[EAI Special Report] Taiwan Special Series ⑤_US-China Technological Hegemony Conflict and Taiwan's Strategy: Focusing on the Semiconductor Sector

[Editor's Note]

In this Special Report, Bae Young-ja, Professor of Political Science and International Relations at Konkuk University, explains Taiwan's strategy in the semiconductor sector amidst the US-China technological hegemony conflict. Taiwan's TSMC (Taiwan Semiconductor Manufacturing Company) has been recognized as the foundry with the world's leading process technology since 2014. However, as the US-China semiconductor conflict intensified, TSMC, which has maintained close relationships with both US and Chinese companies, found itself at a crossroads between the US and China. This is because while the US shows high dependence on TSMC and TSMC itself relies on US equipment, it cannot ignore its ties with Chinese IT companies and China's significance as a potential market. The author argues that TSMC faces both "US risk" and "China risk." In this context, she emphasizes that Taiwan must seek semiconductor technology innovation strategies in cooperation with South Korea, a major economic partner, to ensure stable growth of its semiconductor industry.

1. Introduction

The US-China conflict over advanced technologies, which surfaced after the announcement of "Made in China 2025" in 2015, intensified with the Trump administration's export restrictions on China. Since the Biden administration took office, the US has been formulating a long-term and sophisticated strategy to curb China's rise in advanced technologies and enhance US competitiveness. China, in turn, views the situation where the US precisely targets its vulnerabilities in the global advanced technology supply chain, cornering it, as an existential crisis comparable to the "sword of Damocles," and is strengthening its resolve for continuous technological innovation through indigenous innovation. The US-China competition in advanced technologies is expected to become more intense for the foreseeable future, indicating a shift in the environment where each country's advanced technology innovation strategies are inevitably influenced by geopolitical considerations and choices beyond market factors.

Over the past three years, Taiwan and TSMC have garnered significant attention amidst the advanced technology conflict between the US and China. Based on the official agreement of the One China principle advocated by China, the potential conflict between the US and China over Taiwan had been contained. However, China's rise and the US's intention to counter it have gradually materialized into military-strategic competition between the US and China concerning Taiwan and its surrounding regions. Coupled with the conflict over semiconductors, Taiwan has suddenly emerged as a major arena for US-China hegemonic competition. Taiwan's irreplaceable capabilities in semiconductor manufacturing processes have dramatically increased its strategic value amidst the US-China technological hegemony conflict, entangling both the US and China in closer mutual interests with Taiwan, pushing the conflict surrounding Taiwan to an unavoidable point.

With this situation in mind, this paper examines Taiwan's strategy in the context of the US-China technological hegemony conflict through the lens of the semiconductor sector. First, it will briefly outline how Taiwan's semiconductor industry, particularly TSMC, has achieved its current capabilities. Subsequently, it will review the strategies TSMC has employed amidst the US-China conflict over semiconductors. Finally, it will offer an outlook on the future US-China semiconductor conflict and the challenges facing Taiwan.

2. The Rise of Taiwan's Semiconductor Industry and TSMC

Unlike South Korea, which laid the foundation for economic growth through a large-enterprise-centric export economy in the 1970s, Taiwan's early economic development was based on exports driven by small and medium-sized enterprises (SMEs). Due to a lack of technology and capital, Taiwanese SMEs faced difficulties in conducting their own R&D and even in importing expensive advanced technologies from abroad, posing a significant challenge that needed to be addressed for Taiwan's sustained economic growth. To support the technological innovation of its SMEs, the Taiwanese government established the Industrial Technology Research Institute (ITRI, 工業技術研究院) in 1974. Joint research, consortia, and joint licensing planned by ITRI became the focal point of Taiwan's technological innovation. In the process of formulating a long-term development plan for its IT industry, the Taiwanese government recruited Morris Chang (張忠謀), former Vice President of the US semiconductor company Texas Instruments (TI), as the director of ITRI in 1985. After much deliberation on the development direction of Taiwan's IT industry, Morris Chang established TSMC (Taiwan Semiconductor Manufacturing Company, 臺灣積體電路製造股分有限公司) in 1987 as a spin-off from ITRI, becoming the world's first foundry solely dedicated to semiconductor manufacturing processes, located in the Hsinchu Industrial Park.

