“Taiwan’s security came into question just when they became an irreplaceable supplier of chips”

Everything that is digital or has digital components in it, from smartphones to cars to vast datacenters, is powered by semiconductors, also called chips. These tiny workhorses of the modern digital world are getting smaller and smaller and at the same time more and more powerful. Demand is soaring every year and some analysts already call them more strategically vital than oil.

Maarten Muns – January 18, 2024

What are semiconductors and what is their main strategic importance in the world today, viewed from a security and military point of view?

“Semiconductors are tiny pieces of silicon with millions or even billions of little circuits etched into them. Today, all computing power is provided by semiconductors. Semiconductors are important from a strategic perspective for two reasons. The first reason is that today, every type of manufactured equipment, including military equipment, has more and more semiconductors inside. Because they require better sensors, they require more communications capabilities and they simply require more computing power.”

“A new car has more than a thousand chips inside. The same is true for planes, trucks and drones. Anything that is manufactured requires lots and lots of chips. So having supply chains that are stable and secure, and that can provide you with the chips that you need is critical. That’s a challenge that the entire NATO defense industrial base has faced over the past couple of years.”

“The second reason why semiconductors are important is because as we begin to deploy artificial intelligence to a broader array of systems they will require more advanced chips. All AI systems are trained on semiconductors.  Semiconductors provide the computing power that trains AI systems. And so from a perspective of defense ministries and intelligence agencies, they are also trying to deploy AI in their systems to better sift through intelligence data, for example, or to let drones fly autonomously. All this requires advanced chips for training these AI systems.”

In your book, Chip War, you describe a small but entangled world in which the design and manufacturing of these advanced semiconductors is concentrated in the hands of a small number of companies like TSMC, Samsung and Intel. The Dutch company ASML also has a central position because of their monopoly on the lithography machines that every producer of advanced chips needs. Can you describe what this current situation looks like?

“To produce the most advanced chips requires drawing on the most complex machinery, the most purified chemicals and the most sophisticated software that the world has ever produced. And so there’s no way to avoid relying on individual firms for many different parts of the supply chain simply because the complexity of the chip industry is so immense. There is nothing else that we produce with this level of complexity. And so today, the international supply chain for advanced chips stretches from the Netherlands to Japan, through the United States to Taiwan. There are some places in the supply chain that are essentially choke points, single points of failure, where one company or one country has in some cases a monopolistic position.”

“In some cases this is fine. I don’t worry about the fact that the Netherlands has 100% control over lithography with ASML. Nor do I worry that Japan has a very strong position in many of the specialized chemicals that are required. But for instance the fact that 90% of the most advanced processor chips are made in Taiwan, does present a really serious question about whether we’ve got the security of supply that we need. So I think for the last half decade policymakers in Europe and the US and Japan have been understanding the extent to which the semiconductor supply chain does have these points of concentration. They came to realize that not every single point of concentration is in a geographic area that we feel completely comfortable with.”

ASML Container airplane full load module tests (transport, weight and size). Photo: ASML

Let’s analyze this situation from a historical perspective. Didn’t governments and even tech companies understand the massive importance of semiconductors early enough?

“I think that there are three things that happened. One is that Taiwan’s position as an absolutely central player in the chip industry is something that is relatively new. Taiwan has been a player in the industry for some time, but its very strong leadership position is something that’s only really emerged over the last decade. Second, just as that was happening, the military balance in the Taiwan Straits was also changing. For most of the period during the Cold War and the decades afterwards, it was clear that the military balance favored Taiwan and the United States vis-à-vis China.”

“Today, because of China’s really massive military buildup around Taiwan, the military balance of power has shifted in a way that has called Taiwan’s security into question at the exact time that Taiwan has become an irreplaceable supplier of semiconductors. The third thing that’s happened is that as this was going on, the rest of the world was using more and more chips. Today in a new car there will often be a thousand chips. Ten years ago that was a hundred. So every year we rely on more and more chips in all types of devices.”

What are governments in the West doing to change this uncomfortable situation?

