National and economic security concerns have countries bringing chipmaking back home. We look at the challenges and opportunities from this strategy.
November 14, 2023
Managing Director, Head of Investment StrategyRBC Europe Limited
RBC Wealth Management’s “Worlds apart: Risks and opportunities as
deglobalization looms” series explores the trend away from globalization
and its ramifications for investors, economies, and financial markets. The final feature in the series explores the reshaping of the semiconductor industry and the investment implications.
Powering everything from emails to advanced military systems,
semiconductors, or chips, are the critical enablers of our modern society
and economy. This prominence has brought them to the forefront of national
Created in the U.S. in the 1950s, the semiconductor industry has evolved
into a highly efficient but deceptively complex, dispersed, and truly
global supply chain. And with each step of the production process, highly
intricate and critical, specialization has developed naturally.
Such a complex supply chain has evolved as the most cost-efficient way to
produce the chips. So long as all the steps ran smoothly, such complexity
was of little to no concern. But after COVID-19 burst onto the scene, many
factories were shuttered during the pandemic, causing wide-scale
disruption. Meanwhile, increasing tensions between the U.S. and China have
also highlighted a number of pressure points along the supply chain,
setting off alarm bells within government circles.
In his book Chip War, author Chris Miller lays out the complex
web of production:
“A typical chip might be designed with blueprints from the
Japanese-owned, UK-based company called Arm, by a team of engineers in
California and Israel, using design software from the United States.
When a design is complete, it’s sent to a facility in Taiwan, which buys
ultrapure silicon wafers and specialized gases from Japan. The design is
carved into silicon using [precision] tools produced primarily by five
companies, one Dutch, one Japanese, and three Californian. […] The chip
is then packaged and tested, often in Southeast Asia, before being sent
to China for assembly.”
In particular, parts of the supply chain are dominated by an uncomfortably
small number of firms. For instance, ASML, a company based in the
Netherlands with a $200 billion market capitalization, builds 100 percent
of the world’s extreme ultraviolet lithography machines, which are
essential to produce the most advanced chips that go into smartphones and
data centers. Two South Korean companies, Samsung Electronics and SK
Hynix, produce more than half of the world’s memory chips. But the biggest
concern is probably the outsized role that Taiwan plays, given it is
caught in the geopolitical crosshairs amid U.S.-China tensions.
Taiwan today manufactures 60 percent of the world’s semiconductors under
the “outsourced foundry” model and 90 percent of the most technologically
advanced ones, the logic chips that perform advanced processing. Moreover,
most are manufactured by a single company, Taiwan Semiconductor
Manufacturing Corporation (TSMC).
DRAM chips provide temporary data storage.
NAND chips are used for long-term data storage.
South Korea produces 60% of all DRAM chips; Japan produces 20%.
More than half of all NAND chips are produced in South Korea.
Leading-edge chips are used in smartphones, personal computers,
data centers, and artificial intelligence.
Taiwan currently produces approximately 90% of the most advanced
South Korea produces roughly 10%.
Audio and video signal processing
Japan is home to 27% of global production capacity.
Europe hosts 22% of global capacity.
Source – RBC Wealth Management, RBC Brewin Dolphin, Boston Consulting
Taiwan rose to prominence in the 1990s as a hub for semiconductor
manufacturing thanks to the creation of a new “outsourced foundry”
business model: making chips designed by customers. A relentless focus on
research and development (R&D), a successful drive for production
efficiencies, and generous state subsidies propelled the country’s
Until the mid-1980s, most large chipmakers both designed and manufactured
their chips in-house. But as chips became more advanced, the cost of
building semiconductor fabrication plants, or “fabs,” escalated. At the
same time, it became apparent that scale and process know-how were
necessary to produce a healthy yield, i.e., a high percentage of
well-functioning chips, at low cost.
