China’s Domestic Content Rules Expands To Foment Faster Growth In Chips Sector

Domestic content rules and mandates have worked for China. Should the U.S. try to copy it, in spots, along key supply chains like new energy and semiconductors?

Here’s the latest in Chinese economic policy trends – the old is new again: Beijing is “gently” persuading domestic end-users of microchips – whether they’re going into a car or a laptop – to buy Chinese-made semiconductors and avoid imports. This is China’s response to export restrictions by Washington, and the CHIPS Act, which provides chip makers incentives to build foundries (or “fabs”) domestically, a move designed to counter China’s rise in that supply chain.

Europe complained when Biden signed the CHIPS Act, and other domestic content legislation like the Inflation Reduction Act (IRA) into law. Now Europe is worried that its multinationals will lose market share to Chinese rivals in the Chinese market. But much to Europe – and perhaps Washington’s dismay – China has had this as a strategy for years, with or without export restrictions and industrial policies like CHIPS and the IRA. Many foreign companies are not allowed into mainland China, and when they are, it is only through a joint venture or when the domestic market has built up enough of a market share that the foreign firm will be a minor player there.

The Netherlands-based NXP Semiconductors, Germany’s Infineon Technologies AG and Japanese chipmaker Renesas Electronics Corp. could all be hit by China’s efforts to source locally, according to a report from the European Commission seen by Bloomberg News and published on June 28.

China can focus on its domestic manufacturers, but the U.S. government –whether Biden or the previous Trump government – is often vilified for wanting to do the same. In a global economy, where China is the go-to manufacturer of the world, Beijing’s policies to direct business to local producers takes the U.S. out of the market and entices American multinationals to source from there as China’s expertise and supply chain growth becomes unmatched.

China’s Ministry of Industry and Information Technology asked carmakers this year to expand domestic content for chips, Bloomberg reported in March. The original target was for a fifth of chips in EVs made locally by next year, but Beijing is now directly instructing firms to avoid foreign semiconductors “if at all possible.”

Former Biden official and senior fellow at the Council on Foreign Relations, Brad Setser, said in a series of social media posts on June 29 that “China has its own CHIPS act (de facto) plus (de facto) local content requirements.”

China is on track to spend more than $100 billion to build new chip plants. The total capacity of China-based foundries will grow 15% to 8.9 million wafers per month this year, and 14% to 10.1 million next year, exceeding the average global growth rate of semiconductor producers, including those here in the U.S., according to a report by industry group SEMI.

China is expected to account for about 30% of the world’s total wafer capacity next year, SEMI said. They forecast that China will have 41 new fabs coming online between 2023 and 2027, more than any other nation. Of that 41, some 34 fabs will handle 300-millimeter wafers and seven for 200 mm wafers, whereas these larger wafers allow companies to produce more chips.

German Chancellor Otto von Bismarck once remarked: “Only a fool learns from his own mistakes. The wise man learns from the mistakes of others.” Writing in Foreign Policy magazine on June 20, columnist Stephen Walt said the ex-Chancellor’s remarks should be amended: A wise country learns not just from the mistakes of others, but also from what they’ve done right. “The United States should not seek to become more like China but it could learn a thing or two from Beijing’s more pragmatic approach,” he wrote.

Although China is big on domestic content, companies have been allowed to outsource to Southeast Asia and invest in new manufacturing plants and partnerships in Mexico to maintain global market share. This makes it harder to impose export restrictions as China can just import it through subsidiaries elsewhere and do the work there instead. It is unclear if this is actually happening, however.

Some members of Congress, like Rep. Andy Barr (R-KY-6) of the House Select Committee of the CCP, said in a hearing recently that extending tariffs beyond China “is a mistake”. Export restrictions against China could, in theory, force its multinationals to just set up fabs in Southeast Asia as a way around trade rules that only target the mainland.

Critics on Capitol Hill often say that the U.S. cannot beat China competitively by imitating their economic policies. Usually, such critiques are loosely veiled attacks against industrial policy like the CHIPS Act.

“Chips, like steel or aluminum, are essential for national security and for economic security,” said CPA chief economist Jeff Ferry. “So each of the three major economic regions in the world, the U.S., China, and Europe, will want and need to have their own industries. U.S. chipmakers already have fabs in Israel, Singapore, and elsewhere to access the local talent base. Going forward, they will all need to build fabs to meet national security needs. To make that process more economic and attractive, the U.S. should also invest in building its talent base in this industry, an issue it has ignored for too many years.”

The U.S. does not have to “imitate China.” But in product specific cases, a local content rule is worth copying. It’s part of the trade toolkit that should include tariffs, volume quotas and tax incentives that make it easier, and profitable, to manufacture in the U.S.