US-China & The Escalating Chip Conflict
Breaking down a landmark moment in the battle for techno supremacy
On Friday, the Biden administration drastically ratcheted up the pressure on China’s access to the global semiconductor supply chain. From Nikkei:
The U.S. has introduced sweeping export controls aimed at curbing almost every aspect of China's semiconductor development as part of its toughest crackdown yet on Beijing's tech ambitions.
The U.S. Commerce Department on Friday barred American companies from shipping certain grades of advanced chip equipment to any Chinese client without a license, effective immediately. The same curbs will apply to shipments of American-made electronics parts or other items that China could use to produce its own chipmaking tools and equipment.
Under the new rules "U.S. persons" will also be restricted from providing support to the development or production of chips at Chinese "semiconductor fabrication facilities without a license," starting Oct. 12.
The commerce department also tightened the so-called Foreign Direct Product Rule to restrict China's ability to obtain or build cutting-edge chips used in supercomputers and artificial intelligence applications. These curbs will also apply to global chipmakers, including Samsung of South Korea and Taiwan Semiconductor Manufacturing Co., whose manufacturing relies on American technologies.
To state the obvious, this is a really big deal; a reality openly acknowledged by Chinese Foreign Ministry Spokesperson Mao Ning in a briefing with foreign media on Saturday. Reuters notes that “the raft of measures could amount to the biggest shift in U.S. policy toward shipping technology to China since the 1990s. If effective, they could hobble China's chip manufacturing industry by forcing American and foreign companies that use U.S. technology to cut off support for some of China's leading factories and chip designers.”
I see this as the single biggest escalation in Sino-American trade tensions since the Trump administration’s decision to effectively cripple telecom giant Huawei by placing it on the dreaded “Entity List” back in May 2019. For all the myriad differences between the two administrations, strong-arming China remains a major point of continuity. As Ben Thompson over at Stratechery writes: “in case there was any question, it is clear that China is being viewed as an adversary, and that that view is a bipartisan one. Any tech company with business in China would do well to note that any further investments are fraught with risk, and previous investments need to be diversified sooner rather than later.”
More broadly, the new restrictions signal—in the clearest way possible—an unambiguous commitment on the part of the Biden team to frustrate and constrain China’s technological ambitions. For better or worse, Washinton’s political and national security establishment has settled on the idea that weaponizing the global technology industry to ensure China remains permanently confined to a subordinate position vis-a-vis the United States represents the best option for safeguarding American values, security interests, and economic prosperity in the years ahead.
The immediate response has been severe. Chinese semiconductor companies—including Semiconductor Manufacturing International Corp (SMIC), the PRC’s largest—collectively lost $8.6bn in market value when trading resumed on Monday. Nor was the blowback confined to China. Virtually every major global player—TSMC, Samsung, Tokyo Electron, Nvidia, ASML, AMD, Qualcomm—took a beating; amplifying what’s already been a brutal year for the global chipmaking industry.
Source: Bloomberg
One prominent target: Yangtze Memory Technologies (YMTC), which serves as one of Beijing’s preferred “national champions.” The company was placed on the “Unverified List” along with 30 other organizations—effectively red-flagging it in the eyes of American suppliers. If, as appears likely, YMTC is eventually upgraded to the “Entity List,” it will be effectively cut off from sourcing critical foreign-made chipmaking equipment barring hard-to-obtain special licenses and risks entering a death spiral.
The fallout should extend well beyond the chip industry—with ripple effects will reverberate throughout the entirety of the global tech ecosystem—as analyst Paul Triolo from Albright Stonebridge pointed out to the FT:
“There will be many losers as the tsunami of change unleashed by the new rules washes over the semiconductor and associated industries.”
He added the impact would be especially profound on Chinese companies that use US-origin hardware to deploy AI algorithms, including for autonomous vehicles and logistics, as well as medical imaging and research centres using AI for drug discovery and climate change modelling.
“The full impact will take some time to become clear, but at a minimum will slow innovation in both China and the US, ultimately costing US consumers and companies hundreds of millions or even billions of dollars,” Triolo said.
