Key Takeaways
- Mainland China has a large mature-chip industry, but it remains unable to make cutting-edge chips without imported technology.
- This dependence means recent U.S.-led bans on the export of advanced chips and equipment to China will pose significant challenges to China's efforts to catch up.
- The country will channel its considerable resources across the public and private sectors to close the gap; the recent trade restrictions have only made that call more urgent.
This is the first of a three-part series. The next two reports will examine the latest U.S. restrictions on the sale of advanced chips to China, and the coming winners and losers from the boom in investment into artificial intelligence.
China's path to building a cutting-edge semiconductor industry is narrow. Recent measures to curtail the country's access to advanced chips and equipment will challenge its progress for years to come. However, S&P Global believes the restrictions will drive China to marshal its considerable resources in a "moon-shot" style push to advance the sector.
These restrictions are narrow in scope. We do not expect them to materially hit China's economy, but they do create major obstacles for the country in the global competition in cutting-edge technologies, particularly those applicable to military use.
Although China has a large mature-chip industry that supplies electric vehicles, smartphones and computers, know-how in producing such chips does not easily translate to capabilities in producing advanced chips.
Currently, the country's advanced chips production is heavily reliant on U.S., European, and Japanese suppliers. China has domestic equipment makers, but they also rely on foreign technology, and their abilities remain well behind advanced global peers.
Challenges posed by recent restrictions imply it could take decades for Chinese firms to catch up, requiring significant time and a mobilization of national resources.
That said, innovation doesn't follow a straight line, and developments can occur unexpectedly. One example is Huawei Technologies Co. Ltd.'s new Mate 60 Pro smartphone that uses a 7 nanometer (nm) chip (see Huawei box).
China's efforts to catch up on advanced chips will involve mobilizing the country's financial and human capital, backed by both the public and private sectors, including the country's tech giants. Recent restrictions have only made the call more urgent.
A Matter Of National Security
Jarring supply disruptions during the pandemic drove policymakers around the world to secure access to chips as a matter of national security.
The U.S. passed the CHIPS Act in 2022 to provide US$52.7 billion in semiconductor research and development and manufacturing incentives over 10 years. Less than a year later, the EU passed the €43 billion EU CHIPS Act with an explicit target of doubling its share of global production of advanced chips to 20% by 2030. This came within months of Japan announcing a plan to triple the sale of semiconductors made in the country to more than ¥15 trillion (US$113 billion) by 2030.
These initiatives were accompanied by restrictions against the sale of advanced chips and equipment. The U.S. unveiled sequential measures in 2022, and in October 2023, which restricted the export of advanced chips and equipment to China that could be used for artificial intelligence, military use, and supercomputing. Japan and the Netherlands followed with similar measures in 2023 (see chart 1).
Chart 1
U.S.-Led Export Controls Present A Headache To China
The U.S. has imposed the so-called "small yard, high fence" controls on technology exports to China. This means they are narrowly targeted at specific chip-making processes but are highly restrictive. They will significantly curtail China's ability to buy and make advanced chips.
This is because China relies on imported equipment and materials to make advanced chips, particularly those from U.S., European, and Japanese suppliers. Chinese chip firms are particularly dependent on the offshore providers of electronic design automation (EDA) software, integrated circuit (IC) design, semiconductor manufacturing equipment and materials.
For example, the Dutch government has barred ASML Holding N.V. from selling its industry-leading lithography machines, particularly the more advanced extreme ultraviolet (EUV) standard to "print" circuit patterns onto silicon wafers. This ban effectively prevents mainland Chinese semiconductor fabrication plants (fabs) from making the most advanced chips.
Huawei's Unexpected New Phone
China's challenges imply it could take decades for the country to catch up to advanced global peers. However, innovation does not follow a straight line.
Huawei's new Mate 60 Pro smartphone--although unclear if a true Chinese breakthrough--is a reminder to expect the unexpected. The phone uses a new 7nm chip, which counts as advanced, and was likely made in China.
