A Semiconducted Trade War

“The health and vitality of the U.S. semiconductor industry is essential to America’s future competitiveness,” President Ronald Reagan declared while slapping import tariffs on America’s largest Asian trading partner. “We cannot allow it to be jeopardized by unfair trading practices.” Why semiconductors? “Chips,” the New York Times explained, “the tiny slivers of silicon that are the essence of computers and other electronic products, are considered vital to national security.” The year was 1987. The Asian country on track to be No. 1 in technology: Japan.

Last weekend, U.S. President Donald Trump paused his own trade and tech war with an Asian juggernaut. He promised to ease the limits his administration had placed in May on U.S. component sales to Huawei, a Chinese firm that makes cell phones and network equipment and that wants to play a leading role in the global race to build 5G networks. That month, the Trump administration had added Huawei to the Entity List, making it more difficult for Americans to sell to the Chinese firm. The reason? “Huawei has been involved in activities contrary to the national security or foreign policy interests of the United States,” the White House argued. A ban on sales of U.S. components to Huawei would cripple the firm, the thinking went, because it depends on semiconductors from the United States.

Trump has given Huawei a reprieve—for now. Meeting with Chinese President Xi Jinping in Osaka, Japan, for the G-20 summit, Trump declared that he would permit sales to Huawei provided that they did not pose, in the president’s words, a “national emergency problem.” Yet if the history of America’s last great semiconductor struggle is any guide, Huawei’s travails are far from over. The United States has a history of treating semiconductors as different—and more important—than other high-tech goods. Losing dominance in chips, Americans have long feared, could undermine their country’s technological dominance more broadly.

The first clash over semiconductor trade came in the 1980s, after Japanese firms began to produce chips of equivalent quality to American ones—and at much lower cost. Losing global market share, U.S. companies turned to the government for help, complaining that Japanese firms were dumping excessively cheap chips on world markets. Trade hawks took up the cause in Washington, arguing that Japan’s chip capabilities were not only an economic dilemma but also a security threat. U.S. military power had been built on technological superiority. The loss of dominance in semiconductors might even erode America’s military.

Clyde Prestowitz, who served as an advisor to the U.S. Commerce Department in the Reagan administration, feared that the Japanese might even overtake Silicon Valley as a mecca of global innovation. His influential book from the 1980s, Trading Places: How We Are Giving Our Future to Japan and How to Reclaim It, celebrated the “explosion of start-ups and venture capital that transformed a valley of apricot orchards into today’s Mecca of high technology.” Silicon Valley’s success, he argued, was explained by its unique ecosystem and culture. “There were no coats and ties in these new companies, and no chains of command,” Prestowitz marveled, two decades before Mark Zuckerberg and his hoodie arrived in California.

But the valley was vulnerable, Prestowitz and his fellow trade hawks insisted. The risk: Japanese competitors, under the direction of the far-seeing Japanese government. The Japanese were “the most intent watchers” of Silicon Valley’s growth, Prestowitz declared. “They began to organize to take the lead in electronics, as they had already planned to do in steel and other industries.” It looked like they were succeeding. “Whether in disk drives, robots, printers, optical fiber electronics, satellite ground stations, or advanced industrial ceramics, the Japanese have come to dominate.” Semiconductors were at the core of the Japanese threat. They were the singular product that made Silicon Valley an innovation hot spot. Yet by the late 1980s, the Japanese could make them better.

The Reagan administration sprang into action. In 1986, it pressured Japan into agreeing to set a minimum price for chips sold abroad and to promise that its companies would buy more chips from the United States. Dissatisfied with Tokyo’s implementation of this deal, the following year, Washington slapped tariffs on $300 million of imports from Japan to press the country to buy more U.S. chips. The CIA was even recruited, conducting sting operations to reveal that Japanese firms were selling chips abroad below the agreed-on minimum price. Semiconductors were a matter of intense U.S.-Japanese debate well into the 1990s.

What effect did the tariffs and trade regulations have? The mandatory price floor increased semiconductor prices, as was intended. This helped chip-makers but hurt anyone who used semiconductors—that is, the rest of the tech industry. Because the United States had so many tech firms, higher chip prices “almost certainly did more harm to US industrial interests” than to the Japanese, concluded one leading study of semiconductor trade in the 1980s. The imposition of tariffs shifted companies’ attention away from innovation and toward lobbying. Intel’s chairman, the famed inventor Robert Noyce, spent 20 percent of his time in Washington, according to the trade historian Douglas Irwin. It would have been smarter for the United States to keep him in his lab, rather than on the lobbying circuit.

Even still, U.S. chip producers prospered after the semiconductor struggle of the late 1980s. This was not due to tariffs: Some giants of the U.S. semiconductor industry of the late 1980s are no longer around, while other U.S. firms that were tiny, such as Micron, are now world leaders. This suggests that innovation, not protectionism, explains the success of U.S. chip producers today. More evidence: The heavily shielded Japanese chip industry has failed to keep up. In contrast to the 1980s, Japan is now only a middling player in the global market, overtaken by Taiwan and South Korea.

Today, for a U.S. administration enamored of tariffs and centrally planned trade, the semiconductor struggle of the 1980s holds lessons. First, the prophets of doom habitually underestimate U.S. business. Fear that the United States would lose its semiconductor industry peaked just several years before the economic boom of the 1990s, which was driven in large part by tech-enabled productivity increases. Second, research and development matters. Japan did subsidize its firms, but American R&D was 10 times higher when related Defense Department spending was included. Then as now, bolstering domestic innovation is a smarter way to compete than tariffs and bans. When security is at stake, curbing exports to geopolitical rivals may be required. But the core of any national tech strategy should be to build better technology than your competitors. The White House has shown it can take a sledgehammer to tech supply chains. Now it needs to show that it can build up innovation at home.