THE CHINESE
custom official’s suspicions were first aroused by the size of the
woman’s stomach. She said she was only five to six months pregnant, yet
her belly protruded as if she were close to term. When she was searched,
her baby bump turned out to be fake. Inside an improvised pouch she was
smuggling not drugs or weapons, but computer chips—202 of them. Since
America imposed a ban on sales of certain semiconductors and related
equipment to Chinese entities last year, firms in China have been
running short. Imports have plunged (see chart 1). Entrepreneurial
middlemen (and women) have been coming up with all manner of schemes to
obtain the desired goods, and to avoid customs duties to boot.
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It
is not just small operators who are feeling the effects of the
sanctions. Before the new rules were imposed in October, Yangtze Memory
Technologies Corp (YMTC), a big state-owned maker of
memory chips, was widely seen as the Chinese firm with the best chance
of becoming a global force in chipmaking. Overnight, however, it and all
other Chinese firms were barred from buying the equipment they needed to make the most advanced chips. YMTC’s
inability to procure this gear, in turn, has stopped it from finalising
a business plan for 2023, analysts say. It may have to delay the
construction of a new production facility.
The impact is reverberating through supply chains. YMTC
cannot build production lines with foreign components, which means it
is having to cancel orders for Chinese equipment, too, that would have
gone into the same lines. It has reportedly cut orders from one local
firm by 70%. It may in time be unable to fulfil orders for chips from
Chinese customers. In January it began laying off workers and asked
former staff to repay generous housing subsidies. Disgruntled former
employees claim it is desperately trying to save cash and that its
troubles stem from the sanctions.
The
ultimate effect of all this will be to set back China’s chip industry.
International Business Strategies, a consultancy, had previously
estimated that Chinese firms would be making more than half of the chips
their country needed by 2030. After the American sanctions came into
effect, it lowered that forecast to 33%.
This
is just what America’s policymakers want. The latest sanctions are
different from past measures against China, Russia and, during the cold
war, the Soviet Union. They seek to deny China access not just to
advanced weapons or narrowly defined technologies, but to undermine
whole industries. In a speech in September Jake Sullivan, America’s
national security adviser, explained that the government wanted to
hobble China’s capabilities in “foundational technologies” such as
artificial intelligence, biotech and clean energy, to allow America to
maintain as much of an edge as possible in these areas. Some call this
plan the “Sullivan doctrine”.
FDPRgy-bargy
So far, America’s main technique for hobbling Chinese industry has been export controls using “foreign direct product rules” (FDPRs).
These orders, issued by the Department of Commerce, can be used to
restrict the sale not just of goods made in America but also of any item
made anywhere using American intellectual property. Firms that break
the rules risk prosecution if they do business in America and crippling
sanctions even if they do not.
The FDPR that has spurred chip-smuggling and upended YMTC
was issued in October. In keeping with the Sullivan doctrine, it
attempts to cut China off from the most advanced chips involved in the
machine learning that underpins all ai. It also bars
American engineers, and even Chinese nationals with American green
cards, from working at many Chinese chip companies. This abrupt
escalation, says Joerg Wuttke of the European Union Chamber of Commerce
in Beijing, was tantamount to “a declaration of tech war”.
In fact, the war had already begun. America has been cudgelling Huawei, a Chinese tech firm, with various weapons, including an FDPR,
since 2019. Donald Trump, the previous president, attempted to force
ByteDance, another Chinese firm, to sell TikTok, an app adored by teens
around the world. But America’s assault is clearly intensifying.
Congress has been loudly debating a ban on TikTok.
The mandarins of the commerce department and the Treasury have many
more potential sanctions up their sleeves. China, meanwhile, will not
sit idly by as its industries are pummelled. And, as in any conflict,
bystanders are being pulled into the fight.
How
far will the battle escalate and how severe will the damage be? At the
very least, the fighting will force a drastic reorganisation of supply
chains in the $570bn market for computer chips. It may well spill into
other industries such as clean technology, biotech and even agriculture.
It will in effect split the world into two distinct and mutually
exclusive blocs for many products, and thus undo many of the gains
brought about by globalisation. And it will harm the companies and
countries that are forced to choose between the two rivals.
Processing oriented
The next salvo is likely to be a strengthening and widening of the new export rules. The FDPRs
on chips focus on two factors: processing power and the speed at which
they communicate with other chips. Although in theory Chinese firms
could get around these twin restrictions by using lots of less
sophisticated chips, that would make it very cumbersome and expensive to
train large AI models. But the performance of chips is
always improving, and algorithms used for training are becoming more
efficient. This means that the sanctions will gradually lose their
potency, as more can be done with less.
