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Chip Wars: Industrial Policy a la USA

Nov 09, 2022

The just-concluded 20th National Party Congress is justifiably drawing the attention of journalists and foreign affairs analysts. Xi Jinping’s consolidation of power seems almost complete and will shape Chinese politics and economics profoundly. However, a similarly important development has received far less attention: massive escalation in the US-China chip wars.

Semiconductors, or colloquially chips, are the lifeblood of all modern electronics, and thereby the industrial economy. They are key for everything from smartphones to airplanes and space exploration. Without modern advanced chips, a nation will rapidly regress technologically, economically, and ultimately, militarily. This is the fate that Russia’s defense technology sector is now confronting.

While not as absolute as the bans on exports to Russia, the Biden administration’s prohibition on the export of American technology to China amounts to a rapid throttling of Chinese ambitions for making semiconductors.

Chips are extremely intricate tools which can only be borne out of a far-flung global supply chain. Yet, despite its geographic sprawl, this supply chain turns out to be extremely concentrated when it comes to the highly sophisticated and expensive machines required to actually make chips. Such precise machinery, which can etch, deposit and measure layers of materials at nanoscales, are produced by only a few global companies: three in the United States, one in Japan, and one in the Netherlands. The Dutch company ASML is perhaps the crown jewel of this ecosystem, crafting lithographic chip-building machines that take years to construct and cost hundreds of millions of dollars per unit.

Following in the Trump administration’s footsteps, the Biden administration has been looking into ways to curtail Chinese efforts to build an indigenous chip sector. Admittedly, these efforts have not been going very well to begin with. Earlier in 2022 a massive corruption scandal put a cloud over the central funding vehicle for Chinese chip making innovation.

Nevertheless, the new American policy is highly consequential. It is imaginative, targeted, and aggressive by using a variety of tools in the Commerce Department’s kit to stop American corporations and individuals from working with a growing list of Chinese companies involved in chip making. They also bar the transfer to China of the best American chips and machines to build them.

One example of how consequential these moves are can be found in the memory chip segment, an area in which China truly had the opportunity to catch up. Aided by state subsidies, Yangtze Memory Technologies has been aggressively expanding production capacity and R&D. The company was coming very close to a breakthrough in producing 232 layers of memory cells and catching up with rivals Micron and SK Hynix, the industry leaders based in Idaho and Icheon, South Korea, respectively. But now aspirations of putting such advanced chips into mass production are unlikely to be realized.

Naturally, the restrictions will also have a serious impact on American corporations exporting chip manufacturing equipment to China. Already Lam Research and Applied Materials have issued profit warnings. And while the loss of the Chinese market is likely to stifle available funds for R&D in the short term for these companies, in the longer term the Biden administration can counter this with the new bipartisan CHIPS and Science Act of 2022.

This act invests nearly $250 billion and represents the largest publicly funded R&D program in recent memory. It is intended to boost American semiconductor research, development, and production, ensuring U.S. leadership in the technology as well as industries of the future, such as nanotechnology, clean energy, quantum computing, and artificial intelligence. The federal funds contained in the bill are intended to spur private sector investment across the country, creating a multiplier effect over time.

The chip manufacturing supply chain is thus facing a massive American stick, offset by quite a few juicy carrots. As many analysts point out, the rules barring Chinese chip manufacturers from importing American equipment could potentially set them back decades. Nonetheless, much will depend on implementation. The new rules face two challenges in particular.

First, to be successful, U.S. rules must also apply in full to foreign corporations, especially in the Netherlands, namely ASML, and in Japan. In other words, they will have to be multilaterally enforced to be truly effective. Since these corporations themselves tend to be reliant on American inputs, it is likely that an accord can be forged, such as with the ongoing negotiations under the “Chip 4” initiative including South Korea, Japan, and Taiwan.

In addition, foreign governments are likely to issue their own rules, sometimes paralleling American ones, though likely with a bit more leeway. Taiwan could play an especially crucial role. If its government follows American precedent and bars its citizens from working with a list of Chinese entities involved in the chip making sector, the resulting setback could rival that of American actions.

The second challenge facing American rules is leakage, such as smuggling, diversion of exports, and illicit transfers of technology. Chips are very small, and the most advanced ones now restricted from export to China, such as Nvidia’s H-100 processor, could become the target of smuggling operations. Again, a multilateral approach involving all allies and likeminded governments will be crucial for American efforts to work.

Despite these challenges, the Biden administration’s new rules are a game changer. They have escalated the U.S.-China chip war to a level far beyond the more scattershot sanctions of the Trump administration. Mincing no words, they represent an active policy to strangulate large segments of Chinese high-technology innovation. After all, China still depends on the rest of the world for microchips, costing it more each year than it spends on oil.

Now, there is the possibility that the billions of dollars invested to domestically “secure” the industry could pay off for Beijing, perhaps via a breakthrough technology that goes beyond silicon as the main raw material for chips. But even such a breakthrough would take years, if not more than a decade, to translate into mass production.

For the time being, Beijing policymakers must have the uncomfortable feeling of being at the receiving end of American industrial policy. They are facing a massive American stick, and the potential of most crucial nods in the global chip manufacturing supply chain following the American lead. Even more ominously, American policymakers have taken a page out of the Chinese playbook. They are offsetting the considerable pain the sanctions will create with a juicy carrot: America’s largest investment in technology for at least the past five decades. Welcome to industrial policy a la America!

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