At that time, the integrated device manufacturer (IDM) model, where design, manufacturing, and assembly were all handled within a single company, was common in the semiconductor industry, and the success of a pure-play foundry model was uncertain. Morris Chang, who had worked in the US semiconductor industry for 30 years, foresaw the separation of semiconductor design and production. He decided that specializing in manufacturing, an area where Taiwan held a competitive advantage, would be more effective than nurturing IDMs as the government had requested, and thus established a pure-play foundry company. As time went by, his prediction proved correct: design companies like Qualcomm, Broadcom, and NVIDIA emerged in Silicon Valley, and as they outsourced manufacturing, which required high labor costs and significant equipment investment, TSMC manufactured semiconductor chips for them. From the perspective of design companies, there was inherent risk in handing over their proprietary semiconductor designs to another company for production. Therefore, when everyone was skeptical about the success of the foundry model, TSMC built trust through strict confidentiality and diligent safety management under the motto of "not competing with customers," eventually establishing long-term business relationships with major global semiconductor design companies.

As the foundry model became established in the mid-1990s, many Taiwanese companies entered the market, leading to fierce competition. UMC even approached TSMC's level for a time, posing a challenge. However, TSMC ultimately solidified its position as the leader in Taiwan's foundry industry by consistently investing in advanced process technology, driving the development of Taiwan's semiconductor industry thereafter. In the mid-2000s, Intel, IBM, and Samsung began to invest heavily in the foundry sector, and TSMC also faced pressure to increase its investments. Despite aggressive moves such as increasing investment and constructing a mega-foundry during the 2008 US financial crisis when other companies were reducing investments, TSMC faced a crisis due to the economic downturn. Morris Chang, who had retired in 2005, returned to TSMC in 2009 at the age of 78 and, turning the crisis into an opportunity, pursued large-scale reforms and projects to transform TSMC into a global enterprise. Notably, starting in late 2011, TSMC began collaborating with Apple by dispatching a research team of over 100 people to Apple's headquarters. Concurrently, it built a 20nm fabrication plant in Taiwan to mass-produce the A8 chip, the main chip for the iPhone 6. Based on this, after fierce competition, TSMC succeeded in securing the chip process for iPhones, which had previously been handled by Samsung. This achievement was made possible by the convergence of interests: Apple, seeking to move away from Samsung due to concerns about its competitor manufacturing chips for its own smartphones, and TSMC, aiming to surpass Samsung by securing the chip process for Apple, which required the highest level of technological expertise. With the resounding success of the iPhone 6, equipped with the A8 chip manufactured by TSMC, in 2014, TSMC firmly established its status as the foundry with the world's leading process technology.

The success TSMC achieved over 30 years since its founding was supported by the Taiwanese government's diverse and continuous assistance, including investment in startup capital, provision of factory sites and water, and tax reductions. The ample supply of skilled labor required by TSMC is also a crucial factor in its success. Above all, however, Morris Chang's leadership, which set the right direction in uncertain circumstances and aggressively pursued it to lead TSMC, cannot be overlooked, and it is understandable why he is called the 'godfather of semiconductors' in Taiwan. Morris Chang frequently emphasized the importance of 'qi shi' (器識), meaning breadth of mind and vision, and was known to hold the belief expressed in the Analects: "My way is one that runs through all things" (吾道一以貫之). As he revealed in a lecture, TSMC is a unique success model resulting from the Taiwanese integration of government, industry, and talent pools, which is not easily replicable elsewhere.

