Alexander Hamilton, the first Secretary of the Treasury of the United States (1789), argued for tariffs and subsidies to promote domestic industry. In a society dominated by farmers and powerful commodity exporters (cotton and tobacco), this was not an easy argument to make. Nevertheless, the case made by Hamilton in his seminal “Report on Manufacturers” had a profound influence on policy makers for the next century. Hamilton argued that the case for free trade made by Adam Smith relied on ideal conditions that did not exist in the real world of commerce. He asserted that Britain, which was the main trading partner of the United States, imposed “injurious impediments” on commodity exports from the United States and “bestowed gratuities and remunerations” in support of its own manufacturers. Hamilton argued subsidies were fundamental for “military and essential supplies” of importance to national security. His report to Congress singled out coal, raw wool, sail cloth, cotton manufacturers and glass (windows and bottles) as industries meriting subsidies. He also encouraged support for “infant manufacturers”: “new inventions…particularly those which relate to machinery.” In response to criticism of the fiscal burden of these subsidies, Hamilton responded: “There is no purpose to which public money can be more beneficially applied, than to the acquisition of a new and useful branch of industry; no consideration more valuable, than a permanent addition to the general stock of productive labor.”
The U.S. heeded Hamilton’s recommendations throughout during the 19th century and until W.W. II, sheltering its industry behind a wall of tariffs. The German economist Friedrich List applied Hamilton’s framework to the case of Germany in the 1840s in his book The National System of Political Economy (1841). List echoed Hamilton in arguing that Britain’s defense of “laissez faire” economics was a disingenuous stratagem to contain the development of rivals. He promoted the idea of state-fostered industrial planning as necessary for a country to achieve the capability to compete on equal terms with foreign industries. To transition an economy to the more developed stage, List argued, it is imperative that governments (1) develop public infrastructure, (2) provide incentives for savings and for the accumulation of capital and the channeling of capital into productive industries and (3) promote “mental capital” (education and research). List’s ideas, which came to be known as the German Model, were very influential during Bismark’s Germany (1870s) and Japan’s industrialization (1860s) and later for the development models espoused by Taiwan, Korea, and Singapore. In developmental economics, this model is known as the East Asian Model of Capitalism. Since its opening under Deng Xiaoping in the 1980s, China has, by-and-large, followed the course of its East Asian neighbors, with astonishing results.
The success of the East Asian Model of Capitalism is an anomaly in developmental economics which is not easy to explain. Korea, Taiwan and Singapore are the only countries in the 20th Century that have joined the club of developed industrialized nations, leaving behind other emerging markets which cannot overcome the “Middle-Income Trap” and the myriad other forces which impede economic convergence (Eastern Europe, with its rapid integration with Western Europe is a different case). Many of the policies pursued by the East Asians have been tried, to one degree or another, in most developing countries, but have tended to mainly benefit entrenched elites at the expense of the public. For example, Brazil adopted something quite similar to the East Asian Model framework in the late sixties and enjoyed a decade of high growth labeled the Brazilian “Economic Miracle.” However, political and economic instability, malinvestment and corruption have discredited the model in Brazil. In a bizarre evolution, Brazil has now gone to the opposite extreme and is flirting with Chicago School free-marketism. The one fundamental success which Brazil had in terms of promoting a world class company in a frontier industry, the aeronautics concern, Embraer, has lost government support.
One of the main challenges of development that the East Asian model seeks to address is the creation of world class companies in “infant industries.” Naturally, the targeted sectors change constantly. What Treasury Secretary Hamilton considered to be critical for national security and to ensure industrial development (coal, sail cloth, glass) is now considered mundane. Fifty years ago, every country wanted to dominate the steel and automobiles industries; these are now considered mature and of lesser importance.
