The greatest challenge facing China’s chip drive? It’s neither funding nor talent, but resource allocation

China can plug the talent gap by revving up its universities and use its powerful state apparatus to pool semiconductor funding
But getting the resources channelled to the right companies and minds is a path riddled with subsidy fraud, R&D incompetence and corruption

Chengxin Zhang

Published: 1:30am, 17 Jan 2023

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The United States has stepped up its chip war against China over the past year. The Chips and Science Act blocked China’s access to advanced semiconductor technologies through restrictions on US companies, and this was followed by sweeping US export controls on high-end chips and chipmaking technology. The US has even pressured countries such as the Netherlands and Japan to restrict their hi-tech shipments to China.

All of this is a step up from 2020, when Washington merely targeted specific Chinese companies, institutes or individuals, such as Huawei Technologies Co and Semiconductor Manufacturing International Corporation (SMIC), by putting them on its Entity List, an export blacklist. The attack has seemingly widened into an indiscriminate effort to suppress China.

China’s predicament is reminiscent of Japan’s plight during its 1980s chip war with the US. In 1986, Tokyo finally signed the US-Japan Semiconductor Agreement, ceding a targeted 20 per cent of its domestic market to foreign companies – only for the Reagan administration to still impose a 100 per cent tariff on imports of Japanese tech goods later.

Yet there are differences between China’s semiconductor industry today and Japan’s then. In the 1980s, Japan accounted for more than half of the global semiconductor market. China had just 4 per cent of the market in 2021. Even so, Washington has decided to stifle China’s semiconductor industry, from the upper to the lower reaches of the supply chain. Its chip sanctions on China are far worse than those unleashed on Japan decades ago. It appears Washington is determined to snuff out the industry in China before it fully matures.

Beijing is clearly unwilling to be a sitting duck. But as a more vulnerable competitor, China can expect a tough journey.

Faced with crippling US sanctions, China has no choice but develop self-sufficiency in advanced semiconductors – an enterprise for which talent and capital are indispensable. But China remains short of semiconductor talent, with an estimated gap of over 200,000 over 2022-2023.

In 2021, the combined revenue of China’s top 50 semiconductor companies was only US$40 billion – half of Intel Corp’s US$79 billion. Accordingly, Chinese companies are limited in what they can spend on research and development. For instance, Intel spent US$15.2 billion on R&D in 2021, three times the revenue of China’s top chip maker SMIC.

But neither talent nor capital constitutes the most pressing problem. After the State Council issued guidelines in 2020 to encourage more semiconductor schools in universities, top colleges, including Peking University, Tsinghua University and Huazhong University of Science and Technology, quickly set up their own. By 2021, China’s semiconductor workforce had grown by 17.7 per cent.

The country’s powerful state apparatus also means Beijing can pool from a wide range of resources. The National Integrated Circuit Industry Investment Fund, China’s largest state-run semiconductor investment vehicle, was initiated by the Ministry of Industry and Information Technology, and operated by state-owned enterprises such as China Tobacco and China Mobile. Known as the Big Fund, it has raised more than US$50 billion to invest.

Supported by Big Fund subsidies, Yangtze Memory Technologies grew to command nearly 5 per cent of the global NAND flash memory market in 2021, a share expected to reach 6 per cent this year.

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Given China’s huge population and strong economy, its talent and capital shortages will not last too long – its real challenges are in resource distribution.

Firstly, how can the government make sure that resources go only to qualified entities? There have been fraudulent applications for subsidies, and some companies are simply incompetent at R&D. Giving them resources will only result in waste and losses.

The rise and fall of the government-funded Hanxin microchip project is a cautionary tale. In 2006, the government discovered that Chen Jin, a professor at Shanghai Jiao Tong University, had passed off imported Motorola chips as “home-grown” Hanxin ones. Funds had to be recovered.

And then there is Fujian Jinhua Integrated Circuit Co, sponsored by local authorities in high hopes of developing indigenous DRAM (dynamic random-access memory) chips – but which has ended up offering to rent out its factories after being put on the US export blacklist in 2018.

Jinhua had been collaborating with Taiwan’s United Microelectronics Corporation (UMC) on DRAM chip development. However, the DRAM development team was located in Taiwan. After Jinhua was sanctioned by the US, UMC backed out of the cooperation deal and Jinhua had to stop production with little to show for its investment.

Secondly, how can the government better supervise the managers of its resources? So far, three senior executives of the Big Fund – Ding Wenwu, former Big Fund president, Lu Jun, the fund’s former chief executive, and Yang Zhengfan, another executive at the fund – have come under investigation by the Central Commission for Discipline Inspection, the country’s top anti-corruption watchdog.

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If government funds are reduced to a hotbed of corruption, Beijing’s hope of breaking free of US chip sanctions will crumble.

Beijing must take a good, hard look at its institutional flaws at every stage of industrial policy implementation, from qualification verification and project approval to financial transparency – and make timely adjustments.

Otherwise, these are serious problems that could stand in the way of China’s efficient use of talent and capital in its semiconductor self-sufficiency drive, and could risk ruining the virtuous industrial ecosystem.

Chengxin Zhang is a doctoral candidate at the School of Politics and International Relations of Lanzhou University, China, and a researcher at the Youth Think-Tank of The Glory Diplomacy of China