For over a year now the news has been covering semiconductor shortages, which negatively impact the supply of products that rely on these small components, from gaming consoles, smartphones, and computers to cars and industrial equipment. First impressions suggested that shortages were due to Covid-19 disruptions, both on the supply and demand side. However, there seems to be a lot more beneath the surface.
What drove the current semiconductor shortages?
The global semiconductor supply chain is large and complex, and many moving pieces are affecting its operation. Therefore, Covid-19 is not solely to blame for its current predicament.
That is not to say that Covid-19 has not been an important factor. The pandemic not only reduced demand from consumers and enterprises in 2020 but also reduced supply by shutting down manufacturing plants in Asia, from Taiwan and China to Korea and Japan. And there was also some self-inflicted pain as a result of knee-jerk reactions of clients who arguably went too far canceling orders, as it seems was the case for the automotive industry. From this perspective, it could be said that in 2022 the industry is still working through the backlog of orders and needs more time to stabilize.
With that said, we should not forget the structural demand for more chips on many fronts, such as cloud computing and data centers, smartphones, the adoption of artificial intelligence, and the emergence of autonomous vehicles (as well as more infotainment and automation features in electric and traditional vehicles). At some point in the future, metaverse‑driven demand will kick in too.
There is also a simmering US/China trade dispute, which is leading to a rearranging of the global semiconductor supply chain, as a result of bans on the use of key Western semiconductor manufacturing technology, particularly extreme ultraviolet (EUV) lithography. EUV lithography is the technology that is currently used to manufacture the most advanced chips, by printing the desired circuit design on a disc of silicon or wafer.
Finally, the Russian invasion of Ukraine will drive further shortages if the conflict lasts for too long. This is mainly because these two countries are key suppliers of various minerals used in semiconductor manufacturing, such as neon, xenon, and krypton gases, as well as palladium. But there are also geopolitical implications for the Taiwan/China situation.
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The bigger picture: economic and military competition
Therefore, beyond the pandemic-induced disruption, it is more likely that the industry’s disruption is part of a bigger picture. The US is increasingly concerned about China’s economic emergence from different perspectives, ranging from intellectual property protection to national security and technological leadership in key areas such as artificial intelligence (AI). And the importance of AI technology to the military should not be underestimated.
Already in 2019, under the Trump administration, the US Department of Commerce placed telecom equipment vendor Huawei on its Entity List, which meant that US companies that wanted to continue to sell to Huawei had to apply for licenses. It also banned the use of its products in US infrastructure on national security grounds. Later that same year, an additional 28 companies involved in AI and surveillance and security—including Megvii Technology, SenseTime, and Hikvision—were added to the banned list. In 2020, the leading Chinese semiconductor foundry, Semiconductor Manufacturing International Corporation (SMIC), was also added.
By banning technology exports to China and limiting access to key semiconductor capital equipment technology (from companies such as Applied Materials, Lam Research, KLA, and indirectly even ASML) the global leader in EUV lithography, the US, is effectively preventing China from either importing or manufacturing the most advanced semiconductors.
Just a few days ago, the US gave one more turn of the screw, as it emerged that as part of the $52 billion US CHIPS for America Act just passed by the US Senate, companies who intend to benefit from its subsidies will be prohibited for 10 years from building manufacturing capacity in China for advanced semiconductors. But with that said, US subsidies are dwarfed by the $150 billion China included a few years ago in its National Integrated Circuit Plan, which was expanded in 2019—with a particular focus on achieving lithography self-sufficiency.
This is clearly a commercial battle, but it is certainly not the first time technology has been leveraged as a source of competitive advantage between civilizations. China is no stranger to this. Almost two thousand years ago when China dominated the global trade of silk and spices through the Silk Road, technology was already used strategically.
The Chinese managed to keep silk a secret for over 1,000 years and initially led Europeans to believe it grew in trees. And, once the secret was out, carefully guarded their silkworms and their process of harvesting the silk. It was not until 550 AD that the secret of silk became known to other countries when two monks from the Byzantine Empire managed to smuggle some silkworm eggs out of the country, possibly one of the first cases of industrial espionage and intellectual property theft.
China originally called its Belt and Road Initiative, a global infrastructure development strategy adopted in 2013, the ‘Silk Road Economic Belt’ strategy.
Casualties and unintended consequences of semiconductor shortages
In this commercial dispute between the US and China, there will be consequences. It is likely that in the long run there will be a de-coupling of the global semiconductor supply chain, as countries look for supply chain security and national self-sufficiency, and there will most likely be overinvestment. Excess manufacturing capacity could drive prices down and make the overall industry less profitable, possibly impacting levels of research and development investment.
In addition, regions with no strong semiconductor sectors, from Africa to Europe and South America, may find themselves in uncomfortable positions if forced to take sides. An unintended consequence of the US/China trade dispute will be an acceleration in the development of a domestic Chinese semiconductor industry. For a detailed analysis of China’s potential to lead the world into the Fourth Industrial Revolution by 2030 take a look at our thematic report on ‘China Tech’.