All About the Chips: Taiwan is Next Battleground for Trade Fight
Vital tech production could put the island back at the center of intensifying Sino-American relations.
The media likes to dabble in war-game fantasies between the 21st-century great powers China and the U.S., but it’s a distraction from the hybrid economic warfare that is underway—from Trump’s tariff hikes to the shores of the advanced economy.
Here in a nutshell is the problem facing the United States. The country that used to be a world leader in all forms of high tech, especially semiconductor chips, now spends its time redesigning chocolate chips. By contrast, Taiwan, officially a “rogue province of China,” but in reality operating as an independent nation of 23 million people, ranked 20th as a world economy (right behind Switzerland), is now a leading global player in the production of semiconductor chips. As such it has emerged as the key supply link to a multiplicity of American and Chinese high-tech companies at a time when the Trump administration is working hard to cut China’s access to Taiwan’s semiconductors.
For all of China’s significant technological advancements, the country still lags in the production of semiconductor chips.
Memory chips are principally made by Samsung, SK Hynix (South Korea), and Micron (USA). Intel also makes some memory chips for its own use. Memory chips are a big issue for China. Beijing has deployed considerable fiscal resources into producing them and last year set a goal of producing 5 percent of the world’s total production by the end of 2020.
That’s ambitious. It’s one thing to produce memory chips, another to get a usable “yield,” i.e., the percentage of output that actually works. It is a singularly challenging industry in which to attain industrial self-sufficiency.
Taiwan Semiconductor Manufacturing Company (TSMC) is a “fabless chip maker” that produces customized semiconductor chips for use in various types of electronics, such as digital cameras, smartphones, and the new technologically sophisticated “smart” cars. They also produce chips for the military, and for 5G base stations. China’s leading telecom equipment manufacturer, Huawei, was a large customer, but the Trump administration has now mandated that all semiconductor chip manufacturers using U.S. equipment, IP, or design software will require a license before shipping to Huawei, which has forced TSMC to stop taking fresh orders from Huawei, as it uses U.S. equipment in its own manufacturing processes, such as LAM research and Applied Materials.
The wisdom of so many companies relying on manufacturing facilities located in Taiwan is debatable. Intel and Micron locate fabs around the world, in part to diversify risk (earthquake, weather, politics) and to access skilled labor pools. Intel has long had production facilities in Ireland, Israel, and China itself; it has also purchased Israeli companies for their research and development. But it also has retained significant production facilities still in the United States. Similarly, Micron has fabs in Boise Idaho, Utah, and Manassas, Virginia (right near the CIA and Pentagon.)
TSMC is important because it is pretty much the only place to get processor chips fabricated, unless you’re Intel. In that regard, Intel’s recent 2nd quarter earnings announcement that its planned launch of the company’s next generation of chips will be delayed by six months is most concerning. News of the production delay (which now pushes the production of the company’s latest central processing unit (CPU)—aka the “brains” of the laptop—out to early 2023) generated considerable market anxiety, as evidenced by the 17 percent fall in the share price in the wake of the disclosure. From a long-term perspective, however, the more alarming aspect is Intel’s decision to consider outsourcing its manufacturing capacity, a sharp break from the company’s historic practice.
Intel has been one of the few leading American high-tech companies that has hitherto largely resisted the panacea of offshoring its production. Much of this is a product of the corporate culture established by former CEO Andy Grove, who had warned that Silicon Valley risked “squandering its competitive edge in innovation by failing to propel strong job growth in the United States,” according to a New York Times op-ed by Teresa Tritch written shortly after his death. Tritch explains that:
in [Grove’s] view, those lower Asian costs masked the high price of offshoring as measured by lost jobs and lost expertise…
Mr. Grove contrasted the start-up phase of a business, when uses for new technologies are identified, with the scale-up phase, when technology goes from prototype to mass production. Both are important. But only scale-up is an engine for job growth—and scale-up, in general, no longer occurs in the United States. “Without scaling,” he wrote, “we don’t just lose jobs—we lose our hold on new technologies” and “ultimately damage our capacity to innovate.”
Intel’s decision comes at a time when American policymakers are finally beginning to appreciate the adverse economic and strategic consequences of such moves. Were Intel to follow through on its outsourcing threat, it too would further exacerbate America’s strategic reliance on Taiwan for customized semiconductor manufacturing, as well as undermining the impact of recent legislative attempts to rebuild the country’s semiconductor manufacturing capacity.
By contrast, economic competition that degenerates into out-and-out war would be a disaster for all sides. As David Arase, resident professor of International Politics at the Hopkins-Nanjing Center of the Johns Hopkins University School of Advanced International Studies, recently contended in the Asia Times, “Even an unsuccessful invasion of Taiwan would cause a supply chain disruption.” By the same token, actively upgrading diplomatic relations with Taiwan to something akin to the old mutual defense treaty that existed prior to Washington’s recognition of Beijing in 1979 as the one sovereign government representing China, would almost certainly provoke a more aggressive response from Beijing.
U.S. goals should be far more modest: not to underwrite the freedom aspirations of another country (even a vibrant multi-party democracy such as Taiwan) but, rather, to fix a key vulnerability in the global supply chain that currently renders the U.S. so reliant on Taiwan. Even TSMC has implicitly acknowledged its own geographical shortcomings, as it has recently announced plans to build a new $12 billion chip manufacturing facility in Arizona. Consider this a form of political risk insurance.
A full-scale defense of Taiwan would cost thousands of lives, and potentially entrench the U.S. military in a long-term quagmire; it would also represent a logistical nightmare in terms of supplying such a force over so many thousands of miles (versus an opposing Chinese army a mere 100 miles away.) To say nothing of the risks posed to numerous substantial American multinationals already operating in China.
A key conceptual problem that our policymakers and business leaders have today is an addiction to 19th-century concepts that are anomalous in the context of a 21st-century economy. David Ricardo’s “comparative advantage”—that “refers to an economy’s ability to produce goods and services at a lower opportunity cost than that of trade partners”—has less relevance at a time when such advantage can be largely created as a byproduct of state policy. Countries such as Taiwan, South Korea, and now China itself, can dominate targeted industries by subsidizing them aggressively. Because of increasing returns to scale, there is a winner-take-all pattern in which, at any given time, one nation tends to dominate a huge global market share of the underlying product—since the 1970s, Japan, South Korea and China in that order. It also creates huge employment opportunities in high-quality jobs for the countries as they scale up production. This was also a key insight of Andy Grove.
None of these countries had a natural “comparative advantage” in semiconductor production; they just followed the classic pattern of subsidizing their growth via substantial government support, relentlessly driving down cost inputs to push other marginal manufacturers out of the industry.
The incessant focus on market share usually comes at a cost of short-term profitability (a no-no for Wall Street, which focuses on quarterly earnings as intently as an audience waiting for the white smoke to emerge from a papal election). However, businesses usually recoup these costs later once they’ve established dominant market share.
Semiconductors are a high value-added manufacturing platform industry that has a significant multiplier effect on the domestic economy. It represents an area that should be prioritized by the U.S., not de-emphasized (as Intel’s proposed move threatens to do). The road back to manufacturing relevance is a long one, but the perpetuation of the current policy risks exacerbating longstanding pathologies in the U.S. economy, while simultaneously creating new national security vulnerabilities.
Taiwan is a vibrant multiparty democracy that constitutes a model of economic development. But those virtues could be threatened if we try, shortsightedly, to turn it into a U.S. protectorate to address problems that should be resolved much closer to home.
Marshall Auerback is a market analyst and contributor to the Independent Media Institute.