With these concepts in mind and with generous state support, TSMC soon
thrived. As it did not design chips, it did not compete with its
customers. In time, most U.S. chip manufacturers ceased making
state-of-the-art chips in-house in order to avoid having to build hugely
expensive new fabs on a regular basis. Instead, those American chip firms
focused solely on chip design, outsourcing the manufacturing process to
TSMC. Technology sharing with the U.S. and Europe also allowed TSMC to
successfully commercialize advanced semiconductor manufacturing. The
company ultimately grew to be the largest chipmaker globally by market
value. TSMC, South Korea’s Samsung, and the U.S.’s Intel are now the only
chipmakers capable of manufacturing the most advanced logic chips.
Yet TSMC finds itself in a precarious position today. Taiwan is in the
crosshairs of U.S.-China tensions and ensnared in the technological and
geopolitical competition between the two rival powers, both of which are
highly dependent on TSMC’s semiconductor supply.
In an effort to protect itself, Taiwan strives to retain its prominent
place in the semiconductor ecosystem. While TSMC is building new fabs in
the U.S. and Europe, it will keep its R&D and cutting-edge technology
at home in Taiwan.
For the many nations and regions, such as the U.S., Europe, Japan, and
China, whose phones, data centers, autos, and telecom exchanges among
others all depend so heavily on semiconductors made in Taiwan, this
presents an uncomfortable situation.
It is impossible to know how U.S.-China tensions over Taiwan will play
out, but they do periodically affect financial markets and supply chains.
The geopolitical tensions, U.S.-China trade disputes, and supply chain
disruptions wrought by the pandemic have made many governments around the
world sensitive to semiconductor supply chain vulnerabilities.
Column chart showing the percentage of global semiconductor wafer
fabrication capacity by country in 2019 of Taiwan, the U.S., China,
South Korea, Japan, Europe, and all other countries combined.
Fabrication capacity is broken down by wafer feature size: greater
than 45 nanometers, which requires the least advanced manufacturing
technology; 28 to 45 nanometers; 10 to 22 nanometers, and less than 10
nanometers, which requires the most advanced technology. Production of
the wafers with feature sizes less than 10 nanometers is dominated by
Taiwan, with 92% of global capacity (the remainder is produced by
Japan), and Taiwan also produces more than 20% of wafers in all other
categories. The U.S. is the largest producer of wafers in the 10 to 22
nanometer range (roughly 30% of global capacity), but produces a much
smaller proportion of less advanced wafers, and none with features
under 10 nanometers.
Note: A wafer is a thin slice of semiconductor material used to
manufacture chips. Fabrication capacity includes wafers for memory and
logic as well as discrete, analog, and optoelectronic & sensor
* “Others” category includes Israel, Singapore, and the rest of the
Source – Boston Consulting Group, based on data from the SEMI global
Many governments are focusing on chip security and proposing bold new
incentives to fund and safeguard domestic semiconductor manufacturing
industries. They have been backing this strategy with money and plenty of
intervention. The aim is to manufacture critical technology closer to home
as a hedge against overreliance on foreign supplies.
RBC BlueBay Asset Management estimates total incentives towards the chips
industry over the period 2014 to 2030 are in the range of $350 billion to
$400 billion for the U.S., Europe, China, Taiwan, South Korea, Japan, and
Subsidies are often looked at skeptically by economists as they tend to
lead to a misallocation of capital. While there is certainly some truth in
this, the brief history of the chips industry suggests that advances in
semiconductor technology are often successful when supported by generous
government grants, as was the case in Taiwan. Below, we look at the use of
subsidies in China, the U.S., and Europe.
Source – RBC Wealth Management, RBC BlueBay Asset Management, Boston
Consulting Group, Semiconductor Industry Association
China was the first country to actively and openly reduce dependencies on
foreign-made chips and encourage the development of a domestic industry.
It launched the China Integrated Circuit Industry Investment Fund, also
known as the Big Fund, in 2014 to encourage technological self-reliance.
