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European leaders have grand ambitions to reduce the continent’s reliance on sensitive technologies from abroad. Today, they are debating an update to the European Chips Act, which was finalized in 2023 and allocated billions of euros to subsidize chip-making on the continent. The act was meant to increase Europe’s share of global chip manufacturing from ten to 20 percent by 2030, but it will likely fall short of that target by a wide margin.
A purely European supply chain for semiconductors—the sector that undergirds the digital economy and defense sector—is a fantasy that distracts from real opportunities. Many of the powerhouses of Europe’s chip industry, such as ASML, a Dutch company that makes semiconductor equipment, and Merck, a German firm that produces chemicals for chip-making, don’t manufacture semiconductors. Companies like these are cutting-edge, are often highly profitable, and draw on Europe’s industrial expertise in precision machinery, specialty chemicals, and advanced materials. Yet they are overlooked by politicians who focus on chip output.
At the same time, the semiconductor industry is facing rapid technological changes, trade restrictions, and geopolitical shifts that Europe is not prepared for. The main driver of rising demand for chips is artificial intelligence, an area in which Europe is comparatively weak. European firms are being squeezed out of China’s market, which used to be a primary source of growth for them. And the United States, which used to be a close partner, is threatening tariffs that would limit European sales to the U.S. semiconductor market. Merely setting targets for domestic chip production will not solve these challenges.
A self-sufficient semiconductor industry may be out of Europe’s reach, but a more vibrant one is not. Europe has a meaningful edge in certain steps of the semiconductor supply chain, and it can cooperate with allies—including the United States—for the supply chain segments it lacks. The billions of euros being poured into the continent’s rearmament can also be an opportunity for its chip makers, given how critical artificial intelligence has become to defense. To take full advantage of these trends, European leaders need to build on the chip industry’s strengths with deeper partnerships, not a futile drive for self-sufficiency.
NO SMALL ROLES?
The biggest problem for Europe’s chip industry is the slow development of the continent’s artificial intelligence ecosystem. AI has become the primary driver of growth in chip demand: data centers need chips to power AI training, and devices such as phones, laptops, and cars require chips to run AI. Yet European AI firms are minor players in the global industry, and fewer data centers are being built in Europe than in other regions. Unless European chip companies contribute more to global AI supply chains, their market share will shrink.
European firms, such as ASML, that supply leading Asian chip makers with tools and materials are benefiting from the AI boom. But with the AI ecosystem concentrated in the United States and China, Europe’s chip industry struggles to attract talent, raise venture capital, or anticipate technological trends. Having focused more on regulating AI than deploying it, Europe risks being left behind. Nvidia, a U.S. company that produces AI chips, is worth 30 percent more than the entire German stock market. If European entrepreneurs continue building their AI companies in California instead of at home, European chip makers and designers will lose out, too. Companies in the AI supply chain benefit when they cluster together, as they have in Silicon Valley.
Europe has significant pockets of expertise to contribute to AI supply chains. Arm, a British firm, designs and licenses intellectual property and know-how to AI chip designers around the world. The Netherlands has unique capabilities in photonics, a technology used to accelerate interconnections between AI chips. The Belgian research institute IMEC devises the next-generation technologies that enable the manufacture of ever more advanced AI processor chips around the world. Europe doesn’t need to manufacture cutting-edge AI processors, a business that Taiwan today all but monopolizes. But it does need to ensure that its semiconductor and broader technology ecosystem remains competitive with those of other regions.
This means that European governments and companies must embrace AI development. Centuries-old industries, such as auto manufacturing, need to rapidly adopt advanced technology to stay competitive. Continental, a European auto parts manufacturer, announced in June that it was creating a unit to design chips to sell to auto companies, which are embedding cars with advanced sensors, communications capabilities, and AI. Pirelli, the Italian tire maker, already puts chips in tires to collect vehicle data. Companies that make industrial equipment, medical devices, aviation parts, and robots all require increasingly specialized semiconductor hardware. The faster European industry adopts AI capabilities, the more demand there will be for European chips.
