The Art of Economic War.
Bert Hofman
Director, East Asian Institute
A monumental shift in United States policy vis-à-vis China took place on October 7. On that day, the US Commerce department released a 139 page document listing measures that effectively restrict China’s access to the most advanced semiconductors. These measures are likely to set back China’s ambitions in many areas of technological development. Semiconductors and their information processing power are the basis of technologies ranging from AI to supercomputing to medical and biological innovations—all priorities in China’s 14th Five Year Plan. Advanced semiconductors are also key building blocks for today’s most sophisticated weapons, and that is what led the US to impose the measures.
The new rules not only apply to US firms, but to any company worldwide that uses US semiconductor technology, which practically means all the world’s leading chipmakers makers have to follow the new sanctions regime. Chad Bown’s recent Trade Talk podcast provides a very accessible explanation of where the measures came from and what they mean for China and the rest of the world. In putting up a licencing regime for chip making tools from US companies such as Applied Materials, Lam Research, and KLA, the US department of commerce effectively cuts of China from the supply of the most advanced chips, the tools to make them with and US expert to use the tools.
This is a big step. As CSIS, a US think tank wrote: “In weaponizing its dominant chokepoint positions in the global semiconductor value chain, the United States is exercising technological and geopolitical power on an incredible scale.” An American observer of China’s chips industry remarked: “This is what annihilation looks like: China’s semiconductor manufacturing industry was reduced to zero overnight. Complete collapse. No chance of survival.”
US National Security advisor Jake Sullivan had been very clear in a speech preceding the issuance of the measures: “We previously maintained a “sliding scale” approach that said we need to stay only a couple of generations ahead. That is not the strategic environment we are in today. Given the foundational nature of certain technologies, such as advanced logic and memory chips, we must maintain as large of a lead as possible.”
Sullivan
added that other technologies, including biotechnologies and
biomanufacturing and clean technologies would be considered for similar
measures. In the same speech he pointed
out that similar measures had been very effective for cutting off
Russia from US technology.
At a recent conference of the Peterson Institute of International Economics and the Lee Kuan Yew School, Singapore’s Foreign Minister Vivian Balakrishnan called this “All but a declaration of technological war.”
So the gloves are off. In fact, the measures are unprecedented in peacetime in its breath and reach.
The Trump administration had earlier applied similar sanctions on ZTE, a telecoms firm, because of its involvement in North Korea and Iran. But after a direct appeal from China’s leadership, Trump backed down. In contrast, restrictions on technology against another telecoms firm, Huawei, had stuck, and the US used a cold war instrument, the “Foreign Direct Product Rule” to enforce the restrictions. This rule, a leftover from the cold war, basically says that the It essentially says that a product made with US technology, the US government can halt its sale to any country - including products made in other countries. But the measures were targeted to some extent—to prevent Huawei’s dominance of 5G technology. The same rule is now being used to ban most sale of advanced semiconductors and its technologies to China.
The Biden administration chose not to use a multilateral agreement, the Wassenaar Agreement, to achieve its objectives. Under the “Wassenaar Arrangement” 42 participating countries agree on restrictions on transfer of so-called dual use technologies. This agreement is a successor to the COCOM list, which was in use during the cold war, and which was predominantly aimed at the Soviet Union. Its successor includes countries that used to belong to the Warsaw Pact as members, and even Russia is a member. Aside from that complication, the measures agreed under the Wassenaar Arrangement are narrowly targeted at dual use technology only, or as Evan Feigenbaum coined, they protect “small yards with high fences.” The new US measures are of Botanical Garden size.
Undersecretary of Commerce Alan Estevez, the man in charge of the bureau that enforced the measures, said at an event of the Center for New American Security end-October “I know there's going to be some questions about where the multilateral is in what we just did. And I will say that's a work in progress. We moved out at this point because we felt we needed to for national security reasons.”
The sanctions against China are remarkable in another sense: they are not targeted against specific behaviour of China. In this sense, they are unlike the sanctions on, for instance, Iran, DPRK, or Iraq before the 2003 invasion, which were targeted against these countries developing weapons of mass destruction. Doubtful as the effects of these sanctions are, at least sanctioned countries could take a clear course of action to have the sanctions removed. The current sanctions on China foresee no such change in behaviour—they simply want China to continue to lag the US technologically.
What made the US choose to apply this heavy sanctions weapon now?
It is unclear. Some say this was in reaction to China’s response after Pelosi’s visit to Taiwan, which demonstrated China’s growing military capabilities. Others say that China’s February 4 agreement with Russia and China’s tacit support for Russia’s position (if not its actions) in Ukraine triggered the hardliners in the US administration to push for more measures.
Chad
Bown’s podcast referred to earlier puts forward China’s Civil-Military
Fusion strategy as the bone of contention. This strategy, which aims
for China’s military to benefit
more from civilian technological advances, has been in place for some
years now, and has not demonstrated much visible results to date. What
it does mean, though, is that unlike before, commercial companies in
China could enhance the capabilities of the military.
