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Tuesday, Nov 10, 2009
"It is remarkable," says Peter Kuo, a managing director at the investment bank W.R. Hambrecht, referring to the growth rate of China's chip industry.
Even the most cursory look at the statistics proves that something big is brewing in China. Five years ago, China manufactured only 2 percent of the world's semiconductors. Today it has 8 percent and is predicted to go as high as 20 percent by 2010. Thirty-five chip plants are already in operation, and according to at least one prediction, 20 new plants are scheduled to be built in China in the next three years, an expansion plan that far outstrips that of any other nation.
Such predictions are, it must be noted, highly speculative, as the chip industry is notoriously cyclic. China's own build-out could lead to a global glut of semiconductors that sends prices plummeting and ends up putting the brakes on plans for new plants. Still, every significant global manufacturer of semiconductors, including America's own Intel, Texas Instruments and IBM, is setting up shop in China. And every sector is growing at high speed, including providers of raw minerals, the specialized gases necessary for chip manufacturing, and assembly and testing services. Even the high ground, chip design, is flourishing. The market intelligence firm iSuppli estimates that China now contains 400 chip design companies, many of them staffed by engineers freshly returned from the United States. Industry leaders in China are also lobbying the government for financial support for the development of semiconductor-manufacturing equipment, which would help further reduce dependence on the West.
"A dramatic shift in semiconductor manufacturing is now underway," said George Scalise, president of the Semiconductor Industry Association, during April testimony before the U.S.-China Economic and Security Review Commission in Palo Alto, Calif. "China's semiconductor industry is predicted to grow at twice the pace of the global semiconductor industry over the next five years."
There are many reasons for the China boom. They include government incentives for domestic companies and cost savings for foreign corporations. China's newfound openness to direct foreign investment, its cheap labor costs and generous tax incentives make the Middle Kingdom an attractive destination for global companies. China also has the advantage of being physically close to Taiwan, the world's primary manufacturing center for all kinds of electronic devices, and a leader in semiconductor manufacturing for more than a decade. When so much of the world's electronic devices are being made there, it makes sense to set up shop as close as one can. Last but not least, semiconductor manufacturing is a fairly easy business to get into. The technology behind it is well understood, so if a country has the capital to invest and a large supply of engineering talent, the process is straightforward. China has both resources in plenty.
The surge is great news for semiconductor equipment makers but has ruffled some serious feathers in the U.S. defense community. Witness a report released in April by the Defense Science Board, a federal advisory committee that works with the secretary of defense and investigated the movement of advanced semiconductor chip manufacturing technology away from the United States.
The authors of the report mince no words. Current developments are "alarming" and "deleterious" to U.S. interests. The "security and economic well-being" of the United States are at risk. Their chief concern is the evolution of the "fabless" chip design industry, in which U.S. companies focus on designing chips and leave the manufacturing, or "fabrication," of the chips to companies in East Asia -- meaning that in the not-too-distant future, the U.S. military will be dependent on foreign nations for the production of chips crucial to next-generation weapons systems.
"There is no longer a diverse base of U.S. integrated circuit fabricators capable of meeting trusted and classified chip needs," announces the report, titled "High Performance Microchip Supply." "From a U.S. national security view, the potential effects of this restructuring are so perverse and far reaching and have such opportunities for mischief that, had the United States not significantly contributed to this migration, it would have been considered a major triumph of an adversary nation's strategy to undermine U.S. military capabilities."
Strong words. But while perhaps a bit overblown -- America still owns the leading edge of semiconductor technology -- the United States has clearly aided and abetted the transfer of chip technology overseas. Countries such as Taiwan and South Korea built up their chip-making infrastructure with the direct help and encouragement of U.S. corporations. By one line of argument, it was only by relentlessly moving operations offshore in search of cost savings and flexibility that the United States was able to meet the much-ballyhooed Japanese challenge of the 1980s.
"If it is not economical to have a chip industry in the U.S. then we won't have one," says venture capital firm Mohr Davidows Michael Borrus, who tracks China, expressing a basic tenet of globalization. The segments of the chip industry that can be executed more economically in China will naturally flow there. But according to the DSB report, there are consequences to the migration of technology offshore that could have long-term effects on the balance of industrial power.
It is a "historical fact that leading-edge R&D tends to follow production," the report says. "The most attractive positions for talented process scientists and engineers move with advanced production."
In other words, if you are a cutting-edge engineer interested in working with innovative new techniques for chip manufacturing, the action is not necessarily in Silicon Valley, but at the scores of brand-new chip plants being built in Asia. That is where engineers are being trained to use the newest tools, and that is where further innovations in technology are likely to spring from. To the extent that China represents a "cluster of innovation for semiconductors," says Kuo, "you have Shanghai as a semiconductor hotbed." By ceding manufacturing to China, the United States is ceding the likelihood of future technological breakthroughs.
Or so the theory goes. There are definitely signs that talent that once would have looked for a home in Silicon Valley is now headed to China, and in many cases is doing so with funding raised from U.S. investors. Often, such talent consists of native-born Chinese who came to the United States for graduate education and now are returning to China. (One ironic note: As a result of tightened immigration controls put into place after 9/11, foreign students face much greater difficulty than previously in finding jobs in the United States after graduation. So they are essentially forced to return home.)
So, yes, China's chip industry is booming, and the boom is likely to result in an accretion of expertise and capital that pushes the sector to ever greater heights. But even if the DSB report is completely correct, it fails to give enough attention, say experts, to one salient data point -- it is not how many chips China produces but how many it consumes.
