Bolstering and Securing Semiconductor Supply Chains

Supply chain resiliency has been central in economic and political debates since the start of the Covid-19 pandemic, when a series of disruptions significantly affected global semiconductor supply chains and related industries that rely heavily on chips to manufacture their goods. Coupled with increasing geopolitical tensions, these disruptions highlighted the need for the United States to strengthen its domestic chip industry by expanding manufacturing capacity and reinforcing technological competitiveness in the semiconductor industry.

To address these challenges, Congress enacted the bipartisan CHIPS and Science Act (commonly referred to as the CHIPS Act), which President Joe Biden signed into law on August 9, 2022. Specifically, the CHIPS Act includes $52 billion in chip manufacturing incentives and research investments, as well as an investment tax credit for semiconductor and semiconductor equipment manufacturing. Despite these measures to reinvigorate U.S. leadership in the semiconductor industry, the industry will face uncertainties in the years ahead.

The initial section of this analysis examines the semiconductor supply chains of Japan, the United States, and China, highlighting several key trends: the challenges associated with striving for self-reliance, the significance of fostering “friendshoring,” and the potential risks of pushing China toward self-sufficiency in the semiconductor supply chain. I then propose three strategies for the Republic of Korea (ROK), the United States, and other like-minded partners: safeguarding intellectual property (IP), preserving industrial competitiveness through friendshoring, and cultivating a highly skilled workforce.

Takeaways from Japan-ROK Tensions

On July 1, 2019, Japan imposed restrictions on exports to South Korea following the ROK Supreme Court rulings in 2018 that ordered Japanese companies to pay compensation to victims of Japan’s forced labor during its 1910–45 colonial rule of Korea. Specifically, Japan limited the export of three materials (hydrogen fluoride, photoresists, and fluorinated polyimide) that are essential inputs for manufacturing semiconductors. South Korea relied heavily on Japan for these materials. According to data from the Korea International Trade Association, Japan accounted for 44% of the country’s imports of hydrogen fluoride and 92% of its imports of photoresists in 2019.[1] The following month, South Korea was also removed from Japan’s White List, which allows trusted partners to benefit from streamlined trade procedures.

The ROK responded swiftly to Japan’s moves by announcing a plan to localize the products and diversify the suppliers of the key materials. In the case of photoresists, South Korean companies quickly imported the material from third countries like Belgium. As for hydrogen fluoride, not only has South Korea secured suppliers in the United States and China, but companies such as Soulbrain and SK Materials also have shown progress in producing the materials. According to the ROK Ministry of Trade, Industry, and Energy, imports of products used in chip production from Japan accounted for 34.4% of the total in 2018 but declined to 24.9% in 2022.[2]

Japan’s trade restriction also had a significant impact on companies. SK Hynix had roughly 50% market share for high-bandwidth memory in 2022, while Samsung accounted for 40%.[3] They are the major purchasers of numerous materials exported from Japan. Instead of completely decoupling from South Korean companies, Japanese corporations chose to maintain their close relationship. Sumitomo Chemicals’ Korea-based subsidiary DongWoo Fine-Chem spent 10 billion yen in 2021 to build an extreme ultraviolet lithography (EUV) photoresist line, and Tokyo Ohka Kogyo decided to produce EUV photoresist in Incheon. In addition to building production lines with South Korean companies, Japanese firms substituted their export of restricted chemical materials to the United States or transshipped the materials to South Korea through the United States.

Although these export restrictions were viewed as an effective short-term retaliatory measure in response to the costs imposed on Japanese companies by the ROK Supreme Court’s decision, Japan encountered several unintended effects. First, the export restrictions exposed the potential risks resulting from the high levels of interdependence between South Korea and Japan. As the semiconductor industry developed in previous decades, the two countries established roles in global value chains based on their respective capabilities. South Korea specialized in memory chips, while Japan focused on materials and equipment.

Consequently, Japan faced difficulties in strictly enforcing the restrictions. Any disruption in exports to South Korea would inevitably have adverse effects on Japanese companies and the overall semiconductor value chain. The export restrictions thus taught a valuable lesson that leveraging interdependence as a weapon could be a double-edged sword, disrupting global value chains and adversely affecting corporations in both countries.

