In a knowledge economy, the supply chains that matter are in your head

The big goal of industrial policy advocates these days is to “re-shore” supply chain,s for instance by moving semiconductor manufacturing back to the United States. What these advocates miss is that in our economy, in which all wealth is knowledge and all growth is learning, the real supply chain is equally immaterial.

Today the supply chain is the “experience curve”. And experience curves, unlike factories, cannot be bought, or at least not budgeted.

When Michael Polanyi declared “we know more than we can tell,” he was reacting to his experience with fascist and socialist central planning. Polanyi argued that successful human endeavors depended on “tacit” knowledge. Tacit knowledge is intuitive, unarticulated, and based on personal experience, tradition, and practice, rather than articulable facts. He rejected the positivist claim that what cannot be stated clearly cannot be knowledge.

But planners must be positivists. What cannot be stated clearly cannot be put into the plan. What cannot be stated clearly cannot be made into an order or directive—or a government budget allocation.

The experience curve lives in the minds and even the bodies of those who have the experience. Much of the most important knowledge in a well-functioning civilization cannot be centralized, specified, or planned without being damaged

This becomes more true as tasks become more complex, incorporating more knowledge.

Project Stargate proposes to solve our AI challenges by building $500 billion worth of data centers. This can be budgeted—politicians love budgets—because we know the cost of the bricks and mortar, the cooling systems and the GPU fabrics.

But progress in artificial intelligence does not come from adding bricks, mortar, and machines. Progress is measured by how much material is subtracted. More efficient models using less raw compute power. Capability advances less through brute force than through accumulated organizational learning—architecture, data judgment, training craft, and failure analysis. This is craft knowledge. It lives inside teams. It cannot be mandated, subsidized, or scaled by decree.

Research on experience curves show that, for every doubling of accumulated production, costs fall by somewhere between 15% and 30% depending on the maturity of the industry. In this narrow sense, it is possible to subsidize experience curves by subsidizing increased production. This does not automatically make it wise to do so or mean capital could not be better allocated elsewhere.

At a minimum, the accumulation of experience will always take time, disappointing those who believe bigger budgets and more factories can solve everything.

Consider the huge wafer fabs being built in Arizona by Taiwan Semiconductor (NYSE: TSM) and heavily subsidized under the CHIPS act. The Arizona fab uses the same fantastically expensive equipment as fabs in Taiwan, including ASML photolithography machines costing hundreds of millions. It uses the same process “recipes” to build at advanced nodes.

Yet, currently, finished wafers produced in the Arizona plant cost between 30% and 50% more than wafers produced in Taiwan. Yields—the percentage of good chips per wafer—have been slow to increase.

To address these challenges TSMC temporarily relocated hundreds of experienced workers from Taiwan to Arizona—a direct concession of the experience curve as supply chain. For what the Arizona fab was missing, and will continue to miss for some time, was not machines but the tacit knowledge carried in the minds and bodies of experienced teams.

This does not mean the Arizona fab will fail. It means that even when the same company deploys the same tools and the same processes, manufacturing performance depends on accumulated local learning—teams that have worked together through years of iteration, error, and yield improvement.

It means that you can relocate the material components of a supply chain on a schedule. But experience comes in its own time. Time has a cost. The industrial policy folks ignore that cost at their peril--and ours.