China’s Big Play for Small Chips

February 23, 2017, 12:00 PM UTC
Inside RF Micro Devices Integrated Circuits Manufacturing
A technician puts a set of semiconductor wafers through a processing step at RF Micro Devices Inc. (RFMD) headquarters in Greensboro, North Carolina, U.S., on Wednesday, Feb. 15, 2012. RF Micro Devices Inc. manufactures radio-frequency components and semiconductor technologies. Photographer: Victor J. Blue/Bloomberg via Getty Images
Photograph by Victor J. Blue—Bloomberg via Getty Images

Anyone familiar with China’s history of industrial subversion—see the low-price steel or solar panels that have flooded world markets in recent years—will not be surprised to learn that the country is at it again. China’s latest industrial target: semiconductors, the bedrock of modern electronics.

Computer chips power everything from phones and “smart” devices to satellites and advanced weapon systems. Half of the $340 billion in annual semi-conductor sales flows to U.S. tech giants such as Intel, Qualcomm, and Apple. But the industry may soon find itself facing an existential crisis.

According to a U.S. government report released in January, “Chinese policies are distorting markets in ways that undermine innovation, subtract from U.S. market share,” and, because of the chips’ uses in critical infrastructure, “put U.S. national security at risk.” During his confirmation hearing earlier this year for commerce secretary, Wilbur Ross said he, too, was “very, very concerned.”

At issue is the Communist Party leadership’s plan to jolt China’s domestic chip sector with $150 billion in aid from 2015 to 2025. Industry watchers say they have seen this play before: Prop up indigenous businesses with subsidies, flood global markets with supply, and undercut the competition.

Are U.S. companies fighting back? Not exactly. China is the world’s largest chip market, even though it accounts for less than 10% of global sales. And non-Chinese companies have had little choice but to partner with China’s state-backed enterprises to maintain access to its buyers. Companies like Intel, Samsung, and TSMC have invested billions in local projects, joint ventures, and factories.

In the short term that makes sense, says IDC industry analyst Mario Morales. But in the long term, chipmakers should worry. “These guys are scaling so fast,” he says of Chinese challengers like Huawei, “they’ll inevitably catch up and surpass.”

A version of this article appears in the March 1, 2017 issue of Fortune with the headline “China’s Big Play for Small Chips.”