The CHIPS and Science Act: A potential regulatory issue

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Industrial policy is back with a bang. The COVID-19 pandemic revealed vulnerabilities in global supply chains, prompting intense debates in Congress about government's role in the U.S. economy. The response has been increased support for favored domestic industries. But those decisions presage other problems.

Central to the discussions has been the concern that certain foreign governments strategically support and guide their industries, potentially eroding the global market share and competitiveness of the United States and other nations. Among the various industrial policies, the CHIPS (Creating Helpful Incentives to Produce Semiconductors) and Science Act of 2022 to help reshore the fabrication of computer chips stands out.

According to a study by the Semiconductor Industry Association, the US share of global semiconductor manufacturing fell from 19% in 2000 to 12% in 2020. This is largely because the US has become more reliant on offshore semiconductor production, with particular concern about the rise of China as a global player in chip manufacture.

Given the geopolitical friction between the US and China as the west becomes more skeptical of the benefits of globalization, US policymakers want the nation to be self-reliant in semiconductor production. They also claim US national security concerns. The CHIPS Act aims to increase US domestic semiconductor manufacturing capacity by more than 1 million wafers per month. This will involve subsidies, promising US$39 billion of manufacturing incentives on top of 25 percent investment tax credits.

Why does this matter? Because government funding comes with strings attached, as our colleague Wayne Crews attests. Massive government spending and investments have already reshaped, and will continue to reshape, the industries involved in major enterprises and transactions. The resulting complexities and distortions make a mockery of the concept of free enterprise.

Cutting-edge advances like infrastructure, artificial intelligence, smart cities, and space exploration now predominantly take the form of partnerships with governments, rather than relying on free enterprise. The partnership approach is a mistake, however. As Wayne says, "It is not the job of the government to pick the winning racehorses [technologies], but to improve the track [the business, legal and regulatory environment] so that all the horses can run faster."

Instead, the horses are getting bogged down in bureaucracy. Since the CHIPS Act passed in August 2022, the Commerce Department has received almost 200 applications and concept proposals. However, the actual disbursement from the $39 billion allocated by the legislation has only been several hundred million dollars. The challenge lies in how to ensure that funds are effectively utilized to bolster the semiconductor industry and drive technological advancements.

The CHIPS Act, despite its noble intentions, is fundamentally flawed due to two key issues. The first is the knowledge problem: without the market's guiding forces of profits, losses, and prices, government officials are left in the dark about which projects are worthy of investment. The second issue is the public choice problem: the influence of lobbyists and the tendency of policymakers to favor projects with voter or media appeal over those with genuine merit. These dual hurdles of knowledge and public choice make the success of the CHIPS Act highly unlikely.

The CHIPS Act allocates $280 billion over the next decade, with $200 billion intended for scientific R&D and commercialization. Additionally, $52.7 billion is intended for semiconductor manufacturing, R&D, and workforce development, along with $24 billion in tax credits for chip production. Yet just to reshore enough production to meet 2019 would cost industry $1.2 trillion. This does not include ongoing expenses related to R&D, innovation, and the establishment of cutting-edge fabrication facilities for state-of-the-art chips. Achieving self-sufficiency in chip production for existing market demands seems implausible and a bad use of scarce resources.

Paradoxically, accepting subsidies under this Act might actually increase regulatory compliance costs. As a result, US firms' competitiveness relative to Asian manufacturers could suffer, which will likely spur demand for yet more subsidies.

Policymakers must acknowledge both the limitations and the harm resulting from a politically driven research and development approach. In contrast, strategies focused on competitiveness, rather than politics, will prove more agile and effective in advancing innovation, supporting commerce, securing supply chains, promoting clean energy, ensuring consumer well-being, and elevating the United States' global competitive standing.

Providing subsidies to established corporations and allowing government intervention in the industry is unlikely to make that happen.