CHIPS+ could change the U.S. semiconductor supply chain, and more

CHIPS+ could change the U.S. semiconductor supply chain, and more

Sarah Bauerle Danzman — Read time: 5 minutes

But do industrial incentives work?

Analysis by Sarah Bauerle Danzman

August 9, 2022 at 7:00 a.m. EDT

President Biden is scheduled to sign the CHIPS and Science Act of 2022, or CHIPS+, this week. In late July, Congress passed the $280 billion package to support domestic semiconductor manufacturing capabilities, along with research and development in advanced technology. It’s a massive bill — by some measures even larger than the Apollo moon program.

CHIPS+ is big news for another reason — the bill signals how Washington is rethinking the government’s role in industry, in response to re-emerging great power competition and the fragilities of globalized production networks. CHIPS+ is simultaneously a broad-based high-tech industrial policy, jobs program and secure supply program. Will it also catalyze innovation? Here’s the politics behind the new legislation.

The U.S. doesn’t want to rely on others for chip fabrication

Story continues below advertisement

Silicon wafer chips, or semiconductors, have become integral to a wide array of products, including cars, smartphones and home appliances. The chip supply chain tends to fragment R&D-intensive activities, and concentrate wafer fabrication in a few places. But geopolitical risks — namely, competition with China — along with natural disasters such as the coronavirus pandemic boosted the argument for national security and economic resilience, and a U.S. government push to “reshore” semiconductor manufacturing capabilities.

This marks a shift from confidence in free trade and efficient markets toward concerns over chokepoints in complex economic networks that adversaries could weaponize for political leverage. These concerns reflect multiple factors, including declining confidence in the benefits of globalization, concerns that China and other economies manipulate trade rules and institutions — and, of course, pandemic-related disruptions to supply chains.

While the United States accounts for 47 percent of the global chip industry, this rests on its dominance in R&D-intensive activities like chip design and manufacturing equipment. Most U.S. semiconductor companies operate on a “fabless foundry” model — they design microchip technology in house, but outsource production abroad. This business model makes sense from a “lean supply chain” perspective, and specialization in a small part of supply chain minimizes a company’s capital costs. Under this industry structure, U.S. production of chips declined from 37 percent of global supply in 1990 to 12 percent today. The United States currently has no capacity to fabricate the most advanced microchips.

Incentivizing domestic production is politically complicated

Story continues below advertisement

Chip fabrication is massively capital-intensive, and the countries with the largest market share of chip production heavily subsidize the industry. CHIPS+ attempts to make domestic semiconductor manufacturing more feasible by providing $52 billion in subsidies — and a 25 percent investment tax credit — for companies that build new U.S. plants, or expand or upgrade existing microchip fabrication plants in the United States. Much of the funding will go toward advanced chip fabrication, with $2 billion earmarked for legacy microprocessors used in many commercial applications, including automobiles.

The bill also authorizes an additional $200 billion for programs to spur innovation, including a new National Science Foundation Directorate for Technology, Innovation and Partnerships and $10 billion to seed 20 “regional tech hubs.”

The incentive programs were designed to distribute funds to the benefit of more rural and disadvantaged communities. The research on investment incentives, however, suggests such programs often aren’t sufficient to overcome locational disadvantages and can lead to wasteful rent-seeking.

Story continues below advertisement

Do industrial incentives work?

Whether CHIPS+ incentives can effectively foster semiconductor fabrication and high-tech clusters will depend on many factors, including the process for choosing which projects to support. In co-authored work, I show that investment incentives often reflect genuine development priorities. But, as political scientist Stephanie Rickard has demonstrated, electoral politics often shape which locations the central government chooses to support. And commentary by political scientist Nate Jensen points out that the CHIPS+ requirement to pair federal chip subsidies with state or local incentives could lead to fierce inter-state competition. Already, New York has created a $10 billion tax incentive program to lure certain semiconductor plants.

However, if any industry is a good candidate for industrial policy, it would be semiconductor fabrication — facilities are capital intensive and hard to move once built, they typically generate follow-on investment and complementary innovation, and can create good, high-paying jobs. As others have noted, semiconductor fabrication and R&D requires highly skilled talent, so the new U.S. subsidies may not be enough in the absence of efforts to address the STEM talent shortage through education and immigration policy. While CHIPS+ has workforce development provisions, the new bill is silent on making it easier for STEM professionals to immigrate to the United States.

Ultimately, whether CHIPS+ is an expensive boondoggle or an effective catalyst of innovation depends on program administration. The legislation gives the U.S. commerce secretary considerable discretion over the funding programs; it will be important to watch how the Commerce Department interprets its mandate and whether and how it insulates the department from the politicization of funding decisions.

Story continues below advertisement

What does this say about globalization?

Another question is whether CHIPS+ ultimately sacrifices open markets in the quest for self-sufficiency. The Biden administration has paired efforts to strengthen domestic capabilities with measures to coordinate supply chain resiliency among allies and partners — and anyone from Texas would point out that even closed systems aren’t immune to supply disruptions.

CHIPS+ won’t likely, on its own, stop U.S. companies from continuing to offshore production to China. During negotiations, Congress stripped the trade-related provisions from the original bill, including the National Critical Capabilities Defense Act, which would have added, for the first time, screening provisions for outbound foreign investment into “countries of concern.” Congress will likely revisit the outbound screening issue in the fall, however.

But CHIPS+ does include guardrail provisions to prevent companies benefiting from U.S. subsidies and incentives from building advanced semiconductor plants in China. Korean chipmakers Samsung and SK Hynix, for instance, report that CHIPS+ complicates their China investment strategy. It’s not clear, however, if CHIPS+ will allow companies that seek U.S. subsidies to continue to produce legacy technology in China.

Story continues below advertisement

Would overly restrictive provisions backfire, and lead to a full tech decoupling between China and a U.S.-led semiconductor coalition? While industry will likely lobby against this, my research demonstrates that firms often tolerate restrictions on investment if they also receive subsidized finance.

Sarah Bauerle Danzman is associate professor of political science at Indiana University and author of “Merging Interests: When Domestic Firms Shape FDI Policy” (Cambridge University Press, 2020). Find her on Twitter @sarahbauerle.