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Semiconductor manufacturing.
The semiconductor battle is heating up
Global semiconductor supply chains have some big resistance points that threaten to make microchips a macro-geopolitical flashpoint. On Tuesday, US President Joe Biden will visit Taiwanese chipmaker TSMC’s facility in Arizona, where he'll spotlight the White House’s efforts to ramp up US chip manufacturing amid the US-China chip race.
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In technology, as in geopolitics, a little resistance can make all the difference. Consider semiconductors, the nearly invisible microchips essential for running everything from our computers to our cars to our cruise missiles. They work by doing something deceptively simple: They use carefully calibrated resistance to slow the flow of electricity through a circuit in ways that make computing possible. The smaller they get the more powerful our devices become.
The trouble is, global semiconductor supply chains have some big resistance points of their own, choke points that threaten to make microchips a macro-geopolitical flashpoint.
America’s Democrats and Republicans don’t agree on much, but there’s a consensus at the top of both parties that Chinese advances in digital technologies, especially in supercomputing, threaten US national security. In particular, supremacy in quantum computing by one country could make it impossible for another to encrypt government and personal communications and data. US tech firms, increasingly shut out of Chinese markets, share these worries.
For now, the US is believed to have a significant technological edge over China, and Washington wants to keep it that way. That helps explain why the US has used export controls to deny Huawei and other major Chinese tech companies access to cutting-edge, US-made hardware and software.
But there’s a larger semiconductor-specific geopolitical problem for both the US and China: The vast majority of the world’s most powerful and sophisticated semiconductors are produced on the disputed island of Taiwan, which Beijing regards as a renegade Chinese province and which Washington, despite carefully crafted diplomatic language, still treats as a de facto independent nation.
The company at the core of the semiconductor question is the Taiwan Semiconductor Manufacturing Company, TSMC, a $550 billion company that holds about half the global market for semiconductors and produces about 90% of the most advanced chips. Headquartered on Taiwan's north coast, TSMC sits at the geographic heart of the tensions that divide America and China, and its strategically vital product will only become more essential to the smooth functioning of the global economy as computing power grows exponentially and more digital products are connected to the Internet of Things.
Political leaders in China and the United States know that if a military confrontation shut down TSMC, a shortage of semiconductors would cripple dozens of economic sectors in both countries and in every region of the world. They also know they need to make themselves less vulnerable by sharply increasing the percentage of advanced chips manufactured within their borders. Finally, both know this ambition will be enormously expensive for many years.
Many in Taiwan see TSMC as a “platinum shield” that protects the island’s security because China can’t force Taiwan to unify with mainland China without risking a war with the United States that might destroy the company, which Beijing considers a strategic prize.
China’s leaders also know that the production of semiconductors depends as much on human expertise as on machinery and state-of-the-art factories. Murmurings of a Chinese attack on Taiwan – even just a naval blockade – could create a massive tech brain-drain of the most talented engineers, who might flee the potential battleground for a warm welcome in the West.
For all these reasons, China can’t move on Taiwan until it has much more confidence that it can control what happens to TSMC and the semiconductor industry.
For better and for worse, the Taiwan chip dilemma creates a kind of digital-age mutually assured economic destruction that has so far helped limit the risk that US-China tensions create real conflict.
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Will a “silicon shield” help protect Taiwan?
Tensions between Taiwan and China rose to new highs this summer after US House Speaker Nancy Pelosi’s controversial visit to the island prompted a week-long series of Chinese military maneuvers that were even more threatening than usual. China has pledged to retake what it sees as a breakaway territory — through invasion if necessary — and viewed the trip by a top US official as an affront to its sovereignty.
As China asserts its claims to Taiwan more aggressively, the island’s population has grown increasingly averse to reunification. Yet there are powerful reasons for China not to invade Taiwan — not least the fear that America, the island’s longtime ally, would come to its defense. US ties to Taiwan have grown even closer in recent years as it has come to dominate the global production of semiconductors, tiny silicon connectors that serve as the brains of modern electronics.
We asked Xiaomeng Lu, a director in Eurasia Group’s geo-technology practice, to explain how chips fit into Chinese and US calculations toward Taiwan.
How important is Taiwan for the world’s electronics industry?
A single company, TSMC, produces more than 90% of the world’s smallest and most advanced semiconductors, which are used to power high-end servers and sophisticated AI applications. Taiwan is also home to MediaTek, a leading manufacturer of smartphone chipsets; ASE Group, which provides semiconductor assembly and testing services; and GlobalWafers, which makes silicon wafers. Other important Taiwan firms include PC makers ASUS and Acer, as well as contract manufacturers Foxconn, Pegatron, and Wistron. The island’s manufacturing capacity plays a critical role in the global electronics supply chain.
What would be the impact of a Chinese invasion?
