We get it: all the stories about semiconductors can be confusing. The technology, the supply chains, the business interests, and the geopolitical jostling for supremacy are near constant news items these days in U.S.-China relations. Just this week, China’s largest semiconductor manufacturer, Semiconductor Manufacturing International Corporation, announced plans for a secondary listing in Shanghai that would raise up to $7.6 billion — the biggest fundraising in China in a decade, according to Caixin.

To help clarify what semiconductors are, who the leading businesses are, and why the industry has become such a flash point for U.S.-China tensions, we put together the below explainer. It’s a useful accompaniment to this week’s op-ed from Doug Fuller about Huawei, but we suspect it will be a handy reference for the foreseeable future. 

What are semiconductors? And why have they become such a big deal to U.S.-China relations?

Semiconductors are the tiny circuits that power most of today’s technology, including computer logic, memory, and graphics. Semiconductors are printed on microchips, which are usually made of silicon, and they are typically studded with billions of switches for electrical signals called transistors. The key to developing the most advanced semiconductors is making transistors smaller, so more can fit on a chip. The transistors on the most advanced chips are five nanometers — you would have to line up 60 million of them side by side to reach a foot.

The U.S. is the world leader in semiconductor design and sales, and along with Japan produces the equipment needed to manufacture chips. (One exception is five nanometer chips: the only company that makes equipment for those is based in the Netherlands.) China’s strengths lie in the assembly, testing, and packaging of chips. But as China progresses on its quest to become a global power, it is making a concerted effort to develop its own semiconductor industry and move up the value chain from assembly, testing, and packaging to pioneering advanced chips. It is growing stronger in chip design as well, but it is still far behind the U.S. and other leading countries.

As U.S.-China relations deteriorate, competition over semiconductors has been heating up. Both countries see semiconductors as crucial to national and economic security, as the chips power just about everything, including military missiles and fighter jets, emerging technologies such as artificial intelligence and electric vehicles, and the phones, computers, and gadgets that form a big part of their economies. To stay competitive, both countries will need access to advanced chips, but the United States is starting to limit China’s access to cutting edge semiconductors, and China is working hard to develop self-sufficiency.    

Which companies are the big players in this space?

The U.S. leads chip design, and within that, different U.S. companies have different specialties. Qualcomm, for example, leads chip design for 5G infrastructure. Intel leads designing for computer processors and also manufactures chips, and Nvidia leads graphics chips, which create the images on screens. U.S. companies Synopsys and Cadence Design Systems make the leading software used to design semiconductors, while Arm, a British company purchased by Japan’s SoftBank in 2016, designs the leading chip architecture – the instruction set for how software interacts with a chip, which it licenses to chipmakers around the world.

Outside of the United States, Samsung, a South Korean company, is the memory chip leader. ASML, a Dutch firm, is the only company that makes the extreme ultraviolet lithography equipment necessary to manufacture the most advanced chips, although U.S. companies like Applied Materials produce equipment that can make other advanced chips. Taiwan Semiconductor Manufacturing Company (TSMC) is the largest semiconductor contract manufacturer. The tools, in short, work together to make the most advanced chips.

Chinese companies are not leaders in the semiconductor industry, with the exception of HiSilicon, the Huawei subsidiary, which is competitive in chip design. China’s other big players are Semiconductor International Manufacturing Corporation, which manufactures chips, and Tsinghua Unigroup, which designs and manufactures chips, but they are not among global leaders.

If the U.S. is so far ahead, why does it care about China’s push into semiconductor development? 

China is competitive with the U.S. in some high tech fields, and the prospect of the U.S. losing supremacy in a field so critical to defense and the economy — even if it’s not likely to happen soon — worries some lawmakers. 

“This competition isn’t something that’s going to be won next quarter or next year. It’s a generational competition that’s going to be won in the next ten or twenty years. That’s why it’s so important we lay the groundwork today,” Representative Michael McCaul, the Texas Republican who sponsored a House bill to invest in semiconductors in June, told The Wire.

What is the U.S. doing to restrict China’s access to semiconductors?

The Trump administration recently blocked both U.S. companies and foreign companies that make semiconductors on U.S. equipment from selling chips to HiSilicon, the Huawei subsidiary. It also put in place a range of export controls on semiconductors that could entangle a broad swath of other private sector companies, especially companies that supply to China’s military. The Trump administration also persuaded the Dutch government to stop ASML from selling extreme ultraviolet lithography equipment to Chinese companies, a Reuters investigation found. Because of this, China will struggle to make chips more advanced than 14 nanometers, keeping it two generations behind leading manufacturers.

