Strategic importance of semiconductors
The strategic importance of the semiconductor industry is on the rise, in the context of soaring demand, high concentration of supply, and growing geopolitical considerations.
Soaring demand: The COVID-19 pandemic has spurred global demand for computers, consumer electronics products and digital services since last year. Accordingly, demand has increased for the semiconductors that power hardware devices or enable connectivity and cloud services. This year, as the major economies including China, US and Europe emerge from the pandemic, smartphone and automotive demand is starting to recover. This gives a further boost to semiconductor demand and triggers the shortage of automotive chip supply.
Industry growth is also fuelled by the application of new technologies including AI, IoT, 5G and autonomous vehicles. AI creates demand for the cutting-edge chips with strong computing power and the specialized chips used for specific applications (e.g., GPUs, IPUs). Meanwhile, electric and autonomous vehicles require greater semiconductor content than the conventional cars, which also creates strong potential for the semiconductor industry.
According to the World Semiconductor Trade Statistics (WSTS), global semiconductor market will likely maintain a strong growth of 10.9% this year, on top of the 6.8% in 2020. The value of total semiconductor sales will reach a new record high of USD488bn.
Concentration of supply: The COVID-19 pandemic has also exposed the vulnerability of global supply chain during crisis. Many countries are calling for the review of global supply chain, to reduce the degree of geographic concentration and increase the resilience of critical goods supply. Semiconductor supply chain is a priority area for review, as its production is highly concentrated in Asia (especially Taiwan) today.
Geopolitical considerations: The geopolitical tensions between China and the US also underscore the strategic importance of the semiconductor industry. The US has introduced a series of export controls on Chinese tech companies since 2019, banning Huawei from buying foreign-made semiconductors and restricting SMIC from accessing American technology. Indeed, chips are increasingly used in a wide range of contexts today, including not only computers and smartphones, but also automobiles, medical equipment, and public infrastructures. Concerns are growing that a country’s access to cutting-edge chips could have far-reaching implications for national security.
A massive investment cycle
A massive, government-led investment cycle appears underway, as many large countries pledge to ramp up semiconductor spending.
In order to achieve self-sufficiency in semiconductor supply, China released the Policies for Promoting High-quality Development of Integrated Circuit Industry and Software Industry in August 2020, outlining a wide range of favourable policies with regard to tax breaks, financing, R&D support, talent development, and IP protection. The government also expanded the National Integrated Circuit Industry Investment Fund in October 2019, by RMB204bn (USD30bn).
The US also aims to strengthen its semiconductor production capacity. Two bills were introduced in June 2020 – the Creating Helpful Incentives to Produce Semiconductors for America Act and the American Foundries Act, providing tax credit, grants, support for R&D and workforce development. This May, lawmakers revised the bills to propose USD52bn spending for semiconductor production and research for the next five years, up from the USD37bn originally.
In Europe, 17 countries signed a joint commitment in December 2020 to invest up to EUR145bn (USD180bn) to develop the next generation semiconductor technologies. During the Digital Compass Plan released in March, the European Commission set a goal to grab 20% of the world production of cutting-edge semiconductors by 2030.
In Japan, the government is reportedly to expand funds to support local production of advanced semiconductors, as part of this year’s growth strategy to be unveiled in June. The strategy will also call for Japan to hold 40% share in the next-generation power semiconductors used in electric vehicles and other applications, by the end of this decade.
In addition, South Korea unveiled a K-Semiconductor Strategy in May, vowing to provide more tax deductions, financing, and infrastructure support for the semiconductor industry. In response, the country’s large semiconductor firms including Samsung and SK Hynix pledged to invest KRW510tn (USD450bn) for the next ten years. Taiwan’s TSMC would also spend USD100bn over three years to increase the manufacturing capacity of advanced semiconductors, according to media reports.
The short-term capex momentum in the global semiconductor industry appears strong. As a key indicator, North America’s semiconductor equipment billings surged nearly 50% YoY in April, the strongest growth rate seen over four years since 2017.
We examine multiple factors to evaluate the competitiveness of major economies in this global semiconductor race, including 1) the existing semiconductor ecosystem, 2) capital and technology capabilities, 3) labor and energy costs, and 4) geopolitics.
Existing semiconductor ecosystem: The semiconductor value chain is consisted of three basic stages: design, manufacturing, and assembling, testing & packaging. Companies operate in two key models: Fabless-Foundry and Integrated Device Manufacturer (IDM). Meanwhile, there are supporting companies in the semiconductor ecosystem, including Intellectual Property (IP) companies, Electronic Design Automation (EDA) companies, material suppliers, and equipment suppliers.
Taiwan has a relatively complete and strong semiconductor ecosystem. The island is the world’s largest base of semiconductor foundry (70%) and assembling & testing (50%), and second largest base of IC design (20%). TSMC produces chips at the most advanced technology node 5nm currently, and plans to enter the mass production of 3nm chips in 2022.
