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Goodbye, Mr. Chips: U.S. Creates a High-Tech OPEC

FEBRUARY 01, 1987 by MICHAEL BECKER

Michael Becker is a policy analyst with Citizens ,for a Sound Economy, He is also a research fellow at the Center for the Study of Market Processes at George Mason University.

Playing a role usually reserved for Arab oil sheiks, the U.S. government recently created its own high-tech OPEC in the semiconductor industry. As a result, consumers will likely pay hundreds of millions of dollars more for home computers, videocassette recorders, microwave ovens, and other products which use computer chips.

The new government-enforced cartel results from a recent agreement on computer chip trade between the U.S. and Japan. The agreement, in effect, represents the Reagan administration’s attempt to respond to Congressional pressure to “do something” about America’s negative balance of trade figures. Egged on by the Commerce Department, an agreement has been produced which can only hurt American consumers, workers, and chip users.

The agreement has three major provisions. The two governments agreed to fix minimum prices for chips, assign market quotas, and guarantee that the Japanese would not undercut the agreement with sales in third countries. For those acquainted with OPEC, all of this should sound familiar. Price increases, market shares, concerns about “cheating” and being undercut through third countries—this is the jargon of a cartel.

The agreement already is causing chaos in the chip market. U.S. chip users, who have come to expect declining prices, have seen prices of some chips double and triple since the agreement. Buyers faced with higher prices are cutting back on purchases. And as is often the case when government intervenes in the free market, the agreement will have several unintended consequences—consequences now beginning to show up.

One of these is reduced international competitiveness for American companies which use chips, such as computer and electronics manufacturers. American firms faced with higher domestic prices will relocate in other countries. Immediately following the agreement, Hong Kong and Singapore were described as “mob scenes” as U.S. finns attempted to find manufacturing space overseas to avoid the premium. This will mean a loss of American jobs.

Less visible will be the jobs lost in American finns who find it impractical to move overseas, but will be at a competitive price disadvantage against foreign companies with access to cheaper chips. This disadvantage will mean fewer sales; fewer sales mean fewer jobs.

In addition to these direct costs—higher prices, fewer jobs—the agreement has produced a variety of other unintended consequences. First, it will prove difficult to enforce. South Korea, for example, is not a party to the agreement, and South Korean manufacturers can undercut the cartel’s price. The Japanese companies themselves have been accused of violating the agreement by “dumping” chips in third countries. It has also proved quite easy to attach chips to circuit boards overseas and then import them duty free. After all, the restrictions are on chips, not circuit boards.

The agreement has also produced a black market in computer chips—a black market that some estimate to be a $1 billion-a-year business. Chip smuggling already is so rampant that domestic chip distributors on the spot market are finding that it is necessary to purchase smuggled chips to stay in business. The next stage of this game is now being played as the government sends out customs agents to “crack down” on illegally imported inexpensive chips.

When the agreement is circumvented, American consumers benefit. The danger is that the agreement’s unintended consequences will simply lead to more protectionism.

The U.S. government has started down a course which will require more government intervention to deal with the consequences of the chip agreement. While the chaos in the industry may not reach consumers, higher prices will. Under the original terms of the agreement, for example, the price of imported Japanese 256K memory chips doubled from around $2.40 to $5.00. Consumer products which use chips—personal computers, VCRs, calculators, and home appliances—will cost more. The price of an average personal computer could rise by as much as $45, experts believe.

The chip agreement was premised on charges raised in 1985 that Japanese chip producers were engaging in predatory pricing, that is “dumping” chips into the U.S. for less than it cost to produce them. The U.S. International Trade Commission (ITC) investigation which followed produced little or no evidence to prove this. Japanese 256K memory chips, for example, prior to the agreement sold for $2.60 in the U.S. compared to $1.70 in Japan. Prices for Japanese chips overall were higher in the U.S. than in Japan. Despite this, the ITC simply inferred that because prices were dropping and U.S. firms were losing business, the Japanese were guilty.

The more plausible reasons for the drop in chip prices—declining demand and the obsolescence of some chips—were ignored. Also ignored was another factor which contributes to lower prices for chips: efficiency. The semiconductor industry has a “learning curve” which results in falling unit costs as producers accumulate experience in producing chips. The learning curve gives companies an incentive to price low and generate a high sales volume in order to “learn” how to produce chips more cheaply in the future. This price-cutting incentive has in fact been one of the driving forces behind the sharp price decreases and innovation which have characterized the industry.

Under the terms of the agreement, however, Japanese companies must price above the bureaucratically determined “fair price.” Attempts to price low in order to take advantage of the learning curve are likely to be interpreted as predatory pricing by government regulators. As a result, this beneficial practice will be curtailed.

Essentially, the ITC and Commerce Department have declared illegal the very practices which have produced the high level of growth and innovation in the industry. In the long run, these new protectionist measures can only destroy the competition which has made the semiconductor industry such a dynamic and productive economic force. The industry and consumers can do without a government-enforced high-tech cartel. One OPEC is bad enough.

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February 1987

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