Such advances may prompt America to modify its sanctions on chips, says Bill Drexel of the Centre for a New American Security (cnas),
a think-tank in Washington. It might choose to focus purely on the
computational power of chips. This is a simpler approach than trying to
find a “sweet spot between computing power and interconnect bandwidth”,
says Mr Drexel. But it would entail broadening the restrictions to less
powerful chips. That could ensnare the graphics-processing units used in
the video-games industry, a rapidly growing market worth $40bn last
year. Both American chipmakers and their Chinese customers would suffer.
The commerce department might also target other industries with FDPRs.
Chinese biopharmaceuticals, an industry with projected sales of more
than $100bn by 2025, are highly dependent on American intellectual
property. American firms supply lots of biological materials, technical
information and lab equipment to Chinese facilities which produce new
medicines and therapies, notes Ajay Kuntamukkala of Hogan Lovells, a law
firm. Some of these exchanges could be banned. One possible target is
American-developed software that Chinese companies use to make medicines
that are then exported back to America. Many companies in the West also
export data to China in order to develop new treatments. In future,
such transfers of data could also be restricted, notes Emily Benson at CSIS, another think-tank.
Another option the American government is weighing is an expansion of FDPRs
on companies. The test case for this is Huawei, which continues to
operate despite an array of American sanctions. One of its subsidiaries,
Kunpeng, makes servers used in data centres and licenses its designs
for central processing units (CPUs) to several Chinese tech firms. Those groups are still able to buy kit from Intel and AMD, two American companies, and chipsets from TSMC,
a Taiwanese chipmaker. But America could add these Huawei suppliers to
the “entity list” of blacklisted firms, impeding the expansion of
Huawei’s data centres.
Other big
Chinese conglomerates with global holdings could also get dragged into
the fight. In early March America’s Department of Agriculture announced
it would form a working group to promote fair competition in the seed
industry. The value of bonds issued by Sinochem, a Chinese
agro-industrial group, fell on the announcement, owing to fears that the
new body could recommend restrictions on its seeds. This is a
frightening prospect for China Inc, which has spent years acquiring
technologies overseas and, more recently, bringing intellectual property
to America and Europe. Sanctions against Sinochem could devastate the
operations of Syngenta, a Swiss agribusiness giant that it bought in
2017 for $43bn.
Some industries in Mr Sullivan’s sights will be hard to injure with FDPRs.
China’s nascent quantum-computing firms, for instance, rely very little
on American-made equipment or intellectual property. But Chinese
researchers in the field do collaborate energetically with their
American counterparts. American quantum-computing specialists write more
papers with Chinese ones than with people from any other foreign
country, notes Edward Parker, a scientist at the RAND
Corporation, an American think-tank. Hence the significance of another
of the commerce department’s munitions: “deemed export” controls, which
prohibit the disclosure of certain types of technical information to
foreign nationals, even on American soil.
America
may also place limits on capital flows in its attempt to stifle certain
Chinese industries. It is already illegal for American people or
companies to provide funding to firms suspected of close ties to China’s
armed forces. But American financial sanctions could get much fiercer.
The Treasury is unlikely to try to cut China off from the use of the
dollar altogether, as it has Iran, for example—at least unless relations
deteriorate much more. But American authorities are trying to refine
and develop the use of the dollar as a weapon in international
relations. Observers expect the Treasury may soon try to ban the use of
dollars to invest in some advanced technologies in China.
All
these measures, however, have drawbacks. Barring Americans from
collaborating with foreigners in research on quantum computing, for
instance, would set back the American industry as well as the Chinese
one, by preventing it from recruiting talented foreigners.
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By
the same token, restricting American investment in Chinese technology
would have only a limited effect. The growing hostility between China
and America and the closing of China’s borders for nearly three years
during the pandemic have already crimped the flow of investment (see
chart 2). American money is no longer that important to China’s
venture-capital industry, says Alexander Kremer of Picus Capital, an
investment group. Anyway, American regulators would struggle to enforce
sweeping financial restrictions. Monitoring every dollar fund based in
Hong Kong and in offshore havens such as the Cayman Islands is probably
beyond them, at least without a massive increase in staff and resources.
And then there are the repercussions
for American firms. China’s airlines are reliant on imported planes and
parts, many of them American. America could therefore bring aviation in
China to a standstill with a sweeping FDPR—a prospect
that alarms Chinese officials. But such a move would probably also
provoke a crisis at Boeing, a giant American aircraft-maker.
