The semiconductor choke-point

Taiwan and its semiconductor industry are one of the biggest choke-points in the world economy. Everything from phones to artificial intelligence (AI) models relies on the chips that Taiwan excels at making. Yet the island, which is self-governing but claimed by China, would be at the heart of any Sino-American war. Its chip fabrication plants (fabs) could be destroyed or their output embargoed, with huge knock-on effects across the planet. This danger explains why America, China, Japan and others have been subsidising the production of chips elsewhere.

Diversification makes sense for everyone—except Taiwan. For the island it is an economic threat and a security one. A smaller industry would make Taiwan poorer and strategically less important, which might make the West care less if China invaded it, and make it easier for China to do so without risking its chip supply. As a result, even as Western politicians and bosses boast of making chips at home, Taiwan is now working furiously to remain indispensable. “The first priority is Taiwan, the second priority is Taiwan, and the third priority is Taiwan,” C.C. Wei, the boss of TSMC, the leading firm, told investors on June 4th. In his inauguration speech on May 20th, Lai Ching-te, Taiwan’s new president, called it a “Silicon Island” and vowed it would work to secure a lead in AI.

The Taiwanese sometimes call their industry the “sacred mountain that protects the nation”. The island makes more than 90% of the most advanced semiconductors, which use the so-called three-nanometre process. All of those are made by TSMC, by far Taiwan’s most important firm. Dominance of the global market for chips means the industry is hugely important to Taiwan’s economy, accounting for 13% of its GDP (TSMC alone makes up 8%) and 40% of exports last year.

The worldwide push to end dependence on Taiwan began several years ago and is now in full swing. Under the 2022 chips Act, President Joe Biden’s government has subsidised chip firms including Intel and Samsung to the tune of $22bn to start making advanced semiconductors in America. Germany, India, Japan and others have large subsidy schemes, too: Rapidus, a Japanese government-backed firm, claims it will produce two-nanometre chips by 2027. TSMC is itself building new fabs in America and Japan; and two compatriot firms, UMC and PSMC, are constructing fabs in Singapore and India.

At first glance this means Taiwan’s centrality to the industry will decline. Its share of chip wafers smaller than 10 nanometres fell from over 90% in 2019 to 70% in 2022, and is expected to drop to 47% by 2032. America’s share is forecast to jump from zero to nearly 30%, according to a recent analysis by the Semiconductor Industry Association and BCG, a consultancy firm. The share of TSMC's long-term assets located in Taiwan fell from 98% in 2016 to 81% in 2023, as it set up plants abroad.

Yet look closer and the picture is different. Mr Wei of TSMC has reassured investors that 80-90% of the firm’s capacity remains in Taiwan. Because the technological frontier is moving, foreign fabs may quickly fall behind. The first fabs that are completed in Arizona will make older nodes of four or five nanometres. Taiwanese fabs are expected to make two-nanometre chips by 2025, and 1.4-nanometre chips by 2028. “When tsmc promises advanced manufacturing technology overseas, it is still building that first in Taiwan,” Wu Cheng-wen, Taiwan’s new science and technology minister, insisted on May 22nd.

American talk of bringing chipmaking back is a “political show”, says Lin Hung Wen, a journalist in Taiwan. Despite the global subsidy boom, Taiwan’s relative cost advantage is intact: Wendell Huang, TSMC’s finance chief, has said American fabs cost four to five times more to build than those on the island.

Across the strait

The government and firms are now pushing to widen the gap with the rest of the world even further. One priority is AI, which Taiwanese officials now refer to as a “second sacred mountain”. Nvidia, an American semiconductor firm which has an 88% market share for GPUs, the chips that power AI, relies on TSMC to make and package most of those chips in a complex process that involves stacking multiple chips on top of a wafer. Taiwan also assembles 90% of the servers that those chips go into. In June Jensen Huang, the boss of Nvidia, called Taiwan the “bedrock for the AI industrial revolution”. Jeff Lin, vice-president of the Industrial Technology Research Institute, a tech incubator in Hsinchu, the home of TSMC, says that “Taiwan wants to help international companies become the next Nvidia.”

Last year Taiwan’s government passed laws that offer chip companies 25% tax deductions for research and development of cutting-edge chips and 5% deductions for purchases of equipment for advanced manufacturing. Another priority for the government is expanding beyond hardware into chip design, where it wants the island’s market share to rise from 20% today to 40% by 2033. At all times the goal is to draw intellectual property to Taiwan.

If the existing subsidy boom won’t dislodge Taiwan from the apex of the chip industry, what might? Jiann-Chyuan Wang of the Chung-Hua Institution for Economic Research, a think-tank, notes that America’s government could demand that a share of advanced chips must be procured domestically for security reasons.

Taiwan faces other constraints. TSMC consumed 8% of the island’s electricity in 2023. Fossil fuels still produce around 80% of Taiwan’s electricity. Slow decarbonisation means Taiwanese firms may have to compete for a limited amount of renewable energy, or have to pay carbon tariffs in the EU when its new tax regime is implemented in 2026. Taiwan also has an ageing population and a shortage of workers. It launched a “gold card” visa system in 2018 in order to attract foreign talent, but few of those who moved there were willing to work for local firms, because of low pay.

Another threat involves Western and Taiwanese decoupling from China. Chris Miller, the author of “Chip War”, a best-selling book about the industry, notes that the People’s Republic has partially separated from Taiwan in the face of an array of tech sanctions and export controls imposed by the West (sometimes enforced through Taiwanese firms, including TSMC).

As a result Taiwanese chip exports to China fell by 18% in 2023, from $58bn to $47bn. Chinese firms do not yet pose a technological threat to TSMC, but they do pose a financial one: other Taiwanese firms in less advanced areas may be undercut. China’s share of global capacity for making logic chips at 10-22 nanometres is expected to jump from 6% to 19% by 2032.

This output will compete with TSMC’s older facilities, which are still profitable for the firm, and those of other Taiwanese chipmakers. If China decouples further, the silicon shield could become less effective at deterring a Chinese invasion of the island, because China would be disrupting infrastructure that it no longer relies on.

Despite the wave of semiconductor subsidies and talk of diversification, Taiwan appears set to remain central to the frontier of the Western tech industry. If the risk that creates cannot be eliminated it can be mitigated, to a degree. Urged on by rich-world governments, some consumer firms might accept using less advanced chips in some products, in order to bypass Taiwan. TSMC could try to insulate itself against Chinese “grey-zone warfare” tactics, such as an embargo, by stockpiling: in 2023 it carried 87 days’ worth of inventory, compared with 46 days in 2017.

Contingencies can be made: TSMC’s chipmaking machines, many of them supplied by ASML, a Dutch firm, can be remotely disabled in the event of an invasion by China. Yet the threat of war still hangs over Taiwan’s chip empire. In Hsinchu, one semiconductor executive shakes his head when asked about the worst case. “In this situation, chips are not the priority. We don’t want people to say, ‘Save the chips but not the people.’”

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