So restricting technology transfer to China’s traditional defence
industry, which is often State Owned, would no longer be enough.
Ironically, the United States themselves are the masters of using civilian technology for their military. Indeed, most military equipment in the US is produced by private companies such as Boeing, Lockheed and Raytheon, which also serve civilian, private markets. In that sense, China is following the US with its civil-military fusion.
Whatever the case may be, the US measure pushes the two countries further towards a new cold war. And one that economically will be far more damaging than the previous one. As IMF Chief Kristalina Georgieva said in an interview with the Washington Post, “We may be sleepwalking into a world that is poorer and less secure as a result”
One question is whether the US action are compatible with the WTO.
The WTO allows a country to impose trade measures if it relates to National Security (Article XXI of the GATT 1994 agreement), but this authority, according to a WTO arbitration panel, is not unlimited. Russia, the defendant in the case in question, “Russia—Traffic in Transit dispute” had argued as much, and was supported in this by the US in a Third Party Submission. In the past, the US has motivated other measures with national security, including tariffs on steel imports from its closest allies, as well as on China. So the US wanted the WTO to stay out of the national security issue.
The WTO arbitration panel decided otherwise. Specifically, for countries to be justified in using Article XXI, there should be an “emergency in international relations” such as a situation of armed conflict, or of latent armed conflict, or of heightened tension or crisis, or of general instability engulfing or surrounding a state. Thankfully, this hardly seems to be the case between the US and China at this stage. This means that China could be successful if it were to seek WTO arbitration on the US measures. Unfortunately, the US has also de facto derailed the WTO dispute settlement system by refusing to clear appointments to the Appeals Panel. The “rule based international order” is apparently not always worth applying.
The US position today contrasts with that of the time the national security exemption originated, in the run-up to the establishment of the International Trade Organization in the 1940s. The ITO was meant to become the complement of the IMF and the World Bank, designed to safeguard the world from the devastating economic warfare of the 1930s, when competitive depreciation and trade tariffs added to the misery of the Great Depression. The ITO never came about, and the General Agreement for Tariffs and Trade took its place as a treaty, not an organization. A careful review of the US debate at the time shows that policy makers held different positions on the national security exception, and most saw that allowing for unconstrained application would undermine the fundamentals of any free trade agreement. This position is remarkable in its context, the emerging cold war.
The
use of economic sanctions in international law emerged even earlier, in
the aftermath of World War I. The devastation of the first World War
had thrown out the liberal notion
that economics and international relations and conflict should be kept
separately. The League of Nations in its
covenant took an explicit and expansive view on sanctions—which it saw as a means to deter aggressors:
Should any Member of the League resort to war in disregard of its covenants under Articles 12, 13 or 15, it shall ipso facto be deemed to have committed an act of war against all other Members of the League, which hereby undertake immediately to subject it to the severance of all trade or financial relations, the prohibition of all intercourse between their nationals and the nationals of the covenant-breaking State, and the prevention of all financial, commercial or personal intercourse between the nationals of the covenant-breaking State and the nationals of any other State, whether a Member of the League or not.
In a recent evaluation of the experience with economic sanctions, political scientist Nicholas Mulder concludes: “the success rate differs depending on the objective, the historical record is relatively clear: most economic sanctions have not worked. In the twentieth century, only one in three uses of sanctions was “at least partially successful.” More modest goals have better chances of success. But from the available data it is clear that the history of sanctions is largely a history of disappointment.”
Mulder also describes one of the most famous (or infamous) sanctions—those against Japan in the 1930s. Because of Japan’s invasion of Manchuria and expansion in China and French Indochina, the US and its allies put increasingly stringent sanctions on Japan 9at the time no longer a member of the League of Nations.) Most damaging to Japan’s war efforts were the export ban on aircraft fuel, and later all petroleum and iron ore. This led in the end to Japan’s disastrous decision to invade South East Asia to seek their own oil fields. That invasion was preceded by the attack on Pearl Harbour, which triggered the Pacific War.
Despite the mixed record of success, sanctions have been a bit of a growth industry. As one authoritative source put it: “economic sanctions have increasingly become ‘the tool of choice’ in responses to international political challenges related to geo-political conflicts” (Figure 1). The Global Sanctions Database documents includes a total of 1101 publicly traceable, multilateral, plurilateral, and unilateral sanction cases over the period 1950-2019, some 250 of which are still in place. Most of these are bilateral, and imposed for a plethora of reasons, not just national security. Sanctions include trade sanctions, financial sanctions, travel restrictions, arms sanctions, military assistance sanctions, and more. It is noteworthy that, despite a rapid increase of US-imposed sanctions, it is North-West Europe that uses the tool more than any.
