Succession of Failures in Semiconductor Domestic Production Reveals Lack of Skills and Capital

As the Xi Jinping administration intensifies its confrontational stance towards the U.S., it is speeding up domestic production of semiconductors which are “the rice of industry,” in fear of decoupling from the international supply chain. The plan is to build production sites in various regions by providing thorough support. Yet contrary to the leadership’s intent, plan after plan is coming to a standstill.

 “One Trillion Yen Project” in Midair

The Secretary of the Party Committee Sun Licheng is the top official of Jinan City, the capital of Shandong Province. In June 2020, he visited the high-tech park 15 kilometers east from the center of the city to see the construction site of the semiconductor plant under his auspices.

The operating body was a company called Quanxin Integrated Circuit Manufacturing, established through joint investment by a Guangdong Province firm and the Jinan City government. The company planned to invest a tremendous amount equivalent of one trillion yen to produce 480 thousand 12-nanometer (1 nanometer = 1 billionth of a meter) chips in terms of 12-inch wafers annually, and also produce photomasks. Jinan City considers semiconductors as its priority industry, and gave full support by positioning Quanxin as an important project. The Guangdong firm also headhunted many engineers from Taiwanese semiconductor manufacturers, appealing its stance to make strong efforts for the project’s success.

But this May, less than a year since Sun Licheng’s visit, several Chinese media reported Quanxin had run out of funds with the plant unfinished, and unable to pay salaries, it is forcing employees to quit. The Guangdong firm, the parent company, had not paid the investment money, and reportedly attempted to drive the project with just the funds from Jinan City. Rumors said the owner of the Guangdong firm was the mastermind behind the massive project Wuhan Hongxin Semiconductor Manufacturing (HSMC) that failed in Wuhan City, Hubei Province. The media’s view is that just like in Wuhan, the Jinan City project was a scam by the mastermind to exploit subsidy from the local government, and the project will be dissolved in the end. If the reporting is true, it means Sun Licheng and Jinan City executives were totally taken in.

The Chinese semiconductor market is booming in the last few years. With the spread of electrification, demand for automobiles, PCs, and smartphones and other IT devices is growing. According to a report by the Ministry of Industry and Information Technology, sales of the semiconductor industry were 884.8 billion yuan (about 15 trillion yen) in 2020, increasing 17% from the previous year, and doubled in the four years from 2016. A private research firm predicts further growth in 2021, up 12% from the previous year at approximately 990 billion yuan, approaching 1 trillion yuan . 

China does not supply the massive expanding market by itself. As of 2019, the self-sufficiency rate of semiconductors remained around 16%, and the majority depends on overseas supply. If the U.S.-China conflict intensifies and imports are cut off, China’s industries will immediately come to a dead end.

The Chinese government presented the goal to raise the semiconductor self-sufficiency rate to 70% in the “Made in China 2025” plan, which was established to strengthen the industry. China must drive the domestic production project in full spurt to achieve the goal. In 2020, it decided to provide various benefits, such as tax exemptions, and research subsidies or loans for companies involved in manufacturing, design, and encapsulation of semiconductors.

71,000 Companies Rush In

In response, there was a sudden surge of entering companies. The number of companies entering the integrated circuits and semiconductor-related market during January-November 2020 was 71,000, up 32% year over year. Total investments in the semiconductor sector throughout 2020 was 140 billion yuan. Some estimates show almost fivefold expansion in just one year from the previous year’s 30 billion yuan.

However, things are not so simple as huge industries materializing with just governmental support. For a company to conduct the semiconductor business, it needs both financial resources to continue an enormous investment and advanced technical power. Do the companies planning to enter the Chinese market have that much power?

Like Huawei, that was on the verge of crisis from U.S. sanctions, some excellent companies make bold efforts and continue proprietary semiconductor development despite the sanctions. Yet such companies are rare, and there are endless cases of companies running into financial trouble before the business starts up.

Quanxin in Jinan that came to a standstill without completing the plant, and Hongxin in Wuhan are not the only ones. According to local reports, Tacoma Nanjing Semiconductor Technology in Jiangsu that planned to produce complementary metal-oxide semiconductor (CMOS) sensors, went bankrupt in July 2020. Kuntong Semiconductor Technology in Shaanxi Province planned to mass-produce flexible semiconductors halted business at the site acquisition stage. Most projects are joint investments by private companies and local governments. In some cases, the government’s investments have reportedly gone missing. 

In mid-June this year, there were stories that Tsinghua Unigroup, considered the leader of domestic semiconductor production, asked financial support from the e-commerce giant Alibaba Group. Tsinghua is a company originating from Tsinghua University, the alma mater of President Xi Jinping. The company has rapidly expanded through aggressive acquisitions backed by government subsidies, but because of the unreasonable expansion policy by the management, is now facing financial difficulties.

This is not the first time in China that shady companies have flocked to the government’s coffers intended to promote industry. During the solar cell production boom some time back, manufacturers sprung up like mushrooms. Recently, with an influx of electric vehicles and other eco-car manufacturers, 140 companies were said to be selling 1,300 models of eco-cars at one point. Many companies gave a false report of units sold and cheated the government for subsidies. With the widespread fraud across the country, the government had to review the subsidy system. As a result, the government failed to foster decent manufacturers, and as with gasoline vehicles, foreign companies such as Tesla are leading the eco-car market today. 

The U.S., in a conflicting position with China, is investing 50 billion USD to encourage domestic production and research and development to counter the Chinese government’s initiative to strengthen its semiconductor industry. Japan too is conscious of China and seeks to position semiconductors at the center of its growth strategy. China’s semiconductor industry that Japan and the U.S. see as a threat, in reality, is still unsound, and the enhancement of domestic production remains uncertain.

The Xi Jinping administration sets a long-term goal to become a fully industrialized nation by 2035. To achieve the goal, it is essential to modernize and improve the soundness of the industry. To that end, China must get rid of the dubious companies that thrive across the country. To modernize and improve soundness, China needs to nurture as many quality managers as possible. But whenever talented managers appear, the Communist Party’s leadership suppresses them and even put them in a straitjacket. Will there be a day when such a country becomes a true economic power nation and prides itself as a developed country?

Kenji Yuasa(Japan Center for Economic Research Lead Economist)