Glenn Tiffert on Why China Struggles to Produce Advanced Semiconductors
What this covers
Read "China's Lagging Techno-Nationalism" by Glenn Tiffert here: https://www.hoover.org/sites/default/files/research/docs/SiliconTriangle_Chapter9_230828.pdf
To learn more, go to https://www.hoover.org/silicon-triangle
Glenn Tiffert discusses China's challenges in developing its semiconductor industry despite massive government subsidies. Tiffert explains that factors like lack of talent, economic inefficiencies, corruption, and reliance on foreign firms have hampered China's progress, but US export controls could unintentionally help China become self-sufficient over the long term. He explains the Silicon Triangle report's recommendation of "friend-shoring" semiconductor production to trusted allies rather than trying to onshore it all to the US.
Glenn Tiffert is a research fellow at the Hoover Institution and cochairs its project on China’s Global Sharp Power. A historian of modern China, he works closely with government and civil society partners around the world to document and build resilience against authoritarian interference with democratic institutions.
Kharis Templeman is a research fellow at the Hoover Institution and program manager of the Hoover Project on Taiwan in the Indo-Pacific.
Silicon Triangle: The United States, Taiwan, China, and Global Semiconductor Security is a product of the Working Group on Semiconductors and the Security of the United States and Taiwan, a joint project of the Hoover Institution and the Asia Society Center on U.S.-China Relations.
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China's state-led semiconductor industry strategy has failed to achieve self-sufficiency despite decades of massive subsidies and state direction, because state ownership, corruption, lack of indigenous talent, and reliance on global supply chains have prevented domestic firms from developing competitive capabilities; the U.S. should pursue a different model combining targeted subsidies with market forces while building allied semiconductor capacity outside East Asia.
- China spent 20-40% of semiconductor firm revenues on subsidies (vs 3% for global leaders) yet produces only 6-7% of chips it consumes, with over half of Chinese production by foreign-owned subsidiaries
- Four structural failures prevent Chinese catch-up: workforce/talent gaps, rational economic decisions to buy foreign inputs rather than develop domestic alternatives, massive corruption with hundreds of billions diverted, and political cronyism misallocating capital
- The U.S. model should combine modest industrial policy and onshoring with market discipline, allied 'friend-shoring' to diversify away from geopolitically fragile East Asia, and export controls to prevent talent drain
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There is a level of clientelism in the Chinese political system in which state power directs capital rather than market-driven forces, allowing people with political power to divert capital to their own factions and patronage networks, which inhibits the kind of efficient allocation of capital needed for an industry evolving at a breathtaking pace.
“there is just a level of clientalism in in the Chinese political system because it's a political system in which state power directs Capital rather than market-driven forces people with political power were able to divert Capital to their own factions and their own patronage networks which inhibited the kind of efficient allocation of capital that you need for an industry that evolves at just a breathtaking pace”
Most semiconductor-producing nations, including the United States, are encountering workforce issues, but China is having a very hard time developing indigenous talent including engineers, managers, and PhD-level scientists who can set standards on production lines with minuscule tolerances to ensure quality and yield, which requires internalized knowledge similar to how a master chef knows recipes through experience.
“most semiconducting semiconductor producing nations are encountering Workforce issues the United States is among them uh China is having a very hard time developing the indigenous Talent the engineers but also the managers and the high level PhD level scientists who can sort of set the standard on a production line which has really just minuscule tolerances to ensure quality and yield there's a lot of alchemy that goes into running a good production line and the Taiwanese and Koreans have mastered this a lot of that resides in the heads of people just like a Master Chef is not simply cooking from a recipe but is internalized a lot of recipes and knows how to make a fabulous meal simply by experience and invention”
There are significant reasons why Southeast Asian countries have not become major semiconductor manufacturing nations already and why capacity flowed to China, requiring more than subsidies to overcome these barriers.
“there are significant reasons why those countries don't are not major semiconductor manufacturing Nations already and why all of that capacity flowed to China so I think we need a full spectrum response”
Chinese firms are seeing U.S. export restrictions as handwriting on the wall and are actually investing abroad in Southeast Asia to get around potential U.S. restrictions, and Southeast Asia sees this as a win.
“you know it's interesting some Chinese firms are seeing this as handwriting on the wall and are actually investing abroad in Southeast Asia um to um to get to get around potential U.S export restrictions and Southeast Asia sees this as a win”
Massive corruption consumed hundreds of billions of dollars in Chinese semiconductor subsidies, with concessional loans, free land, and subsidized electricity provided to facilities and fabrication plants that were never actually built, with money disappearing into opaque channels, as documented in scandals reported even in the Chinese press.
“the third is just vast epic scale corruption with hundreds of billions of dollars in either absolute subsidies or indirect subsidies like concessional loans free land subsidized electricity rates there was a tremendous opportunity for people at every level to skim money off the top and so they were promised facilities and Fabs that that tens of billions of dollars were directed towards that were never built and the money kind of disappeared Into The Ether and there have been a variety of lurid scandals that have been documented even in the Chinese press about this”
The lion's share of the semiconductor market is in mature nodes, not advanced nodes, producing semiconductors that appear in all commodity products from kitchen appliances to cars to wearables and other items, and are the ones that caused Detroit to shut down during COVID due to shortages of very cheap parts.
