Name: The Chip War With China Is Heating Up. Who’s Winning? | Growth Stories With IBD
Uploaded: 2024-12-06T11:55:09.000Z
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It wouldn't be an exaggeration to say that chips have become the world's most critical resource.

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These tiny and intricate silicon wafers can be found in almost every appliance we touch and are powering transformative technologies like artificial intelligence, electric vehicles, and advanced wireless networks. Pretty much everything from microwaves to the stock market runs on chips. The boom in innovation has turbocharged leading chip makers like NVIDIA to astronomical market caps. The VanEck Semiconductor ETF, which tracks semiconductor companies, has climbed 45% since the beginning of 2024 despite recent turbulence in the sector.

America has led the world in designing and building the most advanced chips in the market, but that position is being challenged as big manufacturing hubs like Taiwan and Korea rise in prominence. And massive government spending efforts in China to bolster its chip industry also threaten to upend the U.S.'s competitive advantage in the sector.

Policymakers have responded with subsidies to boost domestic chip makers and bring some components of production back to U.S. soil, but industry leaders say it will be a long road.

We are somewhere between a decade to two decades away from supply chain independence.

On this Growth Stories Spotlight, we speak to Chris Miller, economic historian and author of the book, Chip War, the fight for the world's most critical technology, to get his thoughts on the state of the industry and the race to reassert America's dominance over the global semiconductor sector. Chris, thanks so much for joining us today. Thank you for having me.

You give a comprehensive look at the chip sector and the rising tensions between the U.S.

and China in your book, Chip War. So how would you characterize the state of the industry right now?

I think the industry is simultaneously booming because of all the investment in AI, with data centers being built requiring more and more expensive semiconductors than ever before, but simultaneously being stressed by the U.S.-China political competition, which is restricting market access and adding new limits on who can sell which types of chips. And of course, China is one of the world's largest economies. And so it matters tremendously if U.S. companies are unable to sell certain products to them. And we saw that pandemic era shortages were really a wake up call for executives and policymakers and investors as well, about the importance of expanding or at least trying to bring back some chip manufacturing capabilities to American soil. And part of that effort resulted in the 2022 Chips and Science Act, which earmarked $39 billion in subsidies and gave investment tax credits to strengthen domestic chip production. So how would you say that program is doing and what sort of impact have we seen on the industry?

Well, I think it's undeniable when you look at the data that there's been a huge boom in investment in chip making facilities in the U.S., something like a 10 times increase over the last couple of years in investment relative to the prior trend. So that is evidence of success. That's exactly what Congress wanted when they passed the Chips Act. But I think it's also important to keep the scale in context because capital investment in this industry is so huge that even a major multi-billion dollar program like the Chips Act only moves things slowly. And so just to put some numbers on the table, the Chips Act, as you said, allocated $39 billion in capital expenditure over the next couple of years to subsidize chip manufacturing. But the largest chip company in the world, Taiwan's TSMC, spent almost that much money last year in capital investment in just a single year. And so that illustrates just how large the amounts are that you have to spend if you want to change where manufacturing is happening in this industry.

And you talked about that speed because that has been some criticism of this, the speed of getting money out there. You see a number of initiatives experiencing delays in the first year. Taiwan's one of those that delayed a second production facility.

But you say the volume of investment tells a different story there. So why is that? And what would you say to investors that are maybe concerned about a return on that investment?

I think, first off, in terms of the delays, I think the delays that we've seen have not really been about delays to government incentives because we've more or less known which companies are going to get how much, plus or minus a little bit. That's basically been clear from the early stages because the Commerce Department said they wanted to devote most of the money to leading edge manufacturers, of whom there are only three, and the rest to lagging edge. I think the delays that have existed have been because construction is hard, because workforce challenges exist, and those are difficult problems to work through. And they're being worked through now, but they just take time and they take money. I think when it comes to return on investment, from the government's perspective, their job isn't to think about return on investment. Their job is to think about insuring against the worst case scenario around losing access to manufacturing in Taiwan. And that's what the CHIPS Act is trying to do. For companies, their job, of course, is to think about return on investment. And they've had to balance the fact that they're getting new subsidies from the government in the US, but also costs are somewhat higher in the US.

So the long-term costs of running a facility need to be balanced against the subsidies. And I think all of the companies involved have been trying to find the right balance between the cost dynamics and also ascertain, are their customers willing to pay a bit more for that type of supply chain diversification? And we've seen US subsidies, but they pale in comparison to China. Beijing is basically doubling down and setting aside over $47 billion just this year to boost their chip industry. And we've seen a lot of talk about export controls and tariffs being used as the main policy tools to contain China's technological rise. But in your opinion, have they been effective and how has the industry really responded to that?

Well, I think to answer that question, we've got to differentiate between the most cutting edge semiconductors and the more mainstream foundational semiconductors. For the second category, China's got all the technology that it needs to produce these types of chips. And so export controls, limits on technology transfer to China really won't work in stopping China's progress. And that's where we've seen the bulk of China's money going is to building out factories producing mainstream chips. And I think the challenge here is just that China might flood the market in terms of certain segments of the industry, and that it's going to produce chips at very low prices because Chinese firms don't need to make money. And that's going to take market share from Western firms that have traditionally sold to customers in China.

