US chips war hits allies but likely misses long term Chinese strategic target

Authors: Hosuk Lee-Makiyama, ECIPE and Robin Baker, LSE

The US Department of Commerce’s Bureau of Industry and Security (BIS) has implemented the most comprehensive controls on semiconductor fabrication and supercomputing to date. Over the course of October 2022, the Biden administration expanded its controls on the export of semiconductors, supercomputing and their associated inputs and equipment to China.

The sale of related technologies and the activities of US citizens working in these industries are also subject to licensing requirements. These measures significantly expand the ability of BIS to curtail technology transfer by end-use to China.

Markets responded in kind, with billions of dollars wiped from equities in integrated circuits (IC) and wafer fabrication equipment (WFE) — a segment dominated by US companies like Applied Materials, KLA, and Lam Research. BIS scrambled to clarify various legal ambiguities and it is increasingly clear that the fabs manufacturing less sophisticated, ‘legacy nodes’, are relatively unaffected. US, Korean and Taiwanese firms with chip manufacturing facilities in China have also secured temporary, one-year licenses to use US technologies at these sites.

But the respite may be temporary. In mid-November, US Commerce Secretary Gina Raimondo dispatched her undersecretary to the Netherlands and Japan to urge them to take further action. It is unknown whether these countries — specialists in the lithography process, a crucial step in IC production — will agree to US requests.

It is difficult to ascertain what more the Biden administration can demand from its allies. Their dual-use lists already include relevant lithography equipment. Export controls are already subject to treaty commitments and close coordination between the United States, Japan, and European Union (EU) member states. The Netherlands also denies export licences on any Extreme UV (EUV) that is used for scale production of very miniaturised chipsets.

While market valuations have stabilised, October’s developments should not be underestimated. These measures are a departure from the ‘sliding scale’ approach that had kept the United States and its allies one or two generations ahead in key technologies. As US National Security Advisor Jake Sullivan declared – the latest export controls are designed to foster ’as large of a lead as possible’.

It is striking how the US government has mirrored China’s state-run regime, by wrestling control of the free market. Under the foreign direct product rule, BIS’s controls apply extraterritorially due to a global reliance on US patents and talent. The US Department of Commerce can issue export licenses to whichever entities it wants, and block sales deemed contrary to US commercial or strategic interests.

Such power naturally causes unease among US allies. Even Japanese trade officials — known for their measured demeanour — were ’bemused by how Japan’s sovereignty could be so disregarded’. However, US diplomats and lobbyists are keen to ensure that Dutch and Japanese firms are equally unable to serve the world’s largest chip market.

This focus on ‘Burden Sharing’ is conveniently timed. Prior to October, US export controls targeted lithography equipment but remained laissez-faire on half a dozen critical production steps where US companies happened to dominate. China broke the 7 nanometre-chip barrier not by using Dutch EUV equipment, but ‘deposition and etching’ — an alternative process that relied on US tools. Some analysts suggest that the world’s three largest WFEs — which are all American — have increased their Chinese sales by US$5.4 billion since 2019, significantly displacing foreign competition.

The two largest national economies now impose similar state controls over an industry that once epitomised free trade and most-favoured nation principles, and there is little scope for future moderation. While Chinese firms have been removed from the BIS’ Entity List before, the odds of October’s controls being relaxed are as unlikely as Beijing abandoning its pursuit of military–civil fusion. Escalation looks more probable as both US Republican and Democratic parties continue to frame technological rivalry as existential. Further US restrictions have already been mooted on related investments.

Market intervention comes at a price — production silos are rarely economically efficient. US industry losses are measured in billions. Firms in Taiwan, Japan, South Korea and Europe must also restructure their organisations to stay onside. Even when BIS issues export licenses, the procedural opacity stokes hysteria about favouritism or US protectionism. For the EU, the disproportionate focus on lithography was just another example of successive US administrations using China as a pretext to neutralise Europe’s lead. Similar suspicions were also raised over US attempts to enter the 5G race.

Public funding through various ‘Chip Acts’ is hardly an adequate substitute to drive innovation — not least in China’s quest for semiconductor autonomy. Beijing has thrown US$50 billion at its own ‘Big Fund’, with mixed results. Yangtze Memory Technologies Corp, a top recipient, has become a competitive force in producing NAND flash memory chips, but state aid has been overly focused on fabrication and has neglected semiconductor design and manufacturing equipment.

Yet, China has been reluctant to respond to US export controls. Beijing could have retaliated by imposing restrictions on access to critical raw materials, or on US companies operating within its jurisdiction. But in reality, exacerbation of this problem goes against its short-term instincts and interests. Beijing still thinks and acts like a rule-taker — and state control is an amendment to the rulebook it will accept.

Export controls are not insurmountable in the medium term. In the past, much less resourceful nations than China have circumvented stricter embargoes and non-proliferation treaties for weapons of mass destruction. Elsewhere, the first Chinese 7-nanometre chip was manufactured by the Semiconductor Manufacturing International Corporation — a state-owned enterprise that BIS has sanctioned since December 2020.

Beijing — the ultimate savant of power-based statecraft — can simply bide its time. And time, as always, is on China’s side.

Hosuk Lee-Makiyama is Director of the European Centre for International Political Economy and Fellow at the Department of International Relations at the London School of Economics.

Robin Baker is Research Associate at the London School of Economics.