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Nigel Inkster

Emily S. Weinstein

John Lee

September 1st, 2022

Ask the Experts: Is China’s Semiconductor Strategy Working?

1 comment | 28 shares

Estimated reading time: 8 minutes

Nigel Inkster

Emily S. Weinstein

John Lee

September 1st, 2022

Ask the Experts: Is China’s Semiconductor Strategy Working?

1 comment | 28 shares

Estimated reading time: 8 minutes

China’s “Made in China 2025” strategy aims to vastly increase domestic semiconductor production, but the plan has struggled to meet its targets and the chipmaking industry has come under increased scrutiny in recent months. LSE IDEAS China Foresight asked several experts to answer the question “Is China’s semiconductor strategy working?”. Nigel Inkster, Emily S. Weinstein and John Lee have responded below.

 

Nigel Inkster

China has developed a series of initiatives designed to reduce dependence on western technologies and in particular to promote an indigenous microprocessor sector. One driver for this is cost. In 2021 China spent US$ 432 billion on imported microprocessors, equivalent to total expenditure on grain and crude oil imports. The other more compelling imperative is the progressive deterioration in US-China relations and the fear that the US will exploit its dominance of the sector to deny China access both to advanced microprocessors and the equipment need to make them.

China’s own microprocessor industry now manufactures significant quantities of microprocessors at the less advanced production nodes, i.e. 24 nanometers upwards (the nanometer is the measure of the gap between etched circuits on a silicon chip). But China is still a long way from being able to produce microprocessors at the most advanced production nodes, now 5 and soon to be 3 nanometers. The production of these advanced nodes is dominated by two corporations. The Taiwan Semiconductor Manufacturing Corporation (TSMC) and South Korea’s Samsung.

China’s continuing difficulties speak eloquently to the challenges of unwinding the complex global supply chains behind microprocessor manufacture

Production at these advanced levels requires huge investments and access to complex global supply chains producing chemicals at high levels of purity and lenses, mirrors, valves and tubes engineered to the highest levels of precision. And it requires access to sophisticated Electronic Design Automation tools and Deep or Extreme Ultraviolet Lithography tools. Both are dependent on US IP which gives the US government the right to determine who can purchase them. The Dutch company ASML has a monopoly on the production of Extreme Ultraviolet Lithography tools needed for the most advanced production nodes and the US has refused to allow these to be sold to China.

One of China’s major microchip foundries, the Semiconductor Manufacturing International Corporation (SMIC), having previously said that it planned to maximise the production of less advanced microprocessors, has just announced that it will begin manufacture at the 7 nanometer production node. But it transpires that SMIC have, so to speak, gone about this the long way round, using Deep Ultraviolet Lithography tools which it has been able to stockpile to expose the silicon to light three or even four times in contrast to the once needed for Extreme Ultraviolet Lithography. It is doubtful whether this process can ever be commercially competitive.

Meanwhile it has become evident that China’s flagship initiative for promoting indigenous microprocessor manufacture, the China Integrated Circuit Industry Investment Fund (aka the Big Fund), is in deep trouble. Set up in 2014 and backed by the Ministry of Finance, the Big Fund has received over US$ 40 billion of capitalisation. And earlier in 2022 a review conducted by Vice-premier Liu He confirmed that there was little to show for this investment. Those heading the fund are now under investigation for corruption. This failure has been replicated in provinces and municipalities many of whom have capitalised start-ups often headed by individuals with no background in the industry, resulting in a series of failures.

None of this is to say that China’s efforts at indigenisation have been a total failure. The higher nanometer production nodes that China is able to produce are critical inputs for many industries. And China has come up with some innovative methods for financing innovation such as Shanghai’s STAR hi-tech stock market. But China’s continuing difficulties speak eloquently to the challenges of unwinding the complex global supply chains behind microprocessor manufacture. China is not the only country wrestling with these challenges.

 

Emily S. Weinstein

Over the past decade, the Chinese government has doubled down on its efforts to develop and indigenise its semiconductor industry. This emphasis stems from a concern among People’s Republic of China (PRC) leadership that China has been too reliant on foreign firms for access to advanced commercial semiconductors and semiconductor manufacturing equipment (SME). Beijing’s push for chip dominance has indeed yielded some success in recent years; however, due to lack of access to critical intangible expertise, China is likely to remain behind the United States and other key allies in this supply chain.