It initially poured $50 billion into chipmaking, aspiring to meet 70
percent of domestic chip demand by 2025. In total, $100 billion to $150
billion will be allocated in China’s quest to catch up with global
China entered the industry decades after the U.S., but with generous
subsidies along with wooing expertise and executives from Taiwan (and,
according to Miller’s book, allegations of industrial espionage), it now
manages to produce a growing share of the world’s chips – though its focus
so far has been mostly on less advanced chips. Since 2014, the Big Fund
has nurtured domestic champions such as Semiconductor Manufacturing
International Corporation (SMIC), a producer of logic chips, and Yangtze
Memory Technologies Company (YMTC), a manufacturer of memory chips for
Despite efforts at promoting its domestic semiconductor industry, China
hasn’t quite achieved self-reliance yet. China notably spends far more
importing semiconductors than oil. It imported some $400 billion worth of
semiconductors and semiconductor manufacturing equipment in 2021 – about
twice as much as it spent on oil. The country’s large domestic market is
an advantage, however, in that it should enable it to reduce production
costs significantly and increase its market share for less advanced chips.
Line chart showing annual gross domestic spending on research and
development activities since 2000 by the U.S., China, the European
Union, the UK, and Canada. The U.S. is the biggest spender, from $360
billion in 2000 to over $700 billion in 2021. The EU ($230 billion in
2000, $400 billion in 2021) has largely kept pace with the U.S.,
although the U.S. has increased spending more quickly since
approximately 2012. China’s spending has dramatically increased, from
$35 billion in 2000 to $620 billion in 2021, just behind the U.S. The
UK and Canada have maintained annual spending levels below $100
billion since 2000.
Source – Organisation for Economic Co-operation and Development
As part of its more vigorous industrial policy, the U.S. announced the
CHIPS and Science Act in 2022. First proposed under former U.S. President
Donald Trump’s administration, and then championed by President Joe Biden,
it is a bipartisan effort which aims to respond to China’s focus on the
industries of the future. It proposes some $52 billion in subsidies to
support the expansion of local semiconductor manufacturing capacity.
Three-quarters of the funds will be dedicated to building and upgrading
semiconductor manufacturing facilities. The legislation also includes
another $24 billion worth of tax credits for chip production.
Thanks to these incentives, semiconductor companies are building fabs in
the U.S. TSMC has a new facility under construction in Arizona, and
intends to triple its investment in the state to $40 billion, planning to
open another fab in 2026. Samsung is also planning to build a fab in
But it is not only foreign chip manufacturers that will benefit from the
CHIPS Act. Intel, the U.S.’s semiconductor champion, also appears poised
to benefit from U.S. policymakers’ support as it doubles down on its
manufacturing capabilities via two state-of-the-art fabs it is building in
Arizona and Ohio, investing $20 billion in each. Beyond that, other U.S.
players are jumping back in with new fabs of their own in the works.
The EU has its own landmark plan to beef up its chip industry. The
European Chips Act aims to generate public and private investment worth
€45.75 billion ($49 billion) in semiconductor R&D and production. The
scheme intends to double the EU’s share of the global semiconductor market
to 20 percent from 10 percent by the end of the decade. Some €35 billion
($37.5 billion) will be allocated for mega fabs, with the rest going to
chip-design platforms and other infrastructure. As a result, TSMC, in a
joint project with three European companies, announced it will construct a
€10 billion ($10.7 billion) plant in Germany. TSMC is linking up with
Bosch, a German auto supplier, as well as Infineon Technologies and NXP
Semiconductors, two chip manufacturers from Germany and the Netherlands,
respectively, to build a factory near Dresden in response to customer
concerns over geopolitical tensions. This follows a similar move by Intel,
which is planning to build two wafer fabs in east-central Germany.
Europe’s semiconductor industry doesn’t have as high a profile as that
of the U.S. That may be because more than half of the continent’s
capacity is for chips with structures measuring at least 180 nanometers
(1 nanometer equals 1 billionth of a meter), much larger than the most
sophisticated chips produced by TSMC and Samsung, which measure just a
few nanometers wide. But the latter are mostly used in consumer
electronics, whereas the larger European structures are used by the
continent’s industrial firms, which need them for applications spanning
autos, machine tools, and sensors. In a way, Europe’s largest
chipmakers, such as Infineon and STMicroelectronics, focus on their
local customer base.
While reshoring some production may be practical, it is difficult to
conceive that all production of logic chips can be successfully moved
closer to consumer points.