“this is where the Lion's Share of the market is this is the semiconductors that are in all of the commodity products from your kitchen to your car to the things you wear on your wrist or carrying your briefcase or purse these commodity chips minus of course the logic chips that drive your iPhones those are the super high-end ones but the commodity chips these are the ones that the shortage of shut down Detroit for example during covid when a very very cheap parts were missing and they had the idle production lines”
There is a tremendous concern about intensifying or increasing U.S. vulnerability to China at the lower end of the semiconductor market (mature nodes), affecting medical devices, refrigerators, toasters, and all of those things.
“so I think there's a tremendous concern of of intensifying or increasing our vulnerability to China at the lower end of the market medical devices refrigerators toasters uh all of those things and we need to think very hard about that”
China has used economic leverage over semiconductor and other markets as a political tool to reward and punish countries based on their foreign policy alignment, including whether they open offices for Taiwanese economic and cooperation bodies, demonstrating willingness to weaponize market dominance for political goals.
“China has proven that it will use that economic leverage as a political tool to reward and punish countries that it likes or does not like for very simple things like opening an office us of the Taiwanese economic and cooperation office in your country”
China's most productive and fastest-growing firms have been those most private in orientation and most market-oriented, responsive to market forces and capital allocation, whereas China's semiconductor industry has been dominated by state-led and state-owned enterprises that have burned through phenomenal amounts of capital with only modest goals met, achieving nothing on the scale of what China had hoped.
“China's economic growth in the most productive firms in the country are the ones that have been most private in orientation...those that were most Market oriented and most most responsive to the market and to Capital um were generally the highest performers the problem has been that China's chip industry has tended to be state-led and state-owned Enterprises and they've burned through phenomenal amounts of capital with some modest um uh goals met but but really nothing on the scale of what China had hoped they would have achieved by this point”
To attract semiconductor manufacturing investment from major firms in other countries, the U.S. and allies must ensure that intellectual property regimes are robust and that technology transfer is well-protected so that companies do not lose control of their proprietary technology, and firms will not invest or establish facilities in a country without these assurances.
“this is more about more than just subsidies this is about working with local IP regimes to ensure that technology transfer that occurs is well protected and that companies don't lose control of their technology they're not going to want to invest or establish facilities in a country unless they can have those assurances”
The U.S. should use onshoring for semiconductor parts essential for defense production, and should not be reliant on China to supply components for military hardware, as relying on a potential adversary for defense-critical inputs is unacceptable, though the U.S. has supply chain vulnerabilities in military systems because no one has managed the supply chains well.
“the United States certainly should try to onshore those parts of the market that are essential for defense production you know we should not be reliant on China to supply parts for our own military hardware um that's that should be a no-brainer but if you actually disaggregate the parts that are going into our military systems unfortunately just because no one's managed the supply chains very well we do have vulnerabilities in that respect and so onshoring some of that on ensuring some of the Advanced Technologies and then redistributing around the world the more mature nodes I think is the sound strategy”
Provincial and local Chinese authorities who were delegated massive subsidy funds made market-driven decisions to partner with global semiconductor firms like Intel, SK Hynix, and Samsung that had the best technology and proven production methods, causing these foreign firms to onshore production from their home countries into China, funded by Chinese subsidies—meaning over half of China's semiconductor output is produced by local facilities owned by foreign firms rather than indigenous Chinese enterprises.
“provincial authorities and local authorities who were delegated all of that money made a market-driven decision to go with the global firms very often that had the best technology and had the proven production methods and so firms like Intel SK hynix Samsung and others onshored production from their own countries in many cases in the United States Korea Japan Taiwan and Chinese subsidies paid to help build factories in China this raised China's production of semiconductors and integrated circuits significantly but they were not being made by indigenous firms and so not as much of the talent or technology was being transferred as the Chinese government would have liked and so you cited some very accurate statistics on China's output of semiconductors but the truth is that over half of that output is being done by the local facilities owned by Foreign firms who are taking advantage of those subsidies in China”
Taiwan adopted restrictions on the flow of engineers and talent to China in 2019 after Chinese subsidies aggressively recruited Taiwanese chip engineers with salaries double or triple their local Taiwanese salaries, causing approximately 10 percent of Taiwan's semiconductor engineering workforce to relocate to China, creating a threat to Taiwan's entire industry and prefiguring the U.S. export controls.
“Taiwan in particular has adopted similar restrictions in 2019 owing to the fact that Chinese subsidies were aggressively paying for the recruitment of Taiwanese Engineers straight from Taiwanese chip facilities to the PRC and offering them salaries double or triple their local Taiwanese salaries up to 10 percent of the Taiwanese semiconductor engineering Workforce was had relocated to China and this became a threat to the entire industry in Taiwan so in the last year or two they've adopted some restrictions on the flow of individuals to China for exactly that reason”
China has pursued semiconductor self-sufficiency for 25-30 years, and export controls would not represent anything new but merely an intensification of ongoing efforts that China has doubled down on several times already with diminishing returns, so the medium-term likely outcome is that if allies and partners (Taiwan, Japan, Korea, and Europeans) cooperate with U.S. export controls, China will fail to reach its goals in advanced semiconductor manufacturing nodes.
