ANALYSIS Why Beijing won't retaliate against Seoul for 'Chip 4'

By Kim Yoo-chul

• Published Aug 8, 2022 8:10 AM KST
• Updated Aug 8, 2022 5:13 PM KST

S. Korea plans to continue cooperating with China to maintain chip resilience

By Kim Yoo-chul

The South Korean government has begun engaging in active diplomacy to allay Beijing's concerns by defining the “Chip 4” alliance as nothing more than a partnership for supply chain resilience as Seoul confirmed its plan to attend a preliminary meeting of the consultative body sometime early September this year.

“The foreign ministry confirmed the country's plan to attend a preliminary meeting of the Chip 4. The South Korean government will react to participating in the meeting to maximize national interests,” an official at the presidential office said, adding that the meeting will be more on a working level.

The Chip 4, initiated by the United States, is seen by Beijing as a move by Washington's to exclude China from global semiconductor value chains.

The alliance intends to bring together the strengths of each of the four partner nations with the United States standing as the global leader in terms of managing the ecosystem from equipment to semiconductor manufacturing, Japan as the leader in key materials supply, and South Korea and Taiwan based on their world-class manufacturing capabilities.

South Korea is home to the world's two largest memory chipmakers ― Samsung Electronics and SK hynix ― while Taiwan's TSMC is the king of the foundry (contract-based chip manufacturing) industry.

The U.S. Congress recently passed the CHIPS and Science Act of 2022, mostly aimed at strengthening itself in its fight against China by investing billions of dollars in domestic semiconductor production. Intel, AMD and Qualcomm, in addition to foreign companies such as Samsung, will benefit greatly from the passage of the Act, which U.S. President Joe Biden is set to officially sign off on early this week.

Because the $280 billion Act includes $52 billion in incentives, as well as an investment tax credit for chip manufacturing, companies that want to receive the federal financial assistance will have to enter an agreement preventing them from upgrading facilities in China for the next 10 years. That means Samsung Electronics will be unable to expand its memory-chip-producing facilities in two Chinese cities ― Xi'an and Suzhou. Also, SK will not be able to invest more in its DRAM and NAND memory chip business facilities in the Chinese cities of Wu'xi and Dalian after the Act goes into effect.

Unsurprisingly, China strongly opposes the idea and is asking South Korea not to participate in the Washington-led policy initiative

The central question is: Will China apply retaliatory measures against Samsung, SK and other South Korean companies in China if Seoul officially participates in the Chip 4?

Previously, in response to Seoul's decision to deploy U.S. anti-missile battery systems years ago, Beijing embargoed Korean goods and services as retaliation, which had a crippling economic impact on South Korean businesses in China.

But China isn't in a position to implement harsh retaliatory measures against Samsung Electronics and SK even after South Korea joins the Chip 4 as Seoul is viewed as a “linchpin” for Beijing given the South Korean chip duo's huge role in feeding China's semiconductor self-sufficiency drive.

More linchpin than cog

“China needs Samsung and SK as Chinese chipmakers are experiencing major troubles due to U.S. sanctions. China has a huge chip problem. Therefore, it doesn't make sense at all for it to hit back with economic retaliations against South Korea for joining the Chip 4,” a senior government official, who is familiar with the issue, said by telephone.

Samsung and SK are both major foreign investors in China.

In the global technology industry, China is still viewed as the “world's factory.” Government data showed China accounted for 70 percent of global demand in notebook PCs and 81 percent in handsets. As of last year, China imported $350 billion worth of semiconductors, which was 13 percent of its total imports.

China plans to invest $1.4 trillion in high-tech industries by 2025 with the country aiming to achieve a 70-percent self-sufficiency rate by then. As the Chinese chip industry is highly focused on labor- and capital-intensive wafer manufacturing, assembly, testing and packaging, its ambitiously-set 2025 goal will only be achievable with support from the South Korean chipmakers amid the U.S.' crackdown on China's tech sector, said officials and policymakers.

