China’s semiconductor industry currently faces unprecedented headwinds due to expanding U.S. export controls. As a result of its weaker position in global semiconductor value chains vis-à-vis Washington and its allies, Beijing has limited ability to slow the spread of multilateral restrictions or retaliate without incurring devasting costs. Despite being negatively impacted by U.S. export controls, Chinese chipmakers have stayed resilient by focusing on legacy chip production, stockpiling restricted foreign chips, circumventing controls when possible, tapping government support, and betting on open-source RISC-V chip design architecture.
U.S. Semiconductor Export Controls
On October 7, 2022, Washington imposed a sweeping set of rules prohibiting U.S. companies from selling advanced chips and chip-making equipment to China unless they received a special license. The rules also placed restrictions on foreign companies supplying China with products made by U.S.-origin technology through the extraterritorial foreign direct product rule (FDPR) and included an unprecedented measure to block U.S. citizens and permanent residents from working in certain high-end China-based chip facilities. These measures aimed to freeze Chinese advanced capabilities at nodes dictated by Washington—14 nanometer (nm) for logic, 128 layer for NAND memory, and 18 nm half-pitch for DRAM memory—while limiting the impact on Chinese production of more mature legacy chips, whose low prices remain vital to the U.S. and allied economies.
In December 2022, 36 Chinese companies were added to the Entity List, a trade blacklist maintained by the U.S. Commerce Department’s Bureau of Industry and Security (BIS) that subjects listed entities to export licensing requirements. Blacklisted companies include Shanghai Microelectronics Equipment (SMEE) and Yangtze Memory Technologies Corp (YMTC), the top respective Chinese lithography and memory chip companies. Furthermore, BIS also applied the FDPR to 21 of the 36 companies on the Entity List to prevent third-country circumvention.
On January 27, 2023, Washington reached an agreement with The Hague and Tokyo that would extend some of the unilateral October 7 export controls to ASML, Nikon, Canon, Tokyo Electron, and other chip companies based in the two allied nations. This multilateral agreement is significant since the Netherlands and Japan are home to many leading producers of semiconductor manufacturing equipment (SME), which is an area of weakness for the Chinese chip industry. Although the agreement’s exact export control details have not been released, reports indicate that some of ASML’s ArF Immersion deep ultraviolet (DUV) lithography systems may be cut off from China. Targeting older legacy machines that help fabricate mature chips (45nm to 7nm) indicates that Washington’s export control campaign is becoming more expansive.
Effects of Export Controls on Chinese Chip Industry
Washington’s export control regime presents a serious multidimensional threat to the Chinese semiconductor ecosystem, including prominent homegrown champions such as YMTC. Soon after the October 7 controls were announced, Apple dropped YMTC as a supplier despite already certifying its 128-layer 3D NAND flash memory chips for iPhone use. Less than two months after being added to the U.S. Commerce Entity List, YMTC reportedly began planning to lay off up to 10 percent of its workforce. YMTC also had to cut down equipment procurements and halt expansion plans. For instance, the company reportedly cancelled up to 70 percent of its orders from Naura Technology Group—a leading Chinese maker of etching, cleaning, and chemical vapor deposition tools—in the four months after the October 7 rules were announced.
China’s top chipmaker, Semiconductor Manufacturing International Corporation (SMIC), also saw its expansion plans affected by the U.S. export controls. In February, SMIC co-CEO Zhao Haijun admitted on a post-earnings conference call that difficulties with obtaining “bottleneck equipment” had stalled mass production at the company’s new $7.6 billion Jingcheng 28nm fab in Beijing. In January 2023, computer giant Dell Technologies announced plans to stop using Chinese-made chips by 2024 and move about 50 percent of its production out of China.
Given that the October 7 export controls specially targeted Chinese artificial intelligence (AI) chips, there was also a natural shortage and subsequent price increase of high-performance semiconductors, which drained Chinese profit margins and potential clients. Immediately after the October rules went into effect, Taiwan Semiconductor Manufacturing Company (TSMC) suspended production of two Chinese-designed AI chips that reportedly could outperform the advanced NVIDIA A100. In the first two months of 2023, China’s semiconductor output declined by 17 percent year-on-year (yoy) and its chip imports shrunk by 27 percent yoy.