3. US-China Semiconductor Conflict and TSMC

According to a report by the Semiconductor Industry Association (SIA) published in April of this year, the global semiconductor value chain, encompassing design, materials, equipment, processes, and assembly, is distributed as follows: the US accounts for 38%, South Korea 16%, Japan 14%, Europe 10%, China 9%, and Taiwan 8%. These proportions alone do not fully explain why the US is so intent on curbing China's semiconductor rise or why Taiwan, with only an 8% share, has become a focal point of attention. The issue becomes clear when the semiconductor industry is viewed from the perspective of supply chain stability rather than a value-added value chain. The semiconductor design sector is open to companies of various scales and technological levels, with relatively low entry barriers. While there are strong players in the design sector such as Intel, NVIDIA, and Qualcomm, they cannot monopolize the design of chips used in countless electronic devices, allowing Taiwanese and Chinese companies to enter the design sector and achieve prominence without significant hindrance. The assembly sector requires relatively lower technical skills and is easily transferable, thus posing a low risk. From a supply chain stability perspective, the critical sectors are equipment and processes. Specifically, among the numerous equipment and diverse process levels, the extreme ultraviolet (EUV) lithography equipment required for producing semiconductors below 7nm, used in cutting-edge electronic devices, is monopolized by ASML of the Netherlands, and the process for 7nm chips is currently only feasible for TSMC and Samsung. The main customers for ASML's high-end EUVs are TSMC and Samsung, with Samsung having relatively less influence in the outsourced foundry sector compared to TSMC. On the other hand, TSMC holds a 92% market share in the highest-level outsourced processes below 10nm. Furthermore, most US design companies do business with TSMC, and TSMC has also formed close relationships with major Chinese design companies. Consequently, the TSMC has become the central issue in the US-China semiconductor supply chain conflict.

Since "Made in China 2025," the US has employed various means to curb China's advanced technology development. The goals the Biden administration seeks to achieve in the semiconductor sector can be seen as maximally delaying China's semiconductor rise, enhancing the stability of the US semiconductor supply chain, and maintaining a technological gap with China. The US is mobilizing various policy tools, focusing on delaying China's entry into advanced foundry and memory sectors and securing advanced semiconductor manufacturing capabilities within the US. The direct pressure on China through export controls, the formation of semiconductor alliances, and the strengthening of domestic manufacturing capabilities, which the US is currently prioritizing, are all difficult to achieve without cooperation with TSMC. One of the most devastating US export controls on China was the halt of TSMC's chip manufacturing for Huawei. Moreover, since most US design companies outsource their processes to TSMC and TSMC possesses the world's most advanced process technology, it is the most crucial partner for strengthening US semiconductor manufacturing capabilities or forming semiconductor alliances.

China's objectives in the semiconductor sector include ensuring a stable supply of advanced semiconductor chips, continuously upgrading its position in the value-added manufacturing and equipment segments of the semiconductor value chain, and catching up with South Korean and Taiwanese companies to produce advanced semiconductors domestically. Semiconductors have surpassed crude oil as China's top import item, and securing advanced semiconductor manufacturing capabilities is crucial for China's goal of becoming an advanced manufacturing nation. To achieve this goal, China has pursued foreign advanced technology acquisition through official and unofficial channels and has made large-scale investments in the semiconductor sector. Given the weak domestic technological base, China has rapidly enhanced its semiconductor technology innovation capabilities by acquiring foreign companies with advanced semiconductor technology, transferring technology from foreign companies investing in China, and scouting top talent. However, due to US export controls, the supply of advanced semiconductors and related equipment to China has been cut off, and outsourced processes have been suspended, delaying China's semiconductor ambitions. To overcome this, continuous technological innovation, particularly in the process sector, is urgently needed. Therefore, technological cooperation with TSMC and Samsung is more critical than ever for China.

As of 2021, TSMC is one of the world's top three semiconductor companies along with Intel and Samsung, undertaking contract manufacturing for over 11,600 types of semiconductors ordered by approximately 500 companies worldwide. TSMC's regional revenue breakdown is approximately 60% from the US, 17% from China, 8% from Taiwan, and 6% from Japan. The strong relationships and continuous orders from US Silicon Valley companies, including Apple, have been crucial to TSMC's growth. In fact, 92% of major US semiconductor design companies outsource their processes to TSMC, indicating a very high US dependence on TSMC. Furthermore, TSMC cannot build or operate fabs without US equipment. Meanwhile, TSMC has steadily increased its business with major Chinese IT companies since 2010, with Huawei becoming its second-largest customer after Apple, accounting for about 15% of TSMC's revenue. The cooperation between TSMC and Chinese semiconductor companies has been more extensive than officially disclosed. For example, Richard Chang (張汝京), who played a leading role in establishing China's foundry SMIC in 2000, worked with Morris Chang at TI in the US. Richard Chang sold his company in Taiwan to TSMC and moved to mainland China to establish SMIC. Subsequently, many TSMC employees joined SMIC, forming various official and unofficial technical support relationships.

