Semiconductor firms cash in with a collective old block on chips. Chris Mouré explains.
Over the past year, looking into the business of semiconductors, I examined the historical relationships between chip production, chip prices, shortages, and profits. I made some surprising findings.
First, there is an inverse correlation between the expansion of chip production and changes in prices in the US. This means that when production growth slows down, so does the rate at which chip prices fall. While this correlation is not immediately surprising, it suggests that collusion among chip producers to raise prices may be occurring. Second, among the largest semiconductor firms, there is an inverse correlation between the rate of new investment and differential earnings, (that is, earnings relative to those of other large firms). Third, there is a close relationship between the appearance of a semiconductor shortage and the differential profitability of these large firms.
This relationship has two salient characteristics. First, shortages tend to appear immediately following a period in which dominant firms trail, rather than beat, average profitability. Second, dominant firms tend to beat average profitability during years in which a shortage appears. So chip shortages do not appear to occur by accident. They are in truth the product of great collaborative deliberation.
Indeed, collusive price cooperation in the semiconductor business has a long history. In the 1980s, US chip producers faced increasing pressure from Japanese firms, who had developed cheaper, more reliable methods of producing the same chips. Unwilling or unable to compete, they turned to the US government. In turn, the US government placed immense pressure on the Japanese to reduce the production and export of chips. The resulting US-Japan Semiconductor Trade Agreement instituted price controls on Japanese semiconductors. Japanese producers cooperated, reducing production, and increasing prices.
Collusive price cooperation in the semiconductor business has a long history.
The immediate effect was a severe global chip shortage in the final years of the 1980s (and large profits for both US and Japanese firms). This was by no means the first chip shortage to occur. However, the outcome of this trade dispute resulted in the creation of a coordinated coalition of global chip producers and national governments, organised around the control of chip production levels in the service of controlling prices.
Since the 1980s, this coalition has shifted in its power and its membership, adding new entrants, and losing others. Currently, concentration in the industry is again at an all-time high. A detailed account of this historical sequence can be found in Kenneth Flamm’s 1996 book, Mismanaged Trade? Strategic Policy in the Semiconductor Industry.
Now the US government is preparing – via the Creating Helpful Incentives to Produce Semiconductors for America (CHIPS) Act – to hand semiconductor firms around $50bn to help solve the ongoing shortage of semiconductors. It’s worth asking therefore: how do large chip producers profit from shortages? The logic is simple: by constraining production, chip producers can increase prices.
Clearly this suggests that there is a structural relationship between the strategic limitation of chip production, differential profitability and perceptions of a chip shortage (see box, Figure it out).
Figure 1 compares the rate of change in US semiconductor production volume and the rate of change of the sector’s price deflator. It shows a very tight negative correlation between change in output volume and change in price. The correlation implies that semiconductor price changes have an inverse relation to changes in production volume. In other words, the greater the constraints on new chip production, the higher the price of chips can potentially rise.
Where figure 1 looks at production and prices, figure 2 compares changes in investment with changes in the rate of profit. To be specific, it compares the rate of change in differential profitability to the rate of change in capital expenditures for the top ten, US-listed semiconductor manufacturing firms, – the Dominant Semiconductor Capital group.
And figure 2 measures the two rates differentially – relative to the average large US firm – because firms tend to judge their own performance relative to the broader business landscape. All firms share a common goal – profit – and investors invest in the firms they think will offer the highest future returns relative to all other available investments. Thus, investors and managers must constantly make comparisons, and a common way they do this is by reference to a benchmark average.
Figure 2 also shows a significant negative correlation. When the rate of new investment slows or decreases, dominant firms tend to increase their differential earnings. This suggests that by strategically limiting production and thereby by creating greater scarcity, dominant semiconductor firms may be able to charge higher prices for their products. Conversely, if production expands too quickly, they are liable to lose control of pricing, resulting in lower relative prices and lower relative profits, and often, lower differential returns.
The negative relationship in figure 2 runs counter to neoclassical economic theory which has profit as a cost of production which, therefore, should increase faster when production accelerates, and contract when production slows down. And under the same theory, profit and production should increase when there is an increase in demand.
So while neoclassical theory says that the growth of profit and production are likely to move together it focuses on absolute profit growth. But in a landscape of shifting prices and antagonistic business relations, what matters is not absolute but relative return on investment.
Figure 3 compares the differential return on equity of Dominant Semiconductor Capital during shortage and non-shortage years. The shaded areas denote “danger zones” – uninterrupted periods of a year or more in which Dominant Semiconductor Capital trailed the average return on equity. All but one danger zone in the figure ended with a perception of a shortage the following year. In other words, the change in fortune from trailing to beating the average is almost always accompanied by the appearance of a shortage.
In addition, firms are more likely to show differential accumulation during shortage years. Shortages accompanied 61% of years in which Dominant Semiconductor Capital exceeded average profitability, whereas shortages coincided with only 28% of years of below average profitability. There are also large differences in the level of differential profitability. From 1980 to 2021, Dominant Semiconductor Capital exceeded the benchmark by an average of 46% during shortage years. During non-shortage years, Dominant Semiconductor Capital only just met the benchmark.
It could, however, be that a shortage is an unintended effect of over-shooting collective constraints on chip production undertaken by Dominant Semiconductor Capital. Yet the periodic regularity of shortages and their correlation with increases in profitability suggest an alternative explanation. Differential prices tend to generate resistance and reaction because they redistribute income. So the creation of an apparent shortage likely plays a crucial role in justifying the rise in chip prices from which firms differentially profit.
The notion that semiconductor firms cannot technically afford new production capacity is clearly false.
While semiconductor company executives complain about the high price of building new production capacity, it is worth measuring their claims against their actions.
The notion that semiconductor firms cannot technically afford new production capacity is clearly false. Firms like Intel currently make record profits. More importantly, if these firms differentially profit by strategically limiting the expansion of productive capacity, then the logic guiding their behaviour runs counter to the supposed aim of the CHIPS Act – which is to expand production. Therefore, it is unlikely that subsidising those profits will solve the problem of periodic semiconductor shortages.
 Changes in the price deflator are a rough proxy for overall price change. The price deflator estimates how much of the change in the dollar value of production is a result of ‘pure’ price changes, as opposed to a change in ‘real’ output.
 I measure differential profitability as the percentage deviation of Dominant Semiconductor Capital’s return on equity from a benchmark average. I calculate the benchmark as the average return on equity of the 500 largest firms by market capitalisation in the Compustat Capital IQ North America database. Return on equity is net income divided by total common equity. The measures for both Dominant Semiconductor Capital and the Compustat 500 are weighted group averages.
 The focus on dominant firms and on differential accumulation stems from my engagement with the theory of “capital as power”, developed by Jonathan Nitzan and Shimshon Bichler. For a greater elaboration of the concept of differential accumulation, see Nitzan, Jonathan. 1998. “Differential Accumulation: Towards a New Political Economy of Capital.” Review of International Political Economy 5, no. 2: 169-216.
 This figure was inspired by the work of Jonathan Nitzan and Shimshon Bichler. They used a similar figure in their study of the differential accumulation of arms and oil producers in relation to Middle East wars. See Figure 5.8, p.237 in: Nitzan, Jonathan, and Shimshon Bichler. 2002. The Global Political Economy of Israel. London: Pluto.
 I measure ‘shortage’ years by the appearance of news headlines announcing or commenting on ongoing semiconductor shortages. Information on sources was gathered through the online database Nexis Uni.