So this is going to have, I think, significant impacts on the industry, especially market share in China. And that's where the US government is trying to impose some tariffs on Chinese chips coming into the US to make sure that Western firms face some protection from the really massive subsidies that as you say, China's imposing. When it comes to the most advanced chips, that's where

China doesn't have the technology right now. And in order to produce the most advanced chips, you need machines from the US, from Japan, and from the Netherlands to actually manufacture the chips. And those machines are currently illegal to sell into China. And that's where China's really facing challenges. And if you look at the production capabilities in China, they're about five years behind the production capabilities in Taiwan, which is the world's most advanced chip maker. And the US wants to keep it that way, wants to keep that gap so that US firms have an edge over their Chinese competitors. Now, you mentioned the foundational chips that are most likely going to be flooding the market. Do you think the industry has a plan to respond to that?

And if so, what do you think are some of the potential responses to protect that market share?

Well, I think there are really only certain categories where that's likely. When it comes to higher end chips, more sophisticated technologies, chips that need to be closely integrated with software, these are places where Western firms probably have a pretty good chance at fending off Chinese competitors because it's not solely about cost. It's really only at the bottom of the market and super commoditized products where cost really matters. And China's going to produce at lower cost, even if it's not more efficient, it's just the subsidies will enable lower prices. And firms that are competing in that segment need to worry, need to think hard about what their strategy is going to be. And I think more technological differentiation is in many cases going to be the answer. If you've got a technological edge, you don't have to compete on cost. And I think that's what Western firms are increasingly focusing on. I want to look a little bit at the supply chain because the tensions between the US and China are also reshaping how companies are approaching that aspect of their business.

And we've seen companies like Apple maybe considering decoupling their supply chains.

Is that how the industry is responding right now? Or is that a trend we could see more of in the future? I think the way I'd describe the trend is not decoupling, but is rather creating a China business for the Chinese market and a non-China business for the non-China market. The reality is that China is the second largest economy in the world and

Western firms are going to want to keep selling into China to the extent that they're allowed to do so and able to compete with domestic Chinese firms. It's just too large to ignore. But I think many companies are making sure that they've got a fairly separate supply chain for the non-Chinese market, at least separate in terms of critical components, and that they've got enough resilience that they can produce goods outside of China if they needed to. And so you mentioned

Apple. I think it's really striking the extent to which Apple used to produce almost every iPhone inside of China. And now it's really rapidly ramping up its manufacturing operations in India.

And I think most people underestimate the amount of investment and amount of progress that

Apple has made. And this is about diversification. It's not that Apple's going to stop selling iPhones in China or stop making iPhones in China, but they want options. They want more flexibility in case of future regulatory risks, either from the Chinese side or from the U.S. side.

You mentioned diversification. So is that how this is affecting investment patterns then for these big tech players?

Yeah, I think you certainly see that in the data. For example, the collapse of foreign direct investment in China has many causes, but one of them is that technology firms are investing more elsewhere in India, in Vietnam, elsewhere in Southeast Asia, because they want that diversification.

And they realize that although Southeast Asian India can't today replicate just the depth of the

Chinese ecosystem when it comes to electronics assembly and basic manufacturing, there's really substantial buildup happening in India and in Southeast Asia. Labor costs are in some case actually lower than in China, and diversification really matters. And so that's driving a trend of investment dollars flowing into these countries where in the past they would have flowed into China.

And I want to return to the U.S. because Intel is such a critical domestic producer of these chips.

And we've seen sort of the turn or at least attempted turnaround story. And I thought you did such a great job in your book kind of talking about the history of that company and how this isn't really the first time they've had to pivot. So I just wanted to get your thoughts on Intel and some of the changes that are happening with that company.

Well, I think Intel is trying to deal with three simultaneous challenges. Challenge one is to get their manufacturing capabilities back at the cutting edge on par with Taiwan's TSMC. And there it looks like they're having some real progress relative to where they were a couple of years ago.

The second challenge is that one of their key markets is data centers. And data center dynamics have changed dramatically over the past couple of years because of AI. It's benefited firms like

Nvidia, which produce slightly different types of chips than Intel. And that's been a challenge for

Intel because it's found its market share in data centers declining because it doesn't have the right chips focused on that AI. And then the third challenge is that Intel's trying to build up its manufacturing scale because you can't manufacture efficiently in the chip industry without scale.

And to do so it's opening a business to manufacture chips for external customers.

And that's a very expensive business to start up because you need to spend the money building the manufacturing capacity today and get the customers hopefully down the road. And I think investors are looking at this latter part of the business, understanding the huge cost that will be involved in the capital expenditure next couple of years, and not yet seeing the revenue and getting nervous about the financial implications of that. And so these are three challenging problems to deal with simultaneous. They're problems that have been created over the last decade. And so I think Intel's management team is right when they say they need some time to turn such a big ship around, especially because the time cycles in this industry are so long. It takes multiple years to build a single factory. And so I don't think you can measure the success of a turnaround in just a couple of quarters. You really need multiple years to ascertain whether, for example, Intel's new foundry business to manufacture chips for external customers, whether that's going to actually work. And so time is what Intel's management is asking for.

And I think the market is trying to assess how much time they're willing to give them.

Chris, thanks so much for your insights today.