After a failed two-year campaign to stop China’s Huawei Technologies from leading the world’s rollout of 5G mobile broadband, the Trump Administration announced the so-called nuclear option, asserting control over sales of computer chips made anywhere in the world with US equipment.
Silicon Valley firms like LAM and Applied Materials provide high-end fabrication equipment to the chip-fabrication giants who manufacture the chips that Huawei designs, and the US rule announced Friday could shut off Huawei’s access to the top-of-the-line chips it buys from Taiwan Semiconductor Manufacturing Corp (TSMC).
The ban may apply not only to the high-end chips that Huawei buys from Taiwanese fabricators for its high-end smartphones and servers, but also to radio frequency devices that power its 5G base stations.
That might hold back China’s US$170 billion internal rollout of 5G and hamper Huawei’s network building elsewhere, according to industry experts.
Earlier this year, the Trump Administration floated a number of plans for competing with Huawei, including a “virtual 5G” approach that substitutes software for hardware, or the purchase of Sweden’s Ericsson, the second-largest builder of 5G networks.
Ericsson is presently worth about $28 billion; add an acquisition premium and a $15 billion shot to its R&D budget, and for $50 billion the US would have had a national champion to take on Huawei. The tech war might cost the US many times that amount.
If China retaliates by shutting US tech companies out of the Chinese market, the outcome will be a collapse of trans-Pacific technology trade, aggravating what already is the worst economic downturn since the Second World War.
Both sides will suffer, perhaps gravely. The dispute has the potential to escalate into an all-out trade war that would push the world into depression.
In the medium term, China will build substitutes for US equipment. China buys nearly 60% of the world’s semiconductors, and the loss of the Chinese market would cripple the American semiconductor industry.
When the US stopped American chipmakers from selling chips to China’s number two telecommunications equipment firm ZTE in April 2018, the company shut down. By December 2018, though, Huawei had designed its own chipset for smartphones with capability that matched Qualcomm’s.
TSMC fabricates the chips, and that is what the new US ruling threatens to block.
The new US rules pushes