China fights for microelectronic independence

For some time now, it has been said that China has become the first economy in the world, leaving behind the United States. Indeed, if we measure the size of the economy by the indicator of gross domestic product calculated according to the purchasing power parity (PPP) of the national currency, then in 2014 China came out on top in the world.

According to the IMF, by the end of 2021, China's GDP, calculated at the PPP of the Chinese yuan, amounted to $27.2 trillion (18.62% of world GDP); and US GDP – $23.0 trillion (15.74%).

For many types of manufactured goods, China's share in the global market is even higher than its share in global GDP. OECD experts estimate, in particular, that back in 2004, China surpassed the United States in terms of exports of ICT products (information and communication technologies).

In the same year, China made a breakthrough, increasing exports of information and communication products by 46%, bringing their volume to $ 180 billion. In the same year, the United States saw a 12% increase in similar exports, with a value of $149 billion.

In the same year, 2004, China's exports of IT products for the first time exceeded imports of the same products (the latter amounted to $149 billion). For the first time, China has a surplus of $31 billion in foreign trade in IT products.

Since then, it has been said that China is the world leader in the electronics industry market, and the United States, Japan, South Korea, Germany and other familiar leaders of electronics have hopelessly moved into the background. However, such statements are questionable. Or at least ambiguous.

General indicators of production and export of IT products include both electronic "consumer goods" and products that belong to the most advanced and complex technologies (intended for use in industry, aviation, armaments, space industry, etc.). And if we remove "consumer goods" from the overall indicators, it turns out that China does not look like a global giant anymore.

In terms of products classified as "advanced", it is in a number of cases inferior to such countries as the United States, South Korea, Japan, Taiwan, etc. And even more seriously for China, its electronics industry is heavily dependent on the import of individual components from which it makes its final products.

In addition, the Chinese electronics industry depends on imported equipment for manufacturing intermediate and final products. In the second half of the last decade, the annual import of semiconductors, microchips and microprocessors ("raw materials" for the production of final electronic products) reached and even exceeded $300 billion. This, by the way, is more than China's imports of crude oil and petroleum products.

In terms of microchips, China covered the needs of the domestic IT industry with domestic production by only a few percent. In the most "advanced" end products of Chinese production, the share of imported chips was often equal to 100%. One gets the impression that China is an "electronic colossus with feet of clay".

Beijing has become fully aware of the risks arising from such "distortions" in the development of domestic electronics in the past decade. In this it was helped by the American president Donald Trump, who sharply strained US-Chinese relations, especially in the field of trade and economic.

Under Trump, the US Department of Commerce began to maintain a blacklist of Chinese companies that, according to US intelligence, created supercomputers for the Chinese military and helped China develop weapons of mass destruction (WMD). The supply of microelectronic "raw materials" from the United States to such Chinese companies was banned. At first, Beijing did not really feel this sanction, because the import of chips was carried out mainly not from the United States, but from other countries – Taiwan, Japan, and South Korea.

The first major "bell" for Beijing was Washington's demand for Taiwan to stop supplying microchips to the Chinese giant of the IT industry, Huawei. In 2020, the US Federal Communications Commission (FCC) officially classified Chinese companies in the Huawei and ZTE industries as national security threats, and this decision was made after the FCC found that both companies have close ties with the Chinese Communist Party and the Chinese military leadership.

Washington could make such a demand to Taipei (the capital of Taiwan) for the reason that it has long established secret control and guardianship over this island, which calls itself the "Republic of China". The purely formal reason for such a requirement was that the chips produced by the Taiwanese corporation TSMC use American technology.

The next "bell" rang already under the current American president Joe Biden. In April 2021, Washington, through Taipei, forced Taiwan's TSMC to stop cooperation with China's Tianjin Phytium Information Technology (Phytium). The day prior, the US authorities included Phytium on the blacklist of companies allegedly having links with the Chinese military.

Beijing's response to Washington's electronic sanctions was the announcement in 2020 by the Chinese leadership that starting next year, the country will launch a five-year program for the development of the electronic industry and allocate an astronomical amount of $1 trillion, i.e. an average of $200 billion a year.

The declared amount of funding for the industry exceeds any imagination. For comparison, I will say that in the spring of last year, the American President Joe Biden stated a strong backlog of American microelectronics and demanded from Congress to allocate $50 billion for the development of the industry.