TSMC, which has maintained close relationships with both US and Chinese companies, has reportedly faced pressure from the US government since the full-scale outbreak of the US-China semiconductor conflict in 2018. The Trump administration's pressure included, first, demanding the construction of advanced semiconductor manufacturing facilities in the US and, second, regulating transactions with Chinese companies. In 2019, the US Department of Commerce enacted export control regulations requiring licenses for exporting US products to Huawei and related Chinese companies. This measure did not apply to cases where the proportion of US technology or software was less than 25%, or where semiconductors were manufactured in a third country and exported to Huawei, thus not affecting TSMC's transactions with Huawei. Despite these measures, as Huawei remained robust, the US government intensified sanctions in May 2020, regulating the export of products manufactured using US technology, even if produced in third countries, to Huawei. The enhanced measures by the US Department of Commerce also applied to TSMC, which uses US semiconductor equipment. Although these were not export bans but rather requirements for licenses, it was difficult for the US government to make an exception for TSMC. In response, TSMC clearly indicated its strategic direction through two decisions in May 2020: it announced plans to build an advanced semiconductor foundry in Arizona and to cease transactions with Huawei after the completion of orders already received in mid-September. In April 2021, when the US Department of Commerce placed seven Chinese supercomputer-related institutions and companies on an export control list, citing threats to US national security, TSMC immediately announced its intention to halt transactions with the listed Chinese design company, Phytium (飛騰), cooperating with the US.

Given TSMC's reliance on US equipment and the fact that 60% of its revenue comes from US design companies, aligning with the US could be seen not as a choice but as an inevitability. However, considering TSMC's relationships and ties with Chinese IT companies, and China's significance as a potential market, these decisions were likely not easy. While TSMC actively participates in US-led semiconductor alliances, it cautiously maintains its relationships with Chinese IT companies within the scope of US sanctions. A symbolic example of TSMC's approach was observed in September 2020. Morris Chang was the sole corporate representative to attend the official government reception welcoming Keith Krach, Under Secretary of State for Economic Growth, Energy, and Environment, who visited Taiwan as the highest-ranking US government official since the severance of diplomatic ties. Immediately after the dinner, the Presidential Office of Taiwan released a photo of President Tsai Ing-wen, Under Secretary Krach, and Morris Chang together. This was interpreted as a clear message about the strategic choice of Taiwan's semiconductor industry. However, just four days before the dinner, immediately before the US sanctions on Huawei took effect, TSMC operated its fabs around the clock to produce the maximum number of semiconductor chips for Huawei and completed their delivery. This demonstrates TSMC's efforts behind the scenes to maintain its relationship with China while officially aligning with the US. In response to Under Secretary Krach's visit, China conducted a show of force by dispatching military aircraft into Taiwan's Air Defense Identification Zone (ADIZ). Chinese media threatened that Chinese fighter jets would train over Taiwan if the US Secretary of State or Defense visited Taiwan, but there was no criticism or comment regarding this photograph. This indicates that China is also handling its relationship with TSMC very cautiously. In April 2021, TSMC announced an additional investment of $2.8 billion in its Nanjing foundry in China to increase the production of 28nm automotive semiconductors. This announcement sparked considerable debate in both Taiwan and China. Some in China, comparing this investment to TSMC's planned construction of a $12 billion 5nm production line in Arizona, expressed displeasure and called for a boycott of TSMC's investment in China. However, Chinese state-controlled media calmed the controversy by stating that TSMC's investment could contribute to China's semiconductor growth. One Taiwanese media outlet described the cautiously ongoing relationship between TSMC and Chinese IT firms as "dancing with a wolf," referencing the growth potential of the Chinese market, the uncertainty of the political situation in China, and the risk of technology and talent outflow to Chinese companies.

