With money, and waste, China fights for chip independence

Their efforts are starting to pay off. China remains far from hosting real rivals to U.S. chip giants like Intel and Nvidia, and its semiconductor manufacturers are at least four years behind the leading edge in Taiwan. Still, local companies are expanding their ability to meet the country’s needs, particularly for products, such as smart appliances and electric vehicles, that have more modest requirements than supercomputers and high-end smartphones.

The turbocharged chip push could prove one of the most enduring legacies of President Donald Trump’s pugilistic trade policies toward China. By turning the country’s dependence on foreign chips into a cudgel for attacking companies like Huawei, the administration made Chinese business and political leaders resolve never to be caught out that way again.

But as Beijing broadens its ambitions in semiconductors, it is also setting itself up for larger potential failures — and dialing up the amount of money it might lose in the process. Several chip projects have run aground recently because of frozen funding and mismanagement. A state-backed chip conglomerate, Tsinghua Unigroup, warned this month that it was in danger of defaulting on nearly $2.5 billion in international bonds.

In a way, China is hoping to achieve the same kind of liftoff that helped it progress from making plastic toys to crafting solar panels.

With semiconductors, though, “the model starts to break down a little bit,” said Jay Goldberg, a tech industry consultant and former Qualcomm executive. The technology is eye-wateringly expensive to develop, and established players have spent decades accumulating know-how. Europe, Goldberg noted, once had many “incredible” chip companies. Japan’s chipmakers are leaders in certain specialized products, but few would call them bold innovators.

“My point is, there is a ladder — China’s moving up it,” Goldberg said. But it’s “unclear which outcome they go to.”

Beijing’s recent love of chips began with the creation of a giant, chip-focused investment fund in 2014. The government set a lofty goal: China would produce 40% of the chips it consumed by 2020. That didn’t happen. Morgan Stanley analysts estimate that Chinese brands bought $103 billion in semiconductors last year, of which 17% was from local vendors. They predict the share will rise to 40% in 2025, far short of the government’s target of 70%.

China has charged ahead with renewed urgency because of the U.S. assault on Huawei, the Chinese tech champion, which has been choked off from buying U.S. chips or even chips made using U.S. software and tools. The U.S. Commerce Department imposed similar curbs this month on exports to China’s most advanced chip manufacturer, Semiconductor Manufacturing International Corp., citing concerns over military ties. SMIC has denied its products have any military use.

And so, China this year has rolled out new tax breaks for chips, including a 10-year exemption from corporate tax and duty-free imports of materials. State-backed funds have invested in both startups and publicly traded companies, including when SMIC listed shares in Shanghai in July.

At a top-level meeting on the economy in December, the Communist Party’s leaders enshrined technological self-reliance as one of the country’s “Five Fundamentals” for economic development.

Complete self-sufficiency in chips, however, would mean recreating every part of the lengthy supply chains for some of the most complex technology on earth — a mission that would seem to lead, if not to madness, at least to waste.

According to an analysis by China Economic Weekly, a magazine affiliated with the Communist Party’s official newspaper, People’s Daily, the number of chip-related companies in China climbed by 58,000 between January and October this year, or roughly 200 a day. Some of these, the magazine noted, were in Tibet — not a place traditionally associated with cutting-edge tech.

“Up until very recently — this year — the goal had been: With state backing, move up the value chain, specialize where China has a comparative advantage, but don’t really try and fall down the rabbit hole of trying to build everything yourself,” said Jimmy Goodrich, vice president for global policy at the Semiconductor Industry Association, a group that represents U.S. chip companies.

Now, “it’s very clear that Xi Jinping is calling for a redundant domestic supply chain,” Goodrich said. “And so the rules of economics, comparative advantage and the supply-chain efficiencies have basically been thrown out the door.”

The government is conscious of the dangers. State-run news outlets have amply covered the recent semiconductor flameouts. The message to other upstarts: Don’t mess it up.

When the state broadcaster China Central Television visited one stalled project in the eastern city of Huai’an recently, it found dozens of giant machines idling on the factory floor, many of them still sheathed in plastic.

“There have been some stunning absurdities that defy logic and common sense,” China Economic Weekly said.

Yet there has also been progress. Two companies, Yangtze Memory Technologies and ChangXin Memory Technologies, are gearing up to put China on the map in memory chips, which store data. Local manufacturers of logic chips, which perform computations, are expanding production, largely for Chinese customers.

Those manufacturers might not have much choice but to serve domestic clients. Some multinational chipmakers are starting to think twice about working with Chinese suppliers and partners out of concerns about intellectual property theft, said Randy Abrams, a tech analyst with Credit Suisse.

“International companies are becoming more wary about the IP leakage in China,” he said.

Liu, the startup founder in Shenzhen, does not deny being motivated by a certain patriotic purpose. Emblazoned atop the website for his company, Tsinghon, is a proud reference to the Mao-era project that produced China’s first atomic bomb, ballistic missile and satellite: "Inherit the Spirit of 'Two Bombs, One Satellite.' Be Self-Reliant and Bold in Forging Ahead."

Liu says the sense of national mission does not conflict with his work serving customers and putting out competitive products. He does acknowledge, when he looks at the sky-high valuations for some chip startups, that irrationality has crept into the market.

“There is definitely a bubble in China,” he said. “But you can’t overgeneralize.”

The government, he said, is trying to hold local authorities more accountable for bad investments. And the torrent of money might at least persuade more skilled engineers in China to work on chips instead of video games and food delivery apps.

“Something is bound to accumulate, whether it’s equipment, talent or factories, right?” Liu said. “If not you or the other guy, then it will be someone else who ends up using it. I think this might be the government’s logic.”