Microchips subsidies: Protectionism, not security

According to the press and people deemed as experts, a microchip war is going on. China, the United States and the European Union are each setting up production clusters for semiconductors, the chips that process digital information. The justification for these industrial policies is improving national security. In predictable reality, however, the expensive process will produce opposite results.

The demand for semiconductors has surged over the last decade in quantity and quality – unsurprising since they run virtually every advanced electronic device. In contrast, the microchip supply is concentrated in very few nations – including the U.S., Taiwan, South Korea, Japan, some EU countries, and increasingly, China. Notably, Taiwan accounted for more than 63 percent of total semiconductor manufacturing revenue in 2020.

Because of this concentration, microchip supply chains are subject to high interdependencies and exposed to security risks and trade wars, among other risks. Also, the more geopolitical friction, the higher the risk levels affecting those supply chains.

The lure of industry policy

Now, the story turns to political marketing – or even science fiction. Several governments, notably in Europe and the U.S., claim that after the experiences from the Covid pandemic and the war in Ukraine, they need to repatriate chip manufacturing. This claim is based on a loosely constructed link to security, innovation and job creation. It does not seem pertinent that these arguments all fail. The more they do, the more enthusiastic their political defense becomes.

The U.S. has been discussing massive investments and incentives – almost $53 billion under Congress’s bipartisan CHIPS and Science Act to support homegrown manufacturing, research and development and supply chain resilience. The EU also aims to establish global leadership and make similar investments: during the 1990s, the bloc had over 40 percent of the chips market, but by the early 2000s, this figure had fallen to 24 percent. It barely reaches 10 percent today.

The European Chips Act still needs full approval, but the political enthusiasm is already there. With the Act, the European Commission promises to finance innovation and to industrialize processes “to bring the lab to the fab.” The Commission wants to create new applications, including connected and automated vehicles (CAVs), telecommunications, the digitization of the health sector and significantly increase security and defense.

The EU aims to reduce its dependence on international markets because, as the Commission puts it, “The chip industry is one element in the competition for technological supremacy between China and the United States.”

An investment package of around 11.3 billion euros has been pooled from existing EU instruments. These include the research program Horizon Europe, the coronavirus recovery fund and national government budgets. The European bloc aims to mobilize more than 44 billion euros of public and private funds in the hope of doubling the EU’s market share of the semiconductor market by 2030.

Pitfalls of the Chips Act approach

The EU’s plan is so full of problems that it amounts to fiction. They are, for one, the difficulties inherent to industrial policy, but the EU still manages to give them an even more problematic spin.

The first problem is simple: There is no market for the EU’s chips. At least, not in the way the multibillion dollar-package estimates it. That means the EU’s push does not come out of a changing pattern of world demand but only from some politicians’ minds. And since this demand does not stem from markets, there is also no feedback mechanism informing the central planners how to distribute the allocated money. Even if European or U.S. manufacturers welcome the package, this is not a sign coming out of actual market feedback. Most firms obtaining free money welcome it.

The second problem is that there is no unified production of microchips. The link between research in new technologies and materials, their adaption to marketable products, and their manufacture is not easy to establish. Also, the EU package does not address this problem, presupposing the existence of a seamless supply chain that can be onshored frictionlessly into the EU. The task becomes even more questionable in the absence of the feedback mechanism of markets.

The third problem is balancing the EU’s stated aims of decreasing dependence on foreign producers – whatever that means – on one side while continuing to work with international partners on the other. Strictly European solutions to secure semiconductor supplies risk reinforcing autarkic tendencies and creating additional inefficiencies and duplications in value chains. It also risks alienating countries such as the U.S., South Korea and Taiwan.

The additional EU-specific problems are twofold: smaller EU countries fear that bigger states, such as France and Germany, will outbid them for chip investment. This fear is exacerbated by the new EU-U.S. tech alliance, the Trade and Technology Council, in which France is expected to take control of the semiconductors negotiations.

And finally, the EU’s funding is conditioned upon member states’ funding, which is everything but secured.

Source: GIS Reports