Stanford’s Al Sykes on the $280 Billion Chips and Science Act, Government Intervention, and Trade

On July 27, 2022, the Senate approved the $280 billion “Chips and Science Act,” which is reportedly aimed at countering China by building up America’s chip manufacturing and developing other technological innovations. This bill, which passed the Senate with bipartisan support, has been called a national security and economic bill. Here, Stanford Law Professor Alan O. Sykes, a leading expert on the application of economics to legal problems, discusses the bill.

Stanford Law Professor Alan O. Sykes

What are your initial thoughts about the bill?

The first point to note is that of the $280 billion price tag, over $200 billion has no immediate connection to the semiconductor industry.  The bill provides numerous federal agencies with money to fund a wide range of research and educational programs.  I offer no opinion on the wisdom of these expenditures, and indeed the details of what will be funded are not yet known.

The remaining “Chips” portion of the Act provides direct subsidies as well as tax incentives for the expansion of chip manufacturing in the United States.  These subsidies can be utilized by both American and foreign companies building U.S. facilities, subject to restrictions on their ability to expand their production in China.

The Chips Act seems to be a recognition that offshoring suppliers of key components of the supply chain, whether gas from Russia or chips from China, is risky. What are your thoughts? Are there risks of government intervention like this?

One line of argument for the Chips legislation focuses specifically on China and Taiwan.  Their reported market shares of semiconductor revenue today are equal to 24% and 21%, respectively.  Taiwan is also the world’s largest semiconductor “foundry” providing chips to companies that outsource their production.  If China were to acquire control over Taiwan’s industry, proponents of the Chips Act argue, the United States would be at the mercy of a Chinese “monopoly” that could extract exorbitant prices or cut off supplies for political reasons.   This line of argument thus blends worry about the economic consequences of Chinese market power with fear that Chinese dominance would be a threat to national security.

Of course, if China were to disrupt pricing or supplies, it would invite additional production and new entry into the industry elsewhere, and over time China’s power would erode.  But the potential adverse consequences in the short-term, in the view of the Act’s proponents, justify government-funded investment to expand U.S. capacity now.

This argument is difficult to evaluate in part because it rests on an assessment of China’s plans with respect to Taiwan and a forecast of China’s behavior should Taiwan fall under Chinese control.  It is also difficult to assess whether the subsidies and tax credits under the Chips Act will result in enough new capacity to address any worrisome scenarios in a timely fashion.

Some of the other arguments put forward by proponents of the Chips Act are reminiscent of industrial policy arguments found in the economic literature on “strategic trade” policy.  These arguments rest on the idea that some industries yield higher returns to their home countries than others because of above-normal profits earned in foreign markets or intellectual spillovers among local firms (often said to explain the concentration of high technology firms in Silicon Valley).  In such industries, the argument runs, countries can benefit from policies (such as subsidies or trade protection) that encourage the industry to locate domestically rather than abroad.  This thinking is often thought to have the most plausibility in high technology settings.

Such arguments for government intervention have some important shortcomings.  First, intervention primarily shifts profits and spillovers from one country to another, with no net gain from a global perspective.  If multiple countries engage in such policies simultaneously, they may accomplish nothing.  Second, even the economists who made central theoretical contributions to the strategic trade literature, such as Paul Krugman, have expressed skepticism about the ability of governments to identify appropriate settings for intervention and to avoid interest group capture.  Government efforts to “pick winners and losers” may simply dissipate resources and achieve little in practice even from the parochial perspective.   In that regard, it is hardly clear that chip manufacturing, particularly of the “commodity” chips that are now most often made overseas, is a good fit for the “strategic trade” framework.

You’ve written critically about the previous administration’s “buy American” initiatives in “The International Law and Economics of Buy American Requirements” (chapter in Sharing the Gains of the U.S./Global Economy: Proceedings of the New York University 70th Conference on Labor, 2021).  How does this new legislation compare to that, regarding WTO laws and risks?

The Chips Act is a “produce American” rather than “buy American” (or “domestic content”) measure.  Both types of policies are often justified by their proponents on industrial policy or national security grounds.  Both have adverse effects on foreign producers who must compete with subsidies or who find some of the market foreclosed to them.  And both have the potential to encourage production by higher cost and less efficient firms, which are competitive only by virtue of the subsidies they receive or the preferences they receive from buyers.

