War With China? The Economic Factor That Could Trigger It – Forbes

Military tanks and soldiers line up in Tiananmen Square during a military parade to mark the 19th … [+] anniversary of the regime.
The Pentagon undoubtedly draws up various scenarios for how conflict between China and the U.S. might develop. Most of them would involve a Chinese move against Taiwan. But Taiwan and China have co-existed in intense but bloodless antagonism for seven decades without tipping into real war. The crucial question is: What would trigger an actual Chinese military adventure? 
I can answer that question.
To step back – If there is to be a war, an open war, with China – and we may stipulate that this scenario is at the far end of the spectrum of possibilities, and yet not an impossibility – if there is to be a war, it will not arise from Western outrage at human rights violations in Xinjiang, or Chinese outrage at Western outrage, or cyber-crime, or technology theft, or currency manipulation, or security crackdowns in Hong Kong, or indignities visited upon the Filipinos or the Vietnamese or the Australians. 
It will arise from acute economic pain, inflicted on China by actions of the United States to deprive them of the most essential physical resource of the 21st century: semiconductors

A new type of 300 millimeter wafer with semiconductor chips and finished microchips of the … [+] semiconductor. (Photo by JENS SCHLUETER / AFP) (Photo by JENS SCHLUETER/AFP via Getty Images)
The semiconductor problem, and the increasing vulnerability of China’s economy – and its military – to supply constraints, is what will lead China to consider, finally, outright military action against Taiwan. 
In fact, there is a strong historical parallel: China in 2021 finds itself in a situation very much like the situation of Japan in 1941.
 
It’s pretty clear that Japanese military aggression in 1941 was driven by the need to secure the country’s oil supply. 

Japan sought to address its vulnerability by investing in new technology. But it was unsuccessful, as detailed in a peer-reviewed article entitled “Synthetic fuel production in prewar and World War II Japan: A case study in technological failure,” published in 1993 in the journal Annals of Science

Japan’s only other “solution” involved military expansionism. After the Fall of France in 1940, Japan moved to occupy French Indochina, as a steppingstone to oil producing regions in Malaysia and the Dutch East Indies. 
This led the U.S. to retaliate economically, in June 1941. 

From that point on, the sequence leading to Pearl Harbor was essentially deterministic, given the objectives and psychologies of the parties involved. 
In short – Japan in 1941 found itself in a position of acute strategic vulnerability, intolerable in light of its geopolitical ambitions.

Today, China’s tech economy runs on silicon – that is, semiconductors.

To satisfy this enormous appetite for silicon, China buys 60% of the world’s chip production. 90% of it is sourced from outside China or produced domestically by foreign manufacturers (e.g., Intel INTC ). In short, China is highly dependent on a resource that it does not control. 
This problem (from the Chinese perspective) is huge and growing. China’s position in the global industry is small and stunted. The U.S accounts for nearly 50% market share of the global industry, and has maintained this dominant position for three decades. China is stuck at about 5% – and is not really a player outside its captive Chinese market.  
Global Semiconductor Industry Market Share by Country 2018-2019

More important is the qualitative gap. The high-value part of the semiconductor industry is the “fabless” IC sector, the companies that control the design of the chips that power the digital economy. Fabless companies drive the cycles of innovation which lead the broader economy.
China is not a player at all in the fabless segment. 9 of the top 13 fabless IC players (those with more than $1 Billion in revenue) are U.S.-based. There is not a single Chinese company in this group. 
In the foundry sector, the other “half” of the industry where the physical manufacturing of integrated circuits is carried out, China has struggled for decades to gain a foothold. China’s fabrication capabilities are meager, and are four to five technology generations behind the leaders. China’s “champion” in this space — Semiconductor Manufacturing International Corp. (SMIC) – has announced a plan to build a new IC fabrication facility (in partnership with the city of Shanghai) to produce integrated circuits using 28-nanometer technology. This is about ten years behind the Taiwanese foundry, TSMC, which is scheduled to bring out 3-nanometer chips next year. (Samsung already manufactures another version of 3-nanometer IC’s.) Indeed, Taiwan dominates the foundry business – with 63% of the market, 10 times the size of China’s position. (Keep that key fact in mind.) 