The October 7 controls were predictably not well received in China. A Chinese Foreign Ministry spokesperson criticized Washington for weaponizing “export control measures to maliciously block and suppress Chinese companies…[which would] not only damage the legitimate rights and interest of Chinese companies, but also affect American companies.” On December 12, 2022, Beijing initiated an official World Trade Organization (WTO) dispute complaint against Washington for its export control actions. The effectiveness of this approach will be limited since Washington is unlikely to engage in WTO consultations and views its export control actions as a national security issue beyond the jurisdiction of a multilateral body.
In addition to condemning Washington’s export controls through public channels, Beijing diplomatically engaged U.S. allies with companies operating in strategic semiconductor value chain chokepoints. In his phone conversations with Dutch Foreign Minister Wopke Hoekstra on January 30 and Japanese Foreign Minister Yoshimasa Hayashi on February 2, Chinese Foreign Minister Qin Gang urged his counterparts to jointly safeguard global supply chains, market principles, and an open trade environment. These calls seemed to have limited effect as both countries are reluctantly increasing their own restrictions at Washington’s urging while attempting to maintain access to the Chinese market.
Beijing could retaliate by weaponizing supply chains where it enjoys a strong position, such as solar panels, rare earth minerals, lithium batteries, certain consumer electronics, and lower-end legacy chips. More specifically, China could leverage its dominance in critical mineral supply chains to target American electric vehicles and other green technologies through a variety of measures in its legal architecture. There is the Unreliable Entity List, which Beijing recently used on Lockheed Martin and a unit of Raytheon Technologies on February 16, 2023 for their arms sales to Taiwan as a tit-for-tat after the U.S. military shot down an alleged Chinese spy balloon. Beijing could also utilize the Anti-Foreign Sanctions Law adopted in June 2021 or the Ministry of Commerce’s January 2021 measures to counteract unjustified extra-territorial application of foreign legislation. However, these options are all double-edged swords that if utilized, would likely result in even fiercer U.S. sanctions, and accelerate unfavorable economic decoupling with Washington’s allies.
Surviving Washington’s Export Controls
Although Beijing’s diplomatic actions and potential retaliatory measures are largely ineffectual, the Chinese chip industry has managed to weather Washington’s flurry of export controls due to several factors. First, most Chinese producers of older legacy semiconductor have not been seriously harmed, as the U.S. export controls target advanced chips and chip equipment. For instance, Hua Hong Semiconductor Group and two state-backed entities signed a deal in January 2023 to build a $6.7 billion fab in Wuxi, the largest chip investment since the imposition of Washington’s October 7 rules, that would focus on mature 40nm-65nm nodes. Second, leading Chinese chipmakers likely stockpiled spare parts for advanced tools in anticipation of the restrictions. Huawei notably executed this strategy with advanced TSMC chips before they were cut off from the Taiwanese chipmaker by the Trump administration in September 2020.
Third, export controls can be circumvented, as evidenced by the Wall Street Journal’s January 2023 revelation that the China Academy of Engineering Physics—Beijing’s top nuclear-weapons research institute—managed to purchase advanced Intel and Nvidia chips over a dozen times since 2020 through third-party resellers despite being placed on a U.S. export blacklist in 1997. Fourth, Chinese chipmakers continue to benefit from various forms of government support including targeted state investment, human capital development, tax credits, and subsidies.
Finally, the growth of a promising open-source chip design architecture known as RISC-V could free Chinese firms from Western-controlled chip design standards. Although RISC-V’s application are currently limited to consumer electronics, its mass production growth—which surpassed 10 million units shipped in December 2022—may eventually popularize the design standard enough to compete with Intel’s X8 architecture for computers and Arm’s smartphone chip architectures. Huawei, ZTE, Tencent, Alibaba Cloud, and other prominent Chinese entities are among the 22 premier members of RISC-V International, which publishes standards based on reduced instruction set computer (RISC) principles first developed by University of California at Berkeley professor David Patterson in 1980. With its popular open-source characteristics, RISC-V is projected to grow at an annual rate of 73.6 percent through 2027. Collectively, these factors may ultimately enable the Chinese chip industry to survive Washington’s export control campaign.