Chip War
China Matters - Special Issue on AI and the Digital Transformation
Is hindsight always 20/20? Not necessarily. The penalty of hindsight is our tendency to view the eventual outcome as inevitable. Take the Cold War between the US and the USSR. With the “benefit” of hindsight, it is easy to forget the USSR had kept pace in nuclear and missile technology well into the 1970s, while simultaneously achieving numerical superiority in terms of tanks and planes. Meanwhile, the Vietnam War and Nixon's resignation had materially weakened the US, whose military leaders recognized their only viable response was to redefine warfare itself by investing heavily in new weapons systems that capitalized on America's dominance in microelectronics – i.e., chips.
The combination of precision-guided missiles with advanced command and control systems not only neutralized the USSR's numerical advantage but also required investments in a costly catch-up effort. More importantly, Soviet leaders made a critical mistake in deciding to acquire Western know-how through what had worked so well with nuclear technology: espionage and theft. What they failed to understand is that the exponential rate of technological advancement made stealing last year's designs a losing strategy. Manufacturing at scale also proved difficult without access to Western equipment and spare parts. The absence of cheap labor posed further obstacles. Finally, without a reliable supply of quality chips, Soviet leaders opted for minimal use of electronics in their military systems. Meanwhile, the US continued to surge ahead.
The consequences became painfully evident in 1990 after the swift defeat of Iraq’s Soviet-equipped army by technologically superior American forces, highlighting the importance of chips and raw processing power in modern warfare. In the aftermath of the Gulf War, the Soviet security chiefs attempted an ill-fated coup which fizzled out in a mere three days, effectively ending the Cold War, and cementing a US victory that belonged as much to Silicon Valley as the Pentagon.1
Thirty years on, a strikingly similar conflict is unfolding between today’s superpowers, the US and China. Once again, chips represent the main battleground. This time, however, chips are critical not just for developing advanced weapons systems but also as the driving force behind the AI revolution and digital transformation of society itself. Moreover, this time, neither the US nor China are independently capable of developing and manufacturing the most advanced chips by themselves. In fact, no country can, due to the exceptional technological complexity and high costs involved.
Instead, today’s semiconductor industry consists of a handful of players that form an intricate global supply chain. A single Dutch company, ASML, dominates the market for extreme ultraviolet lithography machines, while only two Korean companies account for 44% of global memory chip production, and a Taiwanese company, TSMC, has a virtual monopoly on manufacturing the most advanced chips, including those used for AI. It has become a matter of national security to safeguard access to this uniquely vulnerable ecosystem, especially given the brewing conflict between the US and China, who both aspire to global semiconductor supremacy.
In this context, a Taiwan crisis is increasingly likely. China wants to indigenize advanced semiconductor manufacturing to reduce dependence on foreign technologies, while the US wants greater supply chain security and resilience. As the indispensable player in the global semiconductor industry, Taiwan holds the keys to both goals.
A recent strategy game conducted by the Center for a New American Security (CNAS) provides valuable insights into how the conflict may unfold.2 In the game, a crisis erupts due to US support for Taiwan. Subsequently, three TSMC facilities experience production issues, likely from a cyber-attack, that trigger a two-month suspension in chip fabrication and a disastrous global shortage of advanced chips.
Importantly, the game suggests military conflict remains unlikely, as China prefers exerting control over Taiwan's semiconductor industry through a combination of economic statecraft, punitive economic actions, purchasing stakes in key companies, and employing diplomatic, informational, and military activities. Such gray zone tactics allow China to achieve chip self-reliance and eliminate a potential competitor while impacting other critical states that rely on Taiwan for semiconductor supply.
Taiwan’s strategy is to avoid concessions that weaken US and Chinese reliance on its semiconductor industry. This explains why TSMC's recent commitments to set up facilities elsewhere are limited to technology generations two steps behind Taiwan’s own capabilities. At the same time, China seeks to increase its dependency on TSMC to avoid jeopardizing Taiwan's dominant position in the global market.
The US can either follow China's indigenization efforts or prioritize multilateral partnerships and maintain Taiwan’s democratic foothold in the region. Expectations for achieving semiconductor self-reliance should be tempered, as rebuilding cutting-edge capabilities could take a decade and require substantial investments, with success far from guaranteed. Instead, the US should identify areas within the supply chain, such as assembly and packaging, that could be re-shored to the US.
Finally, what happens in Taiwan will not stay in Taiwan. The immediate impact would go far beyond the semiconductor industry itself and impact the global economy more broadly, including the consumer electronics (e.g., smartphones, home appliances), automotive (e.g., electric vehicles), digital infrastructure (e.g., data centers), and financial services (e.g., stockmarket technical maintenance) industries. Furthermore, the geopolitical impact and related consequences for - for example - global trade flows, would exceed even that of the ongoing war in Ukraine.
Japan, the Philippines, and South Korea are especially vulnerable, due to their geographic proximity to Taiwan and role as US allies. Australia, Hong Kong, and many South-East Asian markets would also be significantly impacted by economic, investment, and financial prohibitions on China. The exposure of India and Indonesia appears lower, while New Zealand is slightly more insulated than Australia. On the other hand, many US multinationals seem dangerously exposed, given the economic pull of Chinese markets and potential for firms to de-Americanize their supply chains in response to export controls or blacklists.3
C-Suite Implications
Few C-Suite executives are fully prepared with detailed contingency plans or thoughtful modifications to their long-term strategies, despite the high risk of further deterioration in U.S.-China relation driven by their competing interest, including advanced chips. Many appear overly optimistic, believing commercial decoupling to be impossible due to the extent of economic ties and obvious harm to both countries. Others seem merely resigned, convinced that it’s no use making this argument because no one will listen.4
In fact, (partial) decoupling is already underway and a Taiwan crisis has become plausible enough that, from an executive decision-making perspective, it can no longer be ignored. In response, more companies should invest in scenario analysis and wargames to stress-test current assumptions and identify potential countermeasures. In addition, companies may want to start tracking indicators that a crisis could be imminent, including cross-border capital controls, a freeze on foreign financial assets, liquidation and repatriation of Chinese assets abroad (e.g., US treasuries), stockpiling of emergency supplies (e.g., medicine), suspension of key exports (e.g., critical minerals), energy rationing, prioritization of key inputs for military production, and travel restrictions for Chinese elites or high-priority workers.5
While no plan survives first contact with the enemy, no C-Suite executive can reasonably expect to succeed without having forced their organizations to anticipate and think through how various disruptions can potentially disrupt their business plans and operations - and prepare accordingly.
1 “Chip War: The Fight for the World’s Most Critical Technology,” Miller, Scribner, 2022
2 “When the Chips Are Down: Gaming the Global Semiconductor Competition,” CNAS, 2022
3 “Conflict over Taiwan: Assessing Exposure in Asia,” EIU, 2023
4 “US Business Leaders Not Ready for the Next US-China Crisis,” CSIS 2022
5 “Economic Indicators of Chinese Military Action against Taiwan,” CSIS, 2022