The Chip Insider®

Why China will fail

Why China will fail in its attempt to develop its own semiconductor supply chain separate from the west: When one looks at China’s rise through a western lens, it seems almost inevitable that it will displace the United States as the world’s leader on many fronts. I remember many thinking the same about Japan in the 1980s. Until I wrote a note in 1988 – ten years before The Chip Insider – predicting they would peak and go into a long decline in the 90’s. Given this is the 25^th Anniversary issue, I thought it would be fun to go out on a limb and speculate again. This time about China’s rise.

There’s no need to predict China peaking as Hal Brands and Michael Beckley have made a very convincing argument in their book, ‘Danger Zone: The Coming Conflict with China.” They see China’s efforts to rise as not the often depicted 100-year marathon, but instead a sprint to seal their global position before an inevitable decline after peaking. They layout multiple reasons for China’s growth peaking, including its former One-Child policy, which means they will have a collapsing tax base as their workforce shrinks; a rising capital/output ratio, which now exceeds rich countries; a growing environmental crisis that includes “Half of China’s river water and nearly 90% of its groundwater is unfit to drink,” which, with its arable land destroyed by pollution, led to a shift of being a net food exporter to becoming the world’s largest food importer after 2011; and more. They see the issue for the CCP is in how to maintain legitimacy, predicting it could well lead them to greater conflict. However, as with Japan in 1998, these types of problems are insidious, not instantaneous. The hard impact of these problems can likely be postponed until after 2030.

That leaves us with the question of China’s attempt to develop its own semiconductor supply chain separate from the west. Those who see it as a sure thing often base it on China’s economic size and population. They are the world’s assembly base for electronics, while their population size and growing income levels have made them the largest market for many products – especially imported high-end luxury goods. While much of the same was true for Japan in the 1980s, they argue Japan didn’t have the population or end-market size that China has today. Thus, China is not following in Japan’s footsteps.

But there is a stark contrast between China’s rise and Japan’s. Before peaking, Japan was already a technology and market leader in many market segments in the electronics stack. Sony was the Apple of its day, designing, making, and selling its products. Japan’s rise had rested on becoming a global leader in consumer electronics, semiconductors, and many areas of semiconductor equipment from the US and Europe. Japan’s 1975 VLSI program focused heavily on developing lithography tools. By the early eighties they led this market. Also by then, its 70s reputation for IP theft was disappearing, as it developed its own chips and tools. America’s dominance in lithography tools was completely lost to Japan by the end of the 80s. It took Japan less than 10 years to pull this off, though they never developed a completely indigenous supply chain.

For all of China’s spending and IP theft, I can’t name a semiconductor area where they have established a technology or market leadership position. Let me know if you can. Maybe batteries, but that’s not chips. China’s leadership is still based on low-cost labor assembling products designed by companies elsewhere. China’s leadership remains labor, not innovation-centric – like Japan in the 50s and 60s. Given they started this quest some 50 years ago in the 1980s, the performance has been remarkably unremarkable, to be polite. Something is filtered out in those western rose-colored lenses that imagine an inexorable rise by China. The question is, if China’s rise to pass the west is inevitable, should we not just give up? I see that as defeatist.

I see the 5X time difference between China’s and Japan’s rise as reason not to give up. Moreover, it lends critical evidence to China failing in its aspirations.

I believe the reasons for this 5X difference are due to the structure of China’s economy, with its unique blend of capitalism and communism. Ironically, Xi Jinping has been pushing them back towards communism and away from market-based reforms after Mao’s Great Leap Forward (1958-62) and the Cultural Revolution (1966-76). There is an ongoing effort to level economic wealth distributions. They dehorn unicorns when they speak out enough to become a visible threat to CCP primacy, like Jack Ma. The question is not if this is right or wrong. It’s their country and they can do what they want to. The question is if these trends aid or hinder China’s efforts to lead the world in innovation. My belief is that communism hinders innovation.

The problem with communism lies in its attempt to command and control everything from the top down. It strips away the profit motive, replacing it with central planning. Bureaucrats attempt to replace the self-interest mechanisms driving capitalist markets. The central problem is self-interest is a human trait that never goes away. Attempts to strip away the profit motive with a vision of collective good only hide it from public view. Without market incentives, data inflation becomes the currency of individual gain. Self-interest without a profit motive focuses individuals on distorting data to get ahead.

Data inflation undermines command and control because central planners need accurate data to succeed. The system is fragile because only positive and enhanced data is passed up the chain, while failures are hidden away like children stuffing wrappers between the couch cushions. Worse, planners can’t fix problems they don’t see, so little problems grow into big ones. For example, in the Great Leap Forward there was a push to increase iron production into the countryside. Farmers turned into iron workers who smelted down farm tools while cutting down forests as fuel for the furnaces. This led to agricultural production dropping and the Great Famine. Planners had data showing food and grain production was hitting record levels, so China was exporting it while their people starved in the name of the “people’s revolution.” Another example is the dam failures, where expert engineers warning of future problems were pushed aside as they were accused of being ‘rightists.’ The disruptors are hammered down. Ideology and politics trump science and common sense in a data-inflation-driven system.

Using chaos theory, communism is an extreme order while laissez-faire capitalism is extreme chaos. In reality, the world tends to range between these two. The modern capitalist economy’s ability to vibrate between chaos and order has allowed it to regenerate over the centuries. It thrives on self-interest and profit motive that drive disruptive innovation. It is anti-fragile because single failures are small scale and seldom threaten the entire system, like what happens in an ecosystem.

One could argue China has learned from this. Most certainly, they have.

But the problem is not in learning from what happened. The problem is in the fragile nature of a command-and-control system and the ideology that promotes it. Communism’s strict top-down command-and-control of order has tended to destroy economies unless they injected market-based reforms like we saw in China after the Cultural Revolution ended in 1976. These extended into the 2010s, but now it’s moving back as it faces the challenges detailed in Danger Zone.

As for China learning, Li Yuan recently wrote in the New York Times that China’s lead in AI was lost to start-ups like Open AI as the CCP took note of AI’s power and threat to censorship. He notes the Chinese AI joke, “We need to teach machines how to speak, but also how not to speak.” He also writes of “unclear results” from government funding of The Beijing Academy of Artificial Intelligence, where a “ChatGPT-like product” introduced two years ago hailed as “China’s first and world’s largest AI Language model… never really caught on.” Some point to the decision cycle-time-and-scale advantage authoritarian governments have in driving innovation. But it is their authoritarian nature that chokes off innovation. Scale is often a hindrance too. If these were not true, Silicon Valley would not exist, while AT&T, RCA, and GE would still be the world’s semiconductor leaders. Oh … and what about the Soviet Union’s semiconductor leadership.

As for those who believe in China’s innovation advantage, how does one explain that it is still accused of IP theft or courts invalidate foreign patents in favor of later-issued Chinese patents? When Japan – and the United States – became innovative leaders on the world stage, they began to follow international standards on IP protection. It is a critical sign of innovation that leaders seek to protect it. Also, when you’re in the lead, you don’t need to steal. Also, what about Huawei? When it could no longer have access to western semiconductor production equipment to make its chips, it completely lost its edge.

My point here is not beat on China, but to beat on the defeatists who believe the west can’t compete with China. The challenge China presents in its pursuit of innovative solutions is just a challenge the west should not shirk from. Competition is healthy. Healthy competition in innovation makes us need each other, which in the end lessons the chance of war. That is my point.