June 21, 2021 - Semiconductors have become so ubiquitous that it is easy to take them for granted until they are suddenly in short supply. Recent changes in global market demand for semiconductors has increased dramatically at a time when the world is moving towards technical innovations in renewable energy, electric vehicles and artificial intelligence. As America recovers from the economic toll the COVID-19 pandemic has caused, a critical shortage of this important electronic component has disrupted production in industries ranging from medical devices, computers, defense technologies, and in no small part, the U.S. auto industry.
While there appears to be no quick antidote to this supply chain malaise, compared to other countries, the United States may be in the best position to help its businesses navigate global semiconductor supply chain limitations, albeit with political leverage rather than through domestic capacity.
Semiconductors are essential to the production of integrated circuits or chips. A single chip can include thousands or even millions of semiconductors. The semiconductors are very difficult to manufacture since they are hundredths of times smaller than a human hair. Modern, technologically advanced cars use a multitude of sensors and controllers which rely on chips to send information throughout the vehicle.
Automakers historically strived to limit inventories of parts, including semiconductors, to "just-in-time," to reduce costs. When auto sales slowed, orders followed suit. Many semiconductor contract foundries switched from making "mature" chips for the auto industry to producing more technologically advanced "emerging" chips for the consumer electronics industry (e.g., 5G), which demand higher prices.
The start of the pandemic saw orders for autos collapse, which resulted in orders for semiconductors from the auto sector to likewise rapidly decrease. As semiconductor orders decreased for autos, orders for semiconductors rapidly increased for consumer electronics as the workforce entered quarantine and a remote work environment. As the quarantine continued, auto sales grew by as much as 90 percent as measured from April 2020 to April 2021. While increased demand has been good for the auto industry, a critical shortage of semiconductors is causing Ford, General Motors and Stellantis to idle machinery and labor. The shortage has forced shutdowns at OEMs and has trickled down to parts suppliers which rely on OEMs for business.
The Biden administration has taken this issue seriously in adopting a holistic approach to finding solutions. In April 2021, the president ordered a 100-day review of the semiconductor supply chain. Congress also has introduced legislation aimed at reducing U.S. dependence on foreign supply while incentivizing domestic production of semiconductors through a $50 billion infrastructure plan. In the meantime, diplomacy and direct government collaboration appear to offer the best option for addressing the shortage in the shortest time.
On the surface, the obvious solution would seem to be for car makers' suppliers to increase their foundry capacity or to find alternative suppliers. But given how difficult and expensive it is to build semiconductors, the commercial reality is that this is not easy.
The Semiconductor Industry Association (SIA) believes its industry is "currently doing all it possibly can in the short-term to increase utilization and meet increased demand both in the auto sector and more broadly for all customers."
Despite existing domestic manufacturing, U.S. demand for semiconductors is highly dependent on foreign suppliers, especially those located in Taiwan. In May 2021, Commerce Secretary Gina Raimondo sought to lobby the Taiwanese government for their help in freeing up capacity to meet U.S. auto industry shortages. According to Secretary Raimondo, "[t]he next best thing to on-shoring is near-shoring with our allies that share our values."
Considering sales of contract foundries, Taiwan-based companies accounted for 73 percent of global contract revenue, U.S. companies accounted for 10 percent, Chinese companies for 7 percent, South Korean companies for 6 percent and Japanese and Singaporean companies accounted for 2 percent each of global revenue.
Taiwan Semiconductor Manufacturing Company's (TSMC) Chairman Mark Liu believes that the capacity for auto semiconductors exceeds the supply. According to Mr. Liu, the shortage is due to the uncertainty brought on by the pandemic and manufacturers stockpiling chips. He makes a point of distinguishing between real demand and stockpiling for inventory.
Secretary Raimondo's comments aside, working with Chinese manufacturers is a possible option, although one issue stands in the way. The United States imposed 25 percent tariffs on semiconductors from China under Section 301 based on China's lack of protection of intellectual property rights and forced technology transfer.
A way to free up supply from China would be for the Biden administration to grant Section 301 exclusions for semiconductors. The exclusion process expired under the Trump administration and has not been renewed. However, the Office of the United States Trade Representative indicated that while the issue is sensitive, it is evaluating whether to bring back certain exclusions for Section 301 tariffs and has been approached by multiple stakeholders to reintroduce this process.
Other traditional regulatory tools normally available to industry and the U.S. government are aimed at addressing import competition and do not offer a ready solution for this shortage scenario (e.g., Section 201 global safeguards; Section 301 unfair trade practices; Section 232 national security investigations; antidumping or countervailing petitions). Pressuring foreign suppliers or sovereigns to place certain U.S. industries in front of their production queue is not part of this regulatory arsenal. Nor is it consistent with pure free market principles. There is also the sensitivity of government intervention on behalf of the auto industry ahead of other industry sectors.
Another option is for an existing supplier to add foundry capacity. According to the Congressional Research Service, North America ranked fifth in fabrication capacity at 11 percent, behind South Korea, Taiwan, Japan and China. Global Foundries, a U.S.-headquartered pure-play foundry, estimates adding capacity would take up to one year and cost hundreds of millions of dollars for what some consider the automotive sector's mature technology.
The slowest and most expensive solution is for a contract foundry to build a new facility. The SIA estimates that a foundry costs from $10 billion to $20 billion, depending on the type of chip to be produced. Over a decade, including initial costs and retooling, such a facility could cost up to $40 billion.
A new facility for mature technology semiconductors, such as those for the auto industry, would not likely cost the same as a facility for emerging technology semiconductors. Nonetheless, the cost would still be billions of dollars. Moreover, a foundry for auto semiconductors would take at least five years to earn even a low profit margin.
Given the high capital expense barrier to entry, it is doubtful that a foundry could be built without some type of government support. An Organization for Economic Development and Cooperation report found that Intel, Micron, Samsung and TSMC, were among the semiconductor companies receiving over $50 billion in government support between 2014 and 2018.
Not only does TSMC, the largest contract foundry in the world, receive subsidies from its own government, but it is also in line to receive subsidies from the U.S. Government. TSMC's Chairman said that "[s]ubsidies will be a key factor in TSMC's decision to set up a fab in the U.S."
As stated above, TSMC's receipt of government support is not an isolated event for the semiconductor industry. In December 2020, Congress passed the Creating Helpful Incentives for Producing Semiconductors in America Act (the CHIPS Act) as part of the National Defense Authorization Act (NDAA). Section 9902 of the NDAA calls for U.S. Government support for both research and development, as well as facilities and equipment for semiconductor fabrication, assembly, testing, and advanced packaging.
Although the CHIPS Act is currently unfunded, estimates are that it could cost as much as $50 billion. Whether the CHIPS Act is funded or not, it will not resolve the auto industry supply chain concerns, nor will building a new foundry or adding capacity to an existing one.
The most realistic short-term solution to address the auto industry's semiconductor shortage is likely to come through diplomacy. The long-term solution depends on whether auto semiconductor technology advances to the point of being considered emerging or whether a company and/ or a government would be willing to invest billions of dollars for a mature industry.
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