Artful dodgers
What
is more, China will also eventually find ways around whatever new
restrictions America lobs at it. The phoney baby bump is a crude form of
evasion, but there are more sophisticated ones, culminating in the
development of a domestic capacity to replace whatever America’s
regulators have withheld. Huawei is a good example. Its
telecoms-equipment and smartphone divisions have been dealt savage blows
by its regulatory pounding. But a recent speech by its founder, Ren
Zhengfei, described the company’s attempt to push foreign IP
from its systems. So far, Mr Ren claims, it has secured domestic
supplies of 13,000 components and redesigned 4,000 circuit boards. Most
strikingly, in April it will launch its own enterprise-resource-planning
(ERP) system, the software that underpins operations
across the corporation. (Until now it has used one developed by Oracle,
an American software firm.)
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The
new system is meant to “plug all the holes” created by the many
American strictures on Huawei, say analysts at Jefferies, an investment
bank. The ERP system was developed alongside a home-grown operating system that has helped further diminish ties with foreign suppliers.
These
substitutes are expensive to develop and may not prove as good as the
systems they replace. But China’s Communist Party is undaunted.
“Self-reliance” in science and technology is one of the top priorities
of Xi Jinping, China’s leader. His government has poured funding into
semiconductor development, among other technologies. Much of the money
has been wasted—but not all. For example, China uses lots of SerDes
circuits, vital components that connect chips, and that were mainly
produced by foreign firms until recently. But local manufacturers have
learned to make them relatively quickly, says Hexigetu of Sincere
Capital, a private-equity firm based in Shanghai. American sanctions may
end up spurring the very thing they are intended to impede: the
development of strategic Chinese industries.
Meanwhile,
the fiercer America’s restrictions become, the more businesses around
the world wince. Many businessmen and some foreign governments complain
that America is rewriting the rules of globalisation at great cost and
to little benefit. Western corporations have been forced to think about
their operations in China more like stand-alone, ring-fenced entities
with fewer and fewer links to their research departments elsewhere. The
looming threat of future sanctions means executives are putting off big
decisions on investments and hiring. Chinese tech firms, too, are likely
to delay investment and expansion in Western countries while they wait
to see what happens to TikTok.
America is moving so quickly that it has not always managed to persuade its allies to form a united front. The FDPRs
issued in October, for instance, were announced before it had secured
the support of the Netherlands, South Korea and Japan. Yet these
countries make lots of advanced chips and chipmaking equipment. If they
do not go along with America’s new rules, the attempt to blockade China
will fail.
After the announcement
American officials did elicit reluctant agreement from the Dutch and
Japanese governments to adopt similar measures, even though they will be
painful for ASML, a Dutch manufacturer of chipmaking
equipment, and several big Japanese firms. South Korean firms have been
granted a one-year reprieve but will eventually have to comply,
according to reports. South Korea exports about half of its memory chips
to China, notes Sam Howell at CNAS. Samsung and SK
Hynix, two big South Korean chipmakers, have invested billions of
dollars in manufacturing facilities in China. They risk penalties from
America if they do not fall into line, and from China if they do.
America’s vast sanctions programme faces many such hurdles, Ms Howell
notes.
China has so far refrained from
dramatic retaliation. Its leaders are happy to see big American firms
such as Apple expanding in their country. On his first trip to China in
three years, Apple’s chief executive, Tim Cook, sought to allay fears of
an economic decoupling between America and China. He told an audience
in Beijing on March 25th that the “symbiotic” relationship between the
two countries over the past 30 years has helped them both grow.
China’s
commerce ministry, however, is said to be mulling a ban on exports of
some advanced silicon wafers used in solar panels, which would hurt many
American firms. (It would also be devastating to Chinese exporters.)
Perhaps a likelier target is biotech, since lots of American companies
have an “uncomfortable dependency” on China for pharmaceutical inputs
and medical devices, says Reva Goujon of Rhodium, a research firm. Some
of the ingredients used in antibodies for anthrax, for instance, are
produced only in China. The more sanctions America announces the greater
the risk of a tit-for-tat cycle.
Critics
of America’s approach say that it is not just harming its own
companies, but also hindering the development of technologies that will
benefit all humanity. It will certainly raise costs for companies in the
affected industries. The sanctions drive also risks making America look
like a bully. Preventing Chinese nationals from participating in
high-level quantum-science research might slow the development of
quantum computing in China, notes Mr Parker, but it would also erode the
notion of American openness. “I was totally shocked,” says a Chinese
economist of the FDPRs imposed in October, “It goes against everything I was told: free trade, a rules-based order, open competition.” ■