Yes, the subsidies that governments are pumping into their chip industries
are substantial and a promising step. Still, they are clearly insufficient
to uproot an ecosystem developed and fine-tuned over four decades, in our
view. Moreover, government efforts are aiming to replicate a business
model that companies – focused on optimizing capital utilization – had
previously chosen to exit by offshoring.
The reshoring strategy, which prioritizes supply chain resilience, should
bolster national security. But in November 2022, CNN reported that at a
press briefing, Morris Chang, founder of TSMC, commented that the cost to
manufacture chips in the U.S. would be 55 percent higher than in Taiwan.
Another big hurdle is a talent shortage. Having outsourced and offshored
the process of turning silicon wafers into electronic circuits at scale to
Asia, the U.S. finds itself low on skilled workers to build, operate, and
run the new fabs. A worker shortage could result in either higher labour
costs or a factory running below capacity. The start of production at one
of TSMC’s new fabs in Arizona was pushed back by a year to 2025 due to
several challenges, chief among them being a lack of workers with suitable
Working in close collaboration with semiconductor companies, universities
and community colleges are creating new fields of study to address these
staffing issues, including some shorter programs with hands-on experience
for both undergraduate and graduate semiconductor degree programs. TSMC
may also send some of its own technicians from Taiwan to train its
Over time, the industry’s hope is that labour shortages wane as the skilled
The U.S.’s semiconductor policy isn’t solely based on subsidizing local
manufacturing processes. It also aims to stymie China’s efforts at
developing advanced chips, so that the U.S. can retain its technological
superiority. In particular, the U.S. is concerned China may be developing
technology which could give it a military edge. Washington has closed down
paths that have enabled China’s technological rise. In 2022, the Biden
administration banned the export of all advanced semiconductor chips and
equipment to Chinese companies on the grounds of national security. It
also pressured allies, such as the Netherlands and Japan, to follow suit.
The Dutch government, which had already restricted exports of the most
advanced semiconductor equipment to China in 2019, increased the scope of
technology that would fall under export controls. In October 2023, the
U.S. tightened export restrictions further to include leading-edge
artificial intelligence chips.
China retaliated by imposing export controls on gallium and germanium, two
critical minerals used in high-end semiconductors. China is the
overwhelming producer of these rare earths, accounting for 90 percent and
60 percent of global production, respectively.
It is likely that U.S. restrictions on the export of advanced chips have
spurred China’s resolve to support its domestic semiconductor industry.
After all, the U.S. could expand its restrictions to include less advanced
technology, a move that would mean semiconductor capacity in China could
become difficult to maintain and service. Chinese companies, encouraged by
ample state funding, have thus redoubled their efforts to develop their
own versions of chip technologies imported from the U.S., seeking to limit
the impact of U.S. restrictions.
China may have found a way around the U.S. export ban on cutting-edge
chips that come from foundries using American technology. It was recently
revealed that Chinese tech giant Huawei and SMIC seem to have been able to
manufacture 7-nanometer (nm) chips, only two generations behind TSMC’s and
Samsung’s 3 nm nodes.
The surge in investment in the semiconductor industry is happening at a
time when there is a glut of chips. This is typical of the notoriously
cyclical chips industry. It takes a few years to construct a fab and bring
it online, by which time the demand trends may no longer be as strong as
when the decision to build was taken. Semiconductor product lifecycles
tend to be short due to technological innovation, particularly at the
leading edge. The new subsidies and investments into reshoring are
turbocharging the current cycle, with supply being boosted just as America
is reducing the sale of all U.S.-made advanced semiconductor chips and
chip equipment to China. Sales to China will not be easily replaced – the
country is the second-largest market for many U.S. firms. For instance, it
represents slightly over a quarter of 2022 revenues at NVIDIA and Intel.
Once these challenges are overcome, new applications, such as artificial
intelligence, and greater chip content throughout the economy should
enable the semiconductor industry to grow by mid-single digits through
2030, in our view. The industry should benefit from secular (long-term)
growth, though some cyclical (economically sensitive) elements do remain.
