Lutao Ning
East Asian Institute, Faculty of Oriental Studies, Cambridge University, UK

Copyright 2006© Lutao Ning, All Rights Reserved.

This short paper concerns how the role of the state in economic development can cause conflicts during globalisation. By examining the trade disputes between four East Asian countries (Japan, Korea, Taiwan and China), and the US over semiconductors, the findings of this research suggest that the conflicts were caused by tensions between the different development visions held by developing and developed countries.

This paper begins with a briefly discussion on the nature of the semiconductor industry.

Semiconductors have become today’s critical components in most electronics applications ranging from consumer electronics, telecommunications and computers, to industrial equipment and modern military systems. The semiconductor industry is thus an industry that can generate huge external spill over effects for other industries and is also of vital importance to national security. The semiconductor industry is a high tech industry, which is not only capital intensive, but also R&D and scale intensive. Competition among chip producers is typically marked by rapid technological progress and sustained product innovation, which leads to a very short product life cycle. This means that firms must be able to earn sufficient profit in a very short time to both offset the huge upfront R&D and capital expenditure in production associated with each new product lifecycle, and to finance themselves for future cycles. One way to bring the overall cost down is to achieve learning economies, but this often requires experience, and only develops with time. It is thus difficult to do this in the short term. Perhaps, the most economically logical way has been to quickly achieve economies of scale in production: the larger the sales, the lower the marginal costs of production and R&D expenditure. Firms are always on the lookout for bigger and larger international markets and try to achieve scale economies before the end of each product lifecycle in order to maximise their profit, and so to maintain a higher level of R&D and capital spending for future competition rounds.

There are two different schools of thought providing different explanations.

The Neo-liberal view sees the success of the East Asian countries in semiconductors as being the result of continuously borrowing technologies from the West, largely though licensing and by taking advantage of their low labour costs to achieve scale economies in production. There is no significant role of the state and there is no need to ensure the development of indigenous technologies. When multinational firms enter their economies, they will provide these.

The contrary developmental state theory argues that the state role of fostering indigenous technological capability has been crucial in the success of the semiconductor industry. While the availability of a cheap labour force has been essential for these countries to enter the industry, it has hardly been sufficient. None of these East Asian countries could simply "borrow" or "get" newer technologies from the West for industrial upgrading. The result of acquiring technologies from multinational firms was mixed: labour intensive sectors prospered but little was achieved in expansion, diversification and upgrading exports in favour of the high valued added sectors.

Development planners found the only way to move up the value chain was to improve their local technological capabilities. These countries developed an institutional "control mechanism" to achieve this goal. This "control system" was used to selectively discipline, encourage or protect certain economic behaviours of all the parties involved. The control mechanism provided many financial subsidies and tax incentives on selected research projects and production activities as well as shielding emerging domestic markets for local semiconductor business, and heavily investing in public research institutions, industry education and training. To learn from foreign knowledge sources, this mechanism was used to make foreign firms form Joint Ventures with local firms, to impose local content requirements for production and to use domestic market access to trade for newer technologies with foreign firms.

However, both technological acquisition and upfront investment in R&D are still too expensive for latecomers. Even though these countries had allocated huge investment to technological learning, the Western monopoly on science and innovation made it impossible for these countries to keep up with the technological changes in the industry. To increase the chances of survival and to bring the overall R&D cost down, latecomers chose two cost-saving but politically costly methods: One was to imitate new chip designs through "reverse engineering"; The other was to increase firms’ production scale through state financial assistance and fast foreign debt expansion - the larger the sales in international market, the lower the marginal average costs of production and R&D expenditure

In order to survive during the semiconductor industrial downturns, firms became more focused on increasing production scale to maximise their returns on relatively fixed huge R&D and investment in production. When both firms from latecomer and leader countries compete to achieve scale economies by selling in the international market, trade frictions inevitably arose. Firms from leading countries were no longer willing to tolerate latecomers’ cost saving or protectionist practices. They began to lobby their governments to attack foreign imports at home and to force latecomers to remove their interventionist policies. Controls or restrictions over FDI and selective industrial promotion policies were subjected to the WTO rules; "reverse engineering" caused these countries to be subject to bilateral US Intellectual Property Rights protection charges; "expansion of production scale" led to antidumping charges directly against any government attempts to facilitate firms to increase investment scale.

The trade disputes in semiconductors were solved through bilateral trade agreements. The central focus was to push these countries away from interventionist policies which were prohibited under the WTO rules. Heavy US unilateral protectionist measures were put in place for anyone attempting to promote the industry though state intervention and not complying with the "market" rules set by the developed countries. In Japan and Korea’s case, the agreements also included a price floor set by the US to specifically prevent these countries from achieving scale economies in production and undercutting the prices of the US firms.

The US trade dispute over semiconductors with China just like those with other East Asian countries was inevitable because the Chinese government was trying to push through the NIE style strategies to foster indigenous technological capability. This was due to several reasons differing from the commercial concerns of other East Asian countries:

Firstly, given the Cold war influence on today’s international political system, China has been seen by many US policy makers as a significant security threat to the US and Asia Pacific regions. Due to the military implications of the semiconductor sector, China had trade restrictions imposed on it, preventing it from obtaining semiconductor technologies, advanced chips, equipment and technology training. The WTO rules now also prohibit many other promotion policies such as tax preferential policies, limitations on state spending/subsidies in R&D and state procurement, and restrictions on promoting selected industrial activities. China therefore faced difficulties in obtaining technology in the same way as other NIEs, and has to rely on the development of indigenous technological capability.

Secondly, Chinese leaders were anxious that China’s technological dependence on foreign countries, the US in particular, would create serious threats for national autonomy. For example, China suspected that US pressure would be directed against it over the issue of Taiwan. Leaders thus had to continuously emphasise the strategic importance of developing independent and proprietary high technologies as a crucial means to build a modern and economically powerful state.

Thirdly, the government was tempted to promote an indigenous semiconductor industry due to the benefits that could be derived from it. China’s ICT sector has become the second largest sector in the world and has generated huge end use demand for semiconductors. E.g China’s Integrated Circuit consumer market is currently the third largest in the world but China’s own capability can only meet about 30% of the domestic demand.

For these crucial reasons, the Chinese government became more willing to bear the cost of pursuing any interventionist industrial policies that can assist firms to obtain knowledge from the leading countries, foster indigenous technological capabilities for both commercial and defence industries or, increase production scale to offset R&D costs. The political and economic factors therefore made the trade dispute between China and the US inevitable.

The real challenge to solve the future disputes in high tech sectors, perhaps also the challenge to ensure further peaceful global development, was to reconcile the different development visions or political concerns held by latecomers who focus on capacity building at the national level, and leaders who set up international rules based on neo-liberal "market opinions". The current multilateral framework should not avoid such tensions between leaders and latecomers but aim to continuously encourage public discussion in order to find a common international interest for all.

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Readers may contact the author at Ln227@cam.ac.uk (East Asian Institute, Faculty of Oriental Studies, Cambridge University)

Copyright 2006© Lutao Ning, All Rights Reserved.

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