Several national-level policies have emphasised a need to improve China’s domestic chip capacity to remedy the country’s overreliance on foreign technology. The infamous “Made in China 2025” strategy, released in 2015, laid out an ambitious set of goals for China’s SME localisation, including achieving 70 percent self-sufficiency in semiconductors by 2025. In August 2020, the PRC released the “Notice on Several Policies to Promote the High-quality Development of the Integrated Circuit Industry and Software Industry in the New Era.” This seminal document outlines important government incentives—financial and otherwise—at the local and national levels to improve semiconductor R&D, talent, education, and more.

Similar to Japan in the 1980s, China maintains a growing semiconductor industry and a large domestic market.  However, where Japan had the advantage of a younger industry, China has found itself in the position of having to break into a difficult industry

Has all this effort paid off? To some extent, yes. According to the Semiconductor Industry Association (SIA), while China held only 7.6 percent of the market for global chip sales in 2020, that number is growing fast, and the PRC is making significant progress thanks to its growing domestic market. Semiconductor device sales in China jumped from $13 billion in 2015 to $39.8 billion in 2020. Furthermore, the size of China’s homegrown chip industry has grown exponentially. In 2011, China had just under 1,300 registered chip companies; by 2020, this number grew to 22,800.

Despite these gains, China’s semiconductor industry still lags behind. Similar to Japan in the 1980s, China maintains a growing semiconductor industry and a large domestic market.  However, where Japan had the advantage of a younger industry, China has found itself in the position of having to break into a difficult industry and catch up to the leading edge chips at or below 14nm, and rumors indicate that the U.S. government is considering broader export controls targeting capabilities at 14nm and below. China also lacks the “decades, if not centuries” of experience and tacit knowledge needed to replicate extreme ultraviolet (EUV) photolithography machines necessary for developing chips at or below 5nm, presenting a critical obstacle for China in progressing its chips to the most advanced nodes.

Despite these impediments, Chinese domestic chip companies are still pushing forward, albeit with limited success. Last month, Bloomberg News reported that China’s SMIC had allegedly produced a 7nm chip using a manufacturing process similar to that of Taiwan’s TSMC—the firm with the most advanced chip manufacturing capabilities. However, experts are sceptical that SMIC can produce these 7nm chips at scale to compete globally. In addition, if the U.S. and other allies relevant in the chip supply chain decide to enact further export controls, China will likely face more challenges in bolstering its domestic chip industry.

What China lacks in terms of logic chips it appears to have made up for in the memory chip industry. Manufacturing NAND flash memory chips is less technologically difficult than manufacturing logic chips and also does not require EUV photolithography equipment. As such, China’s chipmakers like YMTC who specialise in this industry face fewer hurdles than China’s logic chipmakers.

In sum, Beijing’s semiconductor push has clearly proven productive. However, China’s domestic industry still has a long way to go in competing with long-standing globally dominant players.

 

John Lee

China has fallen short of the benchmarks for semiconductor import substitution that it set for itself in the notorious ‘Made in China 2025’ development plan of 2015. For instance, instead of 40% of the nation’s integrated circuit demand being met by China-located production in 2020, the actual figure was around 16%, most of which was accounted for by foreign (including Taiwanese) firms. This number is projected to remain below 20% by 2025, compared to the 2015 goal of 70%.

This reflects less a failure in execution than the goals’ unrealistic ambition. The semiconductor value chain is a transnationally distributed process of highly specialised steps with high entry barriers. No nation can expect to dominate the entire process, in contrast with less complex sectors like solar panels or rare earths refining where Beijing’s industrial policy has ‘brute forced’ Chinese firms to dominance. For semiconductors, more realistic and complementary policy goals are to help firms gain a foothold in higher value steps of the value chain, help firms upgrade technologically within their niche, and mitigate critical chokepoints that can be weaponised through export controls.