The Chinese program has two main goals.

Firstly, "catch up and overtake" the world's industry leaders. And not by the cost of production and sales, but by the technical level of products. Perhaps the most obvious leader is mainland China's neighbour Taiwan. The already mentioned Taiwanese company TSMC produces microchips with a 4-nanometer indicator, and in the second half of this year it will start producing a product with a 3-nanometer indicator.

Even the Americans admit that with maximum effort, they will be able to reach this level of product only in the second half of this decade. The most modern chips that China has the ability to produce independently are 55/40 nanometers. This is not even yesterday – this is a gap of years, this is the level of the zero years.

Individual companies in the United States, Japan,South Korea, and even China sometimes claim that they have reached the level of the best products of the Taiwanese company. But upon closer inspection, it turns out that we are talking about single instances.

For example, in the spring of 2020, the Chinese company Yangtze Memory Technologies announced the creation of a prototype of a 128-layer 3D NAND chip. No one has ever created such products before. But this company uses American technology, equipment that cannot be entirely manufactured in China. The United States has already cut off business contacts with this company, and it cannot repeat its success.

And Taiwan carries out mass production of products with the highest characteristics. At the same time, most of the production was carried out not on the free market, but on orders from companies in different countries. And one of the main customers was mainland China.

Secondly, we need to achieve maximum industry autonomy, i.e. import substitution. Unofficial name of the program – “Made in China”. The priority direction of import substitution is the so-called "raw materials" - semiconductors, chips, processors.

Today's relations between Beijing and Washington are even more tense (compared to the time of the presidency of Donald Trump). And Washington controls key parts of the global microelectronic "ecosystem" and at any time can announce to Beijing a total block on supplies needed for the Chinese industry. Just as such a lockdown was carried out in late February-early March of this year in relation to Russia.

The supply of electronic "raw materials" for Russian electronics was immediately stopped by American companies. Also by Japanese and South Korean. But a particularly painful blow for Russia was the termination of chip supplies from Taiwan, where products necessary for the Russian defence industry were produced on a contract basis.

China is afraid of blocking the import of not only microelectronic "raw materials", but also equipment for its production. Here, the key element of the "ecosystem" is the Dutch company ASML, which has an almost absolute monopoly on the production of the main types of such equipment - photo-lithographs and steppers.

Without going into details, I will note that Washington has leverage over this company. Including a formal argument that ASML uses American technologies. The US government has banned the Dutch company from selling equipment to China's SMIC, one of China's largest manufacturers of electronic components. The Dutch had to heed instructions from Washington.

Since this year, the program for the development of Chinese electronics is already in effect. It turned out that even the claimed trillion dollars is no longer enough. Industry representatives sought to double the amount of funding. So far, they have settled on a compromise figure of $1.4 trillion (for comparison: this is approximately equal to the value of Russia's annual GDP). Thousands of Chinese companies rely on the money. But the list is headed by such giants as Alibaba Group, Huawei Technologies Co. Ltd, SenseTime Group Ltd.

Chinese leaders like to repeat on various occasions that money solves a lot, but not everything. And they remember our Soviet slogan "Cadres decide everything”. The program allocates money for training specialists. A couple of years before the program was launched, Chinese businesses operating in the IT industry began a "bounty hunt" abroad.

Quanxin Integrated Circuit Manufacturing (QXIC) and Wuhan Hongxin Semiconductor Manufacturing Co (HSMC) became particularly active. They have already managed to lure more than a hundred employees from Taiwan's famous TSMC, offering salaries twice as high as they received on the island. In addition, China has begun to recruit professionals in South Korea. There were some cases of recruitment of Russian specialists. Most actively, China "hunts" for specialists in semiconductor lithography, etching, annealing and other similar professions.

The first year of the program ended with very good results. The China Semiconductor Industry Association, which brings together 744 companies in the industry, reported that sales of integrated circuits in China reached 1.05 trillion yuan ($158.6 billion) last year, an increase of 18.2% compared to 2020. This information was supplemented by data from the National Bureau of Statistics of China: 359.4 billion integrated circuits were produced in China last year, which is 33.3% more than in 2020.

In January 2022, the American Semiconductor Industry Association (SIA) made a forecast based on extrapolating from the dramatic acceleration of microelectronics last year. According to its estimates, in 2020, China's share in global sales of electronic chips was 9%, and by 2024 it will increase to 17.4%. This would allow China to join the big four manufacturers of microelectronic circuits, along with Taiwan, South Korea and the United States.

