KAGISO SELOLO: When the chips are down, modern life gets interrupted
The geopolitics of semiconductor microchips gives Asia a lot of clout — and pressure
Long before the Covid-19 pandemic hit, the modern world was rapidly accelerating into the internet of things. From kids’ toys to electric toothbrushes, cellphones, cars and even fighter jets, all these devices are powered by tiny brains called semiconductor microchips. Microchips are fast becoming scarce and valuable commodities as the world shifts further into the digital economy. The semiconductor supply-and-demand game is played on the chessboard of geopolitics and managed through a complex and sensitive supply chain. This supply chain is now constrained, resulting in production bottlenecks across the world.
Traditionally, a company producing semiconductors would be responsible for the process from design to manufacture and sales. Today, however, chipmakers increasingly outsource more elements of the production process to other specialists in many different parts of the world. At the centre of this industry is Taiwan. Based on the 2020 total revenue generated by the semiconductor fabricators, Taiwan accounted for 61% of the market share, followed by South Korea at 17% and China at 5%. Therefore, 83% of the global revenue generated from semiconductor fabrication comes from Asia. The leading-edge chip manufacturers TSMC (Taiwan) and Samsung (South Korea) are the only two companies able to produce the 5nm (nanometre) chip. This microchip is the smallest in production, signifying Taiwan and Asia’s dominance as key players in the supply chain.
In this highly specialised industry, new factories (aka foundries) are expensive, take long to set up, and require a highly skilled workforce to operate. For instance, TSMC has invested almost $12bn for its new foundry in Arizona. Such a foundry would typically break even after five years of operation. Given the delayed profitability profile, government support is necessary for an investment of this scale.
China’s centrally co-ordinated approach to complex problems gives it a competitive advantage in supporting this industry. President Joe Biden has also said he aims to support the semiconductor industry, due to its strategic importance. However, Western economies are structurally different in that there are many private players. Such fragmentation adds complexity to co-ordinating large-scale, specialised investments with delayed break-even points. With the growth in technological innovation highly dependent on chips, demand for semiconductors will continue to rise. Asia is fast becoming a near-monopoly producer, creating a situation not dissimilar to the Middle East and oil.
Geopolitics aside, what makes the semiconductor supply chain so sensitive?
Though the industry grew 6.5% in 2020, there were internal supply-demand dislocations. For instance, the global lockdown led to remote working , e-learning and increased online shopping. This took away from the need to drive, in favour of electronics such as laptops. As a cyclical industry, the sharp demand in one part caused a sharp shortage in another. Supply chain experts refer to this phenomenon as the bullwhip effect, as coined by Hau Lee. Lee likened what he observed in the supply chain to a cowboy cracking a bullwhip. For a bullwhip to oscillate widely, it requires a sharp sudden move of the whip handle. Therefore, the unexpected surge in electronics demand, coupled with a significant drop in car sales, caused a larger shift in the manufacturing of electronics semiconductors relative to that of automotive.
To counteract the economic shocks caused by lockdowns, governments introduced stimulus packages. This resulted in an uptick in demand for automobiles, leading manufactures to urgently place chip orders. Coinciding with a surge in demand, several other key factors worsened the shortage. A major factory in Texas was affected by the February storm, and a factory in Japan had a fire outbreak, both events leading to a halt in production. Additionally, Malaysia experienced a surge in Covid-19 that resulted in lockdown restrictions that disrupted production. Lastly, a decision by the US to prevent the sale of semiconductors and other technology to Huawei caused panic buying.
It is undeniable, semiconductor chips are essential to our modern world. And there is an uneven geographical distribution of the supply chain, a crucial flaw amid rising geographical tensions, especially since production is largely located where China is the big gorilla. Fortunately, other governments are investing in initiatives to lessen reliance on Asia. Until then, expect that your favourite chips may be out of stock.
• Selolo is an emerging-market analyst at All Weather Capital.
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