As if we don’t have enough problems to contend with in our fledgling economy as it attempts to rebound in the face of COVID-19 issues, we are now facing a serious economic drag that may persist well into 2022 if not beyond. We are facing a significant worldwide semiconductor microchip shortage that “has created serious anxiety in some industries and even caused automakers to halt production in several factories across North America,” according to the Brookings Institute.
Microchips, COVID-19, and Auto Production
So acute is the shortage that it is causing automakers to cut or in some cases, completely halt production. Whether it’s a Ford plant in Louisville, Kentucky, or Fiat Chrysler in Brampton, Ontario, automakers around the world are idling production and shifting their priorities to stay afloat. Initially, the shortage was caused by a complex interplay of factors precipitated by the CIVID-19 pandemic. During the initial shutdown phase, which persisted through a good portion of 2020, people began to order a lot of items and materials through the internet. Many of these items are electronic, which often require semiconductor chips.
This onslaught of demand drained the semiconductor supply, so when automakers, who had largely been shuttered due to low demand throughout the initial stages of the pandemic, came back online in 2021, they faced a serious shortage of semiconductors. There was to a degree, a bit of shortsightedness on the behalf of the automakers. Michelle Krebs, executive analyst for Autotrader, points out that “The automakers, who have experienced previous recessions, quickly canceled orders for parts with computer chips, thinking auto sales would nosedive.”
And although the demand did initially plunge, when vaccines came into place and we started to feel like we were turning a corner on the pandemic, demand suddenly surged, catching automakers off-guard. As Don Clark, a contributor to The New York Times on technology issues, explains, “when the car guys came back around in the September time frame, they basically had lost their place in the manufacturing queue to get chip supplies.”
Moreover, during the same time frame, the overall demand for chips was increasing because more and more products are using the chips, including cars. In fact, some car parts could use 500 to 1,500 chips depending on the complexity of the part, and a modern electric vehicle can use up to 3,000 chips, according to some estimates. Each year, as cars increase in complexity, they utilize more and more chips, adding to the overall demand. As Car and Driver states, “The microprocessors and chips that power modern vehicles are now so prevalent that they’re practically a commodity in the same vein as steel and aluminum.”
Source: fool.com
Microchips and Supply-Side Issues
Yet, blaming everything on COVID-19 is not completely accurate, either. Christian Lanng, CEO of Tradeshift, contends, “It is the logical outcome for a supply chain sector that has been asking far too much of outdated technologies for far too long. COVID-19 wasn’t the cause: it was merely the tide that went out and showed which businesses had been swimming naked.”
Another supply-side factor contributing to the chip shortage is the fact that manufacturers operate in boom and bust fashion in order to maximize profit and minimize loss, much like big oil companies. As Clark elaborates, “The history of the chip industry has been marked by these periods where they built too many factories so there’s a glut of chips or they built too few factories and there’s a shortage of chips.”
Complicating the shortage is the fact that there is an all-too-real production limitation caused by the existing technology of current chip plants. In essence, the machinery used to create chips is ostensibly outdated because the machine parts needed to scale up aren’t being manufactured anymore. As a result, the only other option is to build a new chip plant.
The Cost of Making Microchips
However, it takes between 3-5 years to build a semiconductor foundry, at a cost of upwards of $ 5 billion, Extreme Tech reports. Furthermore, there is a mismatch between economic cycles that are favorable to building semiconductor foundries and the cycles of macroeconomic supply and demand. Semiconductor Magazine frames it this way:
“It takes more than two years to build a fab and ramp production. However, technology transitions happen approximately every 18 months, and semiconductor sales peak every 24‐36 months. Neither technology roadmaps nor market forecasts are reliable two years into the future. Yet bringing up production of the wrong technology in the middle of a downturn can have disastrous financial consequences.”