The key equipment used to produce the chip was reportedly foreign-made, and it remains to be seen if the phone can be mass produced. The development nevertheless surprised the industry. Prior to the news, domestic chip producers were able to mass produce chips only as advanced as 28nm. This would imply a technology gap of more than a decade, as commercial production of 28nm chips was first launched in 2011 by Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC).
The Mate 60 Pro sold out in many locations on the first day of its launch in September. Huawei now estimates its smartphone shipments for 2023 can reach 40 million, implying a jump from first-half 2023 smartphone shipments of 14.3 million. The incremental sales increase in the second half will likely come from the Mate 60 series.
Huawei is perhaps the most well-known target of offshore technology restrictions. Its chip design company, HiSilicon Technologies Co. Ltd., designed its own application processor using the 5nm process in 2020.
When U.S. restrictions targeted the company in 2019 and 2020, the firm lost access to EDA software and foundry services. It was subsequently unable to produce those chips. Moreover, it could no longer use Google's operating system for its smartphone devices. As a result, Huawei's smartphone domestic market share fell from a high of 45% in the second quarter of 2020, to 4% in the first quarter of 2021.
Since then, Huawei has developed its own smartphone operating system (Harmony OS), and is reportedly developing its own EDA software. Now it has access to locally produced 7nm chips.
According to media reports, the chip was made using imported deep ultraviolet (DUV) lithography machines that will likely now be subject to expanded U.S. export controls. It is also unclear if Huawei's supplier can profitably mass-produce the chips, given the greater complexity and potentially low yield rates in making 7nm chips using these imported DUV machines.
Furthermore, the technology gap is widening, as TSMC is ramping up 3nm production this year using the more advanced EUV process.
Despite these uncertainties, Huawei's example reminds observers of the unpredictable nature of the technology industry.
China has domestic makers of lithography machines such as Shanghai Micro Electronics Equipment Group Co. Ltd. (SMEE). However, despite being the country's most advanced semiconductor equipment manufacturer, SMEE's lithography machines can only produce chips at the 90nm node, according to its website.
According to media reports, the company aims to deliver its first deep ultraviolet lithography systems later this year that can support 28nm chip production.
Even so, Chinese lithography equipment suppliers use components that may rely on imported technology from foreign partners. For example, the optics firm Changchun UP Optotech Co. Ltd., which sells equipment to SMEE, identifies the German-based iC-Haus GmbH as its second-largest supplier.
How TSMC Became The World's Largest Chipmaker
The case of TSMC shows how a government can foster an advanced semiconductor sector. It also shows why it is important to integrate into the global supply chain and develop close relationships with important trade partners.
Starting in 1974, Taipei orchestrated the import of foreign technology and talent and established chip research institutes, including the Electronics Research and Service Organization of Industrial Technology Research Institute (ERSO of ITRI). Officials invited scholars and engineers working at U.S. companies to return to develop the island's nascent semiconductor industry.
In 1987, Dr. Morris Chang, previously the head of Texas Instruments Inc.'s global semiconductor business, founded TSMC. The government provided most of the startup funds, with remaining capital from its joint-venture partner, Philips Electronics N.V., and other wealthy individuals that invested in the company at the government's encouragement.
TSMC had a number of advantages. It had nearby access to a large pool of educated and low-cost labor. Founded in the newly created Hsinchu Science-Based Industrial Park, the company was next door to two of the island's top universities.
The firm was also able to lure engineers and technicians from overseas, particularly the U.S. They brought not only knowledge and experience, but also relationships with major U.S. technology companies.
Easy access to capital and favorable tax policies allowed TSMC to undertake the heavy investments needed to set up production facilities and develop new technological capabilities.
TSMC highlights the importance of being integrated into the global supply chain. This crucial ingredient could make the difference between success or failure in developing an advanced semiconductor industry.
Localization And Its Discontents
Although current policies focus on curtailing China's access to advanced chips and equipment, shifts in approach may occur over time.
In just one year, discussions among U.S. policy makers have already moved away from "decoupling", or economic separation from China, to "de-risking", or reducing the risk of excessive reliance on China.