Additionally, unlike the diplomatic relationship, which deteriorated over time, the relationship between corporations in the semiconductor value chain remained solid. Instead of completely decoupling, Japanese corporations chose to diversify their imports to Japanese firms outside Japan and localize some production of restricted materials to their subsidiaries in South Korea to allow for continued transactions with Korean corporations. Finally, the export restrictions caused clear harm to Japan’s reputation. Not only do Korean corporations prefer to work with countries that are predictable in terms of regulations, but trust in Japan as a reliable trade partner also decreased in the international community.

U.S. “De-risking” from China

The global structure of the semiconductor supply chain, developed over the course of the past three decades, has served the industry well. The benefits of geographic specialization based on comparative advantage have facilitated the emergence of an interdependent global semiconductor supply chain. Supply chain disruptions caused by the Covid-19 pandemic, however, provided a chance to re-evaluate the associated vulnerabilities.

According to the one-hundred-day reviews by the White House, the United States faced several significant vulnerabilities within the semiconductor supply chain. At the time, the United States maintained only limited fabrication capabilities at levels of 7–14 nanometers (nm) and no semiconductor production capabilities at the most advanced process nodes—currently 3 nm—at which only Taiwan Semiconductor Manufacturing Company (TSMC) and Samsung currently operate. The United States was also dependent on geographically concentrated foreign production for mature-node logic chips. In addition to foreign reliance for leading-edge chips, the United States relies on sources concentrated in Taiwan, South Korea, and China for various non-leading-edge memory chips used in consumer and industrial applications. Finally, U.S. firms in the semiconductor industry were significantly dependent on China for sales revenue. In fact, China served as the largest market for semiconductors—a majority of which were later re-exported as components within end products, including consumer electronics and appliances.

To address these and other vulnerabilities within the semiconductor industry, the U.S. government—with strong support from both Congress and the Biden administration—has made the decision to shore up the United States’ position in the semiconductor industry. Through the implementation of the CHIPS Act, an investment of $52 billion will be made to enhance the country’s semiconductor capabilities, support research and development endeavors, and cultivate a highly skilled STEM (science, technology, engineering, and mathematics) workforce. The primary semiconductor-related objective of the CHIPS Act is to encourage domestic funding for the advancement of U.S. semiconductor manufacturing capabilities. As part of the broader effort to secure U.S. leadership, additional measures have been taken to restrict outbound investments and prevent CHIPS Act funding from indirectly supporting investments in Chinese chipmaking.

The new export controls introduced by the U.S. Department of Commerce’s Bureau of Industry and Security on October 7, 2022, and the CHIPS Act guardrails proposed in March 2023 enforce restrictions on companies that receive funding. They are obligated to refrain from engaging in significant transactions that involve expanding semiconductor manufacturing capacity in China or any other foreign country of concern for a period of ten years. Furthermore, funding recipients are prohibited from utilizing the funds in other countries, and limitations are placed on joint research or technology licensing efforts with foreign entities that pose national security risks. Finally, in August 2023 the Biden administration issued a long-awaited executive order on outbound investment screening, which may bar private equity and venture capital firms from making certain investments in China in the field of quantum computing and advanced semiconductors. Along with the October 7 export controls, U.S. regulations now critically limit the kinds of advanced semiconductors, chipmaking machinery, and related IP and know-how that can be sent to China.

Despite the Biden administration’s objective to achieve resilience in the semiconductor industry, shifting supply chains involves real economic costs. Specialization based on comparative advantage is precisely what had created the mutual dependency that brought tremendous advancements in both cost and innovation to the semiconductor industry. De-risking from China and otherwise shifting the supply chain will not be successful unless the United States can achieve continued lower costs and improved productivity through frie nd-shoring.

Provoking China to Accelerate “Self-Reliance”

In April 2018 the United States imposed extremely strict export controls on ZTE after the company illegally evaded U.S. sanctions by selling telecom equipment containing U.S. chip technology to Iran. Since then, China’s leadership has viewed the semiconductor industry primarily in national security rather than economic terms. The ZTE case suggested to the Chinese leadership that more extreme U.S. moves would be inevitable in the future. Despite this precedent, the October 7 export controls were nevertheless a watershed moment in international relations and posed a major challenge to China’s industrial policy for semiconductors.