Together, these moves will substantially slow China’s development of advanced semiconductor technology, said James A. Lewis, the director of the Technology Policy Program at the Center for Strategic and International Studies, the Washington think tank. But the restrictions are speed bumps, not roadblocks. 

Is the U.S. government worried it could lose its dominant position? 

Yes. Although the U.S. leads the world in designing semiconductors and makes much of the equipment needed to produce them, most chip manufacturing has expanded overseas to countries like Taiwan, South Korea, and Japan. The U.S. has “recognized that it might be on its way to losing a core competency for the future,” said Michael Dennis, a professor at the U.S. Naval War College who researches the government’s role in innovation. (The Boston Consulting Group has an excellent report here on how these restrictions might hurt U.S. leadership.)

Lawmakers want to bring semiconductor manufacturing home, and bipartisan coalitions in the House and Senate introduced bills in June to invest heavily in the semiconductor industry. The legislation would create $22 billion in funding for research, development, and policy coordination, as well as a large tax break for investments in the industry. Semiconductor companies and analysts say it’s a good start to bringing manufacturing back to the United States.

Is there any risk of the current U.S. strategy backfiring?

Yes, and many in the industry are concerned. (See Doug Fuller’s assessment here.) U.S. companies sold $70 billion in semiconductor goods to China last year, accounting for more than a third of sales, according to industry data. While export controls have only marginally decreased sales so far, the effect might increase in coming years, said Stacy Rasgon, a semiconductor analyst at AllianceBernstein, the investment management and research firm, in New York. U.S. industry would have to absorb those losses. 

Moreover, as restrictions ramp up even Chinese firms that have not yet been affected are moving to source their semiconductors from other countries, a shift that could seriously weaken U.S. sales and profitability. U.S. semiconductor companies are expected to lose 16 percent of their revenues over the next three to five years if current restrictions remain and Chinese companies continue to look for other suppliers, according to a Boston Consulting Group estimate. “Restrictions mean less revenue, which means less ability to support research and development. More crucially, it sends that revenue to future competitors,” said Willy C. Shih, a professor at Harvard Business School who studies technology strategy.

What is China doing to catch up to the U.S. and other leading semiconductor countries?

For years, Chinese industrial plans have called for semiconductor development. In 2014, the central government created an investment fund for developing the technology, and analysts estimate over $100 billion has been invested in semiconductors through various levels of government and state-owned enterprises since then. Made in China 2025, Beijing’s strategic plan to become a world leader in high tech industries, calls for developing a high degree of self-sufficiency in semiconductors within the next five years.

But experts think China is still at least a decade from catching up with the U.S. and other leading countries in advanced semiconductor production. It relies heavily on other countries for equipment to make semiconductors, and restrictions are mounting. If China is able to secure equipment or even acquire extreme ultraviolet lithography technology, it could still take decades to develop the know-how to use these tools to make cutting edge chips, analysts say.

If China has so much money to spend on developing the technology, why doesn’t it just buy foreign semiconductor businesses that are leading the industry?

It tried to, but U.S. national security regulators — or the fear of action by them — scuttled most Chinese attempts to acquire foreign semiconductor companies, even in Europe. Still, in 2018 Chinese investors acquired control of the local unit of Arm, the British chip designer now owned by SoftBank. Arm’s technology is used in a vast range of products, including nearly all smartphones. Arm China is now engaged in a high profile spat with SoftBank over who gets to choose its leadership.

What is China doing to respond to U.S. restrictions?

There are indications that China could punish U.S. companies, including Intel and Qualcomm, if they comply with U.S. rules and restrict supplies to Chinese firms. The Global Times, a government controlled Chinese news outlet, said U.S. firms could be place on China’s own ‘unreliable entity’ list, although it has not said exactly what that designation would mean. One industry executive told The Wire that the Chinese government summoned executives at the Chinese operations of U.S. semiconductor firms after Huawei was placed on the entity list in 2019, and again in March, to warn of consequences if their companies stop selling chips to China.

But the bigger concern for many in the United States is that as China loses access to U.S. technology, it builds up is its own capabilities. In the short term, Chinese companies won’t make semiconductors on par with U.S. companies or companies that rely on U.S. equipment. But the increased urgency to develop homegrown solutions will catalyze the growth of China’s domestic industry. So, in a decade, China might be a major competitor in advanced chips, and the U.S. will have lost the leverage it once had.

---