With money and waste, China fights for chip independence

Taipei

LIU Fengfeng had more than a decade under his belt at one of the world's most prominent technology companies before he realised where the real gold rush in China was taking place.

Computer chips are the brains and souls of all the electronics that the country's factories crank out. Yet they are mostly designed and produced overseas. China's government is lavishing money on anyone who can help change that.

So last year, Mr Liu, 40, left his job at Foxconn, the Taiwanese giant that assembles iPhones in China for Apple. He found a niche - high-end films and adhesives for chip products - and quickly raised US$5 million. Today, his startup has 36 employees, most of them in the tech hub of Shenzhen, and is aiming to start mass production next year.

"Before, you might have had to beg grandpa and call on grandma for money," he said. "Now, you just have a few conversations, and everyone is actively bidding and hoping you get started as soon as possible."

China is in the midst of a mass mobilisation for chip mastery, a quest whose aims can seem just as harebrained and impossible - at least until they are achieved - as sending rovers to the moon or dominating Olympic gold medals. In every corner of the country, investors, entrepreneurs and local officials are in a frenzy to build up semiconductor abilities, responding to a call from the country's leader, Xi Jinping, to rely less on the outside world in key technologies.

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Their efforts are starting to pay off. China remains far from hosting real rivals to US chip giants such as Intel and Nvidia, and its semiconductor manufacturers are at least four years behind the leading edge in Taiwan.

Still, local companies are expanding their ability to meet the country's needs, particularly for products such as smart appliances and electric vehicles, which have more modest requirements than supercomputers and high-end smartphones.

The turbo-charged chip push could prove one of the most enduring legacies of US President Donald Trump's pugilistic trade policies towards China. By turning the country's dependence on foreign chips into a cudgel for attacking companies such as Huawei, the administration made Chinese business and political leaders resolve never to be caught out that way again.

But as Beijing broadens its ambitions in semiconductors, it is also setting itself up for larger potential failures - and dialling up the amount of money it might lose in the process. Several chip projects have run aground recently because of frozen funding and mismanagement. A state-backed chip conglomerate, Tsinghua Unigroup, warned this month that it was in danger of defaulting on nearly US$2.5 billion in international bonds.

In a way, China is hoping to achieve the same kind of lift-off that helped it progress from making plastic toys to crafting solar panels.

With semiconductors, though, "the model starts to break down a little bit", said Jay Goldberg, a tech industry consultant and former Qualcomm executive.

The technology is eye-wateringly expensive to develop, and established players have spent decades accumulating know-how. Europe, Mr Goldberg noted, once had many "incredible" chip companies. Japan's chipmakers are leaders in certain specialised products, but few would call them bold innovators.

"My point is, there is a ladder - China's moving up it," Mr Goldberg said. But it's "unclear which outcome they go to".

Beijing's recent love of chips began with the creation of a giant, chip-focused investment fund in 2014. The government set a lofty goal: China would produce 40 per cent of the chips it consumed by 2020.

That did not happen. Morgan Stanley analysts estimated that Chinese brands bought US$103 billion in semiconductors last year, of which 17 per cent was from local vendors. They predicted the share will rise to 40 per cent in 2025, far short of the government's target of 70 per cent.

China has charged ahead with renewed urgency because of the US assault on Huawei, the Chinese tech champion, which has been choked off from buying US chips or even chips made using US software and tools.

The US Commerce Department imposed similar curbs this month on exports to China's most advanced chip manufacturer, Semiconductor Manufacturing International Corp (SMIC), citing concerns over military ties. SMIC has denied its products have any military use.

And so, China this year has rolled out new tax breaks for chips, including a 10-year exemption from corporate tax and duty-free imports of materials. State-backed funds have invested in both startups and publicly traded companies, including when SMIC listed shares in Shanghai in July.

At a top-level meeting on the economy recently, the Communist Party's leaders enshrined technological self-reliance as one of the country's "Five Fundamentals" for economic development.

Complete self-sufficiency in chips, however, would mean recreating every part of the lengthy supply chains for some of the most complex technology on earth - a mission that would seem to lead, if not to madness, at least to waste.

According to an analysis by China Economic Weekly, a magazine affiliated with the Communist Party's official newspaper, People's Daily, the number of chip-related companies in China climbed by 58,000 between January and October this year, or roughly 200 a day. Some of these, the magazine noted, were in Tibet - not a place traditionally associated with cutting-edge tech.

"Up until very recently - this year - the goal had been: With state backing, move up the value chain, specialise where China has a comparative advantage, but don't really try and fall down the rabbit hole of trying to build everything yourself," said Jimmy Goodrich, vice-president for global policy at the Semiconductor Industry Association, a group that represents US chip companies.

Now, "it's very clear that Xi Jinping is calling for a redundant domestic supply chain", Mr Goodrich said. "And so the rules of economics, comparative advantage and the supply-chain efficiencies have basically been thrown out the door."

The government is conscious of the dangers. State-run news outlets have amply covered the recent semiconductor flameouts. The message to other startups: Don't mess it up.

When the state broadcaster China Central Television visited one stalled project in the eastern city of Huai'an recently, it found dozens of giant machines idling on the factory floor, many of them still sheathed in plastic.

"There have been some stunning absurdities that defy logic and common sense," China Economic Weekly said.

Yet there has also been progress. Two companies, Yangtze Memory Technologies and ChangXin Memory Technologies, are gearing up to put China on the map in memory chips, which store data. Local manufacturers of logic chips - which perform computations - are expanding production, largely for Chinese customers.

Those manufacturers might not have much choice but to serve domestic clients. Some multinational chipmakers are starting to think twice about working with Chinese suppliers and partners out of concerns about intellectual property (IP) theft, said Randy Abrams, a tech analyst with Credit Suisse.

"International companies are becoming more wary about the IP leakage in China," he said.

Mr Liu, the startup founder in Shenzhen, does not deny being motivated by a certain patriotic purpose. Emblazoned atop the website for his company, Tsinghon, is a proud reference to the Mao-era project that produced China's first atomic bomb, ballistic missile and satellite: "Inherit the Spirit of 'Two Bombs, One Satellite'. Be Self-Reliant and Bold in Forging Ahead."

Mr Liu said the sense of national mission does not conflict with his work serving customers and putting out competitive products. He does acknowledge, when he looks at the sky-high valuations for some chip startups, that irrationality has crept into the market.

"There is definitely a bubble in China," he said. "But you can't overgeneralise."

The government, he said, is trying to hold local authorities more accountable for bad investments. And the torrent of money might at least persuade more skilled engineers in China to work on chips instead of video games and food delivery apps.

"Something is bound to accumulate, whether it's equipment, talent or factories, right?" Mr Liu said. "If not you or the other guy, then it will be someone else who ends up using it. I think this might be the government's logic." NYTIMES