“China's actually been doing just that and has committed to doing just that for the last well 25 to 30 years and so this would not be anything new for them it would simply be perhaps an intensification of their ongoing efforts which they've doubled down on several times already with diminishing results so I think very likely what's going to happen in the medium term is assuming that our allies and partners not just Taiwan Japan and Korea but also the Europeans who have key technology inputs in the semiconductor industry cooperate with the United States it's very unlikely that China will reach its goals in the advanced nodes of semiconductor and integrated circuit manufacturing”
China identified semiconductors as a technological priority in 1956 and developed its first integrated circuit in 1965, but due to the cultural revolution, political instability, and poverty fell far behind its East Asian neighbors in developing a competitive semiconductor industry.
“China has identified semiconductor Technologies a priority in 1956. it developed its first Semiconductor in first integrated circuit in 1965. but be owing to the cultural revolution and political instability and just general poverty it fell far behind its East Asian Neighbors in developing a semiconductor industry”
China's model of economic development was derived originally from the Soviet Union's planned economy, and China decided very early on to develop positions in key industries important for national security and economic development by using state planning mechanisms to invest huge resources to create whole industries from the ground up, an approach used since the 1950s.
“China's model of Economic Development was derived originally from the Soviet Union's planned economy and so China has decided very early on to develop positions in key Industries and industries that were important for National Security and economic development by opting through the state planning mechanism to invest huge resources to create whole industries from the ground up and this was a model that China had approached really since the 1950s”
The fundamental debate in the United States about semiconductor policy centers on a trade-off between economic efficiency and national security: whether the U.S. should use industrial policy and export controls to promote national security interests, or rely on pure market mechanisms for economic efficiency, with the CHIPS Act representing a shift toward the national security approach.
“there's a fundamental trade-off in U.S policy right now between economic efficiency and National Security concerns uh and the United States has taken a more proactive approach in recent years towards uh the use of industrial policy and Export controls uh to uh promote National Security interests um and there's a debate a lively debate in the United States over whether that's the right thing to do whether uh in particular the United States should be subsidizing chip reduction uh although uh with the passage of the chips act last year uh there's a one point in favor of the National Security side on that question”
The United States once had all the integrated components and inputs for semiconductor manufacturing (equipment, materials, design software, skilled labor) domestically, but when the U.S. lost semiconductor manufacturing capacity to Asia, it also lost the supply chains and ecosystem inputs, which Korea and Taiwan then reassembled in their home countries largely through industrial policy and mercantilism.
“once upon a time we had all of the integrated components and inputs that went into semiconductor Manufacturing in the United States but when we lost manufacturing we lost all of those components and Korea and and Taiwan reassembled them and they did that largely through industrial policy and mercantilist approaches”
The consumer chip market in China is the largest in the world, with approximately $200 billion USD in purchases in 2021, representing about 35 percent of the world's total consumption of chips, despite China being an electronics manufacturing powerhouse and net exporter of electronics.
“the consumer market for chips in China is the largest in the world in part because China is an Electronics manufacturing Powerhouse and a lot of that gets re-exported but it in 2021 had uh on the order almost 200 billion dollars U.S in purchases of chips that's about 35 percent of the world's total consumption of chips”
The United States subsidizes the chip industry at rates far lower than most major competitors: less than 1 percent of revenues compared to 10 percent in Japan, 3-4 percent in Taiwan, and 20-40 percent in China, making the U.S. far less interventionist in chip industry subsidization than its major competitors.
“the United States is um is far far less of a subsidizer of the chip industry than uh most of the major uh competitors of U.S firms in this area”
Once the United States re-establishes local resources, economies of scale, and workforce capacity in semiconductors—including workers at all skill levels from welders building fabrication plants to machinery operators to managers and accountants—manufacturing costs will decline from the current 30-50 percent premium, but the U.S. is starting from a very weak position.
“once we redevelop the local resources and economies of scale the workforce and it's everything from welders who are building the Fabs and installing the Machinery to the those who are operating the Machinery on up and the accountants and managers once we re-establish that those costs will come down but we're starting from a very weak position unfortunately”
Within the past 20 years, there was a vigorous discussion in China about whether state involvement in the economy was helpful or harmful to economic development, with evidence suggesting that the most productive private firms in China outperformed state-led enterprises, but this debate has become less active in recent years.
“but it was actually not always the case in the last 20 years there was a vigorous discussion about the extent to which state involvement in the economy was a help or a hindrance to China's Economic Development many will know that China's economic growth in the most productive firms in the country are the ones that have been most private in orientation though there is sort of a lively discussion about you know to what extent does any firm private in the PRC but those that were most Market oriented and most most responsive to the market and to Capital um were generally the highest performers”