This guest blog post was written by Sebastian Ko, Managing Director of APAC, FiscalNote
Over the last 30 years, China’s economic emergence has led to it challenging the United States for technological pre-eminence — not unlike Japan in the 1960s to 1990s. The West has long labeled China as the “Copycat Nation,” but few commentators today would still doubt its innovation capacity.
A trade war in 2018 precluded what many are now calling the “U.S.-China Technology Cold War.” Since then, each nation has utilized legal and economic instruments such as investigations, sanctions, and tariffs to target each other’s technologies and strengthen their respective geopolitical positions. Recently, the two superpowers have injected tens of billions of dollars to stimulate research and development (“R&D”) of next-generation technologies and boost access to hi-tech manufacturing capabilities, especially those relating to semiconductors. By examining the semiconductor market, can we determine if China will succeed the U.S. in global technological leadership?
Since mid-2019, the United States has issued executive orders and export controls restricting trades with Huawei, ZTE, and other Chinese technology firms. The U.S. has also made high-profile commitments to prioritize strategic resources to address Chinese technological threats. In late 2020, the Chinese government retaliated by issuing its own set of measures, including a restricted entity list and amendments to its Catalogue of Technologies Prohibited or Restricted from Export.
A key battleground in this Cold War is the semiconductor industry. This industry is critical to growth at the dawn of the Fourth Industrial Revolution. The semiconductor is a basic technological building block. No nation can claim technological leadership without ample access to its supply. Moreover, the challenges faced by the United States and China in the semiconductor industry mirror their technological race. The U.S. is maintaining the leadership position, while China is the top contender given the sheer scale of its commitment to technology advancement.
As the U.S. has shown since World War II, technological leadership requires a nation to achieve several areas of ascendancy, including its capability for scientific discovery; access to raw materials; and capacity for advanced manufacturing and production. The United States can maintain its leadership, because it has an outsized share of the world’s top innovators and universities, and it dominates several hi-tech markets. U.S. companies constitute 73 percent of the global IT sector in market capitalization.
But China holds the most patent grants in the world, followed by the United States and Japan. Certainly, patent grants alone say nothing about the scientific and economic value of the inventions. What generates economic value is the capacity to commercialize scientific discoveries and inventions. Yet China is highly experienced in commercialization, having been the “World’s Factory” for four decades.
Global Chip Market
The computer chip market lies squarely at the crossroads between global trade and technological competition. A complex web of cross-border supply chains is needed to support the $400 billion p.a. global chip industry — from extraction and refining of raw metals and minerals to advanced material fabrication and assembly. Chips are typically made of semiconductors and mostly consist of silicon and various alloys. High-end chips also contain rare-earth minerals, which are formed in the Earth’s crust. While, as Table 1 shows, China produces the most silicon and rare earth in the world, Taiwan and South Korea lead in chip-making capacity. Still, U.S. companies dominate chip sales worldwide.
Although China is the largest exporter of electronics, it still lags in acquiring the know-how to design and manufacture cutting-edge chips. Chipmakers typically spend 15 percent of their annual revenues on R&D. Each chip model has a two to four-year shelf-life before obsolescence. Experts estimate that in early 2020, the top Chinese foundry run by SMIC in Shanghai can only produce chips that are two generations behind the much-smaller, cutting-edge chips produced in the foundries of TSMC, Samsung, and Intel. These cutting-edge chips are smaller (5 nanometers or below), and therefore faster in the semiconductor world. They are critical components of graphics and central processing units of personal computers and smartphones, which are the most profitable kinds of chips.
The United States and China have become highly interdependent in many industries — including semiconductors — especially after China joined the WTO in 2001. In the past 10 years, however, driven by domestic and international political shifts, Sino-American relations have transformed from strategic cooperation to strategic competition. While no nation desires to rollback globalization completely and surrender its benefits, Sino-American relations will undergo decoupling over the next decade. As Wright at the Brookings Institution observed, the U.S. and China are expected to adopt domestic and foreign policies, developing “spheres of independence” to ring-fence certain strategic areas.
Since 2019, President Xi Jinping has repeatedly called on China to prioritize hi-tech self-reliance. But China has adopted specific directives since 2014, including the Guidelines to Promote National Integrated Circuit Industry. China aims to meet 70 percent of its domestic semiconductor needs with indigenous production under the “Made in China 2025” policy. By contrast, China could only meet 16 percent in 2019. Meanwhile, Beijing has invested about $150 billion in its semiconductor industry; the equivalent of the annual total market size in China and double the global industry’s total investment in R&D.
