A Semiconductor Base in Peril
The United States must act quickly to maintain vital domestic defense technology.
The changing composition of the semiconductor industry, combined with foreign government action that has leveraged market forces, has resulted in the shift of chip manufacturing from the United States to offshore locations, particularly China and East Asia. This migration has substantial national security ramifications, as the transformation of this nation’s military into a network-centric force requires high-end semiconductor chips to provide the processing power for numerous defense applications.
The loss to the U.S. economy of the high-end semiconductor manufacturing sector, the potential subsequent loss of the semiconductor research and design sectors, and the grave national security implications that this would entail are items of major concern. If the ongoing migration of the chip manufacturing sector to East Asia continues, the U.S. Defense Department and U.S. intelligence services will lose both first access and assured access to secure advanced chip-making capability—just at the time that these components are becoming a crucial defense technology advantage.
The past decade has seen much debate about the revolution in military affairs. Some see the recent growth in military capability as merely evolutionary, while others believe that the increase in capabilities has taken place within the context of a broader—and even revolutionary—change in how the United States prepares for and wages war. The military is undergoing a true revolution, and it is likely that order of magnitude advances will occur with increasing speed. These advances will change the United States’ way of fighting war in profound and fundamental ways.
Regardless of the dispute over the nomenclature of the transformation that is currently sweeping over the U.S. military, all observers agree that it has achieved a dramatic increase in capabilities over the past decade. The U.S. Army, Navy, Air Force, Marine Corps and Coast Guard are able to see through the so-called fog of war better now than ever before. They are able to decide on a course of action and act upon that decision with speed and precision never before attained. These improved capabilities are, as Vice Adm. Arthur Cebrowski, USN (Ret.), believes, based on dramatic new theories of warfare. These theories in turn are made manifest by the relatively recent and extraordinary advances in information technology. The key to the new way of war is the ability to acquire, move, store, assess and use massive amounts of information in near-real-time in networks of ever-increasing scale. This network-centric warfare capability is the core of U.S. military dominance today, and it is the key to continued dominance in the 21st century.
As impressive as it is, this new capability is still in its infancy. Many current defense systems that are envisioned to be part of a future force utilizing network-centric warfare require performance levels beyond those currently available. As the military continues to transform to a network-centric force, the Defense Department’s Global Information Grid will demand extremely high-performance computation to overcome the technical barriers to a seamless communication network. Greater processing capability is required for very-high-performance missile guidance systems and signal processing, and radiation-hardened chips must be available to withstand extremely harsh tactical environments. Intelligence agencies increasingly will need greater high-speed signal processing and data analysis for real-time data evaluation, sensor input and analysis, and encryption and decryption. In addition, more advanced onboard processing capabilities are urgently needed for unmanned aerial vehicles, cruise missiles, ballistic missile defense and the infrastructure that connects all of these systems within a “network of networks.” Yet, many of the integrated circuits and processing platforms that are in use or coming into use today are clearly pushing the limits of their capabilities. The military cannot achieve the performance it needs from chips that are one or two generations behind current state-of-the-art technology.
The next several generations of integrated circuits could meet these needs. However, having these new chips is not assured. The U.S. semiconductor industry is facing dramatic changes. Although the United States currently leads the world’s semiconductor industry with a 50 percent world market share, the U.S. high-technology industry has been in a recession during the past two years with sharply reduced sales and severe losses. The number of state-of-the-art U.S. chip manufacturing facilities is expected to decrease sharply in the next three to five years to as few as one to three firms that have the revenue base to own a 300-millimeter wafer production fabrication plant. The remaining state-of-the-art U.S. chip-making firms face great difficulty in attaining the huge amounts of capital required to construct next-generation fabrication facilities.
The problem of losing assured Defense Department access to high-end chips is a serious one. To put it simply: no chips, no network; no network, no network-centric warfare.
