Semiconductor alliances between U.S. and Asia could hold back China

Leading chipmaking nations, including the US, are forming alliances, in part to secure their semiconductor supply chain and prevent China from coming to the forefront of the industry, analysts told CNBC.

Places like the United States, South Korea, Japan and Taiwan that have strong semiconductor industries have tried to forge partnerships around this critical technology.

“The immediate reason for all of this is definitely China,” said Pranay Kotasthane, chair of the Takshashila Institution’s High Tech Geopolitics Program, in reference to the alliances.

The collaboration underscores the importance of chips to economies and national security, while underscoring the countries’ desire to halt China’s progress in the critical technology.

Kotasthane was a guest on the latest episode of CNBC’s Beyond the Valley podcast, released Tuesday, which explores the geopolitics behind semiconductors.

Semiconductors are a critical technology because they go into so many of the products we use – from smartphones to cars to refrigerators. And they are also crucial for artificial intelligence applications and even weapons.

The importance of chips has been spotlighted during an ongoing shortage of these components, sparked by the Covid pandemic, amid rising consumer electronics demand and supply chain disruptions.

This alerted governments around the world to the need to ensure the supply of chips. The United States, under President Joe Biden, has been pushing to relocate manufacturing.

But the semiconductor supply chain is complex, encompassing everything from design to packaging to manufacturing and the tooling required to do it.

For example, ASML, based in the Netherlands, is the only company in the world capable of manufacturing the highly complex machinery needed to manufacture the most advanced chips.

The United States, while strong in many areas of the market, has lost its dominance in manufacturing. For the past 15 years, Taiwan’s TSMC and South Korea’s Samsung have dominated manufacturing of the world’s most advanced semiconductors. Intel, the largest chipmaker in the United States, fell far behind.

Taiwan and South Korea account for about 80% of the global foundry market. Foundries are facilities that manufacture chips that other companies design.

The concentration of critical tooling and manufacturing in a small number of companies and regions has made governments around the world nervous and pushed semiconductors into the realm of geopolitics.

“What’s happened is a lot of companies around the world are taking a small part of it, which means there’s a geopolitical aspect, right? What if a company doesn’t deliver the things you need? What if you know, one of the countries brings things about espionage through chips? So those things make it a geopolitical tool,” Kotasthane said.

The concentration of power in the hands of a few economies and companies poses a risk to business continuity, particularly in contentious places like Taiwan, Kotasthane said. Beijing regards Taiwan as a breakaway province and has promised to “reunite” the island with mainland China.

“The other geopolitical importance is only related to Taiwan’s central role in the semiconductor supply chain. And because tensions between China and Taiwan have increased, is there a concern that, you know, since there’s a lot of manufacturing in Taiwan, what happens if China is to be occupied or even that there’s tension between the two countries?” said Kotasthane.

Due to the complexity of the chip supply chain, no country can go it alone.

Countries have increasingly sought chip partnerships over the past two years. On a trip to South Korea in May, Biden visited a Samsung semiconductor plant. Around the same time, US Secretary of Commerce Gina Raimondo met with her then Japanese counterpart Koichi Hagiuda in Tokyo and discussed “collaborating on areas like semiconductors and export controls.”

Last month, Taiwan’s President Tsai Ing-wen told visiting Arizona Governor Doug Ducey that she looks forward to producing “democracy chips” with America. Taiwan is home to the world’s most advanced chip maker, TSMC.

And semiconductors are an important part of the collaboration between the United States, India, Japan and Australia, a group of democracies known collectively as the Quad.

The US has also proposed a “Chip 4” alliance with South Korea, Japan and Taiwan, all powerhouses in the semiconductor supply chain. However, details on this have not yet been finalized.

There are a few reasons for these partnerships.

One is about bringing countries together, each with their “comparative advantages” to “bring together alliances that can develop secure chips,” Kotasthane said. “It makes no sense to do it alone,” he added, given the complex supply chain and the strengths of different countries and companies.

The pursuit of such partnerships has one common feature – China is not involved. In fact, these alliances are intended to cut China off from the global supply chain.

“In my opinion, China’s development in this sector will be severely limited in the short term [as a result of these alliances]’ said Kotasthane.

China and the US view each other as technological rivals in areas ranging from semiconductors to artificial intelligence. As part of this struggle, the US has attempted to cut off China’s exports of critical semiconductors and the tools used to manufacture them.

“The goal of all this effort is to prevent China from developing the ability to produce advanced semiconductors domestically,” Paul Triolo, head of technology policy at consulting firm Albright Stonebridge, told CNBC, referring to the goals of the various partnerships.

So where is China?

In recent years, China has pumped a lot of money into its domestic semiconductor industry to increase self-sufficiency and reduce dependence on foreign companies.

As discussed, this would be incredibly difficult due to the complexity of the supply chain and the concentration of power in the hands of very few companies and countries.

China is improving in areas like chip design, but that’s an area that relies heavily on foreign tools and equipment.

According to Kotasthane, manufacturing is the “Achilles heel” for China. China’s largest contract chipmaker is called SMIC. But the company’s technology is still well behind those of TSMC and Samsung.

“It requires a lot of international cooperation … which I think is a big problem for China now because China has kind of upset its neighbors,” Kotasthane said.

“What China was able to achieve three or four years earlier in terms of international cooperation will not only be possible.”

That leaves China’s ability to reach the top spot in chipmaking in doubt as the US and other major semiconductor companies form alliances, Kotasthane said.

“In the long term, I think so [China] will be able to overcome some of the current challenges…but they won’t be able to reach the top position that many other countries have,” said Kotasthane.

Still, cracks are emerging between some partners, notably South Korea and the United States.

In an interview with the Financial Times, Ahn Duk-geun, South Korea’s trade minister, said there were disagreements between Seoul and Washington over the latter’s continued export restrictions on semiconductor tools to China.

“Our semiconductor industry is very concerned about what the US government is doing today,” Ahn told the FT.

China, the world’s largest importer of chips, is a key market for chip companies worldwide, from US giants like Qualcomm to Samsung in South Korea. The mixing of politics and business could create the conditions for more tensions between the nations in these high-tech alliances.

“Not all US allies are keen to join these alliances or expand control over technology destined for China, given their large holdings in both manufacturing in China and selling in the Chinese market. Most do not want to conflict with Beijing on these issues,” said Triolo.

“A major risk is that attempts to coordinate parts of the global development of the semiconductor supply chain will undermine the market-driven nature of the industry and cause significant collateral damage to innovation, driving up costs and slowing the pace of new technology development.”