“The central point is that without South Korea's assistance, it would be impossible for China to advance its 'leapfrogging strategy,' the strategy which had been embraced by Samsung. The success of this strategy depends on how quickly product development plans take place and how well prepared a company is to mass produce them. Chinese chipmakers are far behind Korean companies and that means China needs Korea's support over the next few more years, at least, to keep its technology industry working,” said Kim Young-woo, head of research at SK Securities in Seoul and an adviser to the South Korean government on semiconductor policy.

Mainland China and Hong Kong accounted for 60 percent of South Korea's semiconductor exports last year. Also, China took up about 48 percent of South Korea's $70 billion memory chip exports in 2021, data from the Korea International Trade Association showed. It is also South Korea's largest trading partner.

SMIC, whose role is crucial in China's chip drive, is hugely struggling in terms of improving the production yields of its memory chips. U.S. sanctions have cut it off from the key equipment it requires to manufacture advanced chips. Yangtze Memory Technologies, another leading Chinese chipmaker, is an example similar to the SMIC case as Washington plans to ban the shipment of U.S. equipment for use in NAND chips to China due to national security concerns.

Because of the complexity of the chip supply chain, it really matters for China to see an indigenization of advanced semiconductor manufacturing equipment (SMEs) to sustain itself. But it doesn't have companies with proven ability to design and manufacture the tools which its chip manufacturers require such as photolithography and metrology. Indigenizing advanced SMEs is a very complicated and time-consuming process.

“China hopes to replicate South Korea's success in semiconductors and this is why China offers massive financial assistance for Samsung and SK on their chip plant operations. However, China is struggling to copy the success of this leapfrogging strategy due to U.S. sanctions and its dependence on foreign companies for chip manufacturing,” said Lee Seung-woo, chief of research at Eugene Investment, adding it's unlikely that China would take economic retaliation against South Korean chipmakers.

“As semiconductors are being used in everything and everywhere and it aims to achieve a 70-percent self-sufficiency rate by 2025, China has to navigate lots of options on how to maintain healthy partnership with South Korean chipmakers,” he added.

Despite 'Chip 4,' China's role still matters

Political analysts and experts say despite increased U.S. scrutiny, it's a too-far scenario for Washington to seek a complete decoupling with Beijing in the semiconductor industry.

Some say the intensity of U.S. actions and export controls would be loosened after the U.S. mid-term elections.

“Over the last few years, several U.S. backbone industries have been suffering a lot from the semiconductor supply chain crunches, a part of the reason for the U.S. economy seeing higher inflation. The 'chip trouble' is also cited as being behind the poor public approval rating of President Joe Biden. Rather than seeking full-scale sanctions, the United States would apply tighter control in a more targeted and limited way,” said an aide to former President Moon Jae-in. The aide was involved in handling the country's key trade policies.

As China is the world's top semiconductor consumer, any chip supply glut would also cause a serious impact to U.S. companies in terms of their profits. “We should not underestimate China's significance as it can take on the role of addressing inventory-related issues, the implication of which is also shared by Chip 4 countries,” he added.

South Korea's chip stockpiles jumped 53.4 percent in May this year from a year earlier, marking the biggest increase in more than four years and suggesting a slowdown in demand for memory chips used in electronics worldwide, according to reports.

Within that context, South Korea is in the process of rewriting its positioning statement regarding the country's participation of the Chip 4.

“Seoul will continue cooperating with Beijing about maintaining chip resilience. Developments regarding how the semiconductor alliance can work and key content to be discussed will follow. But this isn't something intended to exclude a specific country,” another official at the presidential office said.

South Korea plans to speak out on why China's role does matters a lot in terms of defending the best interests of U.S. companies. “You have technology and then you should also have the market to massively sell and distribute it at competitive prices,” Kim Dong-won, an analyst at KB Securities, said.

From industry's standpoint, the deepening feud between the world's top two economies has been forcing companies to reevaluate their investments in China. Samsung and SK won't immediately reduce their exposure, there, as various aspects of the Act still need to be fine-tuned, said company sources.

Samsung Electronics declined to comment, while SK said it is closely monitoring the developments in the U.S. regarding the Act.