Semiconductor scarcity will add inflationary pressures

Alicia Garcia Herrero, Natixis Asia Pacific Chief Economist, Bruegel Senior Fellow

From artificial intelligence (AI) to electric vehicles, the world is heading toward a new era, and semiconductors are central to such development, which is as important as oil was in the previous industrial revolution.

As if this were not enough, chips have taken a critical role in the narrative on supply-chain security in the intensified strategic competition between the US and China. Therefore, building a linkage between the semiconductor industry and geoeconomics is increasingly relevant for the world, and particularly for Asia, which is the largest source of chip demand but with some constraints on supply, especially in China.

This was also the case of oil for many years and, as such, its scarcity led to surges in inflation globally in 1979 and again in 1981.

An important question for producers planning for future capacity and global inflation trends is whether the burst in demand for chips is temporary. While part of the chip shortage is driven by temporary pent-up demand, and more investments are being made to boost supply, we cannot forget that medium-term growth in 5G technologies, electric vehicles, and cryptocurrencies all point to a structural increase in demand with potential implications for inflation.

Furthermore, the chip shortage is a wake-up call for the world to address the fragility of the semiconductor supply chain, with some key areas of production concentrating in a few firms and locations, especially for fabrication and lithography equipment.

Such fragility has become more acute because of the push by several US administrations to contain China at its Achilles’ heel, namely its dependence on the outside world for semiconductors.

The Chinese government and more recently the European Union are rushing to pour money into chip production, but a full vertical integration by a single economy is unlikely. After all, semiconductor production is a symphony of technology, with a complex division of tasks taking place over the years.

In other words, even with a deluge of investment, semiconductor prices are unlikely to fall in the short term except for the ones very easy to replicate.

This basically means that the semiconductor industry, as was the case in the past, will constitute an import source of inflationary pressures, adding to those stemming from the surge in commodity prices.

The only wild card is China. Its massive investment in the semiconductor space will, at some point in time, create excess capacity, but that is very unlikely to happen for the highest-end chips that are the most needed for new technologies.

In other words, China will remain a wild card in the medium term, which may mark a new era for more competition and, thereby, consolidation to drive out inefficient players. For the time being, though, we count on the semiconductor industry driving inflationary pressures.

* This article was originally published by Asia Times at

https://asiatimes.com/2021/06/semiconductor-scarcity-will-add-inflationary-pressures/