Equally notable to my mind has been the buy-in from US allies and partners. Because semiconductor production is a collaborative, cross-border affair, efforts to isolate China cannot run through DC alone. Taiwan signaled it will comply with the American measures despite the considerable revenue hit some of its leading tech companies will take on account of the new export controls. In a sop to geopolitical reality, South Korea—the most reticent member of the US-led “Chip 4” initiative aimed at fortifying the global semiconductor supply chain collaboration while reducing dependence on China—will see its leading chip players forced to comply with Washington’s diktats as they continually reassess their relationship to the China market.
At the end of the day, this is about commercial leverage, threat perception, and raw power politics. Because irreplaceable elements of the semiconductor value chain run through the US firms, lawmakers can effectively deploy the Foreign Direct Product Rule to block the export to China of chips made with American tools or components regardless of whether or not those chips come from Korea, Taiwan, or elsewhere. For all of its commercial attractions, China poses the number one national security challenge to both Taipei and Tokyo. The Pentagon ultimately acts as the guarantor of the East Asian security umbrella. Forced to pick a side, all of Taiwan, Japan, and Korea, will, however reluctantly, have little choice but to forgo supplying China rather than risking US wrath.
What’s also striking to me here is the timing. That these restrictions were rolled out mere weeks before the all-important 20th Congress of China’s ruling Communist Party—where President Xi is virtually assured to secure an unprecedented third term as General Secretary—will be seen by Beijing’s paranoid and optics-obsessed political elite as a calculated provocation on the eve of the country’s single biggest political event in years.
All of this comes at a precarious moment for China’s semiconductor industry. At least 12 high-profile executives and government officials associated with China’s $47bn Integrated Circuit Industry Investment Fund (the Big Fund)—which holds major stakes in both SMIC and YMTC—have come under investigation for corruption charges. Those moves have been widely interpreted as reflecting President Xi’s mounting frustration over the country’s lack of progress in building up a leading-edge semiconductor supply chain insulated from American coercive pressures. As reported last month, Beijing appears to be attempting a tricky recalibration of its national semiconductor strategy:
Beijing’s emphasis on manufacturing has underpinned an industry focus on the fabrication plants, or fabs, that build lower-end chips on a large scale. The Big Fund also channelled much of its funding into companies that would soon be profitable, leaving less cash for longer-term R&D efforts.
Homegrown chipmakers such as SMIC, Hua Hong and YMTC, have grown rapidly. Yet China has remained deeply reliant on foreign groups for the design of chips and the equipment needed to make them. For the most advanced semiconductors, critical to products from the latest smartphones and electric vehicles to artificial intelligence and cloud data centres, Chinese companies are still dependent on foreign groups.
In response to the sector’s failures, and pressure from the US, Beijing might respond with a “pivot” that directs investment to focus more on research and development alternatives to “American and allied technology”, said Douglas Fuller, an expert in China’s semiconductor industry and associate professor at Copenhagen Business School.
This gets to the root of exactly why the new restrictions are so problematic. One of President Xi’s overarching goals is achieving a managed technological decoupling from the United States and its allies. To sustain the next stage of the country’s economic development and safeguard national security, Xi and co. believe they must become a self-reliant tech superpower that transcends its dependency on foreign-branded strategic technologies. Because computer chips are the “brains” behind virtually every aspect of our digital world, building out an indigenized chipmaking ecosystem that encompasses every stage of the production process is the critical component of that overall vision.
That will be far from easy. Chipmaking—simply put—is arguably the most technically complex and capital-intensive undertaking known to man and Beijing’s goal of self-reliance remains contingent on access to foreign-made equipment and technical know-how. Without access, the end goal becomes significantly harder to attain. With the new trade controls in place, China’s capacity to attain the technical talent and sophisticated equipment necessary to develop a leading-edge indigenous semiconductor supply chain may be fatally compromised. At the same time, access to cutting-edge chips crucial to the country’s broader technological ambitions in areas like supercomputing and artificial intelligence will also be vastly curtailed.
