Chip shortage exposes fragile supply chain

Source: Content source translated from bloomberg , thank you.

In response to post-pandemic supply chain disruptions, President Joe Biden on Wednesday ordered a broad review of U.S. foreign reliance on key products such as pharmaceuticals, rare earth metals and high-capacity batteries. More consideration was given to the most pressing issue - a semiconductor shortage that has disrupted production at U.S. automakers .

Auto sales plunged last spring as the coronavirus pandemic took hold. Anticipating a prolonged downturn, automakers cut supply orders, including for parts that require semiconductors. At the same time, demand for higher-margin chips used to make laptops, smartphones and other devices soared as much of the country began working from home. When the economy rebounded faster than expected, the result was a supply crunch for auto companies. It could be months before production returns to normal.

In the short term, Biden can’t solve the problem. Some companies are prepared for this disruption, such as Toyota Motor Corp., which has sufficient chip inventory , while others are not, but late-stage government intervention will not bring capacity online quickly. This is best left to both supply and demand.

In the long term, the incident highlights a serious vulnerability. Semiconductors play a vital role in the U.S. economy. They increase labor productivity and power everything from medical devices to consumer electronics to artificial intelligence. Yet the share of global chips produced domestically has fallen from 37% in 1990 to 12% today. Industry groups estimate that the U.S. will add only 6% of new capacity in the coming years, compared with about 40% in China.

If not addressed, it will further concentrate business in East Asia, increase supply chain risks for U.S. companies, and potentially undermine U.S. leadership. The U.S. military requires about 1.9 billion chips each year for (among other things) weapons, communications, and intelligence systems.

An important first step is to develop a new strategy with America’s allies.

Next, there should be a major increase in federal funding for semiconductor research, which has flatlined in recent years. According to one estimate , every dollar invested in these programs would generate $16.50 in additional GDP. Perhaps more importantly, increased investment should increase self-sufficiency, help build a skilled workforce, and lay the foundation for future industries.

One difficult task is encouraging companies to make chips domestically. While two top manufacturers recently said they were building or considering new factories in the U.S., the fact is that the U.S. is at a severe disadvantage due to high labor costs and support from overseas governments. One study found that the total cost of owning a new chip manufacturing plant in the U.S. is 30% higher than in Taiwan or South Korea and 50% higher than in China over 10 years. Government incentives could make up up to 70% of that gap.

Congress should seek to mitigate this imbalance. Last month, lawmakers approved a series of plans to boost domestic chip manufacturing, encourage public-private partnerships, and step up efforts to acquire secure chips, among other things. They should ensure that these efforts are funded. An investment tax credit for chip facilities and equipment could also help. The goal of these efforts shouldn’t be to create jobs (such facilities will be highly automated) or to prop up individual companies. Instead, it should be to create more flexible supply chains on a level playing field and protect national security.

It's not easy to do it right. But for the country that invented the integrated circuit, it's not impossible.