Deep Dive on Semiconductors Market in China

Semiconductors are crucial components for most electronic equipment. Currently, China lags in this aspect because it does not have a prominent chip maker and depends on semiconductor technology from other countries.

For example, in 2020, Qualcomm supplied 4G chips to Chinese manufacturer Huawei despite the fact that Huawei is among the largest smartphone companies in the world.

China continues its efforts to come up with reliable innovations in this industry. Eventually, it wants to gain leadership in the semiconductor market. This is aligned with the country’s bid to become self-reliant instead of being dependent on external sources for its technology needs.

Importance of Semiconductors

A semiconductor also known as an integrated circuit, or computer chip is a tiny electronic device made of silicon or germanium that has billions of components storing, moving, and processing data. Semiconductors are essential for enabling modern technology and indispensable to industrial and national security activities. Semiconductors are also building blocks of other emerging technologies such as artificial intelligence, autonomous systems, 5G communications, and quantum computing.

For over 60 years, semiconductors have helped boost the US economy and have contributed to increased economic output and productivity and enabled new products, services, and industries. Yet, the semiconductor industry has low returns for new entrants and high barriers to entry. Specialist companies exist at every stage of the production process and most of them dominate their respective markets.

China’s Semiconductor Ambition

Chinese companies and other players depend on a globalized value chain, and they get supplies from other companies, but this dependence on overseas countries serves as a chokepoint for China's semiconductor ambitions.

In 2014, China started a plan for an integrated semiconductor industry with unprecedented scope and scale “with the goal of establishing a world-leading semiconductor industry in all areas of the integrated circuit supply chain by 2030” and meeting 70% of China’s semiconductor demand with domestic production by 2025.

How does China plan to achieve these? Its policies provide for a substantial and central role for the government in directing and financing Chinese businesses to obtain foreign IP related to semiconductors. The government plans to use production targets, subsidies, tax preferences, trade and investment barriers (including pressure to engage in joint ventures), and discriminatory antitrust, IP, procurement, and standards practices. The policies seek to further leverage China’s central role in global consumer electronics manufacturing and potential as a semiconductor production hub to incentivize and pressure foreign companies to localize production, share technology, and partner with the Chinese government and affiliated entities.

To implement its semiconductor plan, China created a government fund—the China Integrated Circuit Investment Industry Fund (CICIIF)—to channel an estimated $150 billion in state funding in support of domestic industry, state-directed overseas acquisitions, and the purchase of foreign semiconductor equipment. In October 2019, China announced a second semiconductor fund with an estimated capitalization of $28.9 billion.

China’s Supportive Policies

In 2020 and 2021, China again issued new policies to boost the development of its semiconductor industries. The new policies encourage research cooperation with foreign universities and companies, including joint ventures, technology licensing, and research partnerships. China’s Huawei is reportedly investing $1.2 billion in an optoelectronics R&D and production center in Cambridge, England. China is also turning to U.S.-led open-source technology platforms—such as RISC-V, the Open Compute Project (OCP), and the ORAN Alliance—as a vehicle for technology collaboration.

In an effort to advance rapidly in the industry, China has deployed a set of policies to encourage the return of expatriates, the hiring of specialized industry talent (particularly from Taiwan), and cross-border exchanges of expertise through formal agreements and exchanges. Under these policies, Taiwan has reportedly lost an estimated 3,000 semiconductor engineers to China since 2015.

China has used its antitrust authorities to impose terms on foreign semiconductor firms in ways that advance China’s industrial policies. China’s review of the Dutch firm NXP’s acquisition of U.S. firm Freescale set terms that forced the sale of NXP’s RF power transistor business to JAC Capital, a company controlled by China’s State Council. China imposed antitrust terms on Qualcomm in 2015 that not only required Qualcomm to pay a $975 million fine, but also required the company to license its essential 3G and 4G patents to Chinese companies and enter into a joint venture with the Guizhou provincial government to jointly manufacture server chips in order for Qualcomm to access China’s lucrative wireless market.

Meanwhile, US policymakers worry about the effects of China’s state-led semiconductor policies as they may elbow out the US’ technological leadership in semiconductors. It is also possible that the research and design of global semiconductor production would shift to China.

The Road Ahead

Almost every large Chinese tech company has announced a semiconductor-related project. Oppo and Xiaomi are working on their own in-house 5G chips. Tencent is investing into AI chip startup Enflame, Bytedance into its own cloud AI chips and ARM server chips, and Alibaba into AI cloud computing chips.

The US government continues to implement sanctions against China. To protect themselves against possible sanctions, Chinese companies have been building stockpiles to safeguard production lines. Chinese media has been calling it a “competition for inventory”, noting that some companies are buying chips at up to twenty times normal prices. Huawei, for instance, which has borne the brunt of sanctions, has stockpiled two years’ worth of crucial chips needed for its 5G base stations and cloud business. The rush to stockpile has spread worldwide, leaving suppliers struggling to keep up with demand. That, combined with the impact of the pandemic, has precipitated a global shortage of chips.

China has long been a mere end user in this value chain. Yet the shortage of chips has now compelled Huawei to scale down its mobile manufacturing plans. This threatens Huawei’s 5G business and may also have implications for China’s pursuit of 6G-related programs.

Meanwhile, China’s ambitions to make its own chipsets have even failed with the closure of the state-backed semiconductor plant Wuhan Hongxin Semiconductor Manufacturing Co. (HSMC) that had to let go of all of its employees.

Finally, the US trade sanctions appear to be insurmountable barriers for Huawei and the Taiwan Semiconductor Manufacturing Company (TSMC). Huawei accounts for $5.4 billion of TSMC's revenues in 2019. The US sanctions mean that any chipmaker that depends on American technology cannot sell to Huawei.

The interdependent nature of the semiconductor value chain means that while new players face high market-entry barriers, it’s also difficult to cut large existing players out. As China is the world’s largest consumer of chips, when sanctions landed on Chinese businesses, some of their staunchest defenders were the US semiconductor lobby, who were worried for their own revenues – Qualcomm received a license to sell 4G chips to Huawei last November.

For China, developing the domestic semiconductor industry will continue to be a top priority.