The EU’s Semiconductor Dilemma: What Does it Take to Regain Strategic Autonomy?

To counter a looming change in balance of global power, the US and the EU have adopted respective de-risking measures, whereby supply chains are diversified and onshored to decrease strategic dependencies against China’s geoeconomic leverage. As China’s semiconductor ecosystem grows more strategic, and US measures more pressing, the EU must wager its position between a democratic ally to Washington and a willing trade partner to Beijing. More importantly, to preserve its technological advantage in the semiconductor industry, the EU needs to regain its strategic autonomy.

The semiconductor industry has been at the geoeconomic centre of international politics. Most notably, the EU and the US launched their respective Chips Acts in an effort to de-risk from China’s speed of innovation. With Mario Draghi’s report highlighting European competitiveness, what are the challenges and prospects in the EU’s reality and the semiconductor industry? 

Mario Draghi’s much anticipated report on European competitiveness was published on 9 September 2024, proposing radical change to increase Europe’s productivity on the global stage. The report highlights the urgent need for action in three key areas, notably closing the EU’s technological innovation gap with the US and China, joint action on decarbonisation and competitiveness, and addressing security challenges while reducing strategic dependencies. 

At the convergence of Draghi’s areas for action is the semiconductor industry. As the focal point of the US-China technology war, the sector is at the nexus of technological development and international trade. Worth 500 billion EUR of global market share in 2023, semiconductor chips are crucial to the production of electronic equipment, computing devices, and electric vehicles, making it substantial to European innovation and decarbonisation efforts.

During the Covid-19 pandemic, global shortage of semiconductor chips revealed crucial vulnerabilities in the supply chain, making importing countries reassess the status quo ante. This is largely due to the offshoring of production, where plants in East Asia (namely Japan, Korea, Taiwan, and China) manufacture three quarters of the world production. Moreover, China’s salience on industry domination, compounded with its sovereign determination on Taiwan, creates a ticking-bomb effect to the chip supply chain. 

Political Significance 

During the pandemic, semiconductor shortages resulted in substantial lost revenues of over 450 billion EUR worldwide, more than one fourth of which in the European automotive industry. To the supplier and consumer countries alike, the shortage revealed the considerable bargaining potential in semiconductor supply chain disruption. Therefore, much like critical raw materials – over which China has developed a close monopoly – China’s determination to advance its semiconductor production is a geoeconomic game plan for global power.

To better illustrate the role of semiconductors in global affairs, there are three points of political complication for decoding: 1) the role of ASML in the semiconductor industry; 2) the role of TSMC in Taiwan’s autonomy; and 3) the role of China both as producer and consumer. As detailed below, the three converge to focus the semiconductor industry in today’s geoeconomic stakes. 

ASML stands for “Advanced Semiconductor Materials Lithography.” The Dutch company has over 80% market share in production machinery, making it the EU’s kingpin in semiconductor technology. As the sole supplier of EUV (extreme ultraviolet) machines, it is key to the production of the most advanced semiconductors (namely, the 3nm and the 5nm chips). With multilateral trade restrictions propelled by the US, ASML is blocked from selling its EUV lithography machines to China, causing concern for both political retaliation and ASML revenue loss.

China’s role as a customer accounts for roughly 20% of ASML’s revenue, as well as 53.7% of global chip sales. The high percentages demonstrate the Chinese market’s demand for both rudimentary and advanced chips. Fueled by the government’s ambition in artificial intelligence and demand from the manufacturing sector, chips are indispensable to Beijing’s appetite for technological lead. While China’s manufacturing capability is stunted due to restricted access to ASML EUV machinery, its potential for progress is not to be understated. 

In geographic proximity to Mainland China, Taiwan’s TSMC (Taiwan Semiconductor Manufacturing Company) manufactures 90% of the world’s most advanced semiconductors. This near monopoly not only provides the island with economic independence – evident in its stock market – it also enforces stability against regional unrest. A potential disruption of the global supply chain of advanced semiconductors increases the stakes of any military invasion, as well as the costs involved.

Moreover, the geopolitical vulnerability of the East Asian manufacturing cluster (Japan, Korea, and Taiwan) – with growing concerns over escalation of tensions across the Taiwan Strait – poses an intensified risk to the stability of worldwide supply. The Taiwan Strait is critical to global trade routes in Asia, in addition to the connecting South China Sea, where 21% of global trade passes. A disruption or blockade of any kind in the region is likely to have a great impact far beyond East Asia, and do more damage than semiconductor supply shortage alone. 

A Shift from Import Dependency 

Aware of the different political reality in China, the US and the EU have both begun de-risking from import dependency, with similar goals of incentivising domestic manufacturing and supply diversification. For instance, the European Commission announced the European Chips Act, promising a semiconductor subsidy of 43 billion EUR until 2030, as well as the goal of doubling its global chips output from 10% to 20%. However, the move to de-risk integral supply chains – represented by the EU’s Chips Act and Critical Raw Materials Act – includes developing domestic manufacturing infrastructure, of which the financial and environmental costs remain uncertain.

Following a meeting in January 2023 between the US, the Netherlands, and Japan, an agreement was reached to restrict advanced semiconductor technology export to China. As the US has been inclined in an active trade and technology war with China, both have invested billions in subsidies for domestic technological production.