THE CHIPS ARE DOWN
Limited domestic demand for AI chips and services is not the only force holding back Europe’s chip makers. They also face steep competition from China. Because of U.S., Dutch, and Japanese export restrictions, Chinese chip manufacturers can’t access the tools they need to easily produce advanced chips. But they face no barriers to purchasing equipment to make less advanced versions. China has plowed money into producing these foundational chips, the kind that European firms also tend to make.
Beijing’s subsidies for its semiconductor industry make it difficult for European firms to compete. The Chinese government is also encouraging and in some cases requiring Chinese industrial firms to stop buying components from foreign suppliers. Beijing has pushed Chinese automakers to use 100 percent homemade chips by 2027, for example. This is particularly harmful for European chip makers, which specialize in automotive semiconductors.
The only way European producers can keep their position in the Chinese market is to retain a technological edge. In an ideal world, Europe would also work with the United States and Japan to pressure Beijing to scale back its subsidies and trade barriers. But if that effort fails—as it likely will—Europe should limit market access to Chinese firms profiting from unfair subsidies.
The United States ought to be a natural partner for Europe both in building AI and in standing up to China’s subsidies. Instead, the Trump administration is causing headaches for the continent’s chip industry by threatening tariffs that would limit their access to the U.S. market. Yet there is still a chance to work with Washington. The Trump administration has made exporting U.S. AI technology a central policy goal. Europe would be smart to embrace the use of U.S. data center infrastructure to more quickly adopt AI.
IT TAKES TWO
There is one bright spot for European semiconductor firms: governments on the continent are pouring billions of dollars into their defense industries to deter Russian aggression. European militaries will need a wide variety of chips, including for autonomous systems, which require large quantities of sensors, communications chips, and AI processors. Chips underpin Europe’s ability to “fight from the cloud”—that is, using cloud computing to share and process masses of information. The war in Ukraine provides a glimpse into the future of conflict. Both sides collect huge quantities of data that are absorbed into clouds, parsed almost instantly by AI tools, and then distributed in real time as actionable intelligence, operational decisions, or data for targeting that can be sent to firing units dispersed across the battlefield.
Europe can fight the wars of the future only if it can acquire advanced chips from trusted partners or make them on its own. It needs hardware and software to integrate these capabilities, including interoperable cloud computing systems. And it needs a broader base of talent to develop and deliver these capabilities.
Chips underpin Europe’s ability to “fight from the cloud.”
Europe’s biggest adversary, Russia, is already well versed in this type of war, having fought one for over three years. And China has gained valuable experience by observing Russia’s military in Ukraine and providing Moscow with electronics and machine tools that it needs for its war effort.
The United States and Europe must work together to compete. They should, for example, harmonize standards so they can more easily use each other’s chips in their military technology. They should also supply each other with more basic components in electronic supply chains. Both Europe and the United States heavily rely on Asian suppliers not only for chips but also for resistors and capacitors, printed circuit boards, cables and connectors, flat-panel displays, and fundamental materials including gallium, germanium, and rare-earth minerals. Most of these materials and components can only be produced economically at substantial scale—a scale only achievable with close ties between the U.S. and European markets.
Finally, European policymakers must ensure that their chip companies can capitalize on the surge in defense spending by investing more in new defense technologies and fostering connections between large chip firms and small defense startups. European chip companies that have previously focused on civilian markets must realize that the defense industry, and particularly the drone sector, will drive growth and technological change.
FRIENDS IN HIGH PLACES
European policymakers have yet to grasp the magnitude of the challenge facing their chip industry or the stakes of getting it wrong. The consequences are not only commercial: the continent’s defense requires a more capable semiconductor ecosystem. In the debate over the update to the 2023 Chips Act, a new Dutch-led coalition is rightly pushing to scrap the act’s target to double manufacturing output and instead focus on improving Europe’s environment for research and development and for business growth. Yet Europe still needs a clearer plan to ensure that its defense spending boom and its efforts to revitalize its chip industry are more in sync.
Some European politicians think that strategic autonomy means going it alone, but to be competitive, the continent’s chip makers need even deeper connections with firms from allied countries. The United States has become a vexing partner for European industries and political leaders, yet European industry needs access to the American market and its leading U.S. AI technologies. The United States, for its part, would benefit from European help to reduce reliance on Asia for its technology supply chains. As Europe tries to revitalize its chip sector and rebuild its defense base, the United States remains an indispensable partner.
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