Discussions among foreign companies have also shifted from full onshoring (moving production onshore) to a mix of near-shoring (moving production to a nearby country) and China-plus-one (keeping some production in China but moving some capacity to another country). Over time, if the costs of localization mount and the post-pandemic impulse to localize eases, further policy shifts may occur.
These shifts are more likely for industries with highly specialized and globally distributed supply chains, such as semiconductors. TSMC's case study is often cited as an example of the effectiveness of state support (see TSMC box). However, it equally highlights the semiconductor sector's reliance on imported talent, equipment, and technologies from advanced global peers.
Such interdependence spans the semiconductor supply chain. Currently the U.S. leads in EDA software, chip design, core IP (intellectual property in chip design), and fab tools. Europe leads in core IP and advanced lithography equipment, Korea leads in design and fabs, Japan leads in assembly, testing and packaging (ATP) tools and fab materials and ATP materials, while China and others lead in ATP and ATP materials.
Chinese fabs rely on Dutch EUV lithography machines to make advanced chips, and Dutch machine makers such as ASML rely on equipment from dozens of highly specialized global suppliers.
As China's semiconductor equipment imports decline (see chart 2), global makers of such equipment may feel the pain, particularly if alternative markets of comparable size are not readily available. Managers at international firms unhappy with lost sales could eventually move against further restrictions.
Chart 2
Catching Up Is Hard To Do
As much of the supply chain to make advanced chips resides outside of China, catching up will be difficult. China has little presence in intellectual property (IP) cores, particularly those used for IC design on key microprocessor architectures such as ARM or x86. It is also behind on the fab tools needed to make advanced chips, such as EUV machines.
As one indication of the magnitude of the gap, leading global EDA software companies, chip-design firms, and foundries on average have 4x-7x more patents than their Chinese counterparts (see chart 3).
China is leveraging open-source architectures such as RISC-V to develop its own IP cores for microprocessor designs. However closing the gap in these segments will take significant time, resources, and persistence.
Marathon versus sprint
China has shown a commitment to long-term planning focused on a set of national priorities. Beijing views such endeavors as best led by the state rather than left to the private sector alone. Catching up on advanced chips will be no different.
China began prioritizing chipmaking in June 2014 (see table 1 in the Appendix), when the State Council issued guidelines for the development of the IC industry. This document set out financial, tax and other support for developing design, manufacturing, package testing, and equipment materials.
This was followed in 2015 by the State Council's "Made in China 2025", which aimed to boost domestic chips production to meet 70% of the country's needs by 2025, and to achieve global leadership in all stages of production by 2030. It also designated ICs and special equipment as new-generation IT industries and included them in the 10 key development fields.
The National Development and Reform Commission, China's top economic planning body, issues guidance every year to identify and promote areas for improvement for the country's chip development (see table 1).
In March 2023, then-Chinese Vice Premier Liu He called for a mobilization of nationwide resources across both the public and private sectors to develop the country's semiconductor industry. A week later, in the closing address of the National People's Congress, President Xi emphasized that "China should work to achieve greater self-reliance and strength in science and technology".
Chart 3
State-led development
The government's efforts, in combination with China's large manufacturing production base and entrepreneurial private sector, helped the country to become the global leader in solar energy, making about 70% of the world's photovoltaic modules.
State support also pushed China's electric vehicle (EV) penetration rate to the highest in the world in just two years, producing more EVs than all other countries combined (see "Glimmers Of Winners Emerge In Asia's EV Push," May 15, 2023).
Beijing is also leveraging its dominance in EV batteries and materials and pushing next-generation technologies including 5G, cloud computing, internet of things, and autonomous vehicles (see "Cutting China From Supply Chains--Easy To Say, Hard To Do," June 1, 2022). Catching up on advanced chips is an integral part of these plans.
A Well-Resourced Public Push
Recent advanced-chip restrictions have made catching up more urgent. This has further aligned the interests of the public and the private sectors.
The government is channeling considerable capital to these efforts. For example, the state-backed China Integrated Circuit Industry Investment Fund (CIIF) raised over US$50 billion between 2014 and 2020. In September, Beijing launched another fund under CIIF to raise up to US$41 billion. The fund will specifically target the domestic development of chip manufacturing equipment. The Ministry of Finance reportedly aims to contribute US$8.3 billion.
