China?s semiconductor market accounts for 6 percent of worldwide demand, making it the largest market after the United States, Japan and Taiwan. In the years to come, chip production in China is expected to increase by 42 percent annually, much faster than the world average of 10 percent. But the country starts from a low base: In 2000, China produced $900 million in chips, a third of which (by value) were exported. The domestic industry supplies only 5 percent of Chinese demand; production technologies lag by at least two generations. And because the U.S. government tightly regulates exports of the most advanced manufacturing equipment to China, it will take years for the process technology of its semiconductor industry to catch up with global leaders such as the United States and Taiwan, which has enjoyed much greater access to advanced U.S. technology.
Yet in some respects--market demand, government support, technological sophistication, talent and the supply of capital--China?s present situation resembles that of Taiwan in 1990. Back then, Taiwan?s semiconductor industry had total revenue of $440 million. Ten years on, its revenue had risen to $16 billion--16 percent from design, 64 percent from manufacturing, and 20 percent from assembly and testing.
Three of the factors that helped Taiwan?s semiconductor industry to grow will likewise support the rise of China?s industry. First, domestically produced electronics goods fueled demand for semiconductors in Taiwan, which had become one of the world?s top three producers of computer hardware by 1994. China already accounts for 7 percent of the worldwide output of electronics goods, with revenue of $80 billion in 2000, when the country consumed $13 billion worth of semiconductors.
Second, Taiwan had an ample supply of "human capital" to aid the industry?s growth. Its very competent engineers can be hired for half or sometimes only a third of what their U.S. colleagues receive, and their numbers have regularly been supplemented by emigrants returning home to work in the Hsinchu Science-Based Industrial Park, a government-sponsored business zone near Taipei. In China, about 400,000 science and engineering students graduate each year (not counting the 50,000 current and former graduates who move overseas), and more than 5,000 overseas students and professionals return, bringing up-to-date Western knowledge and skills. Labor costs in China remain low; on average, workers in its semiconductor design houses receive an annual wage of around $10,000.
Third, the Taiwanese government used tax breaks, government shareholdings, low-interest loans, and R&D grants to encourage high-tech start-ups. Similarly, the Chinese government is now offering semiconductor companies favorable tax treatment. It has also designated Shanghai as the capital of the country?s semiconductor industry and is encouraging the local government there to invest in a research center for promoting the design of semiconductors. State-owned banks are thought to have provided interest-free loans to start-up foundries.
From this point on, however, the growth path of China?s industry will probably diverge from that of its Taiwanese counterpart, for in China relatively more emphasis is likely to be placed on the design of semiconductors. Although China could raise the $1 billion or more that is needed to build an advanced chip-fabrication plant, it lacks the technology and management skills to operate one efficiently. But it does have engineers who could potentially design chips, as well as strong domestic demand for them.
By 2010, we estimate, China-based design companies and design branches of domestic and international integrated device manufacturers, such as Motorola, will design chips for which Chinese electronic-goods manufacturers will pay more than $10 billion. The total consumption of chips in China is likely to reach $45 billion a year by then. Chinese chip-fabrication plants, including "pure-play" foundries and the captive foundries of international integrated device manufacturers, will probably generate revenue of more than $12 billion and produce 80 percent of the chips used in non-leading-edge digital and analog products consumed in China. (Pure-play foundries typically provide chip-manufacturing services for design companies and for integrated device manufacturers that prefer to outsource a part of their chip fabrication.) Because of U.S. export restrictions, we expect that Chinese manufacturing efforts will at first concentrate on non-leading-edge foundry operations.
All around the world, increasing standardization and capital intensity are breaking up the semiconductor industry into four segments: design, manufacturing, assembly and test, and distribution. In the industry?s value chain, China and Taiwan may end up complementing each other in both domestic and global markets. Taiwan?s emphasis will be on leading-edge manufacturing, while China will push into the labor-dependent design and assembly-and-test functions, as well as non-leading-edge manufacturing. Taiwanese electronics companies have already made big manufacturing investments in China. Now, many semiconductor companies are setting up design centers there while also considering investments in foundries.
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