chip manufactured by China’s Semiconductor Manufacturing International Corporation (SMIC)—banned from accessing latest technology by the US—was found to be of 7nm capacity. American analyst firm TechInsights bought a cryptocurrency-mining ASIC manufactured by SMIC and found that it used a 7nm process. TechInsights claimed SMIC’s 7nm chip appeared to be a close copy of the one used by TSMC of Taiwan.
The discovery seems unbelievable because the US had banned the sale of equipment that can manufacture chips 10 nm or better to SMIC.
The discovery made by TechInsights means it won't be long before China becomes self-dependent in advanced chips. China must have made this 7nm chip by improvising on old western technology it has. If China is able to manufacture advanced chips without access to expensive cutting-edge western technology, it would be making such chips at less cost too. Once China reaches that stage, it will be in familiar territory—monopolise a sector by producing cheaper knock-offs. The US should be scared of this prospect.
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