Storm Clouds Ahead for Semiconductor Sector

Chip manufacturers will need to navigate new export controls by the United States and decreased global demand for semiconductors in 2023.

In early October, the U.S. announced a sweeping set of export controls that in effect cut China off from advanced semiconductors made with American technology. The move aims to slow Beijing’s technological and military progress amid tensions between the two superpowers.

The Taiwan government has indicated that Taiwanese semiconductor companies, including Taiwan Semiconductor Manufacturing Co. (TSMC), the world’s largest contract chipmaker and Asia’s most valuable listed firm, will comply with the controls.

TSMC leads the world in cutting-edge chip technology – in the fourth quarter of 2022 it had a 90% global market share in the advanced 5-nanometer chip market, according to the Development Bank of Singapore (DBS). The company began research on ultra-advanced 2-nanometer chips in 2019 and is expected to begin production by 2025.

“Taiwan’s semiconductor industry has long served global customers and attaches great importance to compliance with laws,” the Ministry of Economic Affairs (MOEA) said in a statement responding to the export controls. “In addition to complying with domestic laws and regulations, it will also cooperate with the needs of international customers who place orders and the norms of customers in their country.”

The new rules require U.S. companies to stop supplying Chinese chipmakers with equipment to make relatively advanced chips, though Washington has granted some non-Chinese companies operating in China one-year licenses to continue.

Tony Phoo, an analyst at Standard Chartered, says he expects Taiwan’s economy to suffer from the impact of the new American export regime, although he and other economists interviewed were leery of offering any concrete estimates, such as the percentage points this would detract from their 2023 GDP growth forecasts.

China is the largest market – at 60% – for Taiwanese semiconductors, although some of these chips end up in finished products re-exported to Europe and the United States. China’s closest equivalent to TSMC, Semiconductor Manufacturing International Corp. (SMIC), remains generations behind in cutting-edge technology. Phoo adds that roughly 30% of TSMC’s revenues are derived from sales of high-performance chips.

“You simply can’t ignore the potential impact on the Taiwan economy,” says Phoo. “If you look at 2021 to 2022, manufacturing of high-tech items like semiconductors has been a key contributor to GDP growth. The ban will definitely affect Taiwan tech exports next year.”

Phoo also notes that in the short term, other newly developed markets like those in Southeast Asia cannot replace the Chinese demand for Taiwanese semiconductors, as those markets’ manufacturing processes are not as sophisticated as China’s.

After the U.S. announcement on export controls, TSMC share prices fell the furthest they had in 28 years, Bloomberg reported. Further, TSMC in October announced it had cut its annual investment budget by at least 10% for 2022 to US$36 billion. Taiwanese manufacturer United Microelectronics Corp. (UMC) also cut this year’s planned capital expenditure by almost 20% to US$3 billion.

Apart from the changing business climate, expected decreasing demand from weakened Western economies is another reason for the reduced CapEx investment. The global semiconductor market is forecast to shrink by 4% in 2023 to US$557 billion, the sector’s first annual contraction since 2019.

“We’re getting reports of leading semiconductor producers both upstream and downstream looking to cut CapEx spending,” Phoo says. “That includes Taiwanese semiconductor producers.” Phoo adds that this is expected to affect Taiwan’s GDP growth in 2023, noting that “semiconductor investment has been a very strong driver of GDP growth in the last two years.”

Nevertheless, the production value of Taiwan’s semiconductor industry is expected to increase 6.1% year-on-year and hit NT$5 trillion (US$161.54 billion) in 2023, according to the Industrial Technology Research Institute (ITRI). The growth is driven by plans to roll out chips with 3-nanometer process technology.

Circuitous supply chains

Taiwan now finds itself stuck between China, its largest export market, and the U.S., its major unofficial ally and weapons supplier. Although the Taiwan government regards the U.S. as its closest friend, some industry observers see the semiconductor trade as a potential source of tension between the two over the next several years, particularly over the Biden administration’s desire to revive U.S. domestic chip production to lessen dependence on foreign manufacturers.

TSMC is making a US$12 billion investment to build a fab in Arizona that will use 5-nanometer process technology and plans to offer advanced 4-nanometer chips. In addition, sources familiar with the matter have reported the company would commit to adding a second nearby plant that would make even more advanced 3-nanometer chips. While these products are advanced, they are not TSMC’s most cutting-edge technologies. The plant’s “tool-in ceremony,” marking the installation of the first batch of equipment, was held December 6 with such dignitaries as U.S. Secretary of Commerce Gina Raimondo in attendance. Mass production is expected to start in 2024. 

Rupert Hammond-Chambers, president of the Washington-based U.S.-Taiwan Business Council, sees the Taiwan government as determined to keep the most advanced chip technologies at home. Voters support that policy, since the semiconductor industry is not only a major pillar of the domestic economy but also a form of security guarantee, he adds.

Despite offers of subsidies from the U.S. and other governments, TSMC has been wary of bringing the highest-level technologies to overseas facilities. Hammond-Chambers notes that Minister Wang in October made a point of saying that TSMC would invest in the U.S. but would not offshore its most advanced technology.

But Hammond-Chambers suggests that U.S. government policymakers and members of Congress will eventually press companies like TSMC to develop their advanced chip technology in the U.S. as well as Taiwan. The American CHIPS and Science Act passed by Congress in August this year vigorously supports U.S.-based local research, development, and manufacturing. “Congress people are promising voters they will get tech back to the States,” Hammond-Chambers says, noting that many Taiwanese are wondering whether this means “the goose that lays the golden eggs will go.”

One of the key reasons Taiwanese semiconductor companies might want to invest in the U.S. is that it would bring them closer to many of their equipment suppliers and customers, says Ma Tieying, a senior economist with DBS Group Research. But replicating TSMC’s Taiwan success in America will be difficult due to the supply chain’s complexity and high costs. Labor costs in the U.S. are about two to three times those of Taiwan, notes Ma.

If major global semiconductor players move their entire supply chains outside Taiwan, it could push up semiconductor prices by 35-65%, a study from Boston Consulting Group found. The higher cost of the chips would subsequently drive up the prices of finished electronic products.

Standard Chartered’s Phoo is among the many analysts who consider that Taiwan’s status as a global chip hub would not be easy to displace in the short term. TSMC’s production process in Taiwan is sophisticated and complicated, requiring hundreds of manufacturing moves and the involvement of nearly 400 suppliers, MOEA noted in an October statement.

“If you want to copy the long-established infrastructure of TSMC or other companies in other places, even if it costs a lot of money, it’s almost impossible,” the ministry said.

However, Hammond-Chambers says it’s hard for U.S. policymakers to understand the nitty-gritty of Taiwan’s complex industrial structures and how the overall ecosystem benefits  semiconductor production and helps keep down costs. For U.S. policymakers, “there is a gap between expectations and practical applications,” he says.