Another noteworthy aspect of TSMC's strategy is the strengthening of cooperation with Japanese semiconductor companies. TSMC is reportedly planning to build a semiconductor R&D facility in Tsukuba, Japan, with the support of the Japanese government, and is pursuing the construction of a 16nm and 28nm foundry in Kyushu. Japan, under its "New Strategy for Strengthening the Foundation of Digital Industries, Including Semiconductors," has been actively seeking cooperation with TSMC as an opportunity to rebuild its domestic semiconductor industry. TSMC, in turn, has been considering overseas foundry construction to mitigate production risks in Taiwan due to drought and the uncertainties of the Chinese market. This convergence of interests has led to active cooperation between Taiwan and Japan in the semiconductor sector. Europe also seeks cooperation with TSMC to enhance its domestic semiconductor manufacturing capabilities. To date, TSMC has operated its main production facilities within Taiwan and continues to make significant investments in the latest processes in Tainan and other locations. As the strategic value of Taiwanese semiconductor companies has risen amidst the US-China semiconductor conflict, TSMC is now attempting to build and expand production lines overseas in the US, Japan, and China, unlike in the past. It remains to be seen whether this trend will strengthen the US-led global semiconductor supply chain amidst the US-China semiconductor conflict, contribute to the stability of the semiconductor supply chain and sustained global economic growth, or lead to a restructuring of the semiconductor industry in other ways.

4. Outlook

Amidst the US-China semiconductor conflict, Taiwan's semiconductor industry, particularly TSMC, has strategically leveraged its value and responded cautiously and appropriately, while executing strategic choices and investments for sustained growth. However, the future of TSMC, Taiwan, and the semiconductor industry cannot be easily viewed with optimism. This section offers an outlook on the challenges facing TSMC and Taiwan's semiconductor industry. First, there is the risk associated with the US as TSMC's cooperation with the US progresses. TSMC has begun constructing a foundry in Arizona, with reports indicating plans to build up to six production lines, exceeding the initially projected scale. According to the Taiwanese semiconductor industry, addressing the issue of adequate workforce supply for operating a foundry in the US and overcoming a potential 30% decrease in productivity compared to Taiwan are crucial challenges. Market factors have historically hindered the success of specialized semiconductor manufacturing companies in the US; TSMC's investment in the US is driven by national security and alliance logic rather than market considerations, thus posing inherent risks during the construction and operation phases of the foundry. TSMC's US foundry will contribute to building strong relationships with US design companies, further strengthening TSMC's position in the US. Consequently, if the US-led semiconductor alliance operates successfully, the semiconductor industry landscape could be reshaped with a degree of US-China decoupling, excluding China from the highest-level semiconductor process sector. For this optimal scenario, desired by both the US and Taiwan, to materialize, the TSMC-US semiconductor alliance must be well-established. To this end, it is essential to secure sustained support from the current and subsequent US administrations beyond the next 2-3 years when the currently under-construction production lines become operational. Furthermore, US companies like Intel are also planning massive investments in semiconductor processes, and Samsung is scheduled to build advanced process facilities in the US, necessitating a response to the challenges posed by potential competitors. In essence, TSMC's US investment has the potential to maximize synergistic effects from cooperation between Taiwanese and US semiconductor companies and bring about the best outcomes for both the US and Taiwan within the consolidation of the US-led semiconductor alliance. However, it faces challenges related to excess costs, reduced productivity, workforce supply, and the need for sustained political support from the US government over the long term.

Second, the "China risk" arising from the future relationship between Taiwan and China, and the relationship between Chinese semiconductor companies, including TSMC, and other Chinese firms must be considered. The extent to which the Chinese government will tolerate and accept the strengthening of cooperation between Taiwanese semiconductor companies and US semiconductor firms, and the severance of cooperation between Taiwanese and Chinese companies due to US sanctions, remains uncertain. China will not abandon its pursuit of semiconductor dominance and will continue its efforts to achieve it. Indeed, following US export sanctions, Chinese government and corporate entities have been meticulously analyzing their supply chains, components, equipment, and entire production processes to establish indigenous supply chains, often referred to as "red supply chains," excluding US-made parts and equipment. They are also undertaking projects to foster domestic companies in vulnerable areas. Despite these efforts, China faces difficulties and setbacks in acquiring cutting-edge technology, making technical support from Taiwanese semiconductor companies, including TSMC, crucial. The combination of this practical necessity and China's "One China" principle raises the possibility of a crisis materializing at any time and in any form. Furthermore, over the long term, as Chinese companies, backed by capital, market access, strong determination, and government support, enhance their semiconductor process technology innovation capabilities, they may pose a challenge to Taiwan. Taiwan must prepare for a future where it may no longer possess the advanced technologies that China requires, and consider how it will engage with China.

