The prospect of global conflict permeated the room at this year’s Trade and Technology Council, which concluded in France earlier this week. The second annual gathering of U.S. and EU officials yielded a joint statement that mentioned some form of “Russia” or “Ukraine” more frequently than “technology,” “regulation,” “investment,” “security” or “competition.”
The conflict in Ukraine, having already escalated into a U.S. proxy war, seemingly convinced the EU to fall in line with the American tech policy agenda.
“When it was launched, different people had different aspirations for [the TTC],” Christopher Padilla, the leader of IBM’s global government and regulatory affairs team, told Protocol.
“Some people felt like it would be mostly to talk about disputes with the Europeans over how to regulate the tech sector,” Padilla said. But after Russia invaded Ukraine, “people on both sides of the Atlantic got reminded that the U.S.-European relationship is the essential partnership — economically, politically and now militarily — in the world.”
Those officials clearly felt a shared sense of urgency to onshore semiconductor manufacturing. At the TTC, they agreed to collaborate more closely on supply chain transparency and subsidy programs. The strong language contained in those clauses affirmed their commitment to an already aggressive onshoring strategy. The meeting also revealed the centrality of semiconductor manufacturing to U.S.-centric military objectives. For chip manufacturers, that means free-flowing subsidies for now, but at the cost of a potential overcapacity problem in the longer term.
National security “freak out”
“You have to understand that these fabrication facilities, they are not being propped up because of pure economics concerns. They’re being propped up because of national security — people freaking out, really, that’s what it is,” Adi Rao, a PhD candidate in The Department of Government at Cornell, explained to Protocol.
“The level of urgency that we’re seeing from government leaders in the U.S., Europe and Japan is driven mostly by the national security concern,” echoed Padilla. The pandemic-related supply chain crunch helped government officials realize their economies were entirely too dependent on Taiwan for semiconductors, he said. “Every government meeting I have, almost the first thing an official says is, ‘We cannot rely on just Taiwan for chips.’”
Chart: Protocol and Datawrapper
China holds an estimated 89% of global rare earth separation capacity, the TCC statement pointed out. Those rare earth metals are critical to semiconductor manufacturing, and the entire industry worldwide is still entirely reliant on China in that sense.
“If something were to happen between China and Taiwan, that would be catastrophic for the semiconductor industry,” Patrick Penfield, a professor of supply chain practice at Syracuse University, told Protocol. “If we were to do what we're doing to Russia, to China — you would talk about massive supply chain issues throughout the world.”
Chart: Protocol and Datawrapper
The continued fallout of the war in Ukraine put this potential supply chain disaster in sharp relief.
“The world is still waking up to the impact of Russia’s invasion of Ukraine,” said Willy Shih, a professor at Harvard Business School. “We keep discovering more and more collateral impacts as a result of that,” he told Protocol. To illustrate this point, Shih pointed to Indonesia’s recent ban on palm oil exports, which came in response to plunging sunflower oil exports from Ukraine. Ukraine was the top producer of sunflower oil prior to the invasion; now there’s a global shortage.
Fabricating our way into World War III?
Political economists have long theorized that great powers are less likely to go to war if they rely on one another for trade. The so-called “capitalist peace theory” is a core tenet of classical liberalism — one of the many reasons scholars say we should embrace globalization, even if it comes with quite a few nasty side effects. Install a McDonald’s in your capital city, Thomas Friedman posited in 1996, and no other McCountry will invade. (Russia has since served as the counterpoint to this theory, though McDonald’s is now leaving Russia.)
If the capitalist peace theory holds, then reshoring chips would have considerable geopolitical ramifications, according to Rao. In this sense, he added, China poses a greater threat: “The Chinese can’t actually threaten Taiwan currently, or at least not so easily, because they need the chips.” To secure that supply, China is expected to pour well over $100 billion dollars into developing its domestic semiconductor industry. “The way to frame this is whether or not China requires Taiwan — and in the future, they may not,” Rao said.
Chart: Protocol and Datawrapper
China’s stated aim is to reunite with Taiwan, not demolish it. So in theory, Taiwanese manufacturing shouldn’t be at risk. But Rao said delicate chip fabrication facilities could be damaged in the event of an invasion, and that would be a supply risk China would likely not want to take.
There’s an even more direct way that semiconductors enable war: Advanced weaponry is packed with chips. A single Javelin missile launching system contains around 250 semiconductors. The U.S. has already shipped well over 5,500 Javelin anti-armor systems to Ukraine since the invasion. Shih pointed out that Ukraine is consuming those missiles much faster than the U.S. can produce them, which raises concerns over U.S. manufacturing capacity given this is “one really regional conflict between Russia and Ukraine.”
“Back in the 1940s, the U.S. manufacturing industry had a lot of slack capacity, so that it could respond and pivot and be the arsenal of democracy,” said Shih, referring to the term coined by President Franklin Delano Roosevelt as the U.S. mobilized for war in 1940. Though he doesn’t currently anticipate a broader conflict, Shih said the central question is whether the U.S. could replicate its earlier industrial prowess after offshoring “so much basic capacity in basic industrial goods.”
Boeing versus Airbus: Chip edition
The TCC joint statement spells out the shared U.S.-EU goal to “incentivize increased production while avoiding subsidy races.” In particular, government officials agreed to share information on the purpose, budget, form and recipient of semiconductor subsidies.
Multiple sources pointed to the example of the longstanding U.S.-EU subsidy dispute surrounding Boeing and Airbus, an affair rife with accusations of market manipulation. The TTC sets out to avoid a similar conflict: It’s not that the U.S. and EU governments want to avoid propping up the semiconductor industries. Rather, they want to avoid creating an economic quagmire where high fixed costs and excess capacity doom an entire sector to lingering unprofitability.
“I always worry about the sustainability of the subsidies,” said Shih. “But the fact that the EU and the U.S. want to coordinate on that suggests they’re both very conscious of WTO rules.” By calling a truce on the subsidy race, Shih said the U.S. and EU could avoid a “race to the bottom.”
Avoiding such a conflict might be easier said than done. The race to onshore semiconductor facilities over national security concerns represents a long-term solution for a short-term problem, according to Rao.
“It’s too crowded,” Rao said. “Ten years from now, are we really going to require a fabricator in East Asia — at least two locations in East Asia — and America, and Europe?” he asked. (On Thursday, reports came out that TSMC might build a facility in Singapore.)
Even if the U.S. and EU are aware of these problems — and the TCC suggests they are — it’s not so easy to address the issue. “It’s hard sometimes to get away from subsidies,” said Penfield. “If you don’t offer subsidies, if you don’t offer those incentives — it’d be very difficult to attract a company to do what you want them to do in your particular country,” he added.
Given the current semiconductor supply crisis, worrying about excess capacity might seem indulgent and beside the point. And consumers might wonder if a theoretical excess in supply would usher in a wave of cheap consumer electronics. That’s not guaranteed, warned Rao, because moving production to the U.S. would come with additional costs that would actually raise prices, assuming a constant number of suppliers.
“The worst problem is how much it will cost the taxpayer to just keep these industries afloat,” Rao said. “These are industries that are here ‘unnaturally,’ so to speak — they're here because of national security reasons.”
“I’m not worried about the subsidy war,” said Padilla. “In fact, I think the bigger risk is that governments fail to do what they need to do to invest in this area, frankly.”