“One part of the strategy that governments are undertaking is to provide incentives for chip manufacturing closer to home: In the US, in Europe and in Japan. This is quite significant. We’re seeing major new investments in all three of those areas. But that is only one part of the strategy. The second part of the strategy is to encourage companies to think hard about their supply chains. And this is happening not using formal policies, but rather through governments pushing firms to undertake studies of their supply chains and realize where they have single points of failure, and what they would do if there were a crisis around Taiwan. And hereyou see some companies taking the issue quite seriously, and others less so. But I think governments are trying to encourage companies to begin to undertake some planning of their own.”

“The third thing that’s happening relates to China and its production of chips. Right now China is not capable of producing the most advanced chips. China is capable of producing small volumes of moderately advanced chips. And they are capable of producing very large volumes of less advanced chips. Right now, China is in the midst of a really massive campaign to build out its production capacity in less advanced chips. These are not going to be used for artificial intelligence or high-performance computing, but will be used in cars, medical devices and household goods. And so there’s a real risk right now that, if China does expand its production capacity for these low-end chips, we will end up more reliant on Chinese-made chips for our supply chains.”

“I think that if you talk to political leaders in the US or Japan or talk to the European Commission, there’s a lot of concern about this as well. The US has taken steps to begin to threaten defensive measures if Chinese firms begin winning market share with these types of low-end chips. They have no willingness to become more reliant on China to supply our chips, so China is following a dual strategy here. And it’s worth remembering that they’re spending more money than the US Chips act and the EU Chips act combined.”

China has recently shown the world their newest Huawei smartphone, which has an advanced 7-nanometer chip inside. How far behind are they?

“TSMC, the main chipmaker in Taiwan, produced its first 7-nanometer chip in 2018. So the Chinese are about five years behind TSMC. Every chip company makes advances. The question is: who’s making advances at a faster rate? And the reality is that the leading Chinese chip firms, like SMIC, have been some five years behind TSMC for about the last 15 years. In other words, every year, both the Taiwanese and the Chinese are making progress. But the gap between the two has been relatively constant at five years. As of right now there is no evidence that China is making progress in closing the gap.”

In 2022 we have seen the US Chips & Science Act and President Biden announced even tighter export regulations for American technology last October. So what does this US policy mean for the European chip industries, for instance, for companies like ASML?

“In 2022 the US tightened export controls on both the types of chips that are used for training of AI systems and on the tools to make them. Japan and The Netherlands – who also make these tools – announced their own measures to tighten control. The goal is to maintain a technology gap between AI capabilities in the West and in China. You not only need to control China’s access to these most advanced chips, but also need to make sure that China doesn’t make progress in catching up in terms of its own chip-making capabilities. These policies certainly have an impact on companies, although they all are actually reporting more revenue from selling to China than ever before. That is because they’re selling even larger volumes of ‘low-end’-tools. I think the biggest impact is actually not on the toolmakers, like ASML, although they will be impacted, but on the companies that make chips for AI, like Nvidia. They will lose some market share in China because domestic Chinese firms will in the end be able to produce the chips that Nvidia used to export.”

TSMC factory in Taichung, Taiwan. Photo: Shutterstock / Vidpen

How do you see the European Chip Act? Does Europe strive for some form of strategic autonomy in the area of semiconductors?

“It is important to understand that neither the US nor Europe, nor Japan, nor Taiwan or China will ever be fully independent in chip making. They all rely on each other, and they all will rely on each other for a long time. The question is to what extent is Europe or the West in general, willing to be reliant on Taiwan and China for chip making. That’s one of the issues that the European Chips Act is intended to address. One of the goals is to build up more chip-making capacity in Europe in order to reduce the reliance on East Asia.”

“And I think that is where it’s going to have an impact. There are already major investments that have been announced in Germany, France and Ireland for new chip-making facilities. Some European firms are really taking seriously the question of where are they sourcing chips from and trying to minimize the extent to which they’re relying on vulnerable geographies in East Asia. But reducing your reliance on Taiwan is really quite complex. And for any country to be fully independent is just not a realistic goal.”