South Korea is also an important semiconductor manufacturing base in the world. Like TSMC, Samsung is capable to produce at 5nm and is targeting the volume production of 3nm chips. Nonetheless, Samsung and other South Korean semiconductor firms primarily focus on the production of memory chips, i.e., DRAM and NAND flash.
The US’s semiconductor ecosystem is strong but incomplete. American semiconductor firms have a large global presence in IC design, IP cores, EDA tools, and semiconductor equipment, but not in manufacturing. Intel currently still struggles to produce the cutting-edge chips at 7nm or below, behind global leaders including TSMC and Samsung.
China’s semiconductor ecosystem is relatively small. Its share in global IC design, foundry, and assembling & testing stands at only about 10% each today. The largest Chinese foundry, SMIC, has just started mass production of 14nm chips since the end of 2019.
Europe and Japan mainly specialize in the supporting activities in the semiconductor value chain, including semiconductor equipment and materials. Unlike the US counterparts, European and Japanese semiconductor firms don’t have a strong footprint in IC design.
Capital and technology capabilities: Semiconductor industry is known to be capital and technology intensive, requiring large amounts of investment on research and production. Designing a 5nm chip is estimated to cost about USD500mn. Building and equipping a facility with 5nm production lines could cost USD5-10bn.
South Korea has the strongest track record in technology related spending, followed by Taiwan and the G3. R&D expenditures accounted for as much as 4.6% of South Korea’s GDP in 2019, a sharp rise compared to 3.3% in 2010. In contrast, the corresponding R&D ratio in China remained low at 2.2% in 2019, vs 1.7% in 2010.
Labor and energy costs: Labor and energy costs also matter for the semiconductor industry. Certain stages of the semiconductor value chain, such as assembling and testing, still require significant amounts of labor inputs. Meanwhile, the fabrication stage of the value chain normally consumes large volumes of water and electricity.
China appears most competitive, followed by Taiwan. Considering both labor and energy costs, the US may not be as expensive as envisioned. The US’s labor cost for fab construction and operation is about twice as high as China’s. But electricity cost in the US is about 40% lower than in China and also 20% lower than in Taiwan.
Geopolitics: From the geopolitical perspective, a lot of pressure is on China. Huawei and SMIC have faced difficulties to access the US semiconductor equipment, design and software, due to the export controls imposed by Trump’s administration since 2019. Access to advanced foreign technologies will likely continue to be restricted in the years ahead, as the new Biden administration seeks to forge a stronger western alliance to counter China’s rise. During the recent Biden-Suga summit in April, the US and Japan agreed to strengthen alliance and increase cooperation on semiconductor supply chain. Like the US, Japan also plays a critical role in the supply of semiconductor equipment and materials to Chinese companies.
Geopolitical pressure is also felt by Taiwan and South Korea. As a result of the US’s tightening of export controls, TSMC and Samsung halted chip supply to China’s Huawei from September 2020. More recently, Taiwanese and South Korean semiconductor companies also face pressure from the Biden administration to build fabs in the US. TSMC is reportedly considering expanding its investment in Arizona, after announcing to build a USD12bn chip factory last year. Samsung also confirmed a plan to invest USD17bn for a new chip plant in the US, during President Moon Jae-in’s visit to Washington in May.
Tensions between China and the US also result in collateral damages for the American semiconductor companies. This is reflected in the lost sales of semiconductor equipment, design and software, which erodes their revenue bases and weakens the R&D capabilities.
Putting things together, Taiwan and South Korea should still be well positioned in the ongoing global semiconductor race, thanks to their strong existing supply chains, proven technology capabilities and affordable production costs. The US has the potential to make some advance in chip production, given its existing ecosystem in IC design and other supporting activities, as well as the distinct advantage in energy cost. In face of both structural and geopolitical challenges, China still has a long way to go to scale up its semiconductor industry and move up the value chain. Europe and Japan would also need a long time to enrich their semiconductor ecosystems, due to various structural constraints.
We also identify the potential risks as a result of the global semiconductor race in the longer term, including overcapacity, cost increase, and innovation slowdown.
Overcapacity: It normally takes about two years to build new semiconductor plants, which implies global chip supply shortage will remain a problem during 2021-2022. The risk of oversupply could emerge in mid-2020s. Growth in global chip demand would moderate, should the COVID-19 pandemic come to an end and online activities start to decline. On the supply side, however, it may not be easy for semiconductor firms to roll back capacity, due to the high closure costs.
Cost increase: The global semiconductor value chain is highly specialized today, with different countries focusing on different segments based on their comparative advantages. If many countries attempt to establish their domestic semiconductor supply chain encompassing all segments, it could result in lower efficiency and higher costs in the long run.
Innovation slowdown: In addition, aggressive pursuit of domestic semiconductor supply chain could also reduce cross-border collaboration and knowledge sharing, therefore slowing the progress of innovation. This would prove counterproductive during today’s rapidly evolving industry environment, which requires consistent innovation for product improvement and technology development.To read the full report, click here to Download the PDF.
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