A Nexus of Technology and National Security

Semiconductors have become a core component of strategic technological competition between the United States and China. Advanced semiconductors in high-performance AI computing chips power weapons simulations, data analysis, and threat modeling. As a result, semiconductor supply-chain security has become a national security priority for both the US and China. Both countries have deployed publicly funded subsidies and investment to bolster domestic production and expand fabrication capabilities.

The Offshoring of American Dominance

Semiconductor fabrication requires enormous factories and highly controlled clean rooms. Advanced production also uses High-NA Extreme Ultraviolet lithography systems priced near US$400 million per unit. Back during the 1980s, the US accounted for more than half of global semiconductor sales revenue. Early semiconductor innovation in the US received significant funding from the US Department of Defense. These federal funding streams gave the US government significant leverage to restrict global access to semiconductors. However, within the space of just 10 years, from 1990 to 2000, 48% of American semiconductor manufacturing capacity was offshored. Much of this production moved to East Asia, due to lower costs and a nevertheless skilled labor pool.

A Fragile Global Supply Chain

With support from the Taiwanese government, Taiwan Semiconductor Manufacturing Company (TSMC) expanded advanced fabrication facilities in Taiwan through major investments during the 1990s. As a result, TSMC now dominates modern high-powered computer chip manufacturing. Meanwhile in Europe, the Dutch company ASML is the exclusive producer of EUV lithography machines used in semiconductor manufacturing. While American companies like NVIDIA and Intel remain major participants in chip design, the US accounts for only about 12% of global semiconductor manufacturing capacity. Private sector control of the design and fabrication industry in America led to rapid growth and investment driven by market incentives. However, because semiconductor firms profit heavily from overseas sales, restricting exports to geopolitical rivals of the US has been difficult to enforce. As American military hardware became increasingly reliant on complex computer chips, and Chinese intellectual-property theft became increasingly common, this became a major concern of US policymakers.

American Strategy: Sanctions

In recent years, the US government has used a strategy of domestic production expansion and export controls to engage in semiconductor competition with China. In April 2018, the US levied export controls on advanced semiconductors to China by blocking Chinese telecom company ZTE from accessing American technology. In 2019, the Trump Administration pressured the Dutch government to restrict Chinese access to ASML’s lithography machines. In 2022, the US government imposed export controls on cutting-edge domestic chip designs to Chinese firms. In addition to these export controls, the US ramped up enforcement efforts in 2023 by expanding bilateral export restrictions with Japan and the Netherlands. It also revised export-control thresholds for advanced chip products. These changes affected American companies such as NVIDIA and Applied Materials, whose modified products had remained eligible under earlier rules.

American Strategy: Subsidies

Two months before the Biden Administration introduced its sweeping October 2022 semiconductor export controls, President Biden signed the 2022 CHIPS and Science Act into law. The Act incentivized and funded semiconductor manufacturing and research within the United States. It also encouraged foreign firms, including TSMC, to construct fabrication plants in the US. While the investment is projected to increase America’s share of global semiconductor manufacturing to 28% by 2032, the reshoring of chip manufacturing is expected to be gradual. Even with federal subsidies, an analysis by McKinsey & Company points out that US manufacturers continue face high upfront costs. They also cite higher energy and wage costs, along with shortages of specialized workers.

China’s Localization Drive

China accounts for more than 50% of global semiconductor consumption. Onshoring production from foreign nations is not only a policy priority for the US, but likewise a primary state objective of China. Xi Jinping’s 2015 “Made in China 2025” program outlined the goal of mobilizing state resources to increase global technological competitiveness. A key element of this plan was to localize production of 50% of China’s domestic market demand in semiconductors and chipmaking equipment by 2020.

Growth in Chinese Mature-Node Production

In China, state investment has enabled rapid progress in the production of mature-node semiconductors. From 2015 to 2023, Chinese domestic mature-node manufacturing rose from 19% of global market share to 33% of global production. China’s growth was largely enabled by low costs in chip manufacturing compared to the US and European countries, even with similar subsidy policies. Labor inputs, which account for nearly a third of the annual cost of chip fabrication in America, are four times cheaper in China than in the US. Manufacturing input costs for annual mature nodes are estimated to be 10% less in China than in Taiwan, due to government support and lower margins. This has enabled Chinese state-backed firms to grow domestic mature-node manufacturing at a rate four times greater than the increase in global demand.

Complications to Chinese Advanced Chip Independence

Despite their labor cost advantage and state support, Chinese firms such as SMIC and Hua Hong Semiconductor have struggled to produce advanced semiconductors. Facing export controls and a lack of economies of scale, the cost advantages for Chinese firms are significantly reduced. Furthermore, the restrictions on EUV lithography machines have proven to be especially detrimental. EUV machines are vital in the production of 7-nanometer and smaller computer chips used for high-powered computing. Despite controls on EUV access, Chinese firms including SMIC and Huawei produced 7-nanometer chips in 2023 using multi-patterned deep-UV lithography. While this demonstrates the ability of Chinese firms to bypass US restrictions, Chinese firms still face significant hurdles. Huawei’s fabrication process required nearly four times as many lithography steps as with an EUV machine. The complexity of manufacturing has resulted in SMIC’s advanced chips being significantly more expensive and much less reliable than TSMC’s chips.

A Silicon Shield?

Taiwan’s dominance in advanced chip fabrication is likely to continue for decades, reinforcing the idea of a “silicon shield“. This theory, coined first by Craig Addison, argues that international reliance on Taiwanese semiconductor manufacturing deters military conflict over the island. A 2022 confidential report commissioned by the Semiconductor Industry Association (SIA) on the impacts of a conflict over Taiwan supports this theory. The SIA projected that if a conflict severed access to Taiwanese semiconductors, economic output in China and America would decrease twice as much as during the 2008 financial crisis. As a means of supply chain risk reduction within a broader strategic competition, China and the US are set to continue investing billions into domestic production.