Should US Chipmakers Fear China’s Semiconductor Ambitions?

September 5, 2020 Updated: September 11, 2020

News Analysis

U.S. technology stocks suffered the biggest two-day loss since March on Sept. 3 and 4. Leading the way downward were U.S. chipmakers that underperformed the broader sector following the news that China is planning policy changes to boost its domestic semiconductor industry.

The stock drop suggests trepidation from investors. But despite Beijing’s will to build a homegrown semiconductor industry and China’s immense resources, progress is proving elusive.

Bloomberg reported on Sept. 3 that Beijing plans to invest heavily in third-generation semiconductor technology to combat the Trump administration’s export restrictions on semiconductors and other U.S. technology products. The report noted that education and research resources for semiconductors is a priority in the latest draft of Beijing’s so-called five-year plan. The plan will be presented to Chinese Communist Party (CCP) leaders in October, the outlet reported, citing sources with such insider information.

Third-generation semiconductors refer to advanced materials such as silicon carbide and gallium nitride that can support the fast speeds, small footprint, and high efficiency—compared to previous generation materials such as silicon—necessary for emerging technologies such as robotics, artificial intelligence (AI), and 5G.

This development is both a recognition of the importance of emerging semiconductor technologies for future development of China—especially in light of ongoing sanctions—as well as an admission that the battle may be lost on current-generation semiconductor technologies.

A Potential Opening

Global leaders in the current generation of semiconductors include U.S. chipmakers such as Intel, Nvidia, and Texas Instruments, Taiwan’s Taiwan Semiconductor Manufacturing Co. (TSMC), and South Korea’s Samsung. These companies make the chips that power computers, laptops, and smartphones. China is a relative latecomer to the industry, and most experts believe it’s about 5 to 10 years behind in terms of know-how and manufacturing capabilities, which is an eternity in the ever-evolving technology space.

But as technology pivots from smartphones into everyday household products and the application of AI and robotics become more commonplace, there is now a transition in semiconductor technology. China senses an opportunity to become a dominant player in the next phase. It does have a suitable environment—the CCP has been ramping up data collection on residents, and data is fast becoming the new tech currency.

U.S. incumbents have a head start in innovation and diversity of semiconductor research, but China’s will and resources are a credible threat. The Philadelphia Semiconductor Index dropped 6.6 percent on Sept. 3 and Sept. 4, an even worse showing than the Nasdaq Composite Index, which fell 6.2 percent during the same period. The tumble was led by the biggest names in the industry including Qualcomm, Intel, and Applied Materials.

In October 2019, China set up a 204 billion yuan ($29 billion) government-backed investment fund specifically to invest in the domestic semiconductor industry, and announced another $60 billion in funding commitment from municipal and provincial governments. Earlier this month, Beijing introduced tax incentives for domestic semiconductor companies, lasting for a decade, as long as they’re involved in the production of advanced 28-nanometer manufacturing processes.

Shanghai’s STAR market, a 1-year-old stock exchange that fashions itself as China’s Nasdaq, has raised funding for numerous indigenous chipmaker startups. Semiconductor companies account for 40 percent of all listed companies on STAR.

Total anticipated investment figures are hard to come by, but China’s total semiconductor investment will be massive. China plans to import $300 billion worth of semiconductors from abroad this year, according to remarks made by Wei Shaojun, vice chair of China’s Semiconductor Industry Association, at the online World Semiconductor Conference held in late August. That’s a staggering sum, and Beijing is keen to divert some of those resources internally.

Initial Stumbles

But China faces ongoing issues as it seeks semiconductor supremacy.

A semiconductor company in Wuhan, China, that was slated to become one of China’s most advanced chipmakers is on the brink of collapse due to mismanagement, according to a report by mainland business magazine Caixin, citing local authorities with knowledge of the situation.

Wuhan Hongxin Semiconductor Manufacturing Co. Ltd. (HSMC) had 128 billion yuan ($19 billion) in investment commitments and planned to make chips using 14- and 7-nanometer technology and smaller, which would be some of the most advanced on the market.

But a severe funding shortage was flagged in a July 30 Wuhan government work memo, according to the Caixin report. Unrectified, the funding gap would bring the project to a halt.

“The first phase of the project ran into trouble late last year when a dispute erupted between its owners and one of the engineers helping to build it,” the report stated. “As a result, a Wuhan court said the company could not use 55 acres of land where it was building its factory for the next three years, effective immediately.”

Another semiconductor manufacturing facility, in the city of Huai’an in Jiangsu Province, reportedly shut down earlier this year following the outbreak of the CCP virus, according to Caixin. Local governments had already sunk 4.5 billion yuan into the Huai’an project before it was shuttered due to a lack of private-sector funding.

These problems underscore the challenges of building semiconductor capabilities from scratch. It’s both costly and difficult to execute.

Fragmentation Versus Scale

The global semiconductor business consists of three distinct technological processes: design, manufacturing, and packaging. Only a few international giants have all three under one roof, such as Intel, Texas Instruments, and Samsung.

China currently has no such integrated manufacturers, which require investments in the hundreds of billions of dollars. A disaggregated business model that splits the processes has been more popular and cost-effective, with companies specializing in either fabless (design and sales) or foundry (manufacturing). Taiwan’s TSMC for instance, is a major foundry that makes chips for fabless companies such as Nvidia and Qualcomm. China has separate fabless semiconductor companies and foundries. State-owned Semiconductor Manufacturing International Corp., for instance, is China’s largest foundry.

At the recent World Semiconductor Conference—which was held in Nanjing in eastern China’s Jiangsu Province—Wei also raised China’s dependence on the disaggregated semiconductor business model as a red flag that can hold back its potential. To truly dominate the industry, China needs to raise its own Intel or Samsung.

One company that aspires to become an integrated manufacturer is the 3-year-old Yangtze Memory Technologies Co. Ltd., a NAND memory company based in Wuhan. It is managed by the notorious Tsinghua Unigroup, a unit of Tsinghua University, which has experienced its own management woes.

China faces deep systemic issues in growing its semiconductor industry. Despite the policy rhetoric, China’s semiconductor industry is extremely fragmented, as HSMC’s near collapse illustrates. Local and provincial authorities are racing to establish chip companies given it’s a focus of CCP leader Xi Jinping, and authorities know the political rewards of growing a national champion. This “chip rush” is also causing municipalities—already under massive debt burden—to further stretch their finances. Semiconductor equipment to produce high density wafers and transistors requires investments in the billions of dollars.

Municipalities from such far-flung locations as Liaoning Province in the northeast, Sichuan Province in the west, and Fujian Province in the southeast, have all jumped in. At the local and provincial level, systemic corruption and cronyism is another headwind.

These issues are challenging to overcome. Wei alluded to it in his address last month: China faces billions of dollars in fruitless spending it can ill afford. In the end, relative success stories like Yangtze are few and far in between.

As Intel and Samsung can attest, the semiconductor business is a business of scale.

Fan Yu is an expert in finance and economics and has contributed analyses on China’s economy since 2015.