severe challenge from Japan and to a lesser extent from the Western European nations.

Despite the current recession in the United States and elsewhere, the worldwide semiconductor industry is expected to undergo explosive growth during the 1980's not only in sheer volume but also in the diversity of market applications. In 1980, world consumption of semiconductors reached $16.1 billion including both unrelated and related party uses. The world semiconductor industry supports approximately a $200 billion electronics equipment market. Industry analysts predict that the world semiconductor volume will reach or surpass $50 billion before the end of this decade and will support a world equipment market of over $500 billion.*/

The U.S. semiconductor industry in 1980 accounted for 63 percent of world consumption, compared to 22 percent for the Japanese industry, and 12 percent for the European industry. By 1983, however, international competition has become much more evenly matched than 1980 overall market share data would indicate. The Japanese, who only began to export integrated circuits to the United States in volume in the

*/ The semiconductor industry with advancing technology will account for a continued increase in percentage of equipment value from 8 percent in 1980 to 10 percent by the late-1980's.

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mid-1970's, have achieved significant market shares in the

United States for a whole array of advanced large scale

integrated circuits (LSI) products. Currently Japanese industry holds more than 42 percent of the 16K dynamic RAM (random

access memory) market and over 70 percent of the 64K dynamic Furthermore, at a 1982 technical conference in

RAM market.

San Francisco, all five technical papers on the 256K RAM, which will probably be the workhorse memory circuit of the late 1980's were Japanese. These large memory circuits are

the "flagships" of semiconductor technology. Moreover, because they are growing at over three times the rate of all semiconductors, sustained leadership in these commodity products will mean

long-term market leadership.

In 1980, virtually 50 percent of the worldwide

semiconductor volume was consumed outside the United States. In the quarter-century history of the industry, the U.S. merchant industry has fiercely competed in all markets worldwide and currently sells 35 percent of its production outside the United States; if historical trends were to continue, there is reason to believe that within 10 to 15 years, 45 percent to 50 percent of U.S. company sales would be in international markets.

Success in worldwide competition is determined

by a company's innovation rate and the advancement of technological complexity. As recently as 1970, the semiconductor indutry was producing memory circuits containing 1,000 elements of memory. At present, the industry is commencing production of a dynamic RAM with 64,000 elements on a chip, and by 1989, industry sources speculate that the most advanced chips will contain over 1,000,000 elements. These high levels of growth and increasing

complexity cause dramatic increases in the requirements of U.S. semiconductor companies for new capital. The U.S. semiconductor industry's investment in short-lived process equipment and in R&D is now 28 percent of sales, compared to the U.S. industry average of 7 percent of sales. To finance this investment the industry must constantly generate fresh capital. Indeed, the industry's principal challenge is the availability and cost of its capital.

This is not a problem shared equally by the major

foreign producers of semiconductors.

American companies have

a significantly higher cost of capital than the Japanese semiconductor manufacturers, and potentially the Europeans as well, with whom they must compete. A 1980 study prepared by

Chase Financial Policy, a Chase Manhattan Bank subsidiary, revealed that the cost of capital for the typical American semiconductor company averages 17.5 percent, compared to only 9.3 percent for the Japanese competition. The study also revealed that, although American firms are compelled to earn a rate of return approximately equal to the cost of capital, currently 16.3 percent on operating capital, the Japanese companies fall short of covering capital costs with a return of only 7.5 percent.

In the long term, this structural advantage

lower cost of capital and current profit indifference

-

will

work to the distinct disadvantage of American firms, jeopardizing their ability to earn sufficient return to cover capital cost and therefore their ability to compete.

Yet, the support of Japan and other countries for their semiconductor and computer industries goes beyond the relative cost of capital. It includes direct subsidies, research tax incentives and cartels, a sheltered domestic market, accelerated depreciation, soft loans and high leverage. This type of Government supports amounts to a tacit guarantee to investors and results in virtual indifference by shareholders and creditors to low short-term profitability.

The ability of U.S. semiconductor companies to

compete internationally has been significantly set back by the recession. For 1981, revenues from most semiconductor products increased by very small amounts compared to historic trends, if they increased at all, and profits were down dramatically. The picture for 1982 is slightly better.

However,

the U.S. industry is continuing to invest in R&D and in new equipment at a record pace. The industry does not want to be caught without the technology or the manufacturing capacity to deliver the volume of products which will be demanded once the economies of the world begin their recovery.

The R&D Tax Credit Must Be Made Permanent

To Maintain U.S. Technological Competitiveness

Accordingly, Mr. Chairman, I am here today to discuss the continuing problems of funding research and development efforts in the semiconductor industry.

Specifically, I want

to discuss the need for the extension of the R&D tax credit provisions of the Economic Recovery Tax Act of 1981 ("ERTA") Sections 221-223 (Section 44F (a) of the I.R.C. of 1954) which will expire on January 1, 1986.

Generally, Section 44F of the

I.R.C. of 1954 provides for a nonrefundable income tax credit for qualifying R&D expenses to the extent they exceed a base