Five Market-Oriented Policies to Aid the Semiconductor Industry in the United States

Congress is still debating a $50 billion subsidy package for semiconductor production in the United States. Instead, here are five pro-market policies that would provide the intended results...

I've outlined the numerous (many) reasons why such subsidies are costly and unneeded, as well as the shameful history of comparable industrial policies in the United States, while Congress is currently mulling a $50 billion plus subsidy plan for U.S. semiconductor manufacture. However, this does not entail that the US government should do nothing. Instead, there are numerous horizontal, pro-market policy reforms that would provide significant benefits to chipmakers and other capital-intensive advanced manufacturers in the United States while avoiding the common pitfalls of US industrial policy, such as picking losers, politicization, and hidden economic costs. My top 5 are as follows:

1. Expand immigration

Educated immigrants improve US innovation and productivity, as Cato researchers have long explained, and disproportionately benefit the US semiconductor industry and related ecosystem. Around 40% of high-skilled semiconductor workers in the United States were born outside of the country (mostly in India and China), and 87 percent of semiconductor patents given to top U.S. universities in 2011 included at least one foreign born investor. International students make up two-thirds of graduate students in the top fields that feed the semiconductor industry in the United States, and around 80% of international PhD graduates in these fields stay in the country after graduation (stay rates are at around 90 percent for Chinese and Indian PhD graduates).

Certainly, reforming the educational system in the United States should be a top priority, but the advantages of such reforms will take years to manifest. As a result, high-skilled immigration will continue to be important for the semiconductor industry in the United States to thrive in the future, as both the Biden and Trump administrations have recognized:

"The U.S. has agreed to offer as many working visas as TSMC needs for this purpose" 🤔 https://t.co/06hJ7hCmmc pic.twitter.com/7RSq8j2opT

— Scott Lincicome (@scottlincicome) December 24, 2020

Furthermore, human capital remains one of the United States' most significant advantages over China, whose chip industry has struggled to retain talent, and research shows that previous US restrictions on high-skilled immigration pushed R&D activities offshore (including to China), reducing U.S. innovation and output. Expanding immigration is thus a no-brainer for the country as a whole, with significant benefits for American chipmakers as well.

2. Improve tax treatment of capital investments

According to a recent research by the Tax Foundation, the US tax structure favors capital-intensive firms, such as chipmakers (whose vast facilities, known as "fabs," cost billions of dollars). While most business expenses can be deducted immediately in the year they occur, deductions for physical capital expenses must be stretched out over several years (known as "recovery periods"), resulting in a decrease in the real worth of these deductions due to inflation and the time value of money:

"Recovery durations" differ by asset class, with commercial buildings like fabs having the worst (longest) recovery periods. By requiring chipmakers to stretch their deductions over longer periods of time, the cost of making such capital investments rises (especially in periods of high inflation). Because "physical assets like machinery and structures make up a bigger part of the expenses" of the former category, "any regulation falling short of full, immediate expensing for capital investment placed heavy industry at a disadvantage" versus services (which includes semiconductor manufacturing). "Rather than costly, poorly timed subsidies to [a chip] industry already investing in the United States, Congress could boost investment by abolishing tax penalties against it," the authors conclude.

3. Remove tariffs

Tariffs also raise the expenses of American chipmakers and discourage domestic investment. President Trump's "Section 301" tariffs on Chinese imports, for example, have been requested to be exempted by the US Semiconductor Industry Association because they apply to certain products that American manufacturers use but are in "critically short supply." "Imposing a 25% tariff on imports of the parts and components that go into U.S.-made semiconductor manufacturing equipment and other products in the semiconductor supply chain would substantially increase the cost of semiconductor manufacturing in the United States, and thus disincentivize investments in U.S. manufacturing," according to the group, an outcome that's "directly counter to the bipartisan Administration and Congressional goal of urgently expatriating semiconductor manufacturing equipment and other products in the semiconductor supply chain" – an outcome that' With the stroke of a pen, President Biden could eliminate these levies.

Antidumping and countervailing duty taxes in the United States add insult to injury for chipmakers. These tariffs apply to a wide range of imported construction inputs, as well as ingredients required to make semiconductors, such as glycine from China, India, and Japan, which have been found to dramatically raise domestic pricing. Government money are needed, say proponents of semiconductor subsidies, because building a fab in the United States is so much more expensive than in Asia. Reforming the US system to allow these and other levies to be imposed regardless of consumer or larger economic consequences could help level the playing field.

4. Pursue trade agreements

New US trade agreements are another clear step that would benefit the semiconductor business in the United States. The United States' National Technology and Industrial Base, for example, might be expanded to include allies such as Japan, South Korea, Germany, and the Netherlands, which are dominant in particular phases of the semiconductor supply chain. Only Canada, Australia, and the United Kingdom are presently members of the NTIB, which liberalizes defense-related trade, investment, and R&D collaboration among member countries. Adding more allies would, for example, remove them from US investment screening and loosen US export rules on semiconductors and their components, boosting American business.

More comprehensive US trade agreements, such as the Comprehensive and Progressive Trans Pacific Partnership (formerly the TPP) and the Transatlantic Trade and Investment Partnership with the EU, would increase access to imported semiconductor-related goods and services while lowering foreign barriers to US semiconductors and high-tech devices. The United States is already a top five global exporter of semiconductors and related equipment, and expanding export options would boost domestic sector income and stimulate further investment. Furthermore, removing obstacles to cross-border data flows could increase data-driven stages of semiconductor production as well as commercial activity by semiconductor consumers in the US and overseas (thus increasing demand for chips). It's no wonder, however, that the SIA was a strong backer of the TPP and has urged for the US to join the CPTPP (along with Taiwan and South Korea).

5. Reform export controls

Finally, policymakers in the United States should follow the advice of my Cato colleague Clark Packard and reform the US export controls regime by limiting restrictions to genuine national security threats, excluding goods that are available in other countries, streamlining export licensing processes, and ensuring flexibility through sunset provisions or mandatory annual reviews. Export restrictions (such as those placed by the Trump administration on semiconductors and chipmaking equipment shipped to China) can serve a valid national security purpose, but they can also harm American businesses and discourage investment in the industries they cover (while encouraging investment abroad).

In recent years, semiconductor export rules have been tightened to prevent China from gaining access to American technology. Nonetheless, China is a significant market for American semiconductor companies, and a Boston Consulting Group analysis suggests that retaining or strengthening current export curbs could cost American companies more than Chinese industrial strategy. Furthermore, unilateral export controls are unlikely to prevent China from gaining access to protected technologies and may have unforeseen repercussions. The Trump administration's "effort to limit Chinese advances in semiconductors" (via export restrictions on China's largest chipmaker SMIC) "took a major producer of semiconductors basically offline as companies avoided using their product" (thus reducing global supply) and caused companies to "hoard chips to evade US sanctions," according to Georgetown's Abraham Newman (thus increasing demand). None of this bodes well for the semiconductor business in the United States.

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So far, the Biden administration and its congressional allies have chosen subsidies as the principal means of increasing the semiconductor industry's production capacity. But what these businesses actually need is access to global markets and talent, as well as a business climate that allows them to quickly mobilize resources and scale up production in response to shifting global dynamics. The measures outlined above may not result in a lovely ribbon-cutting photo op for Washington, but they would, unlike industrial policy, assist in achieving the stated semiconductor goals.

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