East Asian countries, particularly China, are aggressively, and in some cases illegally, leveraging market forces through their national trade and industrial policies to accelerate the migration of semiconductor manufacturing to that region. The Semiconductor Industry Association estimates that the United States’ share of 300-millimeter wafer production capacity will be only approximately 20 percent in 2005, while the Asian share will reach 65 percent. Only 10 percent of this will come from Japan.
The Pentagon’s Advisory Group on Electron Devices has warned that the Defense Department faces shrinking advantages across all technology areas because of the rapid decline of the U.S. semiconductor industry. In addition, the group contends that the offshore movement of intellectual capital and industrial capability, particularly in microelectronics, has affected the United States’ ability to research and produce the best technologies and products for the nation and the warfighter. Historically, shifts in manufacturing also result over time in the migration of research and design capabilities. This is especially true of leading-edge industries such as advanced semiconductor manufacturing, which requires a tight linkage and geographic proximity to research, development, engineering and manufacturing activities.
The migration of research and design capabilities to China is of particular concern. Chinese policy has resulted in a sharp upsurge in construction of fabrication facilities in that country, with plans for a great many more. To ensure that they develop the ability to build the next-generation fabrication facilities, the Chinese central government, in cooperation with regional and local authorities, has undertaken a large array of direct and indirect subsidies to support their domestic semiconductor industry. China also has developed a number of partnerships with U.S. and European companies that are cost-advantageous to the companies in the short term.
The Chinese government is using tax subsidies successfully to attract foreign capital from semiconductor firms that are seeking access to what is expected to be one of the world’s largest markets. This strategy is a means of inducing substantial inflows of direct investment by private firms. The strategy does not rely on cheaper labor, as that is a small element in semiconductor production. The Chinese are, however, able to draw increasingly on substantially larger pools of technically trained workers as compared with the United States, from the large cohorts of domestic engineering graduates. Importantly, in addition to the graduates from Chinese universities, the work force is being supplemented by large numbers of engineers trained at U.S. universities and mid-career professionals who are offered substantial incentives to return to China to work. These incentives—which include substantial tax benefits, world-class living facilities, extensive stock options taxed at par value and other amenities—are proving effective in attracting expatriate labor. They also represent an important new dimension in an accelerating global competition for highly skilled information technology workers.
The immediate and most powerful incentives for a highly leveraged industry are the direct and indirect subsidies, including the infrastructure needed for state-of-the-art fabrication plants, offered by the government. For example, the Chinese central government has undertaken indirect subsidies in the form of a substantial rebate on the value-added tax (VAT) charged on Chinese-made chips. While many believe this is an illegal subsidy under the General Agreement on Tariffs and Trade (GATT) rules, the impact of the subsidy on the growth of the industry may well be irreversible before—and if—any trade action has taken place. China also systematically undervalues its currency, often by as much as 40 percent, which gives its goods a major price advantage. This practice also may violate trade rules.
The development of special government-funded industrial parks, the low costs of building construction in China as compared with the United States, and China’s apparent disinterest in the expensive pollution controls required of fabrication facilities in the United States all represent further hidden subsidies. The aggregate effect of these individual subsidies may be only a few tens of percentage points of decrease—literally, only 20 to 30 percent—in the manufacturing costs of the chips. However, in such a cost-driven industry, this difference appears to play an important role in driving the entire offshore migration process for these critical components. These actions reflect a strategic decision by the Chinese government to capture the benefits of this enabling, high-technology industry and become a monopoly supplier, and thus control pricing and supply levels.
It is important to understand that the current shift in manufacturing capacity to China is not entirely the result of market forces. It is equally important to recognize that even if some residual U.S. manufacturing capacity remains after this large-scale migration, the shift of the bulk of semiconductor manufacturing will severely constrain the ability of the United States to maintain high-end research and development capabilities.
