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China's Computer Chip Industry Plays Catch Up

Closing China's semiconductor technology gap is one of Beijing's top priorities, but significant obstacles still need to be overcome.

Today, China imports more computer chips than any other country. Yet an overreliance on foreign technology means the Chinese government is desperate to fast-track development of its homegrown semiconductor industry. Semiconductors are critically important to China's technological ambitions, with the next generation of potentially game-changing digital applications dependent on the performance of cutting-edge integrated circuits (IC).

Even though Beijing continues to invest huge sums of money in domestic chip production, the technology gap between China and the world's leading chip-producing nations looks likely to remain sizeable over the short to medium-term.

"Finding chip design talent and manufacturing are undoubtedly big challenges, but the latest drive for semiconductor independence could push progress," says Calvin Cheng, East West Bank's Head of Technology and Venture Banking.

In 2019, an estimated 16% of the chips used in China were domestically manufactured, and about half of these are still made by foreign companies, according to the Center for Strategic and International Studies. Government targets for the Chinese semiconductor industry include producing 70% of domestic needs within China by 2025, and reaching equivalence with the latest international semiconductor technology by 2030. According to industry analysts, however, it is unlikely these goals will be achieved.

In the face of this anticipated shortfall, China's domestic semiconductor industry continues to evolve at a relentless pace. According to the China Semiconductor Industry Association, its value has increased around 14-fold over the past 15 years, with current growth rates of around 16-20% per annum.

"How quickly China can catch up with the world's leading semiconductor producers remains to be seen," says Mike Vinkenborg, a project leader working for China-based research firm Daxue Consulting. "I think we're talking about more than 10 years. But one thing is for sure—recent sanctions have intensified Beijing's determination."

The design perspective

The semiconductor industry comprises numerous subsectors, which makes an assessment of where China ranks in terms of global competitiveness complex. In the key area of design, Chinese companies have learned how to leverage the most advanced global tools and are competing at the cutting edge in some key semiconductor applications. In terms of semiconductors for smartphones, companies such as HiSilicon (wholly owned by Huawei), Tsinghua UNISOC, ZTE, Xiaomi and Alibaba are all competitive with their international rivals. Some might argue that Huawei's Kirin chipset, for example, is one of the most advanced in the world.

But in other key semiconductor verticals, such as memory and logic (CPUs/GPUs), Chinese firms remain well behind their Western counterparts in terms of design and commercial market share.

"Efforts to reduce the dependence of Chinese firms on Western semiconductors, such as domestic targets outlined as part of the Made in China 2025 initiative, have already proven to be unrealistic, given the difficulty of assembling sufficient personnel, technology and commercial credibility that is required to compete at the cutting edge," says Paul Triolo, head of Global Tech Policy at Eurasia Group. "Compared to a decade ago, Chinese firms have made tremendous progress, but they remain unable to garner significant market share outside of semiconductors for mobile devices."

China's manufacturing ceiling

In semiconductor technology, the driving force behind IC design is miniaturization. Essentially, the smaller the distance between transistors, the more computing power per square inch. This makes a 7-nanometer (nm) chip more powerful than a 14-nm one. For reference, the world's leading chip maker, Taiwan-based TSMC, is now working on 2-nm chips, which are expected to hit the market by 2025.

At the moment China has no semiconductor factories (or foundries) capable of manufacturing advanced chips. China's most modern foundry, owned by Semiconductor Manufacturing International Corporation (SMIC) in Shanghai, only began making 14-nm chips towards the end of 2019. This puts SMIC about 10 years and at least two generations behind leading South Korean, Taiwanese and American foundries.

"Chinese firms continue to lag global leaders in all areas of semiconductor manufacturing and manufacturing equipment," says Triolo. "While SMIC claims to be able to manufacture fairly advanced 14-nm chips, it is not really ready for commercial production at this level. More advanced chips such as 7-nm and below will require access to more advanced lithography equipment, which the U.S. government is so far blocking. So SMIC is really stuck at 28-nm commercially, while global leaders TSMC, Samsung and Intel push the nanometer level ever lower."

(Photo credit): Gettyimages.com/sorbetto

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Wide-ranging support

If China fails to close the semiconductor gap over the next decade, it won't be for want of spending. With the country's 14th Five Year Plan set for ratification early this year, Beijing has vowed to make the country an independent "technology power."

To accelerate progress, China will invest an estimated $1.4 trillion in its digital economy through to 2025. A major focus will be the development of its domestic semiconductor industry, with a raft of measures to boost research, education and financing included in a draft of the next Five Year Plan. This comes on top of multi-billion-dollar government investment since 2014 and an increasingly favorable tax environment for chipmakers. Government-led investment resulted in more than 13,000 Chinese enterprises registering as semiconductor companies in the first nine months of 2020, according to Chinese company database Qichacha.

China has a long track record of top-down investment drives failing to live up to expectations. Nevertheless, it would be foolish to write off its latest efforts in the semiconductor space. Critically, China's domestic tech industry is now more bought into the idea of seeking higher levels of self-sufficiency in key tech sectors such as semiconductor manufacturing. This should result in more rapid progress than before, when government support was inefficiently used and primarily benefitted state-owned companies.