Semiconductor equipment manufacturers also operate in a cyclical industry,
but they enjoy a much stronger backlog and healthy order book, given the
new fabs being built on the back of the reshoring trend. Should
geopolitical tensions flare up over Taiwan, this segment could provide a
useful hedge. Still, it is not entirely immune to geopolitical risk – when
reports came out that the U.S. would restrict exports of semiconductor
equipment to China, the share prices of U.S. tool makers, which generate
one-third of sales from China, duly corrected. But the strong order books
provide some degree of cushion, and share prices have since recovered.
As for Asian semiconductor manufacturers, RBC BlueBay Asset Management
Emerging Markets Portfolio Manager Guido Giammattei has noted their
returns could potentially be diluted by the lower return on investments
outside of Taiwan and China. The impact would be marginal, in his view, as
this new capital expenditure and related capacity will be gradual and
relatively small. For instance, TSMC’s U.S. factories could produce
600,000 wafers per year, versus total capacity of some 15 million wafers
per year. To a large extent, the impact of new capacity on returns is
already reflected in current industry valuations, in his view.
Furthermore, Giammattei believes the U.S. government’s friendshoring
strategy should encourage further supply chain relocations into Southeast
Asian nations such as Vietnam, Thailand, and Malaysia, given the region’s
supportive policies, cost competitiveness, and ties to existing
manufacturing hubs. Nearshoring also presents a distinct opportunity for
Mexico to expand its economic role and to become the leading supplier to
Overall, the broad semiconductor sector awaits a favourable cyclical entry
point, which may be delayed by what we see as a likely recession on the
horizon. But with the prospects of new applications, greater chip content,
and further strength in semiconductor equipment order books on the back of
government support and rising technological complexity requirements, we
think investors should now consider this specialized sector for global
equity portfolios, particularly with the need for governments to be less
reliant on Taiwanese supply, as tensions regarding Taiwan might flare up
from time to time.
With contributions from Nishad Subramaniam, CA, CFA, Senior Analyst,
Technology and Industrials, RBC Brewin Dolphin.
The material herein is for informational purposes only and is not directed at, nor intended for distribution to or use by, any person or entity in any country where such distribution or use would be contrary to law or regulation or which would subject Royal Bank of Canada or its subsidiaries or constituent business units (including RBC Wealth Management) to any licensing or registration requirement within such country.This is not intended to be either a specific offer by any Royal Bank of Canada entity to sell or provide, or a specific invitation to apply for, any particular financial account, product or service. Royal Bank of Canada does not offer accounts, products or services in jurisdictions where it is not permitted to do so, and therefore the RBC Wealth Management business is not available in all countries or markets.The information contained herein is general in nature and is not intended, and should not be construed, as professional advice or opinion provided to the user, nor as a recommendation of any particular approach. Nothing in this material constitutes legal, accounting or tax advice and you are advised to seek independent legal, tax and accounting advice prior to acting upon anything contained in this material. Interest rates, market conditions, tax and legal rules and other important factors which will be pertinent to your circumstances are subject to change. This material does not purport to be a complete statement of the approaches or steps that may be appropriate for the user, does not take into account the user’s specific investment objectives or risk tolerance and is not intended to be an invitation to effect a securities transaction or to otherwise participate in any investment service.To the full extent permitted by law neither RBC Wealth Management nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this document or the information contained herein. No matter contained in this material may be reproduced or copied by any means without the prior consent of RBC Wealth Management. RBC Wealth Management is the global brand name to describe the wealth management business of the Royal Bank of Canada and its affiliates and branches, including, RBC Investment Services (Asia) Limited, Royal Bank of Canada, Hong Kong Branch, and the Royal Bank of Canada, Singapore Branch. Additional information available upon request.Royal Bank of Canada is duly established under the Bank Act (Canada), which provides limited liability for shareholders.® Registered trademark of Royal Bank of Canada. Used under license. RBC Wealth Management is a registered trademark of Royal Bank of Canada. Used under license. Copyright © Royal Bank of Canada 2023. All rights reserved.