Here are some more figures for last year, according to official customs data. The value of integrated circuit exports increased by 32% to $153.8 billion in 2021 (the growth rate in 2020 was about two times lower). The cost of importing integrated circuits increased by 23.6% to $432.6 billion. compared to 14.6% growth in the same period of the previous year.

This gap shows how much China still depends on integrated circuit imports, especially when it comes to the most advanced chips. Some experts explain the record import rate last year by the fact that Chinese companies, in anticipation of sanctions imposed by Washington and its allies, made unprecedented large commodity stocks.

In general, we can say that in the first year of the program implementation, extensive development of the industry prevailed. The transition to the new quality has not yet occurred. The bottleneck of the program is the production of our own equipment for the production of the latest generation of microchips. As of today, Chinese factories can provide only 20% of the necessary equipment and technologies needed to produce modern chips with a 28-nanometer index.

In addition to budget funds, it is planned to attract private capital. A specialised fund has been created to accumulate funds for additional financing of the "semiconductor import substitution" program. In China, it is simply called "Big Fund". First of all, it will finance Chinese suppliers of equipment for the production of electronics, such as Naura, Advanced Micro-Fabrication Equipment, Hwatsing, ACM Research, Mattson Technology and Shanghai Micro Electronics Equipment. These companies should eventually provide 100% equipment for the production of chips with an indicator of 28 nanometers.

But that won't happen in five years. By 2025, it is planned to provide only 70% of its needs with purely Chinese-made equipment; 30% will still be covered by imports. During the transition period, you can try to build some grey schemes that circumvent Washington's prohibitions. But it is more important to look for reliable foreign suppliers that cover the remaining 30% of the needs and are not under the strict control of Washington. China considers Russia, India, and Malaysia as candidates for the role of alternative partners.

At the time of the start of the special military operation in Ukraine, Russia was hopelessly behind in terms of microelectronics not only from Taiwan, the United States and Japan, but also from China. Collective West cut off all supplies of microelectronics to us three months ago (with the exception of consumer goods).

Let's be honest: over the past decade and a half, our country has adopted many "Strategies", "programs" and "plans" for import substitution in the field of microelectronics, but all of them have been successfully failed. Because there was a "magic wand" in the form of importing everything that’s needed.

Even the 2014 sanctions against the Russian Federation (in connection with the return of Crimea to Russia) left us with "windows of opportunity" for importing microelectronics. Now the number of such "windows" has been reduced to a minimum. If we want to survive and win the sanctions war, we need to start a real import substitution of microelectronics.

What is necessary for this?

Firstly, dramatically increase the scale of financing for industry. Yes, of course, we will not have $1.4 trillion like China. But we can and must allocate an order of magnitude smaller amount. The money is there. This is the foreign exchange earnings that have suddenly flooded into Russia today. If we do not want it to be "frozen" again (and then, probably, confiscated) by the collective West, the money must be quickly used for the development of microelectronics, which has become one of the most "bottlenecks" of the domestic economy.

Secondly, to establish cooperation in the field of microelectronics with those few countries that are not listed in the list of unfriendly states and at the same time have some potential in this area. This is primarily China. Also, possibly, India, Malaysia.

Until recently, China looked somewhat condescendingly and arrogantly at Russia as a possible partner in microelectronics. It is possible that China and Russia may soon turn out to be "friends in misfortune", Chinese arrogance will disappear and really productive and mutually beneficial cooperation in the field of microelectronics will begin.

Beijing has another fallback option to get out of the difficult situation with microelectronics, which it prefers not to talk about loudly. At a distance of some 150 kilometres from mainland China is the already mentioned island of Taiwan, which houses the capacities of the also mentioned TSMC company, a globally recognised leader in the production of semiconductors and electronic chips. Experts say TSMC accounts for half of the global microchip market.

But this is the entire market where the products of today, yesterday, and the day before yesterday are traded. TSMC specialises, so to speak, only in the products of today (and always prepares the products of tomorrow). In the latest-generation microchip market (with indicators not exceeding several tens of nanometers), TSMC's share exceeds 90%. TSMC is figuratively called the "pearl" of Taiwan and the world of microelectronics.

