China has the potential to become a global semiconductor power by 2010. But a study of the country's fast-growing semiconductor industry suggests that it may achieve world-class status by taking a road less traveled: emphasizing chip design rather than the capital-intensive manufacturing approach that helped Taiwan become a leader in the sector.

China's semiconductor market accounts for 6 percent of worldwide demand, making it the largest market after the United States, Japan, and Taiwan. In the years to come, chip production in China is expected to increase by 42 percent annually, much faster than the world average of 10 percent. But the country starts from a low base: in 2000, China produced $900 million in chips, a third of which (by value) were exported. The domestic industry supplies only 5 percent of Chinese demand; production technologies lag by at least two generations. And because the US government tightly regulates exports of the most advanced manufacturing equipment to China, it will take years for the process technology of its semiconductor industry to catch up with global leaders such as the United States and Taiwan, which has enjoyed much greater access to advanced US technology.

Yet in some respects—market demand, government...