These policies are simply two among a host of instruments that favor domestic producers over their foreign competitors, including tariffs, quotas, and discriminatory regulatory policies.  All these instruments are subject to international legal disciplines under the rules of the World Trade Organization and numerous smaller scale trade agreements such as the US-Mexico-Canada Agreement.

Under WTO law, the Chips Act is a “domestic subsidy” because it is targeted at a particular industry and makes financial contributions to that industry through direct payments and tax subsidies.  Such subsidies are not prohibited but are potentially “actionable” at the WTO if they cause injury to foreign producers of semiconductors seeking to sell into the U.S. market or some third country market in competition with subsidized products.  In addition, if chips produced by subsidized facilities or firms are exported, they are potentially subject to “countervailing duties” imposed by the importing country if their presence in the export market causes “material injury” to producers in that market.

Trade disputes under international rules in the semiconductor industry have arisen in the past.  Several decades ago, Japanese semiconductor manufacturers were accused of “dumping” their products in foreign markets and anti-dumping duties were imposed or threatened.  Japan eventually “settled” some of the disputes with the United States by agreeing to restrict its semiconductor exports, leading to a further dispute under international rules when Europe complained that the settlement had caused semiconductor prices to increase in the European market.

You’ve also written about forced technology transfers that have been central to the ongoing U.S.-China trade war. Is this bill part of the pushback by America and American businesses?

Any effect on technology transfer is indirect and collateral.  The legislation does provide that companies cannot receive subsidies if they build new semiconductor production capacity in China or expand existing capacity.   But it does not address the usual channels through which technology transfer is thought to occur.  The legislation does not address alleged intellectual property theft by China, preclude joint ventures with Chinese companies or introduce any new limits on U.S. exports to China or Chinese investment in the United States.

And you’ve written about the economics and legal issues arising from the pandemic such as export restrictions. Can you talk about the effects the pandemic has had on international trade and how much you expect to be ongoing? Is this bill a continuation of a trend?

The pandemic has had a variety of effects on international trade. The accompanying economic downturn led to a contraction in world trade in many things.  But it also led to an expansion in the demand for things that people need to work remotely or to entertain themselves while in social isolation.  In addition, shutdowns and lockdowns created shortages of numerous products and disrupted global supply chains in many industries.  The exigent public health issues also led numerous governments to intervene to restrict exports of medical supplies needed to respond to the pandemic.

A combination of pandemic-related demand and supply shocks has had a large effect on the semiconductor industry, with widely reported shortages of chips for end products such as automobiles and consumer electronics.  I have little doubt that these developments have importantly affected the political atmospherics surrounding the passage of the Chips Act—the recent shortages play into the hands of those who insist that we need to subsidize the growth of domestic capacity.

Of course, legislation like the Chips Act makes little sense in response to the issues raised by the pandemic.  The pandemic’s effects on supply chains may soon be behind us, and the potential challenges associated with future pandemics, whenever they may occur, are unknown.  The private sector will no doubt draw lessons from the pandemic about supply chain resiliency and adapt to these lessons over time.  Governments may also learn from the experience about the importance of stockpiling certain types of supplies to address emergency scenarios.  But it is difficult to find a rationale from the pandemic for subsidizing semiconductor manufacturing.

Alan O. Sykes is a leading expert on the application of economics to legal problems whose most recent scholarship is focused on international economic relations. His writing and teaching have encompassed international trade, torts, contracts, insurance, antitrust, international investment law and economic analysis of law. In 2010, he founded Stanford Law School’s LLM program in International Economic Law, Business and Policy (IELBP). Professor Sykes has been a member of the executive committee and the board of the American Law and Economics Association, and served as reporter for the American Law Institute Project on Principles of Trade Law: The World Trade Organization. He is on the Board of Editors for the Journal of International Economic Law and the World Trade Review. He formerly served as a member of the editorial board of the American Journal of International Law, and as an editor of the Journal of Legal Studies and the Journal of Law and Economics. He is also a former National Science Foundation graduate fellow in the Department of Economics at Yale University.