China has been in the news a lot recently because many U.S. companies depend on the region for growth. This is especially true for the semiconductor industry, which comprises the brains behind the many electronic gadgets currently selling like hotcakes in the region. So growth concerns, which always hit consumer spending power, put the industry in a tailspin. It wasn’t until stimulus measures were announced that the shares attained an uncomfortable equilibrium.

And this isn’t without reason: China’s chip consumption is the largest in the world (and growing), with most chips coming from international players. While a boon for these international players, it has been a drain for the country. Government policy has therefore focused on strengthening local players to reduce this dependence.

Chinese Policy Making

China’s financial planning since the year 2000 has favoured local semiconductor players with benefits ranging from duty concessions on equipment imports to tax holidays. There was also a substantial amount of government funding for infrastructure development and government-supported establishment of startups.

Over the next decade, this led to the development of foundries like Semiconductor Manufacturing International (SMI - Snapshot Report), Hejian, Grace and Taiwan Semiconductor’s (TSMC) SongJiang Operations. These facilities could be used by U.S. players for their simpler operations, thus reducing costs.

However, despite its poor IP protection systems, the Chinese government placed restrictions on the import of advanced technologies (to spur domestic development), which basically limited the sector’s prospects and continued to widen the gap between Chinese production and consumption. The government then went deeper into the problems faced by the domestic industry, promoting M&A to strengthen players and supporting the building of R&D capabilities through further substantial funding.

Neighbor Taiwan did notably better, giving the Chinese government food for thought. But the Taiwanese government recently relaxed restrictions on semiconductor players the most illustrious of which are Taiwan Semiconductor Manufacturing Company (TSM - Snapshot Report) and United Microelectronics (UMC - Snapshot Report) because competing with local Chinese players for use in Chinese products is becoming more of a challenge.

The government will review its policies again this year and there are implications for semiconductor players. China’s leverage comes from its being one of the largest markets for end devices using semiconductors. At the same time, recent growth concerns can temper enthusiasm on China. Assuming that the government’s recent activities are a trend, it is likely to take a highly collaborative approach to milk U.S. players and develop local talent.

Chinese engineers are cheaper, which is good for business, so U.S. players can benefit from the development of talent (tech companies Intel and Microsoft are already going this route). At the same time, locally developed IP will make the government more concerned about IP protection, which again is positive.

But there are a few negatives too: one, there could be some aggressive acquisition of U.S. companies to rapidly acquire IP and second, the government’s deep focus on developing the sector can lead to global over production and a consequent hit to prices, particularly at the trailing edge.  

Is Moore’s Law Dead?

China doesn’t seem that concerned about Moore’s Law, with existing and new facilities primarily on the trailing edge. That could be because of the increased costs and difficulty of setting up and driving efficiencies at advanced nodes in an industry looking desperately for profits. So U.S. players with leading edge capabilities and IP will likely maintain a lead for a few more years.

But without material innovation or alternative technology, it will be very difficult to continue with Moore’s Law for longer than a couple more shrinks. Intel all but said as much, when it extended the 14nm process as well as its tick-tock cadence for new architecture to 2.5 years (from two years).