The ambiguous position of the South Korean semiconductor industry in the US-China tech war

On 7 October, the US Bureau of Industry and Security (BIS) announced a new round of restrictions to prevent China from obtaining advanced computer chips and manufacturing advanced semiconductors. The sanctions complement an earlier package announced in September and are part of a broader framework with two objectives.

The first one is to strengthen the US semiconductor industry through significant investment. In this sense, President Joe Biden signed the CHIPS and Science Act (for “Creating Helpful Incentives to Produce Semiconductors“) in August with the aim of injecting 52 billion dollars into this sector in the years to come. The Act seeks to strengthen US manufacturing, supply chains, and national security, and to invest in R&D, to ensure that the United States remains the leader in the semiconductor industry.

The second one is to stem or even stop the rise of China in this industrial sector. The PRC’s new five-year plan for the period 2021-25 adopted in October 2020 clearly marks basic research as a key priority and semiconductors have been identified as one of the seven areas that will be prioritised for funding and resources. The stated goal is to make the country the world leader in AI by 2030. To achieve this, China has invested more than $200 billion since 2014 in the sector to control the entire supply chain on its soil and incentives have been renewed.

Containing Beijing in the medium term has thus become a crucial issue for Washington, especially as the East Asian country’s technological and economic advance threatens the United States’ position as world leader in the semiconductor sector. Due to their extraterritorial nature, the US sanctions (detailed in this report by the Centre for Strategic & International Studies) are expected to have an impact on the world’s second largest semiconductor industry, South Korea’s.

Indeed, in 2020, South Korea accounted for 18.4% of this huge, multi-hundred billion dollar and steadily growing market ($439 billion in 2020, $595 billion in 2021 and $676 billion estimated in 2022). In particular, the country accounted for 56.9% of the global memory semiconductor market. Still in 2020, its total semiconductor exports amounted to $99.2 billion, of which memory semiconductors accounted for $63.9 billion or 64.4%. Semiconductors are one of Korea’s most important exports. It accounts for 19.3% of total exports in 2020 and is the backbone of the Korean economy and industry, according to Invest Korea.

Compared to competing countries, Korea is not competitive in terms of number of companies, size and human resources, despite the ambitious K-Semiconductor Belt plan to make the local industry more self-sufficient. The sector employs 165,000 people and is driven by two integrated device manufacturers (IDMs; an IDM is a company that masters all stages of production, from design to packaging, including the complex step of etching), Samsung Electronics and SK Hynix, two of the world’s largest semiconductor producers. In terms of basic technology, Korea is at the stage of designing semiconductors by incorporating semiconductor design patterns, which were developed outside the country – mostly in the United States – and are subject to intellectual property rights and also fall under the spectrum of US sanctions. Moreover, to meet the ever-increasing demand (according to the SIA, the semiconductor market grew at a compound annual growth rate of 7.5% between 1990 and 2020), Korean companies have invested heavily in China in recent years. In this context, South Korea is in a particularly difficult and ambiguous position.

A South Korean industry that has invested heavily in China

After the US, but almost equally, China is the second largest semiconductor market, accounting for 25% of global consumption. As an article published in The Diplomat pointed out, China is the largest market for South Korean semiconductor companies. According to data from the Korea International Trade Association, mainland China and Hong Kong account for about 60% of Seoul’s semiconductor exports. As said previously, South Korea is a world leader in memory chip production (total market value of $70 billion), and China remains its largest trading partner, accounting for over 48% of South Korea’s memory chip exports.

Many foreign semiconductor companies operate manufacturing and design facilities in China, including of course the South Korean chip giants. The latter have invested billions of dollars in key manufacturing facilities in China. According to its website, Samsung Electronics has two production centres in China for NAND (a type of flash memory) and DRAM (for Dynamic Random Access Memory) memory in Xi’an and Suzhou and three R&D centres in Xi’an, Suzhou and Hangzhou (two more than in South Korea). Its two factories in Xi’an account for 42.5% of its total NAND production capacity and 15.3% of global NAND production capacity. This is the company’s largest overseas investment in chip production, with an initial cost of $7 billion. SK Hynix has built its DRAM and NAND memory chip production facilities in the Chinese cities of Wuxi, Chongqing and Dalian but has no R&D centres in the country according to its website. Wuxi’s facility produces more than 40% of the company’s DRAM chips, its main business. These examples can be multiplied if the investments of the numerous South Korean fabless companies are also considered, but focusing on the two IDMs is more striking given the sums involved.

In the light of these few elements, it is quite easy to understand why South Korea is closely observing the developments of this Sino-American trade war because the consequences for its semiconductor industry could be dramatic. At the same time, it can be noted that this same industry has strengthened its ties with its American partners as if to ensure a certain security should things go wrong.

A South Korean industry closely linked to American technology

South Korea’s industry owes much to the US Indeed, following the Korean War, the country benefited massively from American economic aid (from 600 to 900 million dollars per year) in the 1960s and was able to take advantage of its cheap labour to position itself in the labour-intensive semiconductor manufacturing process. Domestic companies began to invest in their own semiconductor production in the 1980s.