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Figure 1: Sanctions |
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Type of Sanctions over time |
Geographical distribution of sanctions |
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Source: Kirilakha et al, 2021, The Global Sanctions Data Base: An Update that Includes the Years of the Trump Presidency. Drexel Economics Working Paper Series WP 2021-10 |
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China is no stranger to unilateral sanctions, formally or informally. In the past, the country has used economic coercive measures to achieve its political and strategic goals. The recent trade measures against Australia, which called for an independent panel investigation into the origins of COVID-19 is one example. Measures against Korea after its decision to install the THAAD anti-missile defence system in light of North Korea’s increased missile testing is another. And the actions against Lithuania in the aftermath of the country’s acceptance of a Taiwan Representative Office (as compared to the traditional Taipei Trade representative Office) is another.
China
also recently adopted regulations to respond to foreign sanctions,
including the Provisions of the Unreliable Entity List, the Rules on
Counteracting Unjustified Extra-Territorial Application
of Foreign Legislation and Other Measures, and the Anti-Foreign
Sanctions Law. These regulations seek to deter the imposition of
sanctions against Chinese individuals, entities, and government organs,
and are defensive in nature. The regulations have all been
enacted after September 2020, following the increase of US and EU
sanctions against Chinese government individuals and entities due to
reported human rights abuses in Hong Kong and Xinjiang. In response to
EU sanctions, it banned members of the European parliament
and some academics and a think tank from visiting China.
The key question is of course how China will respond to the US measures.
There has been no official reaction to the US measures yet, in part because most Chinese officials were busy with the 20th Party Congress, followed by the 5th Hongqiao Import Expo, a big initiative of China to encourage imports, and the G-20.
The sanctions will strengthen the hands of those in Beijing that have argued the US is trying to contain China’s rise—in fact that notion is now in black and white in Jake Sullivan’s speech. Thus, China’s nationalists will likely use the semiconductor measures as exhibit one in their arguments, and policy makers will likely act more in accordance with the assumption that the US is indeed following a containment policy. How this will play out in actual policy steps remains to be seen.
China could take the US measures to the WTO, and doing so would reconfirm China’s stated commitment to the multilateral system. Given the likely outcome though—the process will be stalled in appeals due to the lack of appeal judges—China may go beyond this step.
China could use its own chips, so to speak, to retaliate. China produces about a quarter of the world’s semiconductors itself. Most of these are less sophisticated but are used in products from cars to fridges to electronics. Moreover, companies like Taiwan’s TSMC and Korea’s Samsung have production facilities in China, some destined for exports. The US has for now granted a one-year respite for those facilities to continue to use US tools. But China could put its own export licensing system in place for the chips these companies want to export from China.
China
could retaliate by denying the US or US companies access to other
critical inputs. Often mentioned are a collection of minerals known as
“rare earths” which, like chips, are
inputs into numerous industries, from steel making to chips
themselves. China is not the dominant miner of these minerals, but it
is the dominant refiner and processor, in part because the process is
heavily polluting, thus many western countries would like
to avoid doing so. But the US could find other countries to take on
the refining, so any sanction is likely to have only temporary effects.
Another field in which China dominates production, and which is of strategic importance for the US is renewables. China is the dominant producer of solar cells, wind mills, car batteries and other products critical for the energy transition that the Biden administration pursues. But using that market power would not only run into economics—i.e. the US will find substitutes—but would also damage China’s reputation as a positive contributor in averting climate change.
China will no doubt double down on its “indigenous innovation” agenda and seek to use industrial policies to gain the capabilities for producing its own high-end chips. Recently, SMIC announced that it had developed its own 7 nanometer chips using older technologies that would not be banned under the new sanctions regime. Nevertheless, China will have a hard time catching up. For the past 20 years or more semiconductors have been a key plank in China’s industrial policies, and the results have been disappointing. While it can produce the lower tech memory chips, the high end market is dominated by Korea and Taiwan in manufacturing chips, and the US and Europe in providing the tools for design and manufacturing.
China could also double down on its national security strategy. The 20th Party Congress still confirmed that development was still the first priority for the Party, but general secretary Xi Jinping also pointed out that “security is the root of development.” As I wrote 3 years ago, after the Trump measures against Huawei came on stream: “In addition, it is plausible that, in a more adversarial external environment, China may revert to a more state-driven, less reformist development model, which in the long run lowers its potential GDP.” This of course has already started to happen since then, and some say this was the original intent from the side of the United States: to entice China to take a wrong turn in its development trajectory, and become another Soviet Union. Time will tell.
A final question is how the chips industry in the US and elsewhere will react. They stand to lose a sizable market and billions of dollars if they are no longer able to supply China with chips or tools. China imported $350 billion worth of chips in 2020. Chips producers could fight the measure in US court, and some may choose that route. In particular, the ban on US citizens and green card holders to work in China’s chip industry seems to limit the “pursuit of life, liberty and happiness” as guaranteed by the US constitution.
Companies such as Nvidia, a high end graphical chip maker, may work their way around the sanctions. Nvidia announced that they had produced a high end chip that was compatible with the US measures. Before the measures were announced, China’s largest domestic chips producer, SMIC, announced they had found a way to use old, presumably unbanned, tools to develop high-end 7 nanometer chips.
Necessity is indeed often the mother of invention.
