Why China's Chip Industry Won't Catch America's

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China also suffers from an unhealthy competition for marquee facilities among its local governments. This can lead to overinvestment in favored industries, such as semiconductors. SMIC has been hired by at least two city governments to build and manage chip manufacturing plants for which the municipalities, and not SMIC, will bear the risk. This is occurring at a time when China already has excess chip capacity and idle fabrication lines in a number of semiconductor plants. Such lack of market discipline is critical because semiconductor lines not in use have absorbed billions of dollars in investments that could have been used for far more productive endeavors.

Strong Stimulus

None of this is to say that China won't develop the skills to innovate in the future or won't emerge as a formidable competitor in industries like clean energy, where the U.S. has not yet established an effective beachhead. China has a lot of technological strengths and the advantage of large numbers, and it is making massive investments in this area. It will gain sizable cost and technology advantages and some of her entrepreneurs are bound to be both smart and lucky. The current global recession may even work to the benefit of Chinese companies because the government adopted a large stimulus program and consumer purchasing remains strong. And returnees to China from Silicon Valley have begun to add both seasoning and depth to the Chinese entrepreneurial bench. These returnees have worked for top American companies and know how to compete and innovate.

But will China actually overtake the U.S. and other centers of innovation in the next decade in the most complex areas of value creation such as new designs for semiconductors? To get an answer, it's worth revisiting the U.S. experience with Japan in the 1980s. With fears over the loss of competitiveness hanging like a pall over the U.S., the American government negotiated strict trade agreements with Japan and ponied up hundreds of millions of dollars over a decade to help fund a semiconductor R&D consortium. Oddly enough, neither of those moves proved to be hugely consequential; indeed, the trade agreements were somewhat regressive.

Rather, to compete and survive, U.S. companies changed what they were doing. Intel quit the low-profit, low-innovation field of making commodity memory chips and successfully bet the store on microprocessors. Startups, especially in Silicon Valley, exploited opportunities made possible by advances in design automation and by the contract chip manufacturing pioneered in Taiwan to usher in new forms of semiconductor companies that outsourced the relatively low-margin business of chip production. Today the top three design-only (or fabless) companies—Qualcomm (QCOM), Broadcom (BRCM), and Nvidia (NVDA)—are all based in the U.S., and one of them (Nvidia) was launched by a Taiwanese immigrant to the U.S. These multibillion-dollar companies were all started in the decade after 1985, when the fear of Japan was reaching its peak.

Centralized, Not Spontaneous

And what of Japan's monolithic national technology policies? These policies that favored huge business conglomerates like Hitachi and Toshiba stifled the market for chip startups. As a result, Japan to date has no fabless companies of any size, and fabless ethos never caught hold in a corporate culture where ownership of factories is still viewed as essential. Japanese firms have remained overly inward-looking and dependent on the mature and slow-growing domestic market. With a rapidly aging populace and a stagnant economy, this market has lagged behind the rest of the world. The result has been a distinct lack of competitiveness of Japanese companies in the two biggest boom areas of the past two decades, PCs and cell phones.

China is different from Japan in some key ways but not so different that the lessons of Japan Inc. don't apply. The takeaway from Brown and Linden's book is that our fears of Chinese technology dominance are overblown. Yes, China has produced some successful companies, such as search engine Baidu (BIDU) and telecom equipment maker Huawei. Chinese companies lead the world in the fast-growing sector of multiplayer online games. But a centralized effort to replicate the spontaneous upwelling of creativity and innovation, which has formed and informed the U.S. technology sector in general and the semiconductor sector in particular, is a difficult and unlikely route to global technology hegemony.

Wadhwa is senior research associate at the Labor & Worklife Program at Harvard Law School and executive in residence at Duke University. He is an entrepreneur who founded two technology companies. His research can be found at www.globalizationresearch.com. He can be followed on Twitter at vwadhwa.

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