CIIF has a mixed record in supporting the sector's development in part due to implied government backing, which could lead to poor investments. Nevertheless, the additional funding signals the government's commitment and will fuel related efforts for years to come.
Calls on the private sector
The private sector may also be called upon to channel its significant pools of human and financial capital to this effort.
For example, the government may encourage the country's large tech firms to support the development of an indigenous advanced chips market. Huawei, Xiaomi Corp., Alibaba Group Holding Ltd., Tencent Holdings Ltd., Baidu Inc. and others could be called upon to support domestically made advanced chips. The launch of Huawei's Mate 60 Pro shows that China's large consumer base is also likely to support products seen as made in China.
The advanced chip restrictions also led to an unintended consequence: it created incentives for China's semiconductor industry to collaborate. Before their imposition, because of the industry's highly specialized and globally distributed supply chain, Chinese firms preferred to work with leading foreign firms of the supply chain segment they depended on. The restrictions removed this dependency and compelled Chinese firms to collaborate with Chinese suppliers, which could facilitate the localization of the country's chip industry.
Human capital and talent pools
The government may look for ways to better leverage the country's large pools of science and technology talent.
By 2025, China will produce almost three times as many math and science PhDs annually as the U.S., with nearly 80,000 graduates, versus about 21,000 for the U.S. If the estimated 20,000 international students studying in the U.S. are included in the latter, China's estimated total would still be double that of the U.S. (see chart 4).
Chinese policies that encouraged talent to commit to key, nascent industries has supported the country's rapid progress in technology over the past decades. Although the country is producing more science and technology talent, such policies remain critical to the effective use of that resource.
Chart 4
A Matter Of Time And Economics
China's efforts to catch up on advanced chips parallel state-led efforts in other countries. Recent restrictions only made the call more urgent.
The industry is one where government support makes a key difference, but it is also one where global integration is crucial. The present approach of pushing localization and escalating restrictions may prove costly over time, particularly for global consumers and chip producers, given it raises costs, requires expenditure, and obstructs the industry's development
Advanced chip restrictions are the main factor now limiting China's semiconductor advancement. This suggests these constraints may not deter the country's ambitions as it mobilizes its considerable resources in pursuit of its long-term goals.
Editor's Note: This article, by S&P Global Ratings and S&P Global Market Intelligence, is a thought leadership report that neither addresses views about ratings on individual entities nor is a rating action. S&P Global Ratings and S&P Global Market Intelligence are separate and independent divisions of S&P Global.
Appendix
Table 1
| China's policy support for batteries, electric vehicles, and intelligent vehicles | ||||
|---|---|---|---|---|
| Policy name, issuing department, and description | ||||
| September 2013 | Notice On The Continued Development And Broadening Application of NEVs (MOF, MST, MIIT, NDRC): launched purchase subsidies for buying NEVs. | |||
| April 2015 | Notice on the 2016-2020 Financial Support Policy for the Promotion and Application of NEVs (MOF, MIIT, MST, NDRC): stipulates amount, products, standards, and requirements for firms to receive subsidies, and states policy expectations for the development of the new energy auto industry. | |||
| November 2015 | Notice On The Requirement of Traction Battery Industry (MIIT): first batch of battery manufacturers that are qualified for battery production in China. | |||
| January 2017 | Regulations on the Access Management of NEV Manufacturers and Products (MIIT): clarifies definitions of NEVs, plug-in hybrids, pure EVs, and fuel cell vehicles. | |||