China has little prospect of achieving either dominance or self-reliance in semiconductors, but it is becoming a major player in this globalised value chain, a trend that US-led efforts are unlikely to derail

To date, Chinese state policy has had more success regarding the first two goals than the third. Investments by the ‘Big Fund’, the state-guided fund established in 2014 to drive semiconductor industry investment, have targeted the comparative advantages of Chinese firms and of China as an economy: chip design, trailing-edge fabrication, assembly test and packaging, and memory chips. Relatively little money has gone to the equipment sector that supports leading-edge fabrication, with European and Taiwanese firms still dominating these two value chain segments. Likewise, EDA software tools, dominated by three US-based firms, have received relatively little state support.

Dominance by foreign vendors creates chokepoints that have been targeted by US export controls and political pressure on allied governments, with an increasingly explicit goal to constrain development of China’s semiconductor industry. Such measures have material impacts on China’s technological and economic development. Huawei’s loss of access to Taiwanese semiconductor fabrication providers, for example, has slowed China’s national 5G infrastructure rollout.

In response the Chinese state has doubled down on support for import substitution, while China’s private sector is finally committing to the same goal as essential risk mitigation. The much-cited figure of a trillion-plus renminbi of forward investment into China’s semiconductor sector represents not just state-linked funding but the Big Fund’s anticipated multiplier effect, leveraging China’s boisterous stock exchanges and private equity market. Combined with demand created by end user industries – such as the fast growing electric and intelligent vehicle sector – this is fuelling China’s boom in chip design.

Enormous sums are inevitably wasted, with the recent disciplinary action against senior figures in China’s semiconductor sector suggesting malfeasance on a grand scale. But enough competitive businesses will likely emerge from this ferment to rebalance, although not transform, global markets. Even in older generation technologies like trailing-edge fabrication, growing concentration of capacity in China will have global market effects that other jurisdictions with semiconductor industry ambitions cannot ignore.

Chinese authorities hope that success in chip design will ‘drag along’ development of downstream processes, thereby upgrading the whole semiconductor ecosystem . This is complemented by long term state-led strategic R&D programs that have been slowly filling in critical technology gaps. For EDA software, most recently targeted by US export controls, analysts are now speculating that Chinese industry will make major progress on import substitution within several years.

China has little prospect of achieving either dominance or self-reliance in semiconductors, but it is becoming a major player in this globalised value chain, a trend that US-led efforts are unlikely to derail. Combined with China’s continuing central role in global electronics manufacturing and various emerging technologies, this portends a future in which Chinese technology is increasingly ubiquitous, at least among the great swathe of nations that do date have proved unwilling to ‘decouple’ from China’s economy.

 


This article gives the views of the authors, and not the position of the China Foresight Forum, LSE IDEAS, nor The London School of Economics and Political Science.

The blog image was generated using DALL-E.

About the author

Nigel Inkster

Nigel Inkster is Senior Adviser for Cyber Security and China at the International Institute for Strategic Studies (IISS) and a Director of Enodo Economics, a macro-economic consultancy specialising in China. He is a member of the LSE IDEAS China Foresight Forum.

Emily S. Weinstein

Emily S. Weinstein is a Research Fellow at Georgetown’s Center for Security and Emerging Technology (CSET), focused on U.S. national competitiveness in AI/ML technology and U.S.-China technology competition. She is also a Nonresident Fellow at the Atlantic Council’s Global China Hub and the National Bureau of Asian Research. In her previous role at CSET, Emily conducted research on China’s S&T ecosystem, talent flows, and technology transfer issues. She has written on topics related to research security, export controls, and China’s S&T developments in Foreign Affairs, Foreign Policy, Lawfare, DefenseOne, and other outlets. Emily holds a BA in Asian Studies from the University of Michigan and an MA in Security Studies from Georgetown University.

John Lee

John Lee is director of the consultancy East West Futures. He is also a researcher at the Leiden Asia Center, a consultant for the International Institute for Strategic Studies and Co-lead on the EU China Semiconductor Observatory. John’s research focuses on China and digital technology, in particular China’s cyberspace governance regime, the semiconductor industry and future telecommunications networks. Previously he was a senior analyst at the Mercator Institute for China Studies and worked at the Australian Department of Foreign Affairs and Trade and Department of Defence. He tweets @J_B_C16

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