China’s Chip Designs Concern U.S.
China’s drive to become a leading global supplier of semiconductors within a decade is rapidly propelling that nation up the technology ladder -- and creating new trade tensions with the United States.
U.S. high-tech industry executives contend that China has an arsenal of unfair tactics at its disposal, including complicated, China-only technical standards that are in the works and a tax they say discriminates against foreign chip makers.
At the urging of U.S. producers, the Bush administration is considering filing its first complaint against China with the World Trade Organization, arguing that the tax violates world trade rules. Nicholas Lardy, a China specialist at the Institute for International Economics in Washington, called the tax “a fairly straightforward” WTO violation having “great economic significance” to the United States.
The unbalanced trade across the Pacific has been a thorn in the bilateral relationship. Expanding imports from China contributed to a record U.S. trade deficit of $43.1 billion in January, according to data released Wednesday by the Commerce Department. Overall U.S. imports were down slightly to $132.1 billion, but exports also declined to $89.05 billion despite the weaker dollar, which makes U.S. products cheaper overseas. The U.S. trade deficit with China widened to $11.5 billion in January, a 6.6% gain.
As further evidence of the growing tensions, Secretary of State Colin L. Powell, Commerce Secretary Don Evans and U.S. Trade Representative Robert B. Zoellick took the unusual step of sending a letter this month to Chinese Vice Premiers Wu Yi and Zeng Peiyan urging Beijing to repeal a proposed encryption standard for wireless communications products set to take effect June 1. The U.S. officials said the new security standard violated world trade rules.
Industry leader Intel Corp. said Wednesday that it had warned customers that it would quit shipping its wireless chips to China in May because it could not comply with the proposed new standard. Intel spokesman Chuck Mulloy said the Santa Clara, Calif.-based company had determined that it could not find a way to comply without compromising the quality of its products.
“These are both very serious issues that need to be resolved quickly,” said Patrick Powers, director of China operations for the U.S.-China Business Council, referring to the tax and wireless standard. The stakes in the dispute are high.
Semiconductors, which are small yet highly sophisticated devices also known as microchips, are at the heart of modern industrial economies. Chips power everything from personal computers and airplane navigation systems to ballistic missile defenses. Chip production has become, in many ways, as vital to a nation’s economic and military strength as oil.
Industry executives in the U.S. say China could pose a serious competitive threat in the not-too-distant future. They fear that rapid growth in China’s semiconductor industry could produce a global glut and cause prices to plummet. And some executives and defense experts worry about security implications, considering that semiconductors are essential components of military hardware.
This conflict is heating up just as the ballooning U.S. trade deficit and loss of manufacturing jobs to lower-cost countries including China are sparking heated debate in the presidential campaign. The chip issue is expected to figure prominently in U.S.-China trade talks next month in Washington, with Commerce Secretary Evans arguing that Beijing’s tax policies and its drive to create China-only technical standards are thinly veiled forms of protectionism.
The Semiconductor Industry Assn., the leading U.S. industry group, believes that China’s growing “gravitational pull” will draw capital, talented people and, ultimately, leading-edge research and development away from the United States.
For trade war veterans, many of these concerns contain an echo of the 1980s, when the American semiconductor industry sought protection from Japanese chip makers accused of illegally dumping into the U.S. market. In 1986, Japan reluctantly agreed to restrict sales of its semiconductors to the United States and open its market further to U.S. imports.
Semiconductors are the second-largest U.S. export to China, behind aircraft and spacecraft, including satellites.
Chinese officials play down worries about the growth of its semiconductor industry.
“Don’t be afraid of China,” said Jiang Shoulei, secretary general of the Shanghai Integrated Circuit Industry Assn., an arm of the Shanghai municipal government. “It’s a long way from being a threat. Our growth is fast, but it’s from a very small base.”
As with so much of China’s economic transformation, the scale of the country’s push into this crucial sector is staggering.
According to the Semiconductor Industry Assn., China-based investment is expected to more than triple from $3.6 billion in 2000-02 to $12 billion by the end of next year, then double again to $25 billion by 2013.
Although Beijing has made it more attractive for foreign firms to invest in its market by offering tax breaks and other incentives, it is mainly other draws -- such as a large pool of low-cost, educated technical workers and a booming domestic demand for semiconductors -- that have made China such a magnet for foreign firms, according to technology executives and analysts.
China is the world’s fastest-growing chip market, expected to reach $30 billion by 2006, according to a report last year by management consulting firm McKinsey & Co.