The EU, however, has been keeping a lower profile amidst the ongoing dispute between China and the US in recent years. As the Sino-American race to technology has led to heated competition and a surge in tech-related subsidies, the EU has been slow to react, as the nature of European politics has prevented it from making real headway. Despite the aforementioned European Chips Act, EU member states have been facing difficulties in aligning on the allocation of related funding, presenting an infrastructural and bureaucratic obstacle to the region’s technological development potential. 

Observed Effects of Export Control

Washington’s effort in holding back Chinese innovation may eventually even work in China’s favour. In a recent report from Japan’s semiconductor research company TechanaLye, SMIC (China’s Semiconductor Manufacturing International Corporation) has already produced a 7 nm chip that has the same design as leader TSMC’s 5 nm chip. Despite access to only the less advanced DUV (deep ultraviolet) machines, the chips are found to have comparable capabilities in performance, and a minor size difference of 2 nm, therefore classified to be only three years behind that of TSMC. 

The surprising advancements of Chinese manufacturing capabilities have been raising questions regarding the approach and effectiveness of related multilateral export control. While the US seeks to slow down Chinese innovation through trade restrictions – buying time to advance its own onshoring efforts as a derisking measure – it may have created an immediate incentive for China to double down on boosting its domestic ecosystem. In the 4th quarter of 2023, following US curbs on semiconductor exports to China, China’s import of chip manufacturing machinery rose by 90%. Evidently, its internal ecosystem does not plan on shifting its focus elsewhere. With China’s investment in government-funded R&D, equipment stockpiling, and foreign talent programs, Beijing’s salience for developing semiconductor expertise may overshadow the US’ efforts in export control, contrary to their desired effects.  

Europe’s Dilemma 

The EU is in a conflicted position in the US-China technology race. While the European Union underscores the importance of supply chain security, legislative action requires the agreement and joint decision of all 27 member states. Politically, the EU’s de-risking efforts remain fragmented as a result. 

When on 27 January 2023, the Netherlands, Japan and the US agreed to export restrictions against China, the unilateral negotiations with only Dutch representation, were received with reservations and surprise among the European institutions and EU Member States, depicting an uninformed reality. In addition, while Germany is rooted to be the host of two production site projects – one in collaboration with TSMC and one with Intel – the Dutch Prime Minister is further evaluating the cost of export control on ASML. Evidently, in future economic, industrial, and employment prospects, the two European countries will face vastly different effects of such export control.

On 2 September 2024, the EU’s computer chip industry group, ESIA, called for a revamping of the EU Chips Act, urging for more government aid in offsetting loss from restrictions. Representing European chipmakers and research bodies, ESIA firms consist of domestic consumers of ASML products, and therefore likely to be directly impacted by the negative externalities of trade restrictions. 

At this point, it is vital for the EU to proactively assess its situation. While trade restrictions are not necessarily detrimental to a given industry, governments need to support the welfare and productivity of their local sectors, namely in providing aid to offset losses. As Draghi points out in sequence to his report, Europe’s path to independence creates an “insurance cost” that would need to be mitigated by cooperation between member states..

Further to the point of Europe’s competitiveness, the feasibility of its 20% production goal in the semiconductors sector remains questionable. Unlike the US, whose chip manufacturing accounted for 40% of global supply in 1990, Europe’s production capabilities have not surpassed 15% in the past 40 years. Even with government subsidies, the question remains whether the EU will effectively boost its production competitiveness. 

Nevertheless, the EU plays a crucial role in chip manufacturing through the capacity of ASML and imec (Interuniversity Microelectronics Centre in Leuven, Belgium). While the former’s monopoly in EUV lithography machines makes it indispensable to the advanced chip production supply chain, the latter leads the global chip design infrastructure. Thus, instead of adopting the US strategy of onshoring production, the EU should prioritise the longevity of its technological lead, whilst maintaining a competitive strategic edge.

The allocation of funding for production, which has little statistical evidence for success, does not guarantee Europe’s existing global dominance in the semiconductor (machinery)  industry. In the interest of Europe’s strategic autonomy, as well as supply chain security, the EU should redirect its focus to the protection of high-performance companies (like ASML) and forming strategic partnerships with competitive manufacturers. 

Solutions Ahead

Referring to Draghi’s playbook, he recommends a four-element strategy. “First, funding for innovation and the establishment of testing labs near existing centres of excellence. Second, providing grants or R&D tax incentives for ‘fabless’ companies active in chips design and foundries in selected strategic segments. Third, supporting the innovation potential of mainstream chips. And fourth, coordinating EU efforts in back-end 3D advanced packaging, advanced materials and finished processes.”

Notably, Draghi points out the idealism in European ownership of large foundries, given the investment required for such projects. With the goal of maintaining European dominance in advanced chip technology while harnessing supply chain resilience, the EU should move forward with a centralised budget and strategy to stimulate innovation. Detailed in his four-element common action plan, it is seen as the most efficient and effective tactic for boosting domestic innovation, reinforcing sector indispensability, thus re-establishing European strategic autonomy in the geoeconomics of semiconductor trade. In the EU’s design to de-risk its semiconductor supply chain, the Draghi report provides an ambitious, yet challenging blueprint for Ursula von der Leyen and her incoming Commissioners.

Author: Anaïs Anqi Skok, EIAS Junior Researcher

Photo credits: Pexels