Why the West Shouldn't Panic Over China's Chipmaking Boom

 

Despite China's aggressive investment in its semiconductor industry, Western policymakers' fears of market disruption from a flood of cheap Chinese chips may be premature due to the significant technological and economic challenges Chinese manufacturers still face.

China's hunger for homemade chips is insatiable. In May 2024, it was revealed that the government had launched the third iteration of its “Big Fund”, an investment vehicle designed to shore up the domestic semiconductor industry. The $48 billion ($48bn) cash infusion is aimed at expanding the manufacture of microprocessors. Its generosity roughly matches similar packages from America ($53bn) and the EU ($49bn), both of which are also trying to encourage the expansion of local chipmaking. Concerns that cheap Chinese semiconductors will flood the market may be premature.

China’s ambition to become a semiconductor powerhouse is not new. The country has long sought to reduce its dependence on foreign technology and ensure supply chain security for its burgeoning tech sector. The "Big Fund" initiative, now in its third iteration, exemplifies this strategic goal. Despite significant investments, Chinese chipmakers face substantial hurdles, particularly due to the U.S. government's export restrictions on advanced chipmaking equipment. These restrictions, imposed in October 2022, have effectively barred Chinese firms from accessing the latest technology necessary for producing cutting-edge microprocessors with transistors measuring a few nanometers.

Consequently, China's semiconductor industry has pivoted towards the production of less advanced chips, with transistors measured in tens of nanometers. These mature chips, though technologically behind, are critical components in a wide array of everyday electronics, including televisions, thermostats, refrigerators, and automobiles. According to TrendForce, a research firm, China is poised to account for over half of the planned global expansion in manufacturing capacity for these mature chips, with its share of total capacity expected to rise from 31% in 2023 to 39% by 2027.

The rapid expansion of China's semiconductor manufacturing capacity has undoubtedly alarmed Western policymakers. In April 2024, Gina Raimondo, the U.S. Commerce Secretary, warned that China's substantial subsidization of chip manufacturing could lead to significant market distortions. Both the U.S. and the EU have initiated reviews to assess the impact of China’s burgeoning semiconductor industry on critical infrastructure and supply chain security. Western chipmakers, worried about the potential glut of cheap Chinese semiconductors, fear downward pressure on prices, which could affect their revenues both domestically and in China, a major market for their products.

However, there are several reasons to temper these fears. For one, a substantial portion of China’s new semiconductor production capacity is likely to be consumed domestically. Chinese foundries like SMIC (Semiconductor Manufacturing International Corporation) and Hua Hong Semiconductor have seen a marked decrease in revenue from foreign customers, from nearly 40% in 2018 to just 20% in 2023, while their overall output has increased. This trend suggests that the bulk of China's semiconductor production is aimed at satisfying robust domestic demand rather than flooding international markets.

Despite significant investments, Chinese semiconductor manufacturers still lag behind their Western counterparts in terms of technology, design, engineering, and product reliability. This is particularly evident in the production of complex semiconductors such as microcontrollers and analogue processors. While Chinese firms have made notable strides, capturing around 12% of the domestic market for analogue chips between 2019 and 2021, their market share has since stagnated. By 2026, Bernstein, a broker, expects Chinese manufacturers to supply just 14% of the domestic market, leaving ample room for established Western producers like Analog Devices, Texas Instruments, and NXP to maintain their dominance.

Moreover, Chinese foundries face a cost disadvantage compared to their more established Western counterparts. Mature-chip manufacturers in the West often operate fully depreciated equipment, significantly lowering their unit costs. In contrast, Chinese firms, which are heavily investing in new capacity, must absorb the high costs associated with these investments, resulting in thinner margins and less capital for future growth. This economic reality suggests that even with substantial government support, Chinese chipmakers will struggle to achieve the same level of profitability and market penetration as their Western rivals.

The strategic implications of China's semiconductor ambitions are multifaceted. On one hand, the country’s focus on building domestic capacity for mature chips aligns with its broader goals of technological self-sufficiency and supply chain security. On the other hand, the global semiconductor landscape is characterized by rapid technological advancements and fierce competition, making it challenging for any single country to dominate the market comprehensively.

While the West should remain vigilant and proactive in safeguarding its technological and economic interests, fears of an imminent market disruption due to a flood of cheap Chinese semiconductors may be overstated. China's semiconductor industry, despite its impressive growth, still faces significant technological and economic challenges that will take years, if not decades, to overcome. As such, policymakers and industry leaders should focus on fostering innovation, enhancing competitiveness, and ensuring strategic collaborations to navigate the complexities of the global semiconductor market.

In plain terms, while China's chipmaking binge represents a significant development in the global semiconductor industry, the concerns about its potential to disrupt the market may be premature. The interplay of technological, economic, and strategic factors will shape the future of this critical industry, and it is crucial for all stakeholders to adopt a balanced and informed perspective.