Recently, we learned that ASML was pressured by the US to block the delivery of some DUV machines to China. That was weeks before the announced export restrictions came into effect. What does this say? Is it a sign of growing anxiety in Washington?

“When the US first imposed the restrictions in 2022, they were implemented in a way that was too loose. The US was frustrated to see all of the equipment providers, not just ASML, but also its US and Japanese competitors, providing fairly advanced tools to leading Chinese firms. And so in October 2023 the restrictions were tightened. One of the aims was to make it harder for China to procure some of the most advanced chip-making tools. That’s why you saw this news about ASML facing new restrictions.”

“The Commerce Secretary, Gina Raimondo, has said that she expects that the US will once a year adjust the policy based on how the market changes and how Chinese capabilities change. And so I think the entire chip industry is realizing that there will be ongoing updates to this policy, not necessarily that it’ll get tighter every year, but that it will be adjusted because the market changes and technological dynamics change.”

So tech companies can expect a flexible policy from both the US and Europe towards these high tech developments?

“That’s right. And it is complex because for companies it’s not going to feel flexible. It’s going to feel difficult to plan around because companies will be relying on regulators to decide on strategies about what they can and can’t sell. So companies are understandably not going to like this. But this is the new political reality for them.”

Will the key position that ASML has in the global chip market benefit the company in the long run, or will it be a victim of the tech war?

“ASML is at the center of this technology competition because their technology is irreplaceable and everyone needs it. There’s no doubt that the company is going to sell fewer machines than it would if the restrictions had not been in place. And the point of the restrictions is to limit some of the capabilities you can sell to China. They don’t see an immediate financial impact this year or next year on what they can sell. And they’ve reported, as I mentioned before, a record sales in aggregate to China, because they’ve been selling more of the lower-end tools, even if they can’t sell the higher-end tools.”

“In the future however, I think there will be some impact. But I think it’s also important to remember and they have said this publicly as well, the world’s demand for chips is not going to decline. If chips can’t be produced in one country, they will be produced in another country. And so you see a strong demand in Taiwan, Korea, the US and Europe for ASML’s tools, because the world needs the chips that ASML’s tools create. And if you can’t produce them in China, you’ll produce them elsewhere. So if you listen to what the company says about its about its financial position or look at how investors assess the company, it’s still in a pretty good competitive position.”

Do you think that it makes any sense for China to invade Taiwan for this reason?

“Well, it didn’t make any sense for Vladimir Putin of Russia to invade Ukraine, but he did it anyway. And for most of the last several decades, Chinese leaders were primarily motivated by economic growth, and that has clearly changed over the past couple of years. Xi is evidently more motivated by nationalism and to create what he calls the great rejuvenation of the Chinese people rather than address economic problems. If you ask, is an invasion a good idea for China? The answer, I think, is probably not. A Chinese blockade of Taiwan might be more effective. Suppose we woke up tomorrow and the headlines read: China blockades Taiwan. What would the West do? Nobody has a good answer to that question.”

Do you think that it makes any sense for China to invade Taiwan for this reason?

“Well, it didn’t make any sense for Vladimir Putin of Russia to invade Ukraine, but he did it anyway. And for most of the last several decades, Chinese leaders were primarily motivated by economic growth, and that has clearly changed over the past couple of years. Xi is evidently more motivated by nationalism and to create what he calls the great rejuvenation of the Chinese people rather than address economic problems. If you ask, is an invasion a good idea for China? The answer, I think, is probably not. A Chinese blockade of Taiwan might be more effective. Suppose we woke up tomorrow and the headlines read: China blockades Taiwan. What would the West do? Nobody has a good answer to that question.”

Do you think that the position of Taiwan is important enough for the West US to react to a blockade by force?

“Well, it gets into very complex calculations. So if there’s a blockade, the question will be how do you break it? The West can threaten China with economic consequences, but that won’t be enough to change the dynamics. You could threaten to go to war to break the blockade, but are we really willing to do that? Because even if you do that, you end up getting the disruption in supply chains that you’re trying to avoid. And so that’s why there really are no easy answers to this question.”