How the US Can Win the Chips War With China

On the sidelines of the G-20 meeting of world leaders on November 14, President Joe Biden affirmed that the United States would “compete vigorously” with China. The United States has a lot of work ahead of it in the technology sector. China has spent years mobilizing domestic resources to control the world’s technology supply chains, and Washington is catching up in the form of the recently passed CHIPS and Science Act (hereinafter, the CHIPS Act). Such legislation may financially incentivize some big companies to set up more semiconductor factories at home, but winning the long-term battle for technological superiority requires catalyzing American entrepreneurial energy through special manufacturing innovation zones (SMIZs).

Subsidies are not a panacea for winning the semiconductor race: they create an uneven playing field that reduces innovation and competition. Bureaucrats also don’t know how to funnel money to the right activities, and the CHIPS Act risks doing just that. Intel, which will likely be one of the recipients of the subsidies, could use the money to build factories in Ohio for older-generation chips while pay Taiwan Semiconductor Manufacturing Company (TSMC) to do high-end work in Taiwan. TSMC, another likely recipient, could also start manufacturing tokens at its subsidized factory in Arizona that has yet to be completed in Taiwan.

While such investments may reduce some risks, the United States would remain dependent on an island that makes 90 percent of the world’s most advanced chips and that China has repeatedly threatened to take by force. And the US would need to legislate additional subsidies if Washington hopes to attract further investment in semiconductors or refocus additional high-tech sectors, which are equally vulnerable to Chinese domination.

Facility construction, labor, and utilities are more expensive within the United States than in foreign locations that dominate production. The CHIPS Act is intended to offset these cost disadvantages, but that prospect is unlikely. In fact, the clauses of the legislation, such as those that oblige companies to to pay Prevailing union wages for construction jobs will actually increase costs, undermining the intent of the bill. In April, Morris Chang, the founder of TSMC, I call the efforts to redirect production are “a very costly futile exercise” given that chips made in the United States are 50 percent more expensive than those made in Taiwan. The bill also does nothing to address another problem Chang raised: the difficulty of hiring high-tech manufacturing talent in the United States.

A better approach than massive amounts of direct subsidies, or at least a complementary one now that CHIPS is law, would be to draw on the lessons of one of China’s best devices for catalyzing business development: special economic zones. China initially established SEZs in 1980 to circumvent the country’s rigid statist system of governance, which could not attract foreign investment. SEZs boast favorable geography (close to ports off Hong Kong and Taiwan), excellent physical infrastructure, business-friendly legal and regulatory frameworks, and procedures to speed up construction and permitting. Extensive tax incentives have helped attract businesses. The most successful special economic zones, such as Shenzhen, have also actively recruited the talent companies need.

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Consequently, the SEZs have become one of the key drivers of China’s economic growth. Today there are hundreds of such zones in China. promoting innovation, commercialization and technological development, and have generated about a fifth of China’s GDP, three-fifths of its exports and more than 30 million jobs.

The closest U.S. approximations to the SEZs are the Foreign Trade Zones (FTZs), which are passed by a federal board and administered by public or private corporations. By protecting investors from federal customs duties and excise taxes, they encourage more private investment. exist 195 active free zones operating within a defined area (usually near a port of entry) or a specific facility, with 3,400 companies using them to export close to $100 billion worth of goods in 2020. Instead of doling out subsidies directly to companies, the government of The US should take a different page from the Chinese playbook and adapt the FTZ program to create Special Manufacturing Innovation Zones (SMIZs).

The SMIZs would focus squarely on developing industrial hubs in the key technology sectors where the United States currently lags behind. They would function much like Chinese SEZs by offering tax credits, rebates against construction and labor costs, exemptions from certain regulations (and expedited authorization processes for the rest), and special visas for high-tech workers.

Offering these benefits to any qualifying company, regardless of size, is a more efficient means of driving cost reductions than government handouts to giant chipmakers like Intel. And being strategically located to take advantage of existing infrastructure, talent pools, and livable neighborhoods, think places like madison wisconsin – would have a tailwind from day 1. A separate program could offer competitive grants to small companies launching new technological innovations into large-scale production, something the US has notoriously struggled with.

The presence of these zones would catalyze states to compete for them and then work hard to ensure that each zone succeeds. It would also provide the kind of level playing field that allows entrepreneurs and small businesses to challenge the tech giants. If success were achieved in a few sectors, the program could be expanded to more technological fields considered important to national security.

While industrial policy can work in some cases, the US government is not well equipped to comply in the way CHIPS is envisioned. Creating the conditions for markets and customers to drive innovation is a much better way to cultivate domestic production of key technologies like chips than one-off investments from Washington.

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