| April 2017 | Medium and Long Term Development Plan of Automobile Industry (MIIT, NDRC, MST): promotes coordinated development of the whole supply chain, establishes "whole vehicle-parts" cooperation, improves mechanisms for cost and benefit sharing in innovations, encourages cooperation in R&D and procurement, sets long-term goals for market share of key new energy vehicle firms. | |||
| September 2017 | Measures on the Parallel Management of Average Fuel Consumption and NEV Credits for Auto Firms (MIIT, MoF, MoC, GAC, GAQSIQ): launches dual-credit scheme to promote production and quality upgrade of EVs, implements fuel consumption credit accounting, sets NEV credit ratio requirements, requires traditional automakers to raise R&D on NEVs, promotes NEV industry. | |||
| April 2018 | Special Management Measures for the Market Entry of Foreign Investment (Negative List) (2018 Version) (NDRC): announced gradual removal of foreign ownership restriction in the auto industry. | |||
| June 2019 | Notice to Abolish The Notice On The Requirement of Traction Battery Industry (MIIT): abolished the whitelist of battery manufacturers. | |||
| February 2020 | Innovation and Development Strategy for Intelligent Vehicles (NDRC, MST, nine other ministries, commissions): promotes innovation, ecology, infrastructure, regulations, standards, supervision, and security for intelligent vehicles; aims for large-scale production of intelligent vehicles capable of autonomous driving or other market-oriented applications. | |||
| April 2020 | Notice on Improving Financial Subsidy Policy for the Promotion and Application of NEVs (MoF, MIIT, MST, NDRC): extends NEV subsidies period to end 2022; clarifies aims of subsidies reduction for NEVs; optimizes tech thresholds; accelerates withdrawal of backward production capacity; implements differentiated subsidies; improves policy accuracy, and accelerates EV deployment in specific areas. | |||
| October 2020 | Energy-saving and NEV Technology Roadmap 2.0 (MIIT): sets industry development milestones for 2025, 2030, and 2035; sets goal that, by 2035, NEVs to be half of all vehicle sales, hydrogen fuel cell vehicles to reach 1 million, and all passengers vehicles to be hybrids or fully electric. | |||
| November 2020 | NEV Industry Development Plan 2021-2035 (State Council): clarifies long-term goals for NEVs. By 2025: make major breakthroughs in key technologies (e.g. batteries, drive motors, vehicle operating systems), reduce average power use of pure passenger EVs to 12.0 kWh/100 km, and for NEVs to be one-fifth of all vehicle sales. By 2035: pure EVs to become mainstream new vehicles sold, public vehicles to be fully electric. | |||
| December 2020 | Notice on Further Improving the Financial Subsidy Policy for the Promotion and Application of NEVs (MoF, MIIT, MST, NDRC): clarifies subsidy standards for production of different vehicle products; products tested with the old standards can enjoy subsidies if they meet policy requirements; encourages active defect investigations and voluntary recalls; strengthens management of investments and capacity expansions to prevent excesses. | |||
| NEV--New energy vehicle. EV--Electric vehicle. MST--Ministry of Science and Technology. MoC--Ministry of Commerce. GAC--General Administration of Customs. GAQSIQ--General Administration of Quality Supervision, Inspection, and Quarantine. kWh--Kilowatt hour. km--Kilometer. NDRC--National Development Reform Commission. NMSAC--National Manufacturing Strategy Advisory Committee. R&D--Research and development. MoF. Ministry of Finance. STA--State Taxation Administration. MIIT--Ministry of Industry Information Technology. Sources: Chinese government releases, S&P Global Ratings. | ||||
Table 2
| The initiatives underscoring China's push to compete in tech and keep producers in the country | ||||
|---|---|---|---|---|
| Policy name, issuing department, and description | ||||
| June 2014 | National Guideline for the Development and Promotion of the IC Industry (State Council): sets up the National Industrial Investment Fund; focuses on developing design, manufacturing, package testing and equipment materials; provides support in all areas (e.g. finance, tax, promotion, talent, foreign cooperation). | |||
| May 2015 | Made in China 2025 (State Council): defines IC and special equipment as new generation IT industry and included them in the 10 key breakthrough development fields; focuses on improving IC design and building IP, application adaptability of domestic chips, core chips for national information and network security use, independent capabilities for packaging and testing, high-density packaging and 3D micro-assembly technologies. | |||