The threat to the United States is real, and the time for the country to react effectively is limited. Actions can be taken to maintain domestic high-end semiconductor chip design and manufacturing capacities:
• Enforce GATT trade rules. The Chinese government currently provides a 14 percent rebate on VAT to customers who buy Chinese-made semiconductor chips, which is in clear violation of GATT rules. China also pegs its currency to the U.S. dollar, undervaluing its currency and giving its products a major price subsidy, which may also violate trade laws. The U.S. government must insist that the U.S. trade representative and the treasury secretary undertake bilateral negotiations to remove these measures. And, it must file prompt actions protesting trade agreement violations if negotiations fail.
• Enter into joint production agreements. With the current downturn in the high-technology sector, many chip manufacturing companies will be unable to acquire the necessary capital to invest the more than $3 billion required for new 12-inch wafer advanced chip fabrication facilities. Some companies are contemplating entering into joint ventures. Federal antitrust laws should allow joint production and joint research and development agreements in competitive situations like this. The Defense Department affirmatively should encourage these kinds of ventures to protect this critical industrial base. It also can be an additional guarantor of demand by offering contracting opportunities to meet its own chip-making needs.
• Encourage tax incentives for U.S. investment. The Defense Department and the intelligence community should work with industry and the Bush administration to propose targeted tax incentives, possibly in coordination with state and local government financing, to assist in meeting investment costs.
• Increase the number of science and engineering graduates. The Defense Department should support targeted programs that increase the number of science and engineering graduates at the bachelor’s and master’s degree levels to provide the technical capabilities for the semiconductor industry.
• Increase federal funds for research and development. U.S. federal funding levels for research in microelectronics have been decreasing steadily, while at the same time competitors in Asia and Europe have dramatically expanded public support for semiconductor research and development. The United States needs increased government funding for the research and development of advanced chip technologies as well as funding for the development of new defense-specific chip designs within the aerospace industry.
• Fund cooperative research programs. Initiatives such as the Focus Research Center Program within the Government-Industry Co-sponsorship of University Research program seek to overcome the growing challenges companies face in advancing microelectronics technologies. They encourage government-industry partnerships that focus on cutting-edge research deemed critical to the continued growth of the industry. The Defense Department should ensure that funding levels for this vital area of government-industry collaborative research are properly supported, and that when U.S. universities are the recipients of such funding, the training of U.S. citizens is strongly emphasized.
• Survey trade practices. The Defense Department should survey all possible technologies that the Chinese government may be targeting for subsidies that would assist in the transfer of U.S. chip-making and related fields to China. Then, it should develop a list of those subsidies that are in violation of GATT trade rules and seek U.S. trade representative action.
• Support the semiconductor equipment and materials industry research consortium to address the economic and technical challenges facing the U.S. mask-making industry. Over the past decade, key U.S. semiconductor tooling and equipment capability has migrated offshore. This has been particularly true of the high-technology end of the business—advanced lithography. The migration has had a significant impact on the United States’ ability to guide and direct development in the chip economy as a whole. The Defense Department should support the effort to form a U.S. “mask” consortium to prevent the departure of this important production element.
A prompt, concerted effort by the defense and intelligence communities can reverse the trend of offshore migration of manufacturing, research and design that is now underway. This is vital because that migration may become irreversible if no action is taken in the next few months.
The loss goes beyond economics and security. What is at stake is the United States’ ability to stay pre-eminent in the world of ideas on which the semiconductor industry is based. Much of applied physical science—optics, materials science and computer science, to name a few—will be practiced at foreign centers of excellence. This stunning loss of intellectual capability will impede U.S. efforts in all areas of society.
This country is being confronted by one of the greatest transfers of critical defense technologies ever organized by another government, and the time for action is overdue. By bringing attention to this matter, the country may be able to avoid a potential national security crisis in terms of reliable access to cutting-edge technology necessary to the critical defense needs of the nation.
Sen. Joseph I. Lieberman (D-CT) is a U.S. senator from Connecticut and was a vice-presidential nominee in 2000 and is a candidate for president.