Achieving “self-sufficiency” across all layers of the supply chain is difficult and costly. According to the Semiconductor Industry Association, achieving self-sufficiency at a global level would require a staggering investment, on the order of $900 billion to $1.225 trillion, just to cover each region’s 2019 consumption levels.[4] This amount is equivalent to about six times the combined R&D investment and capital expenditure of the total semiconductor value chain in 2019.

Setting aside considerations of economic feasibility, China’s ambition to attain self-sufficiency poses a risk to the United States. Currently, China’s presence in the global semiconductor industry is relatively limited, with its companies primarily manufacturing lower-tier chips. Although China’s most advanced foundry, Semiconductor Manufacturing International Corporation, may have the capability to produce 7-nm chips, it lags behind TSMC and Samsung Electronics by one or two generations. China is actively engaged in a significant state-led initiative to cultivate a domestic, vertically integrated industry that leads in all segments by 2030. In its 14th Five-Year Plan, China pledged to increase R&D expenditure by more than 7% annually between 2021 and 2025, with the goal of achieving substantial technological breakthroughs and self-reliance. In 2022 the Chinese government allocated over $1.75 billion in subsidies to 190 semiconductor companies listed domestically.[5] As China intensively employs subsidies to foster the growth of a domestic memory chip manufacturer, it will increasingly present a challenge to the world’s three major memory companies: Samsung, SK Hynix, and Micron.

The pursuit of self-reliance in the semiconductor industry will result in clear winners and losers. In that sense, the industry will become a battlefield for zero-sum competition between the United States and China. Currently, U.S. chipmakers are heavily dependent on sales to China. According to 2019 data from the Semiconductor Industry Association, Chinese customers make up 26% of chip demand by the corporate headquarters of electronic device makers, 35% of chip demand by location of electronic device assembly, and 24% of chip demand by location of electronic device end users.[6] In 2021, China was also the world’s largest customer market for semiconductor manufacturing equipment, accounting for 26% of global demand. Heavy reliance on sales to China provides the Chinese government with economic leverage and potential power to retaliate against the United States. In the future, China might use significant retaliatory responses such as antitrust enforcement regimes to ban mergers and acquisitions involving U.S. semiconductor companies, force these companies out of the Chinese memory market through cybersecurity review, and cut off access to rare earth metals by taking advantage of China’s dominant role in mining and refining capacity.

Achieving U.S. Leadership in the Global Semiconductor Industry

To achieve U.S. leadership of the global semiconductor industry, the United States does not need to pursue complete self-sufficiency, which would involve large-scale national industrial policies with staggering costs and questionable execution feasibility. Instead, the semiconductor industry needs nuanced, targeted policies that strengthen supply chain resilience and expand open trade while balancing the needs of national security.

When formulating strategies to enhance the resilience of supply chains, governments should ensure a fair global environment that applies to both domestic and foreign companies, with a strong emphasis on safeguarding IP rights. Despite the common perception that noncompete provisions in contracts, whereby employees agree not to work for a rival or establish a competing business for a specified period after leaving their job, inhibit competition among U.S. businesses, such clauses play a crucial role in the semiconductor industry. This importance is underscored by analysis indicating that trade secrets can constitute as much as 80% of a semiconductor company’s IP portfolio.[7] Given the fierce global competition within the semiconductor sector and the relatively short product life cycles in this field, protecting IP and fostering workforce development, primarily through noncompete agreements, are essential. Policies that encourage foreign investment in R&D activities and promote the inflow of expertise and talent, while simultaneously upholding IP protections, will contribute to enhancing the capabilities of the domestic industry.

