Exposing China’s Semiconductor Vulnerabilities

COMMENTARY Asia

Exposing China’s Semiconductor Vulnerabilities

Aug 18, 2022 4 min read
COMMENTARY BY
Min-Hua Chiang

Research Fellow and Economist, Asian Studies Center

Min-Hua is a research fellow and economist in the Asian Studies Center at The Heritage Foundation.
Chips by Tsinghua Unigroup are seen at the 2020 World Semiconductor Conference in Nanjing in China's eastern Jiangsu province on August 26, 2020. STR / AFP / Getty Images

Key Takeaways

After investing billions of dollars in developing the semiconductor industry, China has not yet been able to reduce its reliance on importing advanced chips.

The investigation into corruption is just one part of a series of troubles exposed in China’s semiconductor industry after the U.S. export restrictions took effect.

When the import of foreign technology was ended, the internal deficiencies were revealed like a domino effect.

The CEO of Chinese tech company Tsinghua Unigroup has become the latest in a number of Chinese executives under investigation in connection with corruption of the so-called Big Fund.

The China Integrated Circuit Industry Investment Fund, established in 2014, is used to develop China’s semiconductor industry. Its turmoil points to a critical Chinese weakness.

Chinese President Xi Jinping has good reason to be angry about the performance of the fund. After investing billions of dollars in developing the semiconductor industry in the past decade, China has not yet been able to reduce its reliance on importing advanced chips produced by other countries.

Instead, the reliance on foreign chips has been growing. According to World Trade Organization statistics, China’s trade deficit in integrated circuits and electronic components (including Hong Kong’s trade deficit) has almost doubled from the equivalent of $135 billion in 2010 to $240 billion in 2020.

The growing trade deficit in integrated circuits reveals one crucial fact: Achieving technological self-reliance is still a faraway Chinese dream. To keep its exports growing, China has no other way but to keep importing advanced chips to assemble into consumer goods with high-tech intensity (e.g., smartphones, tablets, and the like).

Although China (including Hong Kong) is also the largest exporter of semiconductor chips in the world, less than 7% of chips produced in China were made by Chinese semiconductor companies in 2021.

More than 90% of chips produced in China are made by foreign firms. In other words, China’s exports of semiconductor chips are overwhelmingly dominated by foreign companies.

Its inferior level of technology is the main reason for China’s chip reliance on foreign firms. While Chinese firms are stuck with advancing toward 7nm chips, the Taiwan Semiconductor Manufacturing Co. and Samsung are progressing towards mass production of 3nm chips this year. Intel plans to take over TSMC’s leading role in semiconductor technology by 2025.

The competition among a few tech giants in the U.S., Taiwan, and South Korea is clear, and the Chinese firms are not likely to jump into the global technology competition in the semiconductor industry anytime soon.

The U.S. restrictions on exporting chipmaking equipment to China’s largest semiconductor firm, Semiconductor Manufacturing International Corp., have not only deterred China’s technological advancement, but also exposed the fundamental mismanagement problems inside China’s semiconductor industry.

Xi might not have noticed his industry’s poor performance had China been able to continue to produce chips with foreign equipment.

The investigation into corruption is just one part of a series of troubles exposed in China’s semiconductor industry after the U.S. export restrictions took effect.

In 2021, Tsinghua Unigroup filed for bankruptcy after years of massive investment through acquisitions without generating income. That same year, two other prominent chip producers in China—Wuhan Hongxin Semiconductor Manufacturing and Quanxin Integrated Circuit Manufacturing—suspended operation and dismissed their staffs after the government fund was used up.

There are numerous similar failures among other chip companies in China.

Several Taiwanese executives leaving China’s semiconductor industry last year is another major setback in the development of China’s semiconductor industry.

China not only spent tremendously on building chip plants and purchasing expansive equipment, but also on recruiting talent from overseas. Over the past few years, China recruited more than 3,000 skilled workers from Taiwan to work in China’s semiconductor industry.

China amassed enormous capital, talent, and foreign equipment, but the problem is with governance. Xi’s absolute authority encouraged a rush into China’s semiconductor industry. Moreover, the extraordinary integration of the public and private sectors in China has twisted industrial development toward short-term profit-making, instead of long-term accumulation of manufacturing strength and technological improvement.

Xi’s “wolf warrior” diplomacy has further overshadowed the outlook of its semiconductor industry. China’s success relies on close partnerships with various suppliers and customers in different countries across the globe. Alienating them on the geopolitical front only undermines those relationships.  

The U.S. ban on exporting chipmaking machines to China was the straw that broke the Chinese semiconductor industry’s back.

On top of that, the CHIPS and Science Act  just signed into law  bans semiconductor companies receiving U.S. government subsidies from investing in China for the next 10 years. There are major loopholes in that prohibition, but if Congress can manage to keep the administration’s feet to the fire—including by tightening the legal restrictions—it could have a major impact on China’s tech development.

In addition, the U.S. has extended the export restriction to 14 nm chipmaking machines to the Semiconductor Manufacturing International Corp. and other foreign chipmakers in China. A specific electronics design automation software for making advanced chips is also banned from exportation to China.

Without foreign investment and inputs, China is only likely to deepen its reliance on importing advanced chips from overseas.

The Chinese leadership has spent 10 years to learn that its dream is essentially built upon technological inputs from abroad. When the import of foreign technology was ended, the internal deficiencies were revealed like a domino effect. Consequently, the dream has become a nightmare.

The U.S. export restrictions have just accelerated the disclosure of China’s internal vulnerability.

This piece originally appeared in The Daily Signal