Originally published on by Bruegel Institute. Link to original report( 5 mins)
The computer chips that power our digital economy have become pawns in the geopolitical tussle between the great powers. Digital devices such as smartphones or laptops are China’s most important export. ‘Information and communication technology’ goods make up 96% of US high-tech imports from China. But the chips that power these devices are mostly imported to China; they have overtaken oil as the largest Chinese import. Ending this import dependence has become a major focus of Chinese industrial policy, while the US targets China’s dependence with sanctions and invests substantial resources to build up production home. As a global semiconductor shortage disrupts the recovery of European industries, Europe’s lack of production capacity is increasingly seen as a vulnerability. This is why European Commission President Ursula von der Leyen announced a ‘European Chips Act’ during her State of the Union speech to strengthen European digital sovereignty.
However, current shortages are less a reflection of geopolitical tensions than they are of an unanticipated surge in demand of a good for which supply cannot expand easily. The newest generation of fabrication plants can cost over $10bn to build and take years to plan and construct, which creates cycles of oversupply and shortages into the market. Domestic high-end fabrication capacity has not shielded US or South Korean car manufacturers from the supply issues bedevilling European automakers either, as they require different types of semiconductor chips than those produced in these plants. Industrial policy will therefore not be able to alleviate the current supply shortfalls, nor will nearshoring shield European industries from supply cycles in the sector.
While policies promoting domestic high-end fabrication will not help resolve the current supply problems of European car manufacturers, there are risks in the sector worth addressing. All the cutting-edge manufacturing plants are located in South Korea and Taiwan, making world markets susceptible to disruptions caused by local environmental factors such as drought. Furthermore, a deterioration of the security environment in East Asia could have serious repercussion for this important industry. US policy will likely deliver some degree of geographical diversification, but European capacity building could help mitigating these risks. More importantly, Europe interests are already indirectly affected by trade sanctions and the sector has high growth potential. Therefore, securing leverage in this critical industry is both a question of ‘strategic autonomy’ and future growth potential.
This leads us to European industrial policy. Until now, European strategy was centred around using subsidies to lure manufacturers to build a cutting-edge fabrication plant (‘mega-fab’) in the EU. The European Commission wants to double the EU’s market share in the sector by white-listing it for otherwise prohibited subsidies. This strategy has several flaws. Firstly, there is only limited demand for these chips in the EU. Europe accounts for only one tenth of semiconductor imports and the value chains for digital devices that consume most of the cutting-edge chips are almost entirely located in East Asia. European automotive and industrial applications require mostly ‘lower grade’ chips with different material properties and whose production plants are less concentrated to a few countries. Secondly, the subsidies and investments targets are comparatively small. Thierry Breton aims at investments of between €20bn and €30bn by 2030, which is dwarfed by the South Korean government’s goal of more than $400bn over the same period. It is clear that the EU will not be able to catch up with only a fraction of the investments of an industry leader. Furthermore, national subsidies, even when cleared at the European level, are still driven by national priorities. This risks a lack of coordination and outright competition between EU countries. Whether this approach can rival the financial resources with which the US is pursuing the current industry leaders is also questionable. Most importantly, going after high-end fabrication involves large subsidies in a sector courted by governments all over the world, but offers little benefit in reducing supply risks for European industry or geopolitical clout as Europe will only represent a small share of the market either way. But what is the alternative?
If we think about fabrication as just one component in the global semiconductor supply chain, more efficient alternatives become apparent. The value chains of high-tech goods such as semiconductors are best understood as a complex network of specialised producers. Computer chips are highly specialised for a variety of applications and so are their production lines. The high level of technical sophistication and specialisation in almost every step of production makes autarky illusive. Anyone with control over a central ‘node’ can disrupt the supply chain network. In this network, the design of computer chips is as important as their fabrication: the US sanctions on Chinese tech companies don’t bite because of US domestic chip fabrication capacity but rather from the reliance on US software and IP of the dominant Taiwanese and South Korean producers. Meanwhile, the EU already has a monopoly on the manufacturing of a high-tech equipment necessary to produce these chips, which means that the current Dutch export ban on this equipment against China precludes its rise on the technological ladder.
The European Chips Act offers an opportunity to change the focus of EU strategy and go beyond luring high-end fabrication to Europe. The EU should focus its resources on R&D projects in chip design and defend its existing dominance in equipment manufacturing. While short on detail, Commissioner Breton’s initial remarks after the announcement on the European Chips Act give reason for optimism. They mention R&D as a priority (alongside a recommitment to build a European ‘mega-fab’) and include a proposal for a European ‘Chips Fund’, which could offer a way to better coordinate the subsidies offered. This path should be further pursued. Europe needs to step up its game in this core digital technology but it does not need a ‘mega-fab’ to do so.