China’s ‘Zero COVID’ Policy Is Hurting Its Semiconductor Dreams

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China’s ‘Zero COVID’ Policy Is Hurting Its Semiconductor Dreams

China’s approach to the COVID-19 pandemic is hampering strategic efforts to rejuvenate the IC industry.

China’s ‘Zero COVID’ Policy Is Hurting Its Semiconductor Dreams

Employees wearing protective equipment work at a semiconductor production facility for Renesas Electronics during a government organized tour for journalists in Beijing, on May 14, 2020.

Credit: AP Photo/Mark Schiefelbein, File

Notwithstanding the alleviation of Shanghai’s rigid lockdown in early June, the market was obsessed with gloomy prognostications about the city and even the prospects for China’s national economy, especially the supply chain of major industrial sectors, such as integrated circuits (IC). In recent years, the Chinese government has been more ambitious than ever to revitalize its IC industry through the “nationwide system” in response to the fierce tech competition with the United States. Yet, there is no doubt that Beijing’s adherence to pursuing a “zero-tolerance” attitude toward local outbreaks has also heavily hit the development of high-end industries.

In the face of two urgent priorities, the Chinese Communist Party (CCP) will need to make a strategic choice.

The “Nationwide System” and China-U.S. Tech Competition

Adopted from the Soviet Union, the “nationwide system” is a centralized mechanism for developing states to achieve a strategic goal by mobilizing all possible resources. One of the most typical examples is the “Five-Year Plan,” the comprehensive social and economic development initiative issued by the CCP since 1953, mapping out national strategies for the regime’s vision for socialist transformation and industrialization. In particular, this policy model of massive mobilization represents Beijing’s strong response to make up for its deficiencies in a certain area, and it tends to be effective. To some degree, China’s leading position in sports is a result of this nationwide mobilization system.

It is widely acknowledged that worsening China-U.S. relations are the most significant factor behind Beijing’s blueprint in advancing the IC industry. Since March 2018, when the Trump administration successively initiated Section 301 investigations targeting China and imposed a retaliatory tariff on Chinese steel and aluminum, the bilateral conflict gradually spread to the tech industry. Washington and its allies vehemently suppressed and marginalized Chinese high-tech companies in the global market. By December 2021, the U.S. Bureau of Industry and Security had blacklisted 611 Chinese companies and institutions, most of which are in the high-end industry, such as chip design and manufacturing. Furthermore, the two sides’ divergences in human rights and political issues are reflected in U.S. sanctions on Chinese tech giants that allegedly maintain close ties with the CCP, complicating the original technical rivalry.

The China-U.S. tech competition sped up China’s effort in the independent design and production of IC equipment. In December 2020, chip design and manufacturing played an unprecedentedly prioritized role in advancing the state’s capacity in technological innovation and breakthroughindustrial transformation, and expansion of the digital economy in the 14th Five-Year Plan. As a result, Beijing once again resorted to the nationwide system to accomplish its strategic goal in the IC industry.

In 2019, the Ministry of Finance established a special fund with $30.5 billion for investing in the IC industry. The IC enterprises and projects enjoyed tax relief ranging from 10 to 25 percent, depending on the duration of operation and technical criteria. On the other hand, the local authorities also carry out a variety of industrial policies, following instructions from the top decision-makers. Shaanxi province aims to exceed the proportion of the digital economy to more than 10 percent of GDP by 2025. In Guangzhou, the local government pledged to enhance the intellectual property protection of chips through a package of legislation.

Chip talent training is another booster for strengthening the IC industry. Until 2021, a group of China’s top colleges, including Tsinghua University, Peking University, and Fudan University, have inaugurated IC schools or departments for cultivating professionals. The number of research institutions is still growing. Additionally, high-tech enterprises are another incubator for chip talents. Based on the official white book, the demand for talent in the domestic IC market will increase to approximately 745,000 by 2022. That alone helps demonstrate the sheer size and momentum of the semiconductor companies in China’s tech market.

Undoubtedly, the government, higher education institutions, and tech enterprises have constituted an “iron triangle” for China’s strategy in investing in the IC industry. This pattern supports the state’s ambition to be one of the leading actors in the global market. During the period between January and September of 2021, domestic data showed that China’s chipmaking power rapidly grew with a revenue of $108.4 billion, increasing 16.1 percent on a yearly basis. In the meantime, China became the largest market for semiconductor products, as its orders of chip manufacturing equipment from overseas suppliers rose 58 percent.