As Korea’s economy has grown without the need for US aid, trade and investment links have become an increasingly important aspect of the relationship between the two countries. This is exemplified by the implementation of the Korea-US Free Trade Agreement which came into force in 2012 and was amended in 2018. As of 2019, South Korea was the sixth largest merchandise trading partner of the United States. In 2019, the US merchandise trade deficit with South Korea was $20.9 billion and it is likely that semiconductors contributed to this.

Partnerships between US and South Korean semiconductor manufacturers are numerous and are based on the comparative advantages that both countries have developed as the supply chain has become more complex. As a design power and the holder of all the licenses for electronic design automation (EDA) tools, the US controls the fabless market through its private companies. It also has the largest number of semiconductor manufacturing facilities in the world. South Korea, on the other hand, has two of the most powerful IDMs in the market, which are on a par with their US counterparts such as Intel or Micron. Samsung Electronics‘ 5nm etching capacity is even higher than that of Intel, which still produces 7nm chips and is expected to produce its first 5nm etched chips next year.

There are not only industrial rivalries but also many alliances and investments on both sides. SK Hynix has teamed up with NVIDIA to supply its new, highest performance DRAM chip, the HBM3. The HBM3 was chosen to be integrated into the NVIDIA H100 GPU and is expected to improve its computing performance. The Korean IDM is even thinking of opening a production centre in the United States. In the other direction, Lam Research, a US company which manufactures etching equipment for the semiconductor industry, has been present in South Korea since 2011 through its Lam Research Manufacturing Korea branch. The company has two factories in the country, the latest of which, inaugurated in 2022 and located in the K-Semiconductor Belt, cost $100 million. These examples show how multiple partnerships play an important role in strengthening the industrial ecosystem of both countries.

An example of this ambiguity: the case of SK Hynix

As mentioned earlier, SK Hynix is the second largest semiconductor manufacturer in South Korea and ranks among the top ten manufacturers in the world. Over the past decade, it has taken full advantage of the fact that the semiconductor industry has a globalised supply chain to set up production centres in China. However, the Sino-American trade war since the Trump presidency risks putting it at odds. The company is therefore trying to balance the two, as is clearly illustrated by its communication about its establishment in Dalian.

In 2021, SK Hynix acquired Intel‘s SSD business and the assets of its NAND flash memory manufacturing facility in Dalian. This action was authorised by CFIUS and the municipality of the Chinese city. The South Korean company published two articles on its website about the news. Both are clearly aimed at two different audiences.

In the article aimed at the Chinese public, SK Hynix refers to its historical ties with China, recalling that it established its first manufacturing plant in the country in 2004 and has been actively expanding its investments there ever since. By 2020, the company had made a cumulative investment of over $20 billion there. The article even quotes Noh Jongwon, executive vice president of SK Hynix: “With deep roots in the Chinese market for more than 17 years, SK Hynix has always sought co-development and co-prosperity with the Chinese market. The quote is clear and the South Korean company even takes the liberty of adding a sentence aimed to please Chinese officials: “SK Hynix aims to further expand its deep-rooted local presence, and will actively work with the forces in government, business, academic and society to reinvent a better future for China’s IT industry and contribute to a more prosperous future for the global IT sector.” No mention is made of the American Intel, which owned the Dalian factory before this takeover.

The tone in the article for the American public is completely opposite. It only mentions the CFIUS approval of the SK Hynix takeover of Intel‘s SSD business. Neither Dalian nor China is cited, even though the two articles deal with the same case and are published less than two months apart.

It is clear how well SK Hynix managed to play both sides of the fence, but that was in 2021 and now, with the US sanctions, the company knows that it can no longer do what it did before. It is even considering selling all its factories in China and repatriating everything to South Korea if the export restrictions become too severe.

South Korea’s semiconductor industry at a crossroads

South Korean manufacturers will soon face two overlapping challenges. The first is the current tense environment for the sector. After the rise in semiconductor prices during the Covid-19 shortage, inevitable overproduction and falling component prices threaten. This is the end of a cycle that had previously been bullish. The second will be the impact of US sanctions. The stated aim of these is to stifle the Chinese semiconductor industry. South Koreans fear that they will have to choose between their massive investments in China and the traditional economic and technological alliance with the US.

To this end, and perhaps also to force South Korea’s hand, the US announced in March 2022 its “Chips 4 Alliance” project. This alliance would bring together the United States, South Korea, Taiwan and Japan and would have the official goal of eliminating bottlenecks and developing self-sufficiency with the hope of covering all bases in the complex semiconductor supply chain.

However, as China is the largest market for Korean semiconductor companies, the government is wary of the implications and potential restrictions that could be imposed by its neighbour. The last time the South Korean government decided to ally itself with the US explicitly against China’s wishes – by agreeing to deploy US anti-missile systems in 2016 – Beijing imposed harsh embargoes on Korean goods and services in retaliation, crippling its companies that depend on exports.

In October, the Korean government, which until then had been reluctant to discuss the formation of the alliance, joined the discussions. While the “Chips 4 Alliance” remains a work in progress, there is no scenario in which South Korea can continue its balancing act. It will soon be forced to choose sides.

Picture credits: freepik.com