Finding Trusted Friends
Technological self-reliance is necessary but not sufficient for supremacy. Successful semiconductor companies can maintain world-leading levels of innovative growth. They can manage cross-border R&D, highly integrated supply chains, and large expert workforces, and create and protect intellectual property. While Chinese semiconductor companies have regularly recruited non-local talents (e.g., from Taiwan), they are struggling to secure overseas collaborators. For example, the Dutch company ASML is the sole commercial supplier of the extreme ultraviolet scanner, which is a critical equipment for fabricating semiconductors. In late 2019, the Dutch government blocked exports by ASML to the Chinese SMIC after U.S. intervention. Moreover, Huawei is facing massive challenges securing foreign contract manufacturers of high-end chips. In August 2020, Washington, D.C., extended export controls to Huawei’s foreign suppliers. TSMC, with its majority revenue based in the United States, stopped manufacturing Huawei’s designs in September 2020.
The U.S. and China have been battling for the hearts, minds, and pockets of trading partners. In 2020, the United States achieved a tipping point in convincing many EU states to reject or phase out Huawei and ZTE as providers of 5G infrastructure on national security grounds. In 2018-19, there were still plenty of mixed signals in the EU on this subject. Some states resisted American influence in deciding their paths forward; indeed, they welcomed Chinese technologies for their efficiency, reliability, and low costs. Similar struggles have manifested in Africa, Asia, and Latin America. Perhaps, this is the nature of the Cold War in a multi-polarized world. The regional engagements are far more nuanced than those of the Soviet-American era.
There is a global chip shortage, and it is expected to last well into 2022. Among other factors, the COVID-19 pandemic has delayed production worldwide. Since the U.S.-China trade war began, U.S. and Chinese companies have been facing enormous challenges collaborating to produce chips. The shortage presents an international imperative, given the world’s dependence on electronic systems for commercial and military applications. However, addressing the chip shortage involves overcoming a multitude of macroeconomic and political challenges. It will be a great test of global commerce and international relations in the era of Sino-American decoupling.
Kennedy and Lim at the Australian National University observed that the United States has adopted three types of policies to protect its technological advantages:
shielding: policing and prosecuting objectionable behaviors by the competitor;
stifling: preventing/disrupting the competitor’s access to critical resources. e.g. foreign suppliers; and spurring: investments and tax breaks for R&D.
These policies have been implemented using legal and “geo-economic” (economic approaches influenced by geopolitics) measures. China has also employed them against the United States to a more limited extent. The scholars have also observed that China has adopted three strategies to close the technology gap:
making: developing indigenous capacity, transacting: buying foreign firms or investing in foreign commercial projects, and taking: academic and non-commercial acquisition of know-how.
Whether or not China will assume technological ascendancy depends on the future interplay between the U.S. and China in their adoption of shielding, stifling, and spurring policies and China’s making, transacting, and taking policies. It may be sufficient for China — for example, to achieve economic hegemony — to disrupt the American technological supremacy, even if it fails to overtake it.
China’s 13th Five-Year Plan (for 2016-2020) featured prominently the national strategic objectives to enhance semiconductor capabilities and areas heavily reliant on semiconductors, including 5G and artificial intelligence. These areas have taken center stage again in the 14th Five-Year Plan (for 2021-2025). China has an existential need to develop rapidly strategic technologies to sustain economic growth and manage a more hostile international environment.
Unsurprisingly, President Joe Biden issued an executive order in late February 2021 directing the U.S. federal government to conduct a 100-day review of critical supply chains, including those of computer chips. U.S. politicians have attributed the U.S.-China strategic competition to motivating this review and to find “trusted friends.”
The United States is about five to 10 years ahead in semiconductor R&D and manufacturing capability. While the U.S. and its allies are highly influential in the chip markets and are producing the majority of the talents in this area, they will likely adopt more strategies to slow down and contain Chinese technological progress. Lacking access to large talent pools and foreign partners with the necessary know-how, China should continue to lag behind the United States at least in the mid-term. But Chinese firms are resourceful and may catch up quickly; they are backed by the state and the Chinese government is committed to playing the long game. By comparison, American corporates tend to focus on quarterly earnings and plan for shorter timeframes.
The nation that controls the semiconductor market has the upper hand in the Technology Cold War. The computer chip is indispensable to virtually all fields of technological advancement. Undeniably, hi-tech chips are needed to develop revolutionary technologies, such as quantum computing and autonomous vehicles. U.S.-China relations may reduce intensity under the Biden Administration, although both nations are locked into protracted strategic competition. Indeed, the growth of American and Chinese spheres of independence could lead to an era of techno-nationalism, which would reshape capital markets and global commerce in the 21st Century.
Winning the battle for semiconductor supremacy will take more than brains, bucks, and diplomacy.
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