Alongside these measures, enhanced cooperation with U.S. allies is critical for promoting innovation and ensuring supply chain resilience. The imperative for robust supply chains arose due to the Covid-19 pandemic, Russia’s invasion of Ukraine, and the global drive to reduce dependence on vulnerable supply chains. To tackle this challenge, the United States has launched the Indo-Pacific Economic Framework (IPEF). Despite its shortcomings—specifically, the agreement appears to lack substantial actions and binding commitments—the IPEF can serve as a tool to clarify cooperative mechanisms and subsequent actions and initiatives to put the framework into practice. According to former ROK trade minister Yeo Han-koo, the IPEF could focus on sector-specific projects.[8]

For example, by drawing on their individual experiences, members could participate in a hands-on simulation of the supply chain. This exercise aims to pinpoint opportunities for collaboration and devise effective solutions for ensuring a stable supply of crucial minerals and raw materials needed for semiconductor manufacturing. Each IPEF country involved should conduct mapping activities tailored to its specific situation to gather information on reserves and evaluate supply chains in the critical mineral and raw material sector. These approaches are outlined in the negotiated text of the IPEF supply chain pillar, marking the first agreement of its kind. Ultimately, the IPEF seeks to empower nations by enhancing their understanding of vulnerabilities and cooperative possibilities, allowing them to formulate contingency plans.

Last, policymakers need to significantly enhance their efforts to tackle the imminent shortage of highly skilled talent, which poses a potential constraint on the semiconductor industry’s ability to sustain its current pace of innovation and growth. One solution would involve reforming the United States’ immigration system for highly skilled workers to facilitate access to the most exceptional international students worldwide. Integrating foreign students who hold graduate degrees in STEM fields from U.S. universities would be another effective option to address this issue.

Su Hyun Lee is a researcher in the Korea National Diplomatic Academy, focusing on U.S.-China relations and economic security. Previously, she was a 2021–22 Resident Korea Foundation Fellow at the Pacific Forum.

Endnotes

[1] Kim Ki-hoon, “Saneobgye, il ’han hwaiteuliseuteu bogwon’e ‘jeolcha gansohwa’ bansaek” [As Japan Restores South Korea to Export “Whitelist” Korean Businesses Are Pleased]. Korea International Trade Association, June 27, 2023, https://www.kita.net/cmmrcInfo/cmmrcNews/cmmrcNews/cmmrcNewsDetail.do;JSESSIONID_KITA=698E462FC97A833B668F23F81E74434C.Hyper?pageIndex=1&nIndex=76195&sSiteid=2.

[2] Hwang Chae Eun, “Bandoche haegsimpummog suipaegui Ilbon bijung” [The Percentage of Crucial Products from the Korean Semiconductor Industry That Japan Imports], Ministry of Trade, Industry, and Energy of the Republic of Korea, Press Release, February 23, 2023, https://www.motie.go.kr/motie/ne/presse/press2/bbs/bbsView.do?bbs_cd_n=81&bbs_seq_n=166846.

[3] Mark Liu and Caron Ju, “HBM Supply Leader SK Hynix’s Market Share to Exceed 50% in 2023 Due to Demand for AI Servers, Says TrendForce,” TrendForce, April 18, 2023, https://www.trendforce.com/presscenter/news/20230418-11647.html.

[4] Antonio Varas et al., “Strengthening the Global Semiconductor Supply Chain in an Uncertain Era,” Semiconductor Industry Association, April 2021, https://www.semiconductors.org/wp-content/uploads/2021/05/BCG-x-SIA-Strengthening-the-Global-Semiconductor-Value-Chain-April-2021_1.pdf.

[5] Ann Cao, “China Gave 190 Chip Firms US$1.75 Billion in Subsidies in 2022 as It Seeks Semiconductor Self-Sufficiency,” South China Morning Post, May 7, 2023, https://www.scmp.com/tech/tech-war/article/3219697/china-gave-190-chip-firms-us175-billion-subsidies-2022-it-seeks-semiconductor-self-sufficiency.

[6] Varas et al., “Strengthening the Global Semiconductor Supply Chain in an Uncertain Era.”

[7] Semiconductor Industry Association, “Semiconductors & the World Trade Organization: How Global Trade Rules Have Spurred Semiconductor Growth & Innovation,” November 2020, https://www.semiconductors.org/wp-content/uploads/2020/11/The-WTO-and-the-Semiconductor-Industry-Nov-2020_2.pdf.

[8] Yeo Han-koo, “It’s Time for IPEF Countries to Take Action on Supply Chain Resilience,” Peterson Institute for International Economics, July 4, 2023, https://www.piie.com/blogs/realtime-economics/its-time-ipef-countries-take-action-supply-chain-resilience.