Modern semiconductor manufacturing is a complex global ecosystem in which different companies around the world have different specializations. A Chinese invasion would cut Taiwan off from that ecosystem, severing the real-time connections it relies on for things like product designs, materials, chemicals, and equipment. Even in the best-case scenario for China of a rapid, successful invasion in which it gained control of the island without much fighting, international sanctions would probably prevent China from obtaining many key inputs from overseas required to produce chips.
Yet as Russia’s attempt to take over Ukraine has shown, such a move is fraught with risk and uncertainty. An invasion of Taiwan by China would be even more complex, given the body of water separating them. Many semiconductor production facilities are located in areas where China is likely to land troops, so chipmaking offices and factories could unintentionally suffer collateral damage. A prominent Chinese economist affiliated with the government recently said that occupying TSMC factories would be a top priority for China in the event of an invasion. But Taiwan, potentially with US assistance, might choose to destroy them itself rather than let them fall into the hands of China.
How do these risks affect China’s calculations?
Recent events in Hong Kong show that China is willing to inflict damage on a high-performing economy, if necessary, to achieve longstanding political goals. The wrinkle in the case of Taiwan is that its high-tech products – especially its semiconductors – are key to China’s ambitions to establish itself as a global leader in emerging technology areas. Cutting-edge chips support, for example, space and biology research; exposure to advanced technology also offers Chinese engineers the opportunity to acquire new skills.
As a result, China has aimed to maintain commercial ties with TSMC and avoid any measures that would harm it or the broader sector even as its relations with Taiwan and the US have deteriorated. Following Pelosi’s visit, China slapped several sanctions on Taiwan, including a prohibition on the export of Chinese sand for use in the island’s semiconductor industry. This was a purely symbolic measure, however, as Taiwan chip manufacturers do not use Chinese natural sand in silicon wafer production but high-purity quartz sand, primarily obtained from the US.
How worried is the US?
US Commerce Secretary Gina Raimondo recently said the loss of access to chips from Taiwan would cause a “deep and immediate recession” for the world economy. The current global chip shortage, caused by pandemic-related disruptions, provides a small taste of what a semiconductor supply chain crisis may look like.
Pelosi’s visit to Taiwan included meetings with top semiconductor executives including TSMC Chairman Mark Liu and founder Morris Chang. Pelosi reportedly discussed with them the recently passed CHIPS+ Act, which offers $52 billion in support for semiconductor production. The US has been encouraging TSMC to expand its operations in the US to strengthen ties with the company.
Observers have referred to Taiwan’s unique status in the semiconductor industry as a “silicon shield” that both discourages Chinese aggression and encourages US backing for the island.
How has the Taiwan semiconductor industry navigated escalating geopolitical tensions?
Though TSMC has tried to maintain good relations with China, it has moved closer to the US to maintain access to its technology and political alignment with Taipei. The company has committed to building a $12 billion advanced semiconductor plant in Arizona and has expressed interest in receiving CHIPS funding to cover some costs.
However, TSMC has resisted pressure to shift its most cutting-edge production technology to the US, citing concerns such as commercial feasibility, talent shortage, and cultural issues. It is also likely responding to Taipei’s concerns that doing so could erode US resolve to come to Taiwan’s defense in the event of an attack. Nobody on the island wants to weaken the “silicon shield” protecting it.
What We're Watching: Truckers wanted & not-so-cheap chips
Where are all the truck drivers?
The global truck driver shortage has been disrupting already-out-of-whack supply chains, particularly in the US, the European Union, and Britain – further complicating their post-pandemic economic recoveries. Last year, the American Truckers Association said it was around 80,000 drivers short, while in Europe, a deficit of 40,000 truckers has contributed to long waits and empty shelves.
What’s going on? The pandemic has upended the way we work. Trucking is an arduous and ungratifying gig: Drivers often spend days or weeks far away from home, and they don’t get paid for hours spent waiting for goods to be loaded and unloaded. The road can be grueling, the compensation is underwhelming, and the benefits are often … nonexistent. In the US, trucking salaries have plunged in recent decades. Median wages for truck drivers in 1980 were about $110,000 annually (adjusted for inflation); in 2020, they were just $47,130. Unsurprisingly, many truckers are opting for jobs with better conditions and pay, so trucking firms in Europe and the US are struggling to lure drivers back to work and recruit new staff. It’s particularly grim in the UK, where supply side frictions have been exacerbated by Brexit. In the US, meanwhile, companies like Walmart are fighting back by offering massive salary hikes to attract truck drivers. Will it get the wheels turning?
