As AI expands into more and more areas of life, a critical component is fuelling its development: the microchip. These tiny silicon parts, also known as semiconductors, power everything from the most powerful AI model to washing machines and cars. A reliable and trustworthy supply of them is essential, and growing more so with each new technological advance.
As with other strategic sectors, countries are rushing to secure supplies as the international trade system continues to fracture, with the US-China rivalry coming to the fore. The microchip supply chain is also highly concentrated, with just a few companies dominating each level.
Just three US companies – Cadence, Synopsys, and Mentor Graphics – account for about 70 per cent of the market for electronic design automation. Dutch company ASML dominates the global market for machines that can produce the chips, while the manufacture of chips themselves is concentrated in Taiwan and South Korea, where companies fiercely guard their expertise to maintain market advantage. Turning these chips into top-end graphics processing units (GPUs) needed for AI is done mostly by Nvidia in the US.
The EU is attempting to boost its domestic capabilities, from obtaining critical raw materials to manufacturing cutting-edge chips. But with demand increasing rapidly, and with the bloc’s climate ambitions likely conflicting with these industrial goals, it is not clear whether it is doing enough.
The Covid-19 pandemic laid bare the vulnerabilities of this fragmented and siloed microchip supply chain. Lockdowns in 2020 led to significant disruptions in production, just as demand for electronic goods surged as consumers sought out devices to help them study, work and entertain themselves at home. The result was widespread delays and shortages that affected industries around the globe.
A significant part of the demand growth for microchips, particularly for the most advanced models, is likely to come from AI over the next decade. The market for AI-grade microchips could expand tenfold from 2023 to 2033, according to industry projections.
Global contest
The EU last year passed the European Chips Act, aiming to increase its share of global microchip production from around 10 per cent now to 20 per cent by 2030. It plans to mobilise more than €43bn from public and private sources to encourage investment in manufacturing facilities.
But that number pales in comparison to the $280bn (roughly €250bn) allocated by the US under the 2022 CHIPS and Science Act, reflecting the EU’s small budget relative to its constituent states.
The US legislation also aims explicitly to counter China’s efforts in the sector. The US currently holds about 12 per cent of the microchip production market, and China about 20 per cent – but China’s lead is fragile as it relies heavily on equipment imports, particularly for advanced chip production.
In October 2022, two months after passing the CHIPS and Science Act, the US imposed broad export controls on technologies related to advanced microchip production, aimed explicitly at China. It has also been expanding its ‘Entity List’ of companies subjected to tighter restrictions, notably adding Chinese telecom giant Huawei in 2019.
Raquel Jorge, a tech policy analyst at the Elcano Royal Institute think tank in Madrid, tells The Parliament that the upcoming US elections are unlikely to alter the country's stance. “Both the Trump and Biden administrations have expanded sanctions, updated the Entity List, and targeted more firms than in previous administrations,” she says.
The US restrictions have severely limited China’s ability to buy and manufacture cutting-edge microchips. China has been the world’s largest importer of chips since 2005, and spent $350bn (about €313bn) on microchip imports in 2020 alone – more than it spent on crude oil.
This has spurred China to expand its efforts to develop its domestic industry. This year, it invested more than $47bn (about €42bn) in its third investment fund to develop and produce AI-grade microchips. The first fund was created in 2014, substantially before any of the EU’s microchip initiatives.
In 2020, President Xi Jinping said that China aimed to “tighten international production chains’ dependence on China” – in several sectors, not just microchips – to allow the country to respond in kind to hostile trade measures.
China also has a strong position in the market for older generations of chips known as legacy chips, producing around 60 per cent of the global total. While of limited use in the AI race, these are still used in a wide variety of consumer goods, and global dominance of this market could put China in a strong position to extract concessions from its trading partners.
European countries risk becoming “overly reliant on Chinese suppliers,” Chris Miller, the author of Chip War, tells The Parliament: “This would give China leverage. Today, European leaders are blind to this risk.”
The US ban on exporting certain components has also pushed China to invest in alternative technologies. If it makes significant breakthroughs, that could cement its overall lead in the sector. Tsinghua University in Beijing, for instance, is developing a particle accelerator to create a high-quality light source for chip manufacturing, potentially allowing for the production of advanced chips without western technology.
The rare earths dilemma
Look further up the supply chain and China has another ace up its sleeve in the form of rare earth elements, a set of scarce heavy metals which are crucial in developing microchips. China currently produces 60 per cent of the world’s rare earths and processes nearly 90 per cent.
This gives China a point of leverage that it isn’t afraid to exploit: in 2010, it briefly restricted rare earth exports to Japan during a fishing dispute. This precedent raises concerns that China could employ similar tactics against the EU and the US, potentially using its dominance in rare earths as a bargaining chip in geopolitical negotiations.
The EU currently relies on China for around 98 per cent of its rare earth imports. To address this, the EU has passed the Critical Raw Materials Act to diversify its sources beyond China – but, as with the European Chips Act, there are questions over whether it does enough.
“For at least the next five to 10 years, the whole supply chain will depend on rare earths coming from China,” says Patrick Schröder, a researcher at London-based think tank Chatham House. “Even if Europe were to restart mining, the question is whether this would be sufficient, given that the demand with AI will amply increase.”
The EU has therefore been seeking to secure imports from elsewhere, and has signed deals with a dozen countries around the world including Kazakhstan and Namibia – though these nations currently have limited production capacity.
There are also reserves in Europe itself: Norway recently discovered the largest proven deposit on the continent. But Schröder cautions that the process of exploiting these resources could be lengthy, given the ecological considerations surrounding mining in certain areas.
Climate concerns
Besides local ecology, broader concerns about the climate could hamper Europe’s exploitation of rare earths – as well as processes further down the microchip production chain – giving its policymakers some difficult trade-offs to consider.
To reach 20 per cent of global production of chips by 2030 as set out in the Chips Act, the European industry’s emissions could rise eightfold, researchers have found, surpassing those of other heavy industries.
Extracting rare earths requires large quantities of water and energy, and releases considerable carbon emissions. Microchip production also requires chemicals such as fluorinated gases, which have substantial emissions and risk contaminating the environment.
AI applications themselves burn through huge amounts of electricity. The world’s existing data centres would require 508 terawatt hours per year, if run constantly. This is more than countries like Italy.
As a European Commission spokesperson tells The Parliament: “Europe’s strict environmental standards, heavy use of renewable energy, and advanced resource-efficient manufacturing practices” ensure that chip production on the continent minimises emissions and waste.
The Chips Act itself contains provisions for sustainability, the spokesperson adds, encouraging energy-efficient and sustainable production processes.
Schröder points to a largely untapped potential in chip recycling, with companies such as US-based IC Recovery now offering chip recovery services. IC Recovery can reclaim chips for reuse at a fraction of the cost of buying new ones.
Aligning the Chips Act with the Circular Electronics Initiative could also help combine technological advancement with circular economy principles in the microchip industry. Other initiatives, like the new Green Industrial Plan, also support the competitiveness of Europe’s net-zero industry for clean technologies and could support the EU with its supply chain, while minimising its impact on the climate.
The question is whether it can remain competitive with the US and China while doing so. And as the race for AI heats up, the EU can’t afford any hindrances to its industrial policy.