US rules aim to derail China’s chip industry

JUST over a week before the 20th Congress of the Communist Party of China (CPC), which is likely to endorse President Xi Jinping’s unprecedented third term as its general secretary, the US has fired a shot across the Chinese bow.

It has introduced a sweeping set of export controls that will make it much more difficult for Chinese companies to develop cutting-edge technologies, especially semiconductors. Targets are not just companies involved in military applications, but all Chinese technology development firms in the field of advanced computing and artificial intelligence.

Politically, the action confirms that the Joe Biden administration’s approach towards China is following on from that of its predecessor, which ended the phase of engagement with China and replaced it with strategic competition. As part of this, the US has also passed a Bill providing

$280 billion to strengthen the domestic semiconductor manufacturing, design and research at home.

The new rules are the toughest action taken by the Biden administration and can be seen as a watershed of sorts since the goal of the effort is not just to stay ahead of China, but also to degrade Chinese efforts to catch up with the US.

According to the new rules, US companies will be barred from exporting critical chip-manufacturing tools to China. They will also forbid US citizens and companies from providing direct or indirect support to Chinese companies involved in advanced chip-making. The US is using its Foreign Direct Product Rule (FDPR) to complicate things further for China. This bars any US or non-US company from supplying listed Chinese companies with hardware or software containing US technology in its entire supply chain.

The Donald Trump administration had used this rule to deny computer chips to Huawei and gutted its production and sales. More recently, it has been used to block companies from doing business with Russia following the invasion of Ukraine.

Exceptions will be made for US companies and those of its allied countries in China that are exporting chips. But in practice, US companies are likely to find it difficult to continue to do business in China. There is also every possibility that the Chinese will retaliate by making it difficult for certain US companies to do business in China.

Whether the US will be successful is not easy to forecast, but there is little doubt that it will slow down the efforts of China’s leading memory chipmaker Yangtze Memory Technology Company (YMTC) and its top producer of processors Semiconductor Manufacturing Industrial Corporation (SMIC) as also other companies involved in top-quality chip fabrication. This will have a wide-ranging effect on Chinese electronic companies and Internet platforms.

Yet, in many ways, the draconian steps announced are also a measure of the achievement of China. Earlier, it was seen as a copycat nation, whose political system precluded the possibility of independent thinking and research and whose technology achievements were based on stealing technology.

The US global strategy had been to stay generations ahead of its competitors in such cutting-edge areas as semiconductor design and manufacture. But the dogged Chinese efforts and the growth of chipmakers like the SMIC, Hua Hong and the YMTC have changed the narrative. It now demands measures where the US has had to actively undermine Chinese technology efforts, as in the case of 5G and Huawei.

The Chinese have poured a huge amount of money into the development of a semiconductor industry that rivals that of the US, but these efforts have been dogged by issues that were not just technological. In the past year, the former chairman of the YMTC and the head of the $47-billion China Integrated Circuit Industry Investment Fund, also known as the ‘Big Fund’, were placed under investigation for corruption along with several of their associates. Earlier, in 2020, Tsinghua Unigroup, which is YMTC’s parent company, defaulted on $198 million in bonds. The company has since been taken over by another consortium.

The chip industry has today become global, with different areas and companies having the relative advantage. While designing is done in the US, and manufacturing in Taiwan and South Korea, assembly and packaging are done in China and key equipment made in the Netherlands. Each of these areas has developed its comparative advantage after decades of investment and effort.

But when China set up the ‘Big Fund’ in 2014, the Chinese authorities’ mandate to the companies was chip-manufacturing rather than the development of a self-reliant industry based on R&D and fundamental research. This strategy has left important gaps in China that the US is now intending to exploit through its new set of rules.

The US action against China must be seen in the backdrop of the growing tension between the two world superpowers; this has been playing out in relation to Taiwan and the Chinese support for the Russian invasion of Ukraine. In recent years, it has had an important technological component, which is now being ratcheted up.

With the US doubling down in its technology war against China, Beijing has no option but to boost efforts to develop its own industry. But after the fiasco of Tsinghua Unigroup and the corruption investigations, China may also consider a change of approach towards establishing its industry.

The current situation is a personal affront to Xi, who has invested a huge amount of time and effort in promoting a domestic Chinese semiconductor industry since 2014. The US action could not have come at a worse time, when the CPC will be reviewing the progress of the country since the last Party Congress.