Chapter 5: Case Studies
5.1 Integrated Circuits (IC)
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External Alarm: On account of the aforementioned three characteristics, all three case studies engender a considerable level of external scrutiny – both among governmental officials and within the international media. Actions taken by the Chinese state in promoting these industries is often pointed to in foreign capitals as rationale for restricting Chinese outbound FDI and/or imposing future sanctions.
5.1 Integrated Circuits (IC)
ICs can be seen as the “fundamental building blocks of today’s high-tech knowledge economy,”201 with a widespread array of applications in both the commercial and military spheres. Proficiency in the production of semiconductors is seen as a hallmark of a modern, technologically sophisticated economy: the leading East Asia industrializers (Japan, South Korea, Taiwan) successfully developed globally competitive IC firms.
China’s state-led initiatives at enhancing domestic competitiveness in the global integrated circuits (IC) market have drawn a considerable volume of international attention in recent years. According to testimony from Jimmy Goodrich, Vice President of the Semiconductor Industry Association, “Chinese leadership at the highest levels has made it a priority to develop and produce semiconductor technology” where “no other Chinese industrial development program for the information technology (IT) sector is supported with the financial resources and central government attention given to the IC industry plan.”202
State of the Market:
The production and assembly of ICT products is one of the key industries driving overall growth in the Chinese economy today, accounting for roughly one-third of overall exports. As Dan Breznitz and Michael Murphree put it, “in addition to being the largest and most globalized industry worldwide, the IT industry is
201 Stephen Olson. “Keeping an eye on US-China semiconductor supremacy struggles.” East Asia Forum. February, 2017. <
http://www.eastasiaforum.org/2017/02/20/keeping-an-eye-on-us-china-semiconductor-supremacy-struggles/>
202Testimony from Jimmy Goodrich to U.S. – China Security and Review Commission. Hearing on China’s 13th FYP. <
https://www.uscc.gov/sites/default/files/Jimmy%20Goodrich_Written%20Testimony%20042716.pdf>
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far and away the most developed and important high-technology industry in China…This means that, with regard to economic growth, the IT industry is the Chinese high-technology industry.”203
China today represents the largest and fastest growing market for semiconductors worldwide, accounting for roughly half the overall market in 2014. As such, foreign MNCs are increasingly reliant an access to the PRC market as a source of revenue. In spite of this, the bulk of semiconductors consumed in China are later re-exported as component parts of finished electronics systems. As Dieter Ernst points out in a report for the East-West Center, this system of foreign chips powering electronic exports has effectively created a
“closed-loop supply chain that Chinese firms are not part of.”204 In this context, China has not developed cutting edge proficiency in indigenous semiconductor production. Instead, according to research from Stephen Olson of the Hinrich Foundation, approximately 80% of semiconductors used in electronics production in China today rely on imported ICs.205
A report prepared for the Obama White House on the state of the global semiconductor industry lays out the scope of China’s current limitations, stating that: “China lacks a tier-one semiconductor equipment firm”;
“manufacturing of advanced logic chips is significantly behind the state of the art in the United States, Taiwan, and elsewhere”; and, finally, that “China has many semiconductor foundry companies, but all are at least one-and-a-half generations behind the state of the art in volume production.”206
In spite of these limitations, notable progress is being made. Some highlights include:
China’s IC design industry grew from roughly 200 million USD in 2001 to roughly 13.2 billion USD in 2013.
203 Dan Breznitz and Michael Murphree, Run of the Red Queen, 2011. 5-6.
204 Ernst, “From Catching Up to Forging Ahead: China's Policies for Semiconductors.” East-West Center. 2015.
205 Olson, East Asia Forum
206 “Ensuring Long-Term U.S. Leadership in Semiconductors.” President’s Council of Advisors on Science and Technology.
January, 2017. < https://obamawhitehouse.archives.gov/sites/default/files/microsites/ostp/PCAST/pcast_ensuring_long-term_us_leadership_in_semiconductors.pdf>
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Whereas in 2009 only one Chinese company registered in the top 50 fabless, the number jumped to nine in 2014.
There are over 400 Chinese fabless companies operating in the PRC today.207
While Chinese progress in IC design has been substantial, capabilities continually lag foreign competitors.
Many IC designers are simply too small to invest in substantial R&D; preferring instead to concentrate on appealing to lower-end consumer electronics such as toys, TVs, and sound systems. The lack of a world-class indigenous innovation capacity in advanced ICs is widely perceived as the signal weakness of China’s overall domestic semiconductor industry.208
Policy goals and tools:
A number of recent policy documents enshrine the importance placed by the Chinese state on the further development of an indigenous IC sector. In 2014, the State Council released the Outline for Promoting the Development of the Nation’s Integrated Circuit Policy. Contained within the policy document is language
stating as follows: “heavy reliance on importation of IC products makes it difficult to strongly support the formation of core competitiveness in national industries and the protection of information security.”209 The IC guidelines lays out the goal of becoming the industry leader in all segments of the industry by the year 2030, therefore curtailing the need for external reliance on imported circuits.
