A Brief History of Semiconductors: How The US Cut Costs and Lost the Leading Edge

Semiconductors and Industrial Policy

In our previous piece, we explained how failure to manage aggregate demand led to a stagnation in investment, employment, and output, using the semiconductor industry as a prime example. We also showed how any plan to prevent future shortages would require support for demand in addition to sector-specific supply incentives, if it is to be effective over the long term. Today, we take a wider view, and show how the government guided the early years of semiconductor production using a mixture of supply incentives, demand supports and regulatory coordination to create a robust and innovation-focused competitive ecosystem.

Early Days and Industrial Policy

At the industry’s inception, the US government helped foment a diverse ecology of semiconductor firms using both industrial policy and science policy, to ensure that any scientifically viable approach was also economically viable. Fiscal spending provided the necessary liquidity to get this highly speculative industry off the ground. This strategy required consistent intervention to maintain an innovative and vibrant competitive ecosystem.

The 1970s: Booming Commercial Markets

Between the boom in commercial applications and the absence of serious international competition, the 1970s represented a golden age for US domestic semiconductor firms, despite the relative unimportance of government procurement and guidance.

Source: ICE Semiconductor Data, Authors’ Calculations

The 1980s: Fierce International Competition

However, the optimism and largesse inculcated by this competitive environment was cut short in the 1980s, when the US lost market and technological dominance to Japanese firms guided by industrial policy from the Ministry of International Trade and Industry.

Source: ICE Semiconductor Data, Authors’ Calculation
Source: ICE Semiconductors Data, Authors’ Calculations

The 1990s: Science Policy, Not Industrial Policy

As the industry confronted the technological and competitive changes of the 1980s, the 1990s saw the culmination of the US’ new ‘science policy’ approach. Rather than return to industrial policy — whether the kind the US had used in the past, or an approach more influenced by MITI — the 1990s saw the introduction of “science policy” as the new paradigm for government action in semiconductor manufacturing. Science policy focused on fostering public-private partnerships with individual firms, the closer integration of industry R&D with academic R&D, a broad division of research labor, and an industry structure that allowed innovative firms to run asset-light.

Source: Semiconductor Industry Association
Source: BLS, US Census Bureau, Authors’ Calculations

The 2000s: Dot Com Crash and Diminishing Returns

However, the near-term success of this strategy came at a steep long-term cost. Redundancies in labor and capital helped ensure that firms were able to quickly internalize process improvements while also training the next generation of engineers and technologists. While this duplication may have been “redundant” from the perspective of static maximization of shareholder returns in a single period, it was critical to ensuring long-run innovative trajectories. “Eliminating redundancies” and “increasing fragility” are two sides of the same coin.

Source: https://www.nber.org/system/files/working_papers/w19637/w19637.pdf, Authors’ Calculations
From: https://www.nber.org/system/files/working_papers/w19637/w19637.pdf

The 2010s: ‘Fabless’ Firms, R&D, and Offshoring

Strange inconsistencies and feedback loops have also begun to appear in the path from R&D to production. Key to the science policy strategy was the analytical and economic separation of innovations in intellectual property from innovations in the production process. In layman’s terms, policy privileged research, design and ideas over implementation, production, and investment. The rise of “fabless firms” that leveraged the process improvements of foreign fabrication plants was a direct consequence of this strategy.

Source: American Association for the Advancement of Science, Author’s Calculations
Source: American Association for the Advancement of Science, Author’s Calculations

Today: Policy Implications and Strategy

Now that the US faces a shortage of lagging-edge semiconductors and diminished innovative capacity, policymakers are considering serious interventions. While it is probably too late to address the present shortage, the time to prevent the next shortage is now. Together, the broad bipartisan support for infrastructure spending, the imperative of building back better after the pandemic, and national security anxieties about semiconductor sourcing should encourage policymakers that the time is right for ambitious reforms. As should be clear from the above, the history of industrial policy in semiconductors offers many lessons about how best to create high employment, technological innovation, and robust domestic supply chains.

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Employ America

We write, crunch #’s, and tweet about the labor market and economic policy.