In harmony with Hamilton, China has boldly outlined its own list of essential “infant industries” in its “Made in China 2025” initiative. China today finds itself in a position similar to that the U.S. faced relative to Britain in the 19th Century, and which Germany and Japan faced relative to Britain and the U.S. in the late 19th Century and the first half of the 20th Century. As is to be expected, the dominant commercial power of today (United States) preaches free trade and reacts with outrage to the newcomers use of tariff and subsidies to support “infant manufacturers.” China, like the U.S., Japan and Germany did before, objects that the U.S. is determined to unfairly contain its development. This dynamic between rising states and hegemons is a recurring pattern described as “the Thucydides Trap” by Harvard’s Graham Allison in his book Destined for War. Thucydides, an historian of ancient Greece, attributed the cause of the Peloponnesian Wars to Sparta’s inability to accept the rise of Athens as an equal. In his book, Allisson reviews 16 cases of rivalries between rising and established powers over the past 500 years, and he notes that 12 of the cases ended in wars.
Semiconductors are a pillar of “Made in China 2025.” If sail-cloth and coal were considered vital in Hamilton’s time, it is no wonder that semiconductors are the same for China today. Semiconductors are the “new oil” because they are at the core of the modern economy and drive all critical frontier technologies (communications, 5G, quantum computing, artificial intelligence, autonomous vehicles, drones, etc…), many of which have obvious military uses. No country can aspire to play a leading role in any of these industries without having secure access to state-of-the-art microchips. China imported $350 billion in semiconductors in 2019, almost entirely from the United States, Taiwan and Korea. Furthermore, it relies on U.S. technology for the vast majority of its own semiconductor industry, which is two to three generations behind market leaders.
One of the main fronts of the semiconductor industry wars is currently being fought in East Asia, so it is interesting to understand the history.
Korea and Taiwan are key global players in semiconductors. Both countries singled out semiconductors in their industrial planning and provided vital government support (logistics, financial, fiscal, R&D). In 1974, following the government designation of electronics as one of six strategic industries, Korea’s Samsung entered the memory chip industry (integrated circuits) by partnering with Kang Ki-Dong, an electronic engineer with a PHD from Ohio State University, who had worked at Motorola before starting a chip fabrication line in Korea. Samsung faced huge challenges in securing technology and invested heavily to reverse engineer advanced technologies. Defying the odds, by 1993, Samsung Electronics became the largest manufacturer of memory chips in the world. Samsung today is one of the very few fully integrated semiconductor firms, from foundry to design.
Taiwan Semiconductor Manufacturing Company (TSMC) is another outstanding outcome of the East Asian Model. TSMC is now the world’s most valuable semiconductor firm, with a market value of $240 billion. It was founded by Morris Chang, a native of China who studied electrical engineering as an undergraduate at MIT and as a doctoral students at Stanford University. Chang worked for decades for Texas Instruments, an American company at the forefront of semiconductor technology, and he rose to the ranks of senior management after making important contributions to the company’s success. Chang was eventually lured to Taiwan to head the country’s technology research institute (ITRI). With extensive logistical and financial support and subsidies from the government, Chang started TSMC in 1987. TSMC has been hugely successful, carving for itself a niche as the dominant independent semiconductor foundry (both Intel and Samsung are fully integrated) and as the primary supplier to independent chip designers. In fact, because of the importance it has for “fab-less” U.S. chip designers, TSMC is a significant geopolitical concern for the United States, given Taiwan’s unique relationship with the mainland.
Neither Samsung Electronics nor TSMC were sure bets. In addition to requiring massive and long-term government support, they faced stiff competition from established players and frequent litigation for patent infringement. They would never have been successful without extensive access to American technology and American markets
China’s leading semiconductor firm, SMIC (Semiconductor Manufacturing International Corporation), has an origin story similar to TSMC’s. The company was founded by Richard Chang (no relation to Morris Chang), a native of Taiwan, who also studied electrical engineering in the U.S. and worked at Texas instruments for over 20 years. Like Morris Chang, he was lured back to Taiwan by ITRI where he ran a rival to TSMC until the two government-supported firms were merged. Finally, with the support of the Shanghai government and financial investors from the U.S., Taiwan and Singapore, he took on the mission to create a Chinese version of TSMC. SMIC has basically followed TSMC’s non-integrated foundry model, with the objective of providing a domestic alternative for Chinese chip designers.