According to the analysis of Ernst, China’s leadership see the evolving international IC market as rife with strategic opportunities for rapid catch up. He keys in on four areas China hopes to take advantage of in building up domestic capabilities: mobile device demand within China; changes in the nature of IC foundries; the use of partnership, industrial consolidations and international M&A; and, finally, emerging opportunities to gain market share in “trailing-node” semiconductor technologies.210
207 Ernst, East-West Center, 2015
208 Ibid
209 “Preventing Deglobalization”
210 Ernst, 2015
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To ensure implementation of state objectives in the industry, a leading small group (LSG) on IC
development overseen by Vice Premier Ma Kai has been set up, working in close collaboration with senior officials in MIIT. While the LSG draws on a considerable range of expertise in industry and research, foreign stakeholders are not seen as well represented. Written testimony prepared for the U.S. – China Economic and Security Review Commission quotes Vice Premier Ma as stating, “our government places great
importance…on promoting the program of replacing foreign technology with leading, secure, indigenous domestic products.”211
IC-specific policies are seen as complementary to the broader thrust of Chinese techno-industrial policy, with similar language seen in both the SEI and the 2006 MLP, as well as in the 12th and 13th FYP. In particular, China has, for over a decade, been investing in a number of “mega projects” to facilitate indigenous innovation in core technologies. To that end, the 2014 IC circular called for raising over 100 billion USD in public and private funds for use in sectoral upgrading with MIIT playing a leading role. It’s estimated that, as of 2016, the National IC Fund raised over 21 billion USD, primarily from government and SOE sector. National level funding is complemented with an estimated 26 billion USD in local government funding. Analysis suggests that “the national and local funds have supported overseas mergers and
acquisitions (M&A) by domestic Chinese IC firms as a tool to rapidly gain access to key semiconductor technology and intellectual property.”212 Billions of dollars in state funding are also directed toward helping domestic IC firms expand operations and invest in R&D. The 2014 IC policy seeks to address pervasive weakness in the domestic sector by both reducing the funding gap in R&D and strengthening coordination among different segments of the value chain.
Targeted industrial policies focused on the IC sector are also seen as complementary to broader techno-industrial policy goals and bolstered by a number of more generalized innovation policies. According to a
211 Testimony of Jimmy Goodrich.
<https://www.uscc.gov/sites/default/files/Jimmy%20Goodrich_Written%20Testimony%20042716.pdf>
212
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report prepared for the Obama White House entitled “Ensuring Long-Term U.S. leadership in
Semiconductors,” China also promotes indigenous IC technology via a range of overtly discriminatory mechanisms: directly and indirectly forcing domestic customers to purchase Chinese brand ICs via public procurement policy and national security regulations; compelling the transfer of technology from foreign producers hoping to gain access to the Chinese market; and by the theft of IC IPR through both outright covert action and overt “secure and controllable” inspections.213
The government impetus for pushing IC development also corresponds with a growing fear over US intentions toward China’s push into core technology. According to Ernst’s report: “In the view of China’s leadership, the United States has now shifted to more aggressive industrial, innovation, and trade policies to retain its leadership in the semiconductor industry.”214
Future Outlook:
China’s approach to the development of its IC sector mixes elements of top-down central planning with a more bottom-up approach taking advantage of market forces. The government continues to play a major role in shaping industry outcomes. At the same time, the array of voices shaping government processes has expanded and now better accommodates the voices of industry players and researchers.
While seeking to develop independent and leading-edge capability in all segments of the domestic IC value chain, Chinese state planners recognize the globalized nature of the industry and the centrality of firm competition. In this sense, while globalization and interdependence are seen as threatening, they also present an opportunity for rapid indigenous technological catch-up in IC development through the harnessing of external markets, technology and expertise. In spite of this newfound appreciation of bottom-up drivers, the balance between state management and market competition remains in a constant state of tension. The state
213 “Ensuring Long-Term U.S. Leadership in Semiconductors.” President’s Council of Advisors on Science and Technology.
214 Ernst, 2015
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deploys available industrial policy levers and control over the vast PRC market (subsidies, procurement, technology transfers, state backed M&A etc.) in making globalization work for the benefit of its overarching focus on national strengthening and development embodied by the possession of a leading indigenous IC industry.
Going forward, several issues will likely challenge future development of domestic IC capacity:
overcapacity exacerbated by extensive state and local subsidization of domestic IC producers; structural impediments toward innovation resulting from both a top-down centralized approach and the fragmented nature of China’s innovation system; cybersecurity and excessive protectionism, particularly in response to mounting regime insecurity in the face of external and non-traditional security threats; and, finally, tension with key trading partners leading to restrictions on access to global markets and technology.215
However, given the extensive reliance on foreign branded chip to power China’s overall electronics export sector - coupled with the need to promote domestic upgrading through outbound M&A - it’s unlikely China will suddenly drive out external IC providers, instead leveraging control over the domestic market and extensive state fiscal resources to gradually build up indigenous alternatives.