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Artillery Row

The technological escalation

Will the US semiconductor strategy prevail against China?

On 7 October, the Cold War between the U.S. and China entered a phase of technological escalation. The Biden administration announced new export restrictions that would cut the Middle Kingdom off from the most valuable parts of the U.S. semiconductor supply chain. “The US,” as one analyst observed, “is forcefully decoupling the entire advanced technology supply chain before China insources it.

It was President Trump who first responded to the CCP’s neomercantilist stance by trying to constrict access to American technology. Faced with aggressive state-sponsored technological espionage and intellectual property theft, impermeable barriers to market access and dumping, the Republican president introduced the Export Control Reform Act. Government agencies were to focus on previously unrestricted technologies: these include supercomputers and AI and all the tools and elements it takes to develop them. Now the Biden Administration has introduced export controls on the latest cutting-edge chips, on the software necessary to design them and on manufacturing equipment necessary to produce them. Restrictions also apply to U.S. personnel associated with China’s advanced semiconductor sector. 

Why are the new measures so far-reaching? Before, they covered only those technologies and companies that worked directly on military endeavours. Advanced semiconductors, supercomputers and AI, however, are not neutral technologies, but rather conditions of possibility for modern weapon systems. Jake Sullivan, Biden’s National Security Advisor, referred to them as “force multipliers”. Simply forbidding the sale of chips and equipment directly to institutions or entities affiliated with the Chinese military was ineffective for two reasons. First, the Chinese had established a network of shell companies that allowed them to circumvent these restrictions. Secondly, and more importantly, China’s technology sector operates in a “civil-military fusion” framework, meaning that the line between commercially used technology and military technology is blurred, as private actors are subject to the control of the Communist Party. In this environment, the only option for the Biden administration seemed to be to cut off access to their entire advanced semiconductor ecosystem.

Whilst many of the essential tools needed to manufacture chips and the software to design them remain in U.S. hands, a great deal of the supply chain components are located in other countries. The unilateralism of the U.S. initiative may well prove to be its weakest point if non-U.S. companies realise that they can gain a much larger chunk of the Chinese market thanks to the withdrawal of their American competitors. If the U.S. fails to convince allies to join the restrictions, in the long run these efforts may prove less successful than anticipated. When Biden proposed the Chip 4 alliance, the Korean government was already reluctant about the idea (after all, 48 per cent of Samsung’s chip exports go to China.) In the face of technological escalation, finding the “win-win solution”, recently mentioned by the chief of Samsung’s semiconductor division, seems increasingly unlikely.

China has had uneven results in the semiconductor sector

Commenting on the U.S. announcement of new export controls, China expert Tanner Greer noted that technology is the key to fulfil the Party’s historic mission: “make China great again”. Semiconductors constitute a vital element without which this ambition cannot be achieved.

With Xi’s rise to power, technological development has been given top priority. At the Party’s 20th Congress, its leader stated unambiguously that China “must adhere to science and technology as the number-one productive force, talent as the number-one resource, [and] innovation as the number-one driving force”. He has previously placed special emphasis on “technological self-reliance”, regarding the pursuit of sovereignty in this sphere as the most important task in an era of increasing decoupling between the U.S. and China. Xi appointed Liu He, his “economic czar”, to oversee the semiconductor sector. Previously, Liu was involved in other sensitive areas, leading attempts to fix China’s financial sector and representing his country in trade negotiations with the Trump administration. In the face of export restrictions, he is expected to supervise the chip industry’s embrace of the so-called “whole nation system”. It is a mechanism for mobilizing resources, which was used in Mao’s era for rapid industrialization, and later for building the atomic bomb. “For our country, technology and innovation is not just a matter of growth,” Liu stated. “It’s also a matter of survival.”

