How semiconductors became the flashpoint in the US-China rivalry

What are semiconductors?

Also known as microchips or integrated circuits, semiconductors are made from silicon, and consist of millions or billions of transistors that act like miniature electrical switches that flip on and off to process data such as images, radio waves, and sounds. They are practically inside every essential product of the modern world — from household appliances to sophisticated defence systems, mobile phones to cars, toys to high-end luxury products.

In his book ‘Chip Wars’, economic historian Chris Miller describes the importance of these microchips as follows: “We rarely think about chips, yet they’ve created the modern world. The fate of nations has turned on their ability to harness computing power. Globalisation as we know it wouldn’t exist without the trade in semiconductors and the electronic products they make possible.”

How did semiconductors become a flashpoint between the West and China?

Until relatively recently, the critical importance of semiconductors was not commonly known or realised outside the tech ecosystem and its enthusiasts. The coronavirus pandemic that broke out in early 2020, changed this. Lockdowns around the world brought the microchip industry to a standstill. Both the supply and demand of these chips were disrupted as factories shut, and the demand for laptops and computers shot up dramatically with people switching to work from home.

The following year, the situation worsened after a series of mishaps, such as a fire at a Japanese microchip-manufacturing facility, and led to a further scarcity of semiconductors. The sum of these events didn’t just shed light on the importance of microchips, it also exacerbated tensions between the US and China, which were already embroiled in a trade and technological conflict — Washington had imposed sanctions on Chinese telecommunications giant Huawei in 2019, citing a national security risk.

The shortage of semiconductors made both countries realise their dependency on Taiwan, the world leader in manufacturing microchips. Taiwan produces more than 60 per cent of semiconductors globally, and more than 90 per cent of the most advanced ones. The US’s share of the market is only around 12 per cent and European nations together account for just 9 per cent. In 2021, Reuters reported that “more than 90% of semiconductors used in China are imported or manufactured locally by foreign suppliers”, with Taiwan being a “critical supply” source.

But Taiwan remains a hugely contested territory. Although it has been governed independently of China since 1949, Beijing sees it as a “renegade province”, and has vowed to unify it with the mainland, using force “if necessary”. America, quite apart from its perceived obligation to uphold the ideals of democracy everywhere, fears that if Beijing were to invade or blockade Taiwan in the near future, it would result in an immediate cutting-off of the supply of the bulk of the semiconductors used in products around the world.

There is a related concern for the West. China aims to make the People’s Liberation Army (PLA) a “world class” military by 2049, the centenary of the Chinese Communist Party’s rule. The plan involves developing autonomous weaponry, including hypersonic missiles, and using artificial intelligence (AI) for applications that include electronic warfare — all of which are heavily dependent on microchips. Hence, it doesn’t come as a surprise that China, as scholars like Miller have pointed out, now spends more money each year importing chips than it spends on oil.

Washington is clearly anxious worried. Miller told Verge in a recent interview: “The US is thinking about next-generation military and intelligence systems that will increasingly rely on artificial intelligence. AI systems are trained in vast data centres that are full of sophisticated chips like GPUs, which are the type of chips that are used to train AI systems.

“If you can’t mass manufacture cutting-edge chips, then you can’t get the data centre capacity that you need to train AI systems. The US is ultimately trying to accomplish stopping China from developing advanced data centres.”

Washington has resorted to various ways to choke the supply of semiconductors and related technology to Beijing. In January, after weeks of lobbying by the US, Japan and the Netherlands agreed to tighten shipments of their most high-tech machinery to China. Parallely, the US has stepped up its investments in semiconductor manufacturing facilities. In August 2022, it passed the landmark CHIPS and Science Act, providing $280 billion in new funding for domestic research and manufacturing of semiconductors in the country.

How did Taiwan emerge as the leader of the semiconductor industry?

Taiwan’s rise as a foremost semiconductor manufacturer is quite recent. Earlier, the US dominated the sector for decades after World War II. It was in the US that transistors, the key component in semiconductors, were developed. The US also pioneered the design and production of microchips by making them smaller, cheaper and more powerful.

However, facing tough competition from East Asian rivals such as Japan, South Korea, Hong Kong, and Singapore, the US, during the 1990s, decided to offshore manufacturing to Taiwan and South Korea, which provided cheap labour, to regain its competitive advantage.

This primarily helped in the expansion of Taiwan Semiconductor Manufacturing Company Limited (TSMC), founded by Morris Chang in 1987. Chang — a Harvard, Stanford, and MIT graduate — had strong relations with the US chip industry, and his customers were American chip designers.

“The founding of TSMC gave all chip designers a reliable partner. Chang promised never to design chips, only to build them… TSMC’s business boomed during the 1990s and its manufacturing processes improved relentlessly. Morris Chang wanted to become the (Johannes) Gutenberg of the digital era. He ended up vastly more powerful,” Miller writes in his book.

Today TSMC has around 55 per cent of the global market for contract chip fabrication, far more than OPEC’s 40 per cent market share for oil, a 2022 report by Time magazine said. The company also produces around 90 per cent of the most advanced processor chips that are used in smartphones and computers and advanced data centres.

During the Cold War, the Soviet Union tried to set up its own version of Silicon Valley. But they failed because, according to Miller, they focused only on “vast espionage campaigns” to copy American microprocessors that ultimately produced substandard semiconductors.

The Europeans too dabbled with microchip technology — largely unsuccessfully, with one notable exception, the Netherlands. Unlike Taiwan, the Netherlands, through its ASML company, began producing advanced lithography tools, which generate EUV (extreme ultraviolet) light and use it to manufacture semiconductors. Currently, ASML is the only firm in the world which produces such tools, without which making an advanced chip isn’t impossible — one of the reasons why the US asked the Netherlands to curb the company’s export to China.

What happens in the chip war now?

Although Beijing produces 60 per cent of the world’s germanium and 80 per cent of gallium, experts believe the restrictions on their export won’t have a major impact as some other countries also produce these metals, and their substitutes are available as well.

Germanium and gallium are mostly used in computers, defence, and renewable energy technology. While germanium is important for low-carbon technologies such as solar cells, semiconductor wafers made by using gallium arsenide instead of silicon can run at higher frequencies and are heat resistant, according to Wafer World Inc., a leading American company.

While the consequences of China’s move may not be severe, it does serve as a warning to the US and its allies that it has enough retaliatory options to stop them from imposing further curbs on Chinese access to semiconductors and the technology to build them. It also highlights the possibility of exacerbation of the ‘chip war’ with more tit-for-tat restrictions.

In the meantime, the future of Taiwan hangs in the balance. Under President Tsai Ing-wen’s “New Southbound Policy”, the Taiwan is trying to shift its trade and investment from China to countries in Southeast Asia, South Asia, and Australasia. It is also deepening economic ties with the US and other Western nations — TSMC, in December 2022, announced that it would open its second chip plant in Arizona, raising its investment in the state from $12 billion to $40 billion.

Yet, until last year, China continued to be Taiwan’s top trading partner. China accounted for around 25 per cent of Taiwan’s total exports and about 20 per cent of total imports that year. A hot war over Taiwan between China and the US will have global consequences that will be likely bigger than the ongoing Russia-Ukraine war.