Many Chinese chips are destined for export-oriented factories that produce a vast array of goods dependent on semiconductors, from robotic toys to consumer electronics. Local consumers also are fueling demand. China is already the world’s largest market for cellphones and one of the fastest-growing markets for personal computers.
“China is part of an emerging ecosystem for the industry,” noted James Hexter, a principal in McKinsey’s Beijing office who monitors the semiconductor industry. “Those who want to be winners will have to learn how to operate here.”
Taiwanese and Hong Kong investors are behind much of China’s semiconductor manufacturing boom. U.S. firms such as Intel, Texas Instruments Inc. and Advanced Micro Devices Inc. aren’t manufacturing chips in China, although many firms have sunk millions of dollars into test and assembly plants and research facilities.
Intel, the world’s biggest computer-chip maker, recently announced plans to invest $375 million in a test and assembly plant in Chengdu, its second in China. The country is one of Intel’s largest markets.
Among the most prominent examples of the boom is the first phase of a new $1.6-billion Grace Semiconductor Manufacturing Corp. fabrication plant in Shanghai -- a “fab” in industry parlance.
In addition, Semiconductor Manufacturing International Corp., run by former Texas Instruments executive Richard Chang, is boosting production at three facilities in Shanghai and is constructing the first of three planned fabs in Beijing. Industry analysts expect the company to spend $2 billion on new capital expansion this year.
And the world’s largest contract producer of microchips, Taiwan Semiconductor Manufacturing Corp., is building its first mainland Chinese foundry just west of central Shanghai.
China is on track to become one of the world’s biggest contract suppliers of microchips by the end of the decade, according to industry analysts. A forecast published early last year by investment house Citigroup Smith Barney projected that China’s share of global foundry capacity would jump to more than 20% by the end of 2005 from 7% last year.
Government incentives to high-tech companies are considerable. Grace, for example, received low-interest loans, land at half the market value and a five-year tax holiday as part of the package that led it to set up at a high-tech industrial park, Executive Vice President Daniel Y. Wang said.
But Americans have focused criticism on two issues: the creation of Chinese-only technical requirements that are incompatible with global standards and that force foreign firms to divulge sensitive technology or partner with Chinese companies, and Chinese tax policies.
China levies a 17% value-added tax on imported semiconductors. Domestic producers also are subject to the tax but qualify for rebates of as much as 14%. Americans claim that in an industry where profit margins are thin and money is only really made with high-volume sales, this difference can be crucial.
Under WTO rules, governments aren’t allowed to treat foreign firms differently from domestic companies.
Chinese semiconductor industry official Jiang said the discrimination charge was bogus because China’s incentives package was open to all companies willing to set up manufacturing operations in China.
“Lots of people are making a fuss about this,” he said, but China’s information technology sector is “small and weak.”
“Supporting this sector is a good thing for the global industry,” he said.
Many observers in China also question the security concerns expressed by U.S. firms, noting that even China’s most modern foundries will produce chips that lag well behind the global cutting edge. They say China’s scientific base in chips is nascent, its research and development weak and its design capabilities severely underdeveloped.
U.S. firms acknowledge that the problem isn’t dire in the short term. Even with new plants coming online, China is still forced to import more than 80% of its chips because of limited domestic production and exploding demand.
China has asked for time to study the tax issue. But Washington is ready to press forward soon with its WTO complaint if Beijing doesn’t take steps to amend the practice, according to a U.S. trade official speaking on the condition that he not be named. He said the goal was to have the dispute settled before mid-April, when China Vice Premier Wu Yi is scheduled to visit Washington for a meeting of the U.S.-China Joint Commission on Commerce and Trade.
“We will make our best effort to have it resolved by the time she comes,” the official said. “But if China says no flat-out, then we will take it to the WTO.”
As for the development of China-only technical standards, they are viewed in the U.S. as giving local producers an edge by increasing costs for global firms that would need to create special products for China.
The Chinese government has cited several reasons for going it alone, including the desire to develop a superior technology and a concern for national security.
In the case of the encryption standard set to take effect June 1, China is requiring that foreign firms partner with Chinese companies to sell chips, computers, scanners and other wireless products there. But U.S. executives have refused to sign co-production agreements because they would be required to turn over sensitive technology, including chip designs, to potential Chinese competitors. Lax enforcement of intellectual property laws has made China a breeding ground for piracy of everything from tennis shoes and T-shirts to drugs and chips.
Marshall reported from Shanghai and Iritani from Los Angeles.