Third, there is the inherent risk within Taiwan itself. Taiwan's export dependence on China, including indirect exports via Hong Kong, is estimated to be around 60%, significantly exceeding the official statistics released by the Taiwanese government. Semiconductors account for approximately 30% of Taiwan's total exports, with the foundry sector comprising about half of that. Even during the tenure of the Democratic Progressive Party (DPP), which advocates for decoupling from China, Taiwan's economic dependence on China has not decreased, and growth rates in sectors other than semiconductors have stagnated. Moreover, Taiwan's semiconductor industry occasionally faces production disruptions due to droughts, earthquakes, and power outages, raising concerns. Taiwan's excessive economic dependence on China and the semiconductor sector, coupled with TSMC's dominance in 54% of the world's outsourced foundry capacity, can act as vulnerabilities for Taiwan and the global semiconductor industry. While TSMC's remarkable achievements contribute to Taiwan's economy and security and enhance its international standing, they also create risks by concentrating too much of the national economy or industry in a single country or company. While this is not an issue when the semiconductor industry and TSMC serve as a strong "silicon shield" for Taiwan, the longevity of this shield is uncertain, and alternative means of hedging risk are insufficient.

Tamsui, located in the northwestern part of Taiwan, has been an important gateway and fortress connecting Taiwan with the outside world since the 17th century. The path leading up to Fort San Domingo (Hongmaocheng) in this area is lined with the flags of eight nations: Spain, the Netherlands, Ming China, Great Britain, Japan, Australia, the United States, and Taiwan. These are the flags of countries that occupied or leased this area, starting with Spain in 1628. It prompts reflection on how long Taiwan's flag can flutter in its current position at the very end. From a semiconductor perspective, for Taiwan to protect its security and prosperity amidst the US-China hegemonic competition, it must desperately strive to maintain its unparalleled superiority in semiconductor process technology and next-generation advanced technologies for as long as possible. Simultaneously, it must prepare for risks arising not only from the threat posed by China's rise but also from cooperation with the US. Furthermore, solutions must be found for Taiwan's excessive economic dependence on China and the semiconductor sector. This is a challenging path, but it is the one Taiwan must take for its continued survival and prosperity.

Taiwan is an important economic partner for South Korea, ranking sixth or seventh in terms of trade volume. Semiconductors constitute 60% of South Korea's imports from Taiwan and 30% of South Korea's total exports to Taiwan. Despite this economic and industrial cooperative relationship, South Korea and Taiwan are primarily perceived as competitors in the semiconductor sector. Indeed, Morris Chang of TSMC has stated that Samsung is its sole competitor. After winning the bid for Apple's smartphone chip processes against Samsung, TSMC has been recognized as the company with the world's leading process technology. Recently, as Samsung has begun to invest aggressively in foundries, TSMC is expanding its foundry capacity even more aggressively to widen the gap. On the other hand, both South Korea and Taiwan share commonalities: they have semiconductor-dependent economic structures, are key partners in the US-led semiconductor alliance, yet cannot afford to abandon their relationship with China. For both South Korea and Taiwan, maintaining an unparalleled advantage in semiconductor manufacturing technology is a critical challenge for their security and prosperity. While competition between South Korea and Taiwan in the semiconductor sector is undeniable, there is also room for cooperation, as both countries can achieve continuous technological innovation only within the context of stable and sustained growth of the overall semiconductor industry. Amidst the US-China technological hegemony conflict, South Korea and Taiwan must jointly explore ways to lead the stable growth of the global semiconductor industry and continuous semiconductor technology innovation through both competition and cooperation. ■

■ Author: Bae Young-ja_Professor of Political Science and International Relations at Konkuk University. She graduated from Seoul National University with a degree in Political Science and International Relations and earned a Ph.D. in Political Science from the University of North Carolina at Chapel Hill. Her main research areas include international political economy, the political economy of foreign investment, science and technology and international politics, the internet and international politics, and science and technology diplomacy. Her major publications include "International Political Hegemony and Technological Innovation: The Case of US Semiconductor Technology" (2020), "The Rise of Chinese Internet Companies and Internet Sovereignty" (2018), "US-China Hegemonic Competition and Scientific and Technological Innovation" (2016), and "Science and Technology and Public Diplomacy" (2013).

■ Managed and Edited by: Baek Jin-kyung _EAI Director of Research

Inquiries: 02 2277 1683 (ext. 209) j.baek@eai.or.kr