However, in spite of abundant capital and government support, SMIC has not found it easy to follow in TSMC’s path. From its start in 2001, SMIC encountered obstacles rooted in the different objectives of its shareholders: financial backers saw a road to quick profits for SMIC in using older generation technology that could easily be secured from the U.S.; government backers wanted the company to invest heavily to climb the technology ladder and promote regional dispersion in collaboration with municipalities. Richard Chang left SMIC in 2009 having failed in reconciling the interests of the different shareholders.
Moreover, from the beginning SMIC has been stalled by restricted access to advanced technologies, always remaining two generations behind the industry leaders. Unlike TSMC, the company was severely handicapped by export restrictions tied to the Wassenaar Arrangement (WA), a multinational pact set up in 1996 to limit dissemination of technology that could have military use. SMIC also was embroiled in litigation with TSMC and other technology suppliers who were determined to slow its progress.
SMIC’s difficulties highlight some of the particular barriers that China faces in climbing the technology ladder to compete in strategic industries. Most importantly, unlike Korea and Taiwan, which are important strategic geopolitical allies of the United States, China has been considered to be a rival and a potential threat to Pacific Basin stability. The United States is disposed to promoting the development and prosperity of South Korea and Taiwan to an extent that it will never be for China which is much bigger and a much greater ideological and commercial adversary. Inevitably, as China’s economic clout grows and its diplomacy becomes more assertive, the probability of confrontation with the U.S. becomes more likely.
The arrival on the scene of Xi Jinping as paramount leader in 2012 brought a new sense of nationalism, bravado and urgency to China’s government and contributed to triggering a more confrontational relationship with the U.S. This became immediately apparent in semiconductor policy with the announcement in 2013 of the new Guidelines to Promote National Integrated Circuit Industry (National IC Plan) and the establishment of the National Integrated Circuit Investment Fund (National IC Fund). China’s growing dependence on semiconductor imports ($311 billion in 2018) was identified as a serious vulnerability to be addressed through the identification of “national champions,” increased investment in research and the promotion of both inbound and outbound FDI. This was followed in 2015 by the “Made in China 2025” initiative, setting a roadmap for “the main segments of the IC industry . . . to reach advanced international levels” by 2030.
Xi’s ambitions have ruffled feathers in Washington. The Office of the United States Trade Representative (USTR) recently commented: “China’s strategy calls for creating a closed-loop semiconductor manufacturing ecosystem with self-sufficiency at every stage of the manufacturing process—from IC design and manufacturing to packaging and testing, and the production of related materials and equipment.” According to the U.S. based Semiconductor Industry Association, China threatens to :
“ (1) force the creation of market demand for China’s indigenous semiconductor products; (2) gradually restrict or block market access for foreign semiconductor products as competing domestic products emerge; (3) force the transfer of technology; and (4) grow non-market based domestic capacity, thereby disrupting the fabric of the global semiconductor value chain.”
As the China-U.S. relationship has spiraled downwards during the Trump Administration, the U.S. has become increasingly determined to thwart China’s “Made in China” initiative. The U.S has campaigned aggressively against Huawei, China’s leader in both 5G technology and smartphones, blocking its sales in the U.S. and lobbying for other countries to do the same, and cutting off its access to Google’s software for its smartphones.
The Bureau of Industry and Security (BIS), an agency under the US Department of Commerce, has put Huawei on an Entity List, requiring that any US firm wanting to sell American tech components or software to Huawei obtain a license from the U.S. government. Moreover, the BIS announced that all foreign firms that supply semiconductors to Huawey will also need a license if they in any way rely on U.S technology, which they all do.
The BIS licensing requirement puts China’s technology development at the mercy of America’s increasingly jingoistic politicians. For China’s leaders it confirms their worst fears that the U.S. will stop at nothing to contain Chinese development.
Ironically, the only certain consequence of the U.S.’s war against Chinese technology companies is that it will motivate China to double down on its efforts to reach the technological frontier in the key industries of the future.
Two weeks ago, SMIC announced that it has secured an additional $2.2 from government funds to accelerate investment. SMIC now appears to be the domestic champion in the sector.
The U.S. and China appear to be entering into a “great decoupling” with profound consequences for global trade and the tech sector.