Chipping away at supply chains
The US Congress this week passed the behemoth CHIPS and Science Act, which ponies up $52 billion in subsidies and incentives to boost domestic production of semiconductors, the invisibly thin microchips that are essential for everything from phones, cars, and factories, to fighter jets, cruise missiles, and artificial intelligence. With the bill, Congress is making a big move in a new global “Chips race” for dominance of the industry: the EU is now spending close to $50 billion on the same thing, and China, which still depends on the US and its allies for inputs into its home-grown chips, has poured hundreds of billions into some day becoming a semiconductor superpower itself. For all three of the world’s largest economies the concern is the same: the semiconductor market is highly concentrated, particularly in Taiwan, which produces more than 60% of the world’s chips. That’s a problem commercially – in 2021, there was a global shortage after tech firms gobbled up the entire supply, leaving automakers scrambling for chips. But it’s also a problem geopolitically. China doesn’t want to be dependent on chips from a Taiwan that’s allied with the US, while the US and EU don’t want to rely on a Taiwan that could be taken over by China any year now. Critics of the US CHIPs act say its a sop to powerful tech companies that can well afford to build their own factories, and there are questions about whether the money will be spent on the right things: making the chips is one thing, cutting edge R&D is a whole other bowl of chips, and the supply chain for a single chip can pass through many countries before final assembly. As a cautionary tale: the EU aimed in 2013 to double its share of global semiconductor production to 20% by 2020. It didn’t work.
The geopolitics of the chips that make your tech work
Why may a drought in Taiwan perhaps screw up your next computer purchase?
For one thing, the island is one of the world's top producers of semiconductors, which bind the electrical circuits in the tech we use in our daily lives. Cell phones, laptops, modern cars, and even airplanes all rely on these tiny computer chips. For another, Taiwan is now suffering its worst climate change-related dry spell in almost 70 years. This is a problem because Taiwanese chip factories consume huge amounts of water.
The wider issue, though, is a pandemic-fueled worldwide chip shortage that began way before it stopped raining in Taiwan, has wreaked havoc on entire sectors like the US auto industry, and is shaking up the increasingly contentious geopolitics of global supply chains.
COVID upended supply/demand. In the early stages of the coronavirus pandemic, auto makers around the world assumed people quarantining at home would probably buy fewer cars, so they ordered fewer semiconductors. Meanwhile, other companies were scrambling for all the chips they could get their hands on for personal computers and video game graphics cards, which have been flying off the shelves during COVID lockdowns.
A year later, car manufacturers have been forced to halt assembly lines because they can't get hold of chips for anti-lock brakes, air bags, navigation, and in-car entertainment systems. Sales of the products that locked up the inventory of semiconductors are booming.
So, why don't we just make more? Because it's not that easy. Semiconductors are highly specialized products that rely on global supply chains that have been severely disrupted by COVID. If one part is missing or late, you can't make the chips (this is precisely what happened with broken supply chain links after the 2011 Fukushima disaster.)
The US is the top global producer of semiconductors but consumes most of its own chips, while China — by far the biggest consumer — makes a lot itself and gobbles up most of the supply from South Korea, Taiwan, and India. Very little is left over for other customers from the rest of the world.
What are the US and Europe doing about it? Americans and Europeans were already thinking about ways to reduce their reliance on cheap Asian chip suppliers before the recent shortages hit — they're both teeing up tens of billions of dollars in subsidies to entice the world's leading suppliers to build advanced facilities within their borders, like Taiwan's TSMC in Arizona.
The current squeeze, which has cost Ford and General Motors a combined $4.5 billion in losses, has increased the political urgency for President Biden and Congress. But ramping up domestic production of semiconductors in the US and Europe will be immensely expensive, and will take too long to address the current shortfall.
Meanwhile, the Chinese are burning through cash to get a bigger slice of the global semiconductor pie. Chips are so essential to feed China's tech beast that last year Chinese firms spent over $35 billion in ramping up production, four times more than in 2019.
Beijing cannot afford to rely on foreign suppliers in its race with the US to dominate artificial intelligence or quantum computing. They don't want to go through hoops like Huawei, which was forced to stockpile chips following Trump trade war-related US export restrictions on Taiwanese semiconductor.
Taiwan is the big kahuna. One of the (many) reasons President Xi Jinping is pushing harder than ever to annex Taiwan is the self-governing island's outsized chip manufacturing capacity. TSMC alone makes more than half of the chips outsourced by all foreign companies, which means your iPhone runs on Taiwanese-made semiconductors. If China were to someday reunify Taiwan with the mainland, it would become such a chip juggernaut that it could bend individual countries to its will by controlling supply — as the Chinese often do with their rare earth metals.
The US, for its part, has its own clear interest in propping up Taiwan as a global chip-making power. Taiwanese-made semiconductors are cheaper than those produced on US soil, and the more are sold to the US and its allies, the less China gets.
But if climate change makes not only droughts but also earthquakes and typhoons more frequent in Taiwan, global chip shortages will become a recurring problem — and geopolitical power struggle — for the entire world.
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