"This level of investment is important, and it will have a positive impact," says Vinkenborg. "Not every dollar will be used effectively, but I think we'll see Chinese smartphones using locally manufactured chips more and more going forward."

The availability of virtually unlimited capital, however, is no guarantee that China's semiconductor industry is going to make the great leap forward that Beijing is looking for. Other significant bottlenecks remain, such as a lack of experienced engineers and an ability to innovate at the cutting edge.

"It is here that Chinese firms will remain behind for the foreseeable future," says Triolo. "There will be progress in some areas, but self-sufficiency is a long way off, except possibly in some niche areas."

"Chinese industrial policy is throwing money at these problems, rather than spending judiciously by targeting key bottlenecks and selecting the best firms to address them," says Dr. Douglas B. Fuller, a professor at the City University of Hong Kong and an expert on China's semiconductor industry. "There is also a human capital gap in memory fabrication, which is the newest area of Chinese interest."

Deepening the talent pool

Beijing is now taking steps to try to develop more homegrown semiconductor talent. In 2020, the government approved China's IC university program, elevating IC design and production as a recognized major. The aim is to boost the attractiveness of IC-focused education to Chinese students, who will benefit from enhanced educational resources.

This was followed in October 2020 by the establishment of China's first IC university. According to news reports, Nanjing Integrated Circuit University (NICU) is more a "talent training organization" than a conventional university, selecting college and university graduates with knowledge of or a desire to work in the semiconductor industry. The vocational syllabus will be taught by experienced chip engineers, industry experts and university professors.

This focus on young talent hasn't stopped Chinese chip manufacturers from attempting to lure homegrown and overseas chip engineers with job offers that are hard to refuse. Intense competition has led to an upsurge in salaries, with burgeoning demand from recently established companies that are flush with cash but short on experience. This, in turn, is leading some to worry that China's meager domestic chip talent may be wasted, with those engaged in continual job-hopping failing to fulfill their potential.

Cross-border recruitment

Chinese semiconductor firms also covet foreign personnel, with media reports claiming that more than 3,000 Taiwanese semiconductor engineers have swapped their posts for high-paying jobs in China in recent years. According to information from the Taiwan Institute of Economic Research, this represents around 10% of all Taiwanese engineers engaged in semiconductor research and development.

While the enticement of Taiwanese semiconductor engineers by Chinese firms is nothing new, the number of high-level engineers crossing the Taiwan Strait has increased significantly over the last five years. TSMC has been the most high-profile target for Chinese chip companies looking to secure talent. According to media reports, Quanxin Integrated Circuit Manufacturing (QXIC) and Wuhan Hongxin Semiconductor Manufacturing Co. (HSMC) have each hired more than 50 former TSMC employees, with both at one point led by ex-TSMC executives. The two companies are pushing hard to bring 14-nm and 12-nm chips to the market.

China's semiconductor talent gap is likely to grow in the short-term. According to a report from China's Ministry of Industry and Information Technology, demand for such talent is expected to reach 720,000 by the end of 2021. The report claims only 460,000 Chinese semiconductor professionals were available at the end of 2018.

Over the longer term, however, things are less certain. Many believe China's semiconductor bubble is almost certain to burst, with the collapse of many start-ups leading to huge job losses. The trials and tribulations of HSMC may be a harbinger of things to come: At the end of 2020, the Wuhan-based semiconductor factory was taken over by the local government after a massive shortfall of cash. The ex-TSMC chairman leading HSMC has since left, while the fate of the company's personnel has yet to be decided.

Equipment bottleneck

In addition to a lack of engineers, China's semiconductor industry also faces a critical equipment bottleneck. Extreme ultraviolet (EUV) scanners, which shrink IC circuit patterning, are essential to cutting-edge chip manufacturing. Dutch company ASML, practically the only commercial supplier of EUV scanners for chip manufacturing, has been prevented from sending a single EUV scanner to SMIC, or any other Chinese company, by the Dutch government, thanks to some persuasion from the U.S.

"Acquiring advanced extreme scanners from ASML will continue to be tough for SMIC unless the U.S. government under Joe Biden relents and allows ASML to ship the system," says Triolo. "At the moment, this looks unlikely. Chinese firms have made incremental progress in developing the complex set of tooling required to manufacture semiconductors, but are even farther behind here than on the manufacturing process side."

Future focus

How far China's semiconductor industry can and will evolve over the next decade divides opinion. Companies such as Huawei, which have previously benefitted from easy access to cutting-edge manufacturing in places like Taiwan, now have to take stock and go about establishing replacement manufacturing ecosystems. While huge levels of funding and a preferential policy environment will help, a shortage of domestic talent and a lack of access to and experience with advanced manufacturing technologies are likely to constrain growth for some time.

Backed by strong venture capital funding, several Chinese chip companies are now aspiring to serve AI, smart city, autonomous driving and data center sectors. Some sensor and industrial chip companies have also started moving into essential markets such as healthcare and consumer electronics.

"Increasing government support, capital injections in a growing number of chip startups, and broad Chinese press coverage on the need to develop the national semiconductor industry have gradually created an air of optimism that self-reliance can eventually be achieved," says East West Bank’s Cheng. "Seeing how China's chips fall will continue to be a matter of international interest for quite some time."

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