On December 12, China filed a complaint with the WTO’s dispute settlement mechanism. China contends that the US’s export control measures, on computer chips and other products, are based on an excessively broad concept of national security.
I think that China’s case is very strong. However, even if a WTO panel finds that the US’s export restrictions contravened its WTO obligations, China is unlikely to receive any meaningful satisfaction. That is because the US can appeal an unfavourable ruling and – since it has refused to allow the appointment of members to the WTO’s Appellate Body – appeals can no longer be heard. This would effectively put the status of the export restrictions into legal limbo.
It is telling that Jiang Zemin, China’s President from 1993 to 2004, foresaw this situation decades ago.
Jiang, who passed away last month at 96, is best known for spearheading China’s entry into the WTO, promoting market-based reforms and overseeing a decade of strong growth.
An electrical engineer, Jiang worked at the Ministry of Electronic Industry just as the microelectronics revolution was taking off. He understood that microelectronics was quickly becoming the foundation of the electronics industry and that producing electronics without microelectronics was like “cooking a meal without rice”.
Jiang laid the foundation for China’s microelectronics industry by launching “Project 908” and “Project 909”, which accelerated the building of integrated circuits during the Eighth (1991-1995) and Ninth (1996-2000) Five-Year Plans.
After he stepped down as President, Jiang maintained a keen interest in how China could best move to the technological frontier in informatics. This quote from On The Development of China’s Information Technology (论中国信息技术产业发展), published in 2006, was circulated widely on the internet after Jiang’s passing. It seems prophetic.
“Forecasts suggest that by 2020, leading international microelectronic technology will develop to a level of 14nm. We must be clear-headed and acknowledge that core technologies cannot be bought. We need to rely on ourselves. We will never reach the leading edge if, generation after generation, we import the newest production capacities. Our researchers need to redouble their efforts. Otherwise, advanced countries will have a stranglehold over our access to core technologies.”
In fact, technological progress was faster than what Jiang foresaw. Fourteen-nanometer chips were developed in 2014 and, by 2020, 5nm chips were being produced by Samsung and TSMC (the smaller the technology node, the higher the chip’s transistor density and the greater its computing power).
Sadly, Jiang was right about advanced countries trying to gain a stranglehold over China’s access to leading-edge technologies.
Jiang’s fears were partially based on his reading of history. Japan had successfully ramped up its production of dynamic random-access memory (DRAM) chips and increased its US market share from 30 to 75 percent between 1978 and 1986. As its market share dropped, the US semiconductor industry lobbied the government for protection. Under the 1986 Semiconductor Trade Agreement, Japan was forced to limit its exports of DRAM chips to the US.
Jiang was also familiar with the controls on exports of semiconductors and semiconductor manufacturing equipment, which the US had imposed on China, in one form or another, since the Cold War. The export restrictions were ostensibly designed to deny China the ability to purchase technologies that would bolster its military capabilities. However, a 2002 report from the US’s General Accounting Office noted that the export restrictions were actually intended to keep China two generations behind the state-of-the-art.
For decades, the Chinese semiconductor industry has been caught between rising ambition and external constraints. What can we say about its current state of affairs?
China has been able to increase its production of integrated circuits – semiconductors with multiple transistors – extremely rapidly. Between 2010 and 2021, integrated circuit production grew at a 17 percent average annual rate. Average annual growth between 2019 and 2021 was in excess of 30 percent (Figure 1).
Figure 1
Despite the very rapid increase in production, China remains far from self-sufficient as its demand continues to be robust. China’s apparent integrated circuit demand can be calculated as domestic production plus imports minus exports. In value terms, China’s domestic production covers 35 percent of apparent demand, up from 14 percent in 2010 (Figure 2).
Figure 2
China’s reliance on imported integrated circuits need not indicate a problem.
Much of China’s semiconductor demand ultimately feeds into the consumer products it exports. According to the US Semiconductor Industry Association, laptops and smartphones accounted for 62 percent of global semiconductor demand in 2021. In many cases, the foreign firms producing these products in China require foreign-produced inputs.
What is more problematic is China’s challenge in producing leading-edge chips – a challenge that will only be exacerbated by the US’s export restrictions.
Notwithstanding this challenge, there is evidence that the quality of the Chinese semiconductor industry continues to improve.
The production chain for semiconductors involves three distinct processes: design, manufacturing and assembly, testing and packaging (ATP). Industry estimates suggest that 90 percent of the value of a chip is split evenly between design and manufacturing, with ATP adding the final 10 percent.
A breakdown of the Chinese semiconductor industry’s revenue shows a distinct movement up the value chain. The share of sales accounted for by ATP fell from 44 percent in 2010 to 26 percent in 2021, as design and manufacturing became much more important sources of revenue (Figure 3).
Figure 3
Another indicator of improved quality comes from the prices of the chips China imports and exports. Historically, the prices China received for the integrated circuits it exported were only about half as high as what it paid for those it imported. But in mid-2017, the price of Chinese exports began to converge toward those of imports. So far this year, export prices have risen to 77 percent of import prices (Figure 4).
Figure 4
To some extent, China’s approach to the semiconductor industry is informed by the “latecomer strategies” employed by other Asian countries. A key element of this strategy is large-scale government support. Such support makes good economic sense in this industry given the large up-front costs for manufacturing and the potential for significant “knowledge spillovers” across all three industry sectors.
These spillovers occur when knowledge developed by a particular firm is exploited by other firms whether they be partners, competitors or even those in other industries. The ability to exploit these spillovers is contingent on having enough educated workers that understand their potential applications.
It is very difficult to assess whether China has enough human capital to exploit these knowledge spillovers. Historically, a significant number of Chinese electrical engineers chose to emigrate and work for leading-edge foreign firms. However, we have seen a dramatic increase in the share of semiconductor patents obtained by China-based researchers (Figure 5). This suggests that human capital may be sufficient.
It remains to be seen whether the US’s export controls, which prevent US citizens and green card holders from aiding China’s semiconductor industry, will be a turning point.
Figure 5
China’s semiconductor industry has grown rapidly and its quality has improved. Still, despite Jiang’s admonition that “core technologies cannot be bought” China has not been able to develop the indigenous innovation needed to reach the technological frontier. This is understandable given China’s initial starting point and the dynamic nature of this industry in which the frontier continues to advance rapidly.
Given the current rise in technological protectionism, it appears that a redoubling of efforts is now China’s only option.
Terrific article--structure of the production process and evolution of China's place in it. Clarified a lot for me.