Additionally, the very nearly glacial nature of how semiconductor chips are made influences how quickly, or more appropriately, how slowly, a foundry can crank out functioning chips. That’s because chips are not built in a few steps, but in several hundred steps in a multi-layered, painstaking process. Christopher Belfi, a supervisor at GlobalFoundries, a chip manufacturer in Malta, N.Y., offers the following analogy: “Think about making a cake. In this case, it’s going to be a 60- to 75-layer cake, and that cake is built over approximately two and a half, three months.”
Microchips and Business Decisions
All of these issues are compounded by the calculus that goes into how to prioritize the use of limited chips to which automakers do have access. To begin with, automakers must decide whether to preference their chip usage to cars with combustible engines, or to electric vehicles (EV), which are becoming more in demand as the technologies and market evolve.
Burke Files, Advisor to the Board at Unicus Research, puts it this way: “If we assume all orders are filled — which they won’t be — the EV makers still face significant expenditures of cash just waiting for the chips and paying an estimate two to three times what was budgeted. Many of the startup EV makers just do not have enough cash to wait a year for the chips.”
When you combine global supply-chain issues, complex market timing, the lag time of building a foundry, the byzantine manner in which chips are created, and the business preferences made by automakers, you have the perfect storm for a sustained shortage.
Microchips and Downstream Damage
And there are downstream consequences not just for the consumer, but for auto manufacturing employees as well. Even though the auto industry has mostly recovered, the methods they used to recover have had a deleterious effect on the average worker. In response to the microchip shortage, not only did automakers increase the sticker prices, they also laid-off employees. Business Insider writes even “with the economy recovering and the auto market hotter than ever, some dealerships aren’t planning to hire back the employees they cut loose last year.”
The bottom line is that this dynamic has led to a hyper-competitive environment in which automakers can choose from the elite pool of employees that demonstrate the highest productivity values. As David Smith, CEO of Sonic Automotive, argues,”We tried to keep the ‘A’ players and they are a lot more productive. I think they are happier making more money.”
Not everyone feels so fortunate.
Paul Jacques, who works in Tecumseh, Ontario, for a division of components supplier Magna International, is fearful about the future. Amid rumors of layoffs, Jacques laments, “The mood became incredibly somber,” at the manufacturing plant.
And on a larger scale, the microchip shortage may eventually cause a ripple effect in the highly interconnected global economy because automakers create a huge demand for other items and materials, including plastics and steel. Indirectly, they also support, “vast supplier networks as well as restaurants and grocery stores that feed autoworkers.”
Analysis by the Center for Automotive Research (CAR) reveals that historically, automakers “have contributed 3 – 3.5 percent to the overall Gross Domestic Product (GDP),” and moreover are “a major driver of the 11.5% manufacturing contribution to GDP.” So extensive is the reach of this industry that CAR states “Without the auto sector, it is difficult to imagine manufacturing surviving in this country.”
Of course, it’s hard to imagine that automakers will go completely under. In addition to trimming the number of workers and passing costs on to the consumer, we have a history of rescuing these giants.
During the great recession of 2009, the Obama Administration bailed out General Motors (GM) to the tune of $11.2 billion, despite the fact that GM later shut down factories. A central issue was a lack of stipulations that usually accompany traditional bankruptcy proceedings. Writing for HubPages, GA Anderson reminds us that “many industry and bankruptcy experts are convinced there would have been other avenues available for GM to emerge from a Chapter 13 filing that would have resulted in the same job and tax income savings in the report without the government’s intervention.”
Just a year and a half ago, members of Congress pushed for a large-scale bailout of the auto-manufacturing sector. And though the push was mostly unsuccessful, there were carveouts for some, such as Telsa, who stated in a regulatory filing, “As part of various governmental responses to the pandemic granted to companies globally, we received certain payroll-related benefits which helped to reduce the impact of the COVID-19 pandemic on our financial results.”
With Congress already proposing over $2 trillion dollars in new infrastructure and social spending programs, consumers should be wary of loose purse strings that reward favorites and even looser guidelines for repayment.
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