SMIC compared to Industry Best IC Fabrication Standards

In short, China is not investing in semiconductor technology at anywhere near the level of the U.S. or Europe, either in quantitative or qualitative terms. As a percentage of sales, the Americans invest twice as much as the Chinese companies do. In absolute dollar terms, the U.S. invested about 18 times more than China (2018).
R&D as Percentage of Revenue for the Semiconductor Industry – US, EU, China
R&D Investments by the Semiconductor Industry in the US and China, 2018
The three industry leaders in IC manufacturing – TSMC, Samsung, and Intel – have announced plans to invest over $300 Billion in the next ten years. That’s a big number even for Beijing. (Despite its government support, SMIC has not been able to commit the full amount of the $8.8 billion its 28-nm foundry will require. They’ll still be looking to raise billions from outside investors.) 
These are all symptoms of China’s structural inability to compete in this industry, to solve the semiconductor problem organically, through internal development. With such a massive investment deficit, it is virtually certain that the technology gap will widen. China will likely fall further behind.  
Why can’t the Chinese government solve this through direct public investment — a moon-shot approach, the sort of thing that authoritarian regimes supposedly excel at? 
They have certainly tried. Semiconductor independence has been the explicit focus of Chinese government industrial policy for decades. New initiatives have repeatedly been announced, with grandiose, soviet-style bravado – in 2014, for example, Beijing set “a goal of establishing a world-leading semiconductor industry in all areas of the integrated circuit supply chain by 2030.”  
The track record has not been encouraging. In another column, we’ll review the history of these efforts more closely. For now, BusinessWeek summarizes the matter succinctly:

Industrial policy, government funded and directed, just may not work here. An industry expert quoted in BusinessWeek put it this way:

The last few years have added new pressure, as the U.S. has slowly choked off the IC pipeline. American policies directed against unfair trade, technology theft, national security risks, and complicated by geopolitical rivalries and diplomatic conflicts, have tightened the noose. For example, Huawei – China’s champion in the telecommunications sector – has been crippled by the denial of access to American semiconductors.  
The net-net: Like Japan in 1941, China now finds itself in a position of acute strategic vulnerability, intolerable in light of its geopolitical ambitions. 

The potential pathway to conflict is straightforward. It can be described abstractly: 

The parallels between the Japanese situation in 1941 and the Chinese situation today are striking.  

The Historical Parallels – 1941 & 2021

There are many reasons China might wish to move on Taiwan, and finally, after 70 years, to be done with it. But until now, clearly none of those reasons have been sufficiently compelling to risk the possibility of open conflict with the U.S. 
The semiconductor crisis outlined here could change that. Beijing might come to see how a takeover of Taiwan would solve this worsening strategic vulnerability all at once. Indeed, given the dominant bottleneck-status of TSMC in the global eco-system of semiconductors (as described in a previous column), a Taiwan takeover might turn the tables on the West, and enhance China’s geopolitical position beyond alleviating the supply shortage.

Are we complacent? Media descriptions of the political and economic tension between the U.S. and China often favor military metaphors – “trade wars,”“wolf warriors” – attacks, assaults, attrition, technological “arms races” etc. – all of which bring a certain energy and flair to stories covering what are often rather dry bureaucratic disagreements (over tariff policies, currency exchange rates, audit standards). The press coverage can sound over-excited, the “threats” are often exaggerated – but eventually the news is consumed with the morning coffee, digested, and discounted back to normalcy. We are used to it. Scare headlines sell newspapers. 
Is there a risk that Metaphor could morph into Reality? Is open military conflict unthinkable?
It is easy to assume that we are all too grown-up to let mere trade disputes get out of hand. Or we may assume that “globalization” and economic interconnectedness – “interlocking interests” – will defuse any real possibility of war. Maybe so. I myself make these assumptions. It helps me to sleep more easily.  
However, there is History to consider, in the form of the Angell thesis. Norman Angell (1872-1967) was “an English Nobel Peace Prize winner, a lecturer, journalist, author and Member of Parliament.” He led a fascinating life, but is remembered today for his book, published in 1909 and titled with unintended irony, The Great Illusion. Angell’s premise was that because of what we would now call globalization, War in Europe had become economically impossible – 

Of course, the sequel didn’t play out that way in 1914, or in 1941, and it should be a caution to our complacency in 2021.

My first career: I spent 25 years in the high-tech segment of the wireless technology industry, involved in the early development and commercialization of digital

My first career: I spent 25 years in the high-tech segment of the wireless technology industry, involved in the early development and commercialization of digital wireless architectures (2G, 3G etc). I was the chairman of an engineering joint venture with the advanced development arm of the Israeli military, Rafael. I served as CEO and Chairman of Illinois Superconductor Corporation, at the time a portfolio company of the investment firm Elliott Associates. I have been the audit committee chairman for several public companies, and managed a wide range of capital raising projects, including public offerings, and many private financings. I have performed technical and commercial “due diligence” assessments on a range of investments for several leading hedge funds and private equity firms.

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My second career: In 2003, I joined Stevens Institute of Technology, where I created and oversee a number of programs in Quantitative Finance and related fields. I am the Executive Director of the Hanlon Financial Systems Research Center at Stevens. I am also the co-Principal Investigator for a recently awarded planning grant from the National Science Foundation to create an Industry/University Cooperative Research Center focused on financial sciences and technologies. I am the author of several books on wireless technology, and my new book is Price & Value: A Guide to Equity Market Valuation Metrics, published this year by Springer/Apress. 

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I can be contacted by email at gcalhoun@stevens.edu.

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