Intel’s Troubling Pledge on Outscourcing

Intel has been conspicuous among Silicon Valley high-tech companies, insofar as until now it has resisted the siren song to send much of its manufacturing offshore.  As the Indian Express has written: “The Santa Clara, California-based company has been the largest chipmaker for most of the past 30 years by combining the best designs with cutting-edge factories, several of which are still based in the U.S.” Much of this is a product of the corporate culture established by former CEO, Andy Grove, who years ago warned that outsourcing risked squandering America’s competitive edge in innovation, as well as diminishing high-quality job creation.

Sadly, it appears that Grove’s successors have forgotten his valuable insights, if we are to go from the company’s recent Q2 earnings announcement. In the earnings press release, Intel stated that the planned launch of the company’s next generation of chips would be delayed by 6 months.  News of the production delay (which now pushes the production of the company’s latest central processing unit, the CPU – a.k.a. the “brains” of the laptop – out to early 2023) generated considerable market anxiety, as evidenced by the 16 percent fall in the share price in the wake of the disclosure. From a long-term perspective, however, the more alarming aspect was CEO Bob Swan publicly mooting the possibility of Intel shifting the remainder of its American manufacturing capacity offshore.

While consistent with recent historic trends of other Silicon Valley companies, Swan’s suggestion comes at a time when American policymakers are beginning to appreciate the adverse economic and strategic consequences of such outsourcing.  Were Intel to embrace this option, Taiwan Semiconductor Manufacturing Company (TSMC) would likely be the new beneficiary. That would represent an “own goal” for Intel, as it almost certainly extends TSMC’s advantage in technical execution.

Swan parroted the now standard justification used by all offshoring advocates, suggesting that it mattered little where the chips were actually manufactured. He’s wrong for a number of reasons, many of which were noted by his predecessor. In a New York Times op-ed written by Teresa Tritch shortly after Grove’s death, Tritch articulated Grove’s opposition to outsourcing:

“[T]hose lower Asian costs masked the high price of offshoring as measured by lost jobs and lost expertise. Silicon Valley misjudged the severity of those losses, he wrote, because of a ‘misplaced faith in the power of start-ups to create U.S. jobs.’

“Mr. Grove contrasted the start-up phase of a business, when uses for new technologies are identified, with the scale-up phase, when technology goes from prototype to mass production. Both are important. But only scale-up is an engine for job growth — and scale-up, in general, no longer occurs in the United States. ‘Without scaling,’ he wrote, ‘we don’t just lose jobs — we lose our hold on new technologies’ and ‘ultimately damage our capacity to innovate.’”

Not only would outsourcing damage Intel’s capacity to innovate, but additionally, it would undermine the impact of recent legislative attempts to rebuild the country’s semiconductor manufacturing capacity. It would also exacerbate America’s supply chain reliance on Taiwan for customized semiconductor manufacturing. That in turn raises the prospect of a significant manufacturing disruption were Taiwan to become the focus of a conflict extending beyond today’s hybrid economic warfare between Washington and Beijing, due to the fact that so much customised semiconductor manufacturing already takes place in the country via TSMC.

To address this geostrategic vulnerability, some commentators have suggested that the U.S. should contravene the country’s agreed-upon “One China” policy and move to re-establish formal diplomatic relations with Taiwan. Undoubtedly that would be viewed as highly provocative by Beijing, as it would breach the agreed terms of the 1979 mutual recognition pact, thereby increasing the possibility of a full-scale invasion from mainland China.

Economic competition that potentially degenerates into out and out war would be disastrous for everybody. As David Arase, Resident Professor of International Politics at the Hopkins-Nanjing Center of the Johns Hopkins University School of Advanced International Studies, recently contended in the Asia Times, “Even an unsuccessful invasion of Taiwan would cause a supply chain disruption.”

It is ironic how often American policymakers reflexively look to military solutions to solve a perceived strategic threat, while dismissing the concept of a revived national developmentalist strategy as somehow akin to retrograde “protectionist” thinking. But consider the full implications of a perceived military “solution”: a full-scale defense commitment of Taiwan would cost thousands of lives, and potentially entrench the U.S. military in a long-term quagmire. It would also represent a logistical nightmare in terms of supplying such a force over so many thousands of miles (vs. an opposing Chinese army a mere 100 miles away).  To say nothing of the risks posed to the assets of numerous substantial American multinationals already operating in China, including Intel itself.

U.S. goals should be far more modest: not to underwrite the freedom aspirations of another country (even a vibrant multi-party democracy such as Taiwan) but, rather, to fix a key vulnerability in the global supply chain that currently renders the U.S. so reliant on that country in the first place.  Even TSMC has implicitly acknowledged the risks of placing all of its geographical eggs into one basket; it recently announced plans to build a new $12bn chip manufacturing facility in Arizona. Consider this a form of political risk insurance, much as American companies such as Intel or Micron have diversified geographically.  In addition to its significant production facilities still in the United States, Intel also has facilities in Israel, Ireland and, indeed, China itself.  Similarly, Micron has fabs in Boise Idaho, Utah, and Manassas, VA (right near the CIA and Pentagon).

A better approach is something like the economic  patriotism bill that Joe Biden has proposed: namely, one that would reward companies for insourcing.  Research and development tax credits on their own are unlikely to induce the requisite shift (as these can easily be matched by the recipient investment country’s government). The state can and must drive this redomiciling process in other ways:  via local content requirements (LCRs), tariffs, quotas and/or government procurement local sourcing requirements.  The Biden bill doesn’t go that far, but at least it has changed the political conversation. Both parties are now ostensibly “America Firsters.”

The reticence of policy-makers to move in a more economically nationalist direction in part has reflected an addiction to 19^th century concepts that are anomalous in the context of a 21^st century economy.  But David Ricardo’s  “comparative advantage” – which “refers to an economy’s ability to produce goods and services at a lower opportunity cost than that of trade partners” – has less relevance at a time when such advantage can largely be created as a byproduct of state policy.  That has become increasingly understood by countries all across the world, especially in Asia, where countries such as Japan, Taiwan, South Korea, and, increasingly, China, have begun to dominate targeted industries by subsidizing them aggressively.  Because of increasing returns to scale, there is a winner-take-all pattern that  at any given time means that a limited number of nations tend to dominate a huge global market share of the underlying product—since the 1970s, Japan, South Korea, and China, in that order. It also creates huge employment opportunities in high-quality jobs for the countries that undertake this policy. This was also a key insight of Andy Grove.

None of these countries has had an inherent “comparative advantage” in semiconductors; they just followed the classic pattern of subsidizing their growth via substantial government support (creating them from nothing in the few decades, in the case of South Korea and China), aggressively driving down costs and driving marginal, less efficient producers out of the industry.

Even if this means prioritizing market share over short-term profits (a no-no for Wall Street, which focuses on quarterly earnings as intently as an audience waiting for the white smoke to emerge from a Papal election), the businesses that engage in this strategy can usually recoup the costs later via new oligopoly power. Semiconductors represent a great high value-added, high tech manufacturing platform industry that has employed lots of people, has a huge, growing global market, and a multiplier effect on the domestic economy.  It represents an area that should be prioritized by the U.S., not de-emphasized (as Intel’s proposed move threatens to do). The road back to manufacturing relevance is a long one, but the alternative risks turning the U.S. into a hollow industrial shell, while simultaneously creating new national security vulnerabilities. We don’t want to solve these problems through a perpetual embrace of militarism. We should therefore be doing all we can to dissuade Intel from making a potentially disastrous mistake that would not only exacerbate longstanding problems in the U.S. economy, but also weaken further a flagship American company, which is still a world-class competitor.