Despite its prioritisation, China has had uneven results in the semiconductor sector. Its champions lag behind Taiwan’s TSMC, failing to break into the cutting-edge chip category, and their production is concentrated in older-generation semiconductors. When it comes to foundries, or complex factories with very subtle manufacturing processes where chips are made, the two largest Chinese companies in this sector total only 7 per cent of the market. In the logic semiconductors category, which includes central processing units (CPUs) and graphics processing units (GPUs), the share of Chinese companies is even smaller. They are far behind the market leaders in lithography tools, without which the most advanced chips cannot be built. The greatest breakthroughs have happened in semiconductor design: here PRC’s companies have managed to make a real leap and only the U.S. stays ahead of them. Chinese share in this segment went from 3.6 per cent in 2004 to nearly 43 per cent in 2019. 

Specialisation in the semiconductor supply chain is so complex and difficult to duplicate that the pursuit of self-sufficiency in this field is rightly taken as seriously by the CCP as the effort to develop the nuclear program. Nevertheless, no country has achieved self-reliance in chips. Given the complexity of the sector, it is probably unfeasible. The ambitious plan for technological independence, “Made in China 2025”, envisioned that 70 per cent of domestic demand would be met by national manufacturers. At the moment, Chinese companies only cover about 20 per cent of it.

China has many advantages, like cheap capital and cheap labour. Furthermore, their market is immense. Despite the fact that China mints several times more STEM graduates per year than the U.S., it faces a shortage of the right engineering talent. The CCP realises this and is launching university programs dedicated to electrical engineering with a special emphasis on semiconductors, but the tacit, practical knowledge that Taiwanese engineers have accumulated over generations cannot simply be copied. There is a war for talent going on already: Chinese companies try to recruit engineers from Taiwanese and Western companies. In order to counter the poaching attempts aimed at engineers, Taipei has set up a special investigation bureau. Perhaps these talent shortages will be replenished by the Chinese returning from the U.S. to their homeland. With tensions between the two powers intensifying, we are witnessing a reverse brain drain, as “more than 1,400 Chinese scientists in the U.S. returned to China in 2021, a 22 per cent jump from the previous year”.

Will the CCP treat this move as an existential threat?

There are two facets to the U.S. strategy. On the one hand, it involves efforts to cut China off from tools and resources that would allow it to excel in advanced chips. The second aspect of it concerns American potential in this domain. The much needed boost for the U.S. semiconductor sector was supposed to be the CHIPS Act, although the scale of this initiative is considered by some to be inadequate. As David P. Goldman notes, “With its huge population and vast talent pool, China is a far bigger challenge than Russia ever was, yet the United States spends a small fraction of our 1980s commitment relative to the size of the American economy.” Moreover, the CHIPS Act has been taken over by various lobbies. Instead of being a step toward rebuilding the US manufacturing base, it ended up amounting to corporate welfare and subsidies for incumbents. Pressure from the latter has reshaped the bill beyond recognition, allowing funds to be used not only for future share buybacks, but also for investments in China, as Julius Krein has pointed out.

How will China react? After the bans that crippled Huawei, the retaliation was rather negligible. Still, the blow that the Biden administration has dealt to the very core of China’s technological ambitions is of quite a different magnitude. The consequences of these new regulations will only appear after a few months, and Beijing will most likely wait to see the results before deciding on a response. 

There is speculation that Washington won’t stop there and will introduce a review mechanism to monitor investments by U.S. companies, with the aim of restricting the deployment of American capital in China. This would bring down further bastions of resistance to decoupling, in the likes of Blackrock, Sequoia Capital or Apple. As China may have less and less to lose, its reaction could be unpredictable. 

Much is made of the crippling effects of the export curbs, but will they prove effective or will they turn out to be “limited and manageable”, as TSMC Chief executive asserts? Will the CCP treat this attempt to stunt its technological development as an existential threat? Will it move the timetable on Taiwan? It is said that when Zhou Enlai, the first premier of the PRC, was asked how he assessed the impact of the French Revolution, he replied: too early to tell. It may be too early to pass a judgement on what Washington’s latest measures will entail. There is no doubt that they will capture the attention of future historians, however.

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