On the one hand, this "pearl" is under the tacit supervision of Washington. On the other hand, it is only an arm's length away from mainland China. Yes, in addition, Taiwan, according to Beijing, is a legitimate part of a united China, which, by some misunderstanding, exists independently from the People's Republic of China.

Talks and negotiations on the reunification of mainland China and the island of Taiwan have been going on for many decades. There were moments when it seemed that a little more and a united and indivisible China would emerge. But those times are over. Taipei (the capital of Taiwan) is increasingly distancing itself from Beijing. And Beijing's appetite for the island is growing.

The reason for this appetite is that Taiwan is now interesting to Beijing not only as part of the territory of historical China and as an "unsinkable aircraft carrier", but also as the owner of the "pearl" of the world's microelectronics. Beijing wants to speed up the annexation of the island and thus become the kingpin in the global competition for microelectronic leadership.

Both Beijing and Washington are well aware that leadership in the field of microelectronics is a prerequisite for global leadership in the economy and military sphere. Military tensions around the island are escalating. Experts note that the likelihood of a special military operation by China on the island of Taiwan is growing every day.

At the same time, there is a risk that in the course of military operations, the "pearl" of Taiwan may be seriously damaged or even purposefully destroyed. But such destruction is not just a risk for Beijing. The elimination of TSMC will deal a heavy blow to the IT industries of many countries, and will throw the global microelectronics industry back to the noughties.

Some indirect signs indicate that the probability of the worst scenario in Taiwan (i.e., the termination of TSMC's work) is quite high. The Taiwanese company is working to the limit of its capabilities. Moreover, to date, it has only two priority clients left - American Intel and AMD (all the others are on the side).

Apparently, these corporations are making extra-planned purchases in reserve, accumulating reserves. There are reports that TSMC's most valuable equipment is being prepared for evacuation. And where to? I think there are two options – Japan or the United States. The fact is that TSMC has agreements on the construction of its factories with these countries. Japan is closer to Taiwan, but the facility under construction in the United States is significantly larger (Phoenix, Arizona).

I think that the main "spare airfield" for TSMC will still be America. After all, it is no secret that TSMC products have been used and are being used in weapons and military equipment purchased by the Pentagon. American experts did not hesitate to consider TSMC as part of the US military-industrial complex. It would be better, in their opinion, if this part of the military-industrial complex was located on the territory of the United States, and not at the side of China, which is an enemy of America.

The chess game between Beijing and Washington, held on a chessboard called "world microelectronics", continues. Washington wants to pull Taiwan's "pearl" out from under Beijing's nose and regain its glory as the world's electronics leader. According to some estimates, the United States accounted for 37% of the global microelectronics market in 1997.

Today, according to some estimates, only about 12%. By 2030, Washington expects that the share will be raised to 30%. It's funny, but Beijing has set itself about the same benchmark. Will there really be a draw? Or will the game of chess drag on for many years?

The next move of the chess game is Beijing. Everyone is waiting in suspense for the Taiwan denouement. Not just in Washington, but all over the world. Some experts expect that the move will be made in the fall of this year. Why?

Firstly, because until then, all of Washington's attention will be focused on Ukraine. Beijing believes that the war in Ukraine will continue until the end of the year, or at least until the autumn. And this is a good time to annex the island. Secondly, because a further delay will, among other things, strengthen the island's defence capability (supply of American weapons). Partial evacuation of TSMC equipment may also begin.

However, the number of scenarios for the development of events around Taiwan is very large. And some of these scenarios can have very painful consequences for the whole world and for us. From this, it should be concluded that domestic electronics and microelectronics should develop as independently as possible from the global economic and political situation, which is becoming increasingly volatile.

There have been similar situations in our history. For example, in the 1930s, an economic crisis raged in the world, which affected almost all countries. In the Far East (in the same China), a bloody world war was already beginning (which only in 1939 spread to Europe). And the USSR set a course for achieving complete self-sufficiency and economic independence.

Even in the early 30s, it seemed that the USSR had no prospects, our lag behind the collective West was very strong. By the early 1940s, the Soviet Union had largely industrialised, become the world's second largest economy, and strengthened its military might. And managed to come out victorious in the Second World War. Solving the problems of domestic electronics and microelectronics, we will, of course, study and use the experience of modern China. But first of all, it’s necessary to not forget one’s own experience.