| December 2016 | Guideline on State Informatization for the 13th Five-Year Plan (State Council): promotes innovation in IC; deploys chip design and R&D for new computing, 5G, intelligent manufacturing, industrial Internet, internet of things; promotes 32nm/28nm and 16nm/14nm IC production lines; develops 10nm/7nm technology; develops R&D and industrialization of chip-level packaging, wafer-level packaging, silicon through-hole and 3D packaging; and break throughs in electronic design automation software. | |||
| January 2017 | Guidance Catalogue of Key Products and Services of Strategic Emerging Industries (NDRC): defines IC design and services as key products in the catalogue. | |||
| February 2018 | Green Paper on Technological Innovation in Key Areas of Made in China 2025--Technology Roadmap 2017 (NMSAC): lays out goals, priorities, strategic support and safeguard measures for 10 key industries including new generation IT; promotes innovation and gathering of resources and social capital in manufacturing. | |||
| November 2019 | Guidance Catalogue for Industrial Structure Adjustment 2019 (NDRC): promote advanced packaging and testing industries including ball grid array, pin grid array, chip scale, multi-chip, land grid array, system-in, flip-chip, wafer level, micro electro-mechanical system. | |||
| August 2020 | Policies to Support the High-quality Development of the Integrated Circuit and Software Industries (State Council): support IC and software industries in taxation, investment, financing, R&D, import/export, talent, IP, market application, and international cooperation. | |||
| December 2020 | Announcement on Corporate Income Tax Policy for Promoting High-quality Development of the Integrated Circuit and Software Industries (MoF, STA, NDRC, MIIT): increased support by launching the first 10-year income tax exemption policy for the industry. | |||
| March 2021 | Outline of the 14th Five-Year Plan (2021-2025) for National Economic and Social Development and Long-range Objectives through 2035 (State Council): promote IC industries by implementing smart and green manufacturing projects, developing new models of service-oriented manufacturing. | |||
| March 2023 | Draft of central and local budgets in 2023 (MOF): Promote advanced scientific and technological self-reliance, support the establishment of a modern industrial system. Improve the efficiency of technology investment, strengthen national strategic science and technology capabilities, and promote the optimization and upgrade of China's industry. | |||
| IC--Integrated circuit. IT--Information technology. IP--Intellectual property. 3D--Three dimensions. nm—Nanometer. STA--State Taxation Administration. MST--Ministry of Science and Technology. MoC--Ministry of Commerce. GAC--General Administration of Customs. GAQSIQ--General Administration of Quality Supervision, Inspection, and Quarantine. kWh--Kilowatt hour. km--Kilometer. NDRC--National Development Reform Commission. NMSAC--National Manufacturing Strategy Advisory Committee. R&D--Research and development. MoF. Ministry of Finance. STA--State Taxation Administration. MIIT--Ministry of Industry Information Technology. Sources: Chinese government releases, S&P Global Ratings. | ||||
Writer: Jasper Moiseiwitsch
Digital designer: Evy Cheung
Related Research
- Glimmers Of Winners Emerge In Asia's EV Push, May 15, 2023
- China's Semiconductor Industry Can't Quit German Optics, The China Project, May 1, 2023
- Cutting China From Supply Chains--Easy To Say, Hard To Do, June 1, 2022
This report does not constitute a rating action.
| Greater China Technology Lead: | Clifford Waits Kurz, CFA, Hong Kong + 852 2533 3534; clifford.kurz@spglobal.com |
| China Country Lead, Corporates: | Charles Chang, Hong Kong (852) 2533-3543; charles.chang@spglobal.com |
| U.S. Technology Lead: | David T Tsui, CFA, CPA, San Francisco + 1 415-371-5063; david.tsui@spglobal.com |
| APAC Technology: | David L Hsu, Taipei +886-2-2175-6828; david.hsu@spglobal.com |
| S&P Global Market Intelligence: | Aries Poon, Hong Kong (852) 2912-3025; aries.poon@spglobal.com |
| Jeffery McElroy, Taipei; jeffery.mcelroy@ihsmarkit.com | |
| Yating Xu, Beijing +86 186 0066 9596; yating.xu@ihsmarkit.com |
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