Chip shortage exposes vulnerable supply chains

The world is running low on semiconductor chips, and automakers aren’t the only ones who should worry.

Intel processor. (Unsplash)

Hoping to address supply-chain disruptions following the pandemic, President Joe Biden on Wednesday ordered a wide-ranging review of U.S. reliance on foreign sources for critical goods such as pharmaceuticals, rare-earth metals and high-capacity batteries. On the most urgent matter — a shortage of semiconductors that has upended production at American automakers — he needs to think bigger.

Last spring, car sales collapsed as the coronavirus took hold. Expecting an extended downturn, automakers reduced orders for supplies, including parts that require semiconductors. At the same time, demand for the higher-margin chips used to make laptops, smartphones and other devices soared as much of the country began working from home. When the economy bounced back more quickly than anticipated, the result was a supply crunch for car companies. It may be months before production is back to normal.

In the short term, Biden can't do much to resolve this problem. Some companies were prepared for such disruptions — Toyota Motor Corp., for instance, had an ample chip stockpile — and others weren't, but a government intervention at this late stage won't get additional capacity online any time soon. That's best left to the forces of supply and demand.

In the longer term, though, this incident highlights a serious vulnerability. Semiconductors play a crucial role in the U.S. economy. They turbocharge labor productivity and power everything from medical devices to consumer electronics to artificial intelligence. Yet the share of global chips produced domestically has declined from 37% in 1990 to 12% today. Industry groups reckon that only about 6% of new capacity will be built in the U.S. over the next few years, compared to some 40% in China.

Left unaddressed, that will further concentrate the business in East Asia, increase supply-chain risks for U.S. companies, and potentially undermine America's leadership. It's also a threat to national security: The military requires about 1.9 billion chips a year for (among other things) weapons, communications and intelligence systems.

An essential first step, as Biden seems to recognize, is devising a new strategy with America's allies. Japan, South Korea, Taiwan and Europe all contribute significantly to the global semiconductor business. They should create a strategic supply-chain alliance that would allow them to collaborate on R&D efforts, coordinate export controls, expand “trusted foundries” programs and take other steps to increase mutual resilience.

Next, federal funding for semiconductor research — which has flatlined in recent years — should be boosted significantly. By one estimate, every dollar invested in such programs yields $16.50 in additional gross domestic product. Perhaps more important, added investment should boost self-sufficiency, help build a skilled workforce, and lay the groundwork for industries of the future.

A much harder task is to encourage companies to make chips domestically. Although two top manufacturers have recently said they're building or considering new plants in the U.S., the reality is that America is at a steep disadvantage due to high labor costs and government support overseas. One study found that the total expense of owning a new chipmaking facility in the U.S. is 30% higher over 10 years than in Taiwan or South Korea, and 50% higher than in China. Government incentives amounted to as much as 70% of the difference.

Congress should seek to lessen this imbalance. Last month, lawmakers authorized a range of programs to promote domestic chip manufacturing, encourage public-private partnerships, boost efforts to acquire secure chips and more. They should ensure that these efforts are funded. An investment tax credit for chip facilities and equipment might also help. The goal of these efforts should not be job creation — such facilities will be heavily automated — or propping up individual companies. Rather, it should be leveling the playing field, creating more resilient supply chains, and protecting national security.

Getting this right won't be easy. But for the country that invented the integrated circuit, it shouldn't be impossible.