However, with Beijing’s uncompromising position in implementing a zero-COVID policy to deal with local outbreaks, China’s strategy for rejuvenating the IC industry is facing the domestic challenge of another nationwide policy.

How “Zero-COVID” Policy Impacted China’s IC Supply Chain

Alongside the deterioration of China’s diplomatic ties with the Western world, the global pandemic forced the ruling elites in Beijing to transform economic statecraft into “dual circulation,” which prioritized domestic consumption while remaining open to international trade. Nevertheless, the IC supply chain has still been tumbling along with the local authorities’ harsh response to the Omicron outbreak since March in Shanghai. The megacity hosts many of China and the world’s leading semiconductor manufacturers, such as SMIC and TSMC.

Despite the supply chain management approach having previously shifted to be more conservative, prioritizing resiliency instead of expansion, the crude measure of compulsory shut-downs still triggered a new wave of crisis in supply chain logistics in the Yangtze Delta Region. According to the official data released by the National Bureau of Statistics (NBS), China’s IC output dropped 4.2 percent in the first three months of the year as chipmakers reported a steeper decline in March. That is the worst quarterly performance since the first quarter of 2019 when there was a slump of 8.7 percent. Since the chips business was already fraught due to the shortage of semiconductors, the coronavirus lockdown has been a double blow to China’s IC industry.

In response to the industry’s challenges, Beijing has taken several steps to rescue the supply chain. On April 18, a national conference held by Chinese Vice Premier Liu He proposed that the government would leverage RMB 1 trillion ($157 billion) in funding from the central bank’s receding projects to bolster the supply chain. Following the instruction, the Ministry of Industry and Information Technology released a whitelist including 666 enterprises in IC, automobile, equipment manufacturing, and pharmaceuticals, granting them to resume production. At least 62 semiconductor companies profited from the new policy.

Upon receiving permission to resume work, the IC factories were allowed to operate under  “closed-loop” management; the system allows relevant people to move and act in the designated area, guaranteeing the operation of a specific mechanism while preventing spreading the coronavirus. Shanghai’s local chip plant of TSMC, one of the world’s leading semiconductor companies based in Taiwan, was permitted to remain running to produce 8-inch wafers under the “closed-loop system.” The manager said that even 70 percent of the manpower could maintain full production capacity.

Under the government’s bailout package and the easing of COVID-19 restrictions, China’s semiconductor output in May has slightly rebounded by over 6 percent to 27.5 billion compared with 25.9 billion units in April, according to NBS data. But this number was still less than the 28.5 billion units produced in March, before the Shanghai lockdown. Moreover, with the increase of new confirmed cases in July, it is uncertain whether the local authorities’ potential drastic pandemic management measures will affect the IC industry’s production. Consequently, China’s semiconductor strategy faces a greater domestic challenge than the external one.

The Double-edged Sword of China’s “Nationwide System”

Geoffrey Gertz and Miles M. Evers’ comparative study on the government-business relationship between China and the U.S. points out Beijing’s strengths in tackling geoeconomics competition with Washington. The nature of the party-state and state capitalism, combining elements of a market economy with substantial government intervention in key sectors, shows China’s resilience more than Soviet blocs. In the short term, Chinese competitiveness in the tech industry would be dampened, but the institutional advantage will enhance state capacity to guarantee the security of the supply chain in critical industries.

In the case of the IC industry during the COVID-19 pandemic, there is more evidence that Beijing has suffered from a backlash caused by its own proud institutional superiority. While the “zero-tolerance” approach toward the local epidemics suppresses the further spread of coronavirus, on the downside, it also hinders China’s ambitious plan to invigorate the semiconductor industry. Which one is a higher priority? It is clear that the conflict of interests between two national strategies is almost irreconcilable.

As Gertz and Evers argued, both state-led businesses and private sectors are highly incentivized to comply with the CCP’s directives. This point has manifested in the current deadlock the Chinese IC companies face. This is only the tip of the iceberg of the Chinese economy under the global pandemic. In that sense, the “nationwide system” has turned into a “double-edged sword” that poses a strategic dilemma for Beijing’s ruling elites.