As CSIS’s Greg Allen succinctly puts it, the Biden team has keyed in on four semiconductor chokeholds—with a focus on harming China’s AI prowess:
There are four interlocking elements of the new policy targeting different segments of the semiconductor value chain, and all elements must be understood simultaneously to grasp the scope of what the Biden administration plans on achieving. In short, the Biden administration is trying to (1) strangle the Chinese AI industry by choking off access to high-end AI chips; (2) block China from designing AI chips domestically by choking off China’s access to U.S.-made chip design software; (3) block China from manufacturing advanced chips by choking off access to U.S.-built semiconductor manufacturing equipment; and (4) block China from domestically producing semiconductor manufacturing equipment by choking off access to U.S.-built components.
I’ll be blunt: the gauntlet has been thrown down and realizing Xi’s entire techno-vision just got that much harder. I think the president is onto something when he speaks about China’s great struggles in the years ahead on the path to national rejuvenation.
RIP Techno-globalism
This latest round of stringent export controls speaks strongly to our 2022 reality: the post-Cold War techno-global paradigm, in which information, talent, capital, and critical technologies moved, more or less seamlessly, across national borders with minimal regard for national security imperatives—has irrevocably broken down.
This is not to say that globalization is dead and buried, that we’re heading for a total US-China decoupling, or that major chip players like Intel, Applied Materials, or South Korea’s SK Hynix will exit the China market altogether. I fully expect the industry giants to seek out loopholes and lobby for exemptions so they may continue doing brisk business with their Chinese partners. However, in a rapidly shifting and frankly chaotic international environment, “global” tech companies (think Nvidia, ASML, Intel, and TSMC) at the front line of the ongoing Sino-American battle for techno-supremacy will find it ever more difficult to shirk national obligations. As we’ve seen again and again over the past few years, these tech behemoths will be subordinated to the forces of geopolitics…commercial fallout be damned.
I’ll attach a name to this phenomenon: techno-nationalism. The Hinrich Foundation’s Alex Capri, writing for Forbes, provides an excellent working definition here:
Techno-nationalism is a new strain of mercantilist thinking that links technological innovation and capabilities directly to a nation’s national security, economic prosperity and social stability.
The state, therefore, must intervene and guard against opportunistic or hostile state and non-state actors. Techno-nationalism seeks to attain competitive advantage for its stakeholders, both locally and globally, and leverage these advantages for geopolitical gain.
Techno-nationalism is built on the premise that the world has entered a new era of systemic competition between the West’s increasingly short-sighted laissez faire model and China’s state-centric capitalism.
While I disagree with Alex’s contention that techno-nationalism is “new” (this type of strategic thinking has long animated East Asian policymakers) so much as resurgent in the face of China’s disruptive rise as a global superpower, I believe his analysis perfectly captures the prevailing mindset in Beijing, Taipei, Tokyo, and DC. Like it or not, China and the US are locked in a long-term power struggle and technology is the key determinant of the balance of power.
This reality was effectively captured by National Security Advisor Jake Sullivan in what I view as a landmark speech at last month’s Special Competitive Studies Project Global Emerging Technologies Summit. Here’s the key bit:
On export controls, we have to revisit the longstanding premise of maintaining “relative” advantages over competitors in certain key technologies. We previously maintained a “sliding scale” approach that said we need to stay only a couple of generations ahead.
That is not the strategic environment we are in today.
Given the foundational nature of certain technologies, such as advanced logic and memory chips, we must maintain as large of a lead as possible.
Earlier this year, the United States and our allies and partners levied on Russia the most stringent technology restrictions ever imposed on a major economy. These measures have inflicted tremendous costs, forcing Russia to use chips from dishwashers in its military equipment.
This has demonstrated that technology export controls can be more than just a preventative tool. If implemented in a way that is robust, durable, and comprehensive, they can be a new strategic asset in the U.S. and allied toolkit to impose costs on adversaries, and even over time degrade their battlefield capabilities.
To my mind, Sullivan’s remarks outline the likely path ahead. Going forward, nation-states will continue proactively inserting themselves into the operation of the global tech industry. Security will increasingly trump efficiency. Freedom of movement will keep giving way to an obsession with control. It’ll be a world shaped by export restrictions, reinvigorated industrial policy (CHIPS Act), investment screenings, and the splinternet. Underpinning all of this is the idea that connectivity must be restricted by governments to both protect national interests and dish out pain against rival actors rather than foster mutually beneficial commercial interaction. If they weren’t already, the latest measures out of DC have put the entire global tech industry on notice.