The Ongoing Semiconductor Chip Shortage and the Sustainability of the Automotive Industry’s Profit Boom: Outlook for 2023 and Beyond

Since 2020, a shortage of semiconductor chips, commonly referred to as “chips,” has disrupted global supply chains across more than 169 industries (Thorbecke 2022). Among the most impacted of these has been the automotive industry. The chip shortage has significantly hindered American automotive manufacturers’ capacity to meet rising automobile demand, leading to restricted inventories, extended wait times, and an overall decline in sales. In 2022, automotive sales dropped approximately 9% from 2021 (Wayland 2023). While seemingly detrimental to the industry, the shortage of supply coupled with increasing demand has caused new car prices to soar to unprecedented levels, leading to significant profit increases (Domonoske 2023). In the third quarter of 2022, domestic automobile manufacturers earned over $32 billion in profits, the largest amount observed since 2016 (Goodkind 2023).

Many economists are questioning how long the shortage and its increased profits will persist. This article will demonstrate that the chip shortage will likely continue into 2023 and the foreseeable future, owing to escalating geopolitical tensions, climate change, insufficient chip production capacity in the United States, and AI growth. While this shortage should sustain the low supply of vehicles, rising inflation and interest rates may decrease automobile demand. Together, the limited supply but decreased demand will likely cause sales prices to fall, reducing the profit opportunity afforded to the automotive industry by the chip shortage.

Conventional wisdom holds that the shifts in supply and demand for chips stemming from the COVID-19 pandemic are the largest cause of the chip shortage. Specifically, economists argue that the pandemic caused a surge in chip demand catalyzed by the heightened usage of technology products–such as smartphones, computers, at-home video services, and video game consoles–while simultaneously reducing chip production capacity (Ramani et al. 2022; Kharpal 2023). Because the demand for these technology products is declining as more individuals return to in-person work, some economists anticipate that the chip supply chain will normalize by the end of 2023 or early 2024 (McCrea 2023; Zurschmeide 2023). While economists are correct that these pandemic-induced changes were strong drivers of the shortage and are beginning to reverse, these viewpoints overlook the fact that the chip shortage stems from broader chip supply chain vulnerabilities and weaknesses likely to persist into the future (Ramani et al. 2020; Mohammad et al. 2022).

Geopolitical tensions weakened the supply chain before the pandemic and are now an increasingly significant threat. The chip supply chain is highly globalized, with more than 90% of semiconductors produced in East Asian nations and manufacturing materials globally sourced from various countries (Thiéry 2023; Ji et al. 2023). Trade wars between the United States and China that began in 2018 have escalated during 2023, with restrictions on the import and export of chips and materials needed to manufacture chips imposed by both nations (Harburg 2023; Hawkins 2023; Palmer 2023). Furthermore, the conflict between China and Taiwan over Taiwan’s political status has prompted China to consider employing military force to achieve unification (Engel et al. 2023). The Russian-Ukraine war has also reduced manufacturing capacity due to reliance on Ukraine for neon gas and Russia for Palladium (De 2023). Lastly, the conflict between Israel and Hamas may further limit chip supply as Israel is one of few countries outside East Asia with substantial chip manufacturing capacity (King 2023).

In response to these global strains, the United States has begun investing in its chip manufacturing capacity. In August 2022, President Biden signed the CHIPS and Science Act into law, which provides over $53 billion for semiconductor development and manufacture (Furlow 2023). Although this represents a substantial investment, it is unlikely to resolve the chip shortage for three reasons. First, chip manufacturing plants require substantial development and technological expertise. In some cases, plants require five to ten years before starting production (Heilweil 2022). Second, as noted above, geopolitical tensions are reducing the supply of materials needed for chip production. Third, this funding is insufficient to build capacity comparable to East Asia; economists estimate that this investment will increase the United States’ market share of global chip capacity by only 1% (Goldman Sachs 2022).

Along with geopolitical conflict, the semiconductor supply chain is also susceptible to extreme weather (Mohammad et al. 2022). In 2021, Winter Storm Uri caused widespread power outages in Texas, forcing multiple plants to close and exacerbating the ongoing chip shortage (Fitch 2021). Another notable example was a drought that halted production in Taiwan for months, given the large amount of water required for chip production (Barbiroglio 2021). Climate change is anticipated to increase the frequency of extreme weather events, such as heat waves, wildfires, heavy rains, floods, and droughts, increasing the probability of weather-related disruptions (Wening 2023). East Asia's recent vulnerability to climate change may further attenuate an already weak chip supply chain (You et al. 2022).

Lastly, the rise of AI will likely exacerbate the chip shortage by creating a new demand for chips. Forecasts suggest that the AI sector will expand by more than 50% with an estimated worth of $390 billion by the close of 2025 (James 2020). This growth will inevitably drive up the demand for chips, necessitating a significantly expanded production capacity (Goasduff 2023). This AI-driven increased chip demand will likely offset the chip demand decline resulting from the decreased purchasing of household technology products as individuals return to work post-pandemic.

As a result of these weaknesses and exacerbated vulnerabilities, the supply of chips and, therefore, automobiles should remain low. Nevertheless, a possible decline in demand due to rising interest rates could limit the ability to increase prices and generate profits in comparison to recent years. In response to surging inflation, the Federal Reserve raised the federal interest rate to 5.25%-5.5% in July 2023, the highest rate in more than 22 years (Cox 2023). The increased federal interest rates prompted numerous banks to raise their rates, causing car loan interest rates to sore; the average rate for new cars is 7.4% and 11.2% for used cars, representing a three and four percentage point increase from March 2022 (Huetter 2023). These increased interest rates make new automobile purchases unaffordable and unattractive, reducing the overall demand for vehicles (Wayland 2023). This decline in demand will make it increasingly difficult for automotive businesses to justify their price increases, limiting their profitability.

​​The ongoing global chip shortage has unexpectedly benefited the automotive sector. This scarcity is likely to endure in the near future owing to geopolitical tensions, extreme weather events, and the growing demand for chips fueled by AI. While this sustained shortage will result in constrained car supplies, the rise in vehicle financing interest rates will likely reduce overall demand for vehicles. As a result, the automotive industry will be unable to charge high prices and make substantial profits like it has been able to over the past few years. While addressing the shortage might not have seemed appealing to automotive manufacturers and retailers, falling profits will force them to finally confront deep-rooted supply chain issues. Expanding in-house chip production capacity or advancing policies that allocate more funds for research and development could be viable solutions that should be considered.

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