The chip war is costing China and the West hundreds of billions

In Japan meanwhile, TSMC is investing more than $US20 billion to build chip factories, with some minority investments from Japanese companies and more than $US3 billion of support from the government.

Japan has also provided more than $US1 billion of funding for flash memory chip plants being built by Western Digital, a US company. Rapidus, a new government-backed entity, and America’s Micron Technology are also building chip factories with government support.

There are a number of reasons for the massive government interventions in the semiconductor market, with China and its ambitions at the forefront.

Semiconductors are essential for most technologies, whether for consumer products or the military. Yet one company, TSMC, manufactures about 90 per cent of them.

Whether it’s China’s openly stated ambition of absorbing Taiwan, by force if necessary, or its location in an earthquake-prone region – it was hit by a 7.4 magnitude event last week – that creates a massive point of vulnerability for the global economy and for the US and Europe, given China’s larger ambitions, its increased military capabilities and the multiplying tensions and potential flash points between China and the West.

The pandemic and the disruptions to global supply chains it generated – including a severe shortage of semiconductors that had a particularly significant impact on the global auto industry – underscored the vulnerabilities created by an over-reliance on a single manufacturer.

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The re-shoring of chip-making capabilities (the US once had a market share approaching 40 per cent) is a key part of the larger effort by the US and its allies to reduce their reliance on China, where TSMC, some US companies and China’s own are major manufacturers of relatively low-end chips while constraining China’s own efforts to compete in more advanced technologies.

The US has imposed a raft of sanctions on Chinese companies and shut off access to sensitive US intellectual property and technologies while also pressuring its allies – the EU, Japan and South Korea – to do the same.

It pressured the Netherlands to ban sales to China of the most sophisticated chip-making machines made by ASML, the dominant manufacturer of the machines needed to make the leading-edge chips.

It has asked Japan and South Korea to restrict their technology sales to China of high-end logic and memory chips while also asking its allies to limit their servicing of chip-making equipment in China. South Korea is a major producer of chips and spare parts for the machines that make them.

China has its own goal of achieving semiconductor self-sufficiency and has been adding to its previous $US150 billion of subsidies with new tax credits and subsidised funding. It lags the West, however, in designing and manufacturing the more advanced chips – it’s several generations of technology behind what is a continually moving target.

It stockpiled semiconductors and manufacturing equipment in recent years to get ahead of the US sanctions but doesn’t have access to the chip-making tools needed to produce the 2 nm chips that are the current frontier of the technology and which will power the next generation of artificial intelligence. It takes tens of thousands of advanced chips to train one of the latest AI models, like GPT4.

Artificial intelligence will be central to future economic development and military supremacy, hence America’s efforts to deny China access to cutting-edge chip technologies.

The Americans did get a shock last year when Huawei unveiled a new smartphone last year powered by an advanced 7 nm 5G-capable chip. That set off a scramble by the Americans to find out how China had managed to develop a chip that, while several generations behind the US, was more advanced than America’s sanctions were designed to allow.

It appears that the chips and equipment China stockpiled in advance of the layers of sanctions played a role in the development and manufacturing of the chip, but China’s Semiconductor Manufacturing International Corp (SMIC) is reported to be close to mass production of a new 5 nm chip developed by Huawei.

It appears that the technologies used by SMIC are not the most sophisticated or efficient – it can’t get access to the leading edge ASML machines – which means that the chips will be costly. SMIC is said to charge up to 50 per cent more for its chips than TSMC.

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Its yields – the proportion of useable wafers produced by the fab – are also said to be only about a third of TSMC’s, raising a question mark over not just their competitiveness but the viability of production.

China is, however, playing a long game for very high stakes and will inevitably subsidise its semiconductor sector indefinitely.

Given the unexpected rate of progress it has already made in the face of the deepening sanctions and the scale of the funds it is deploying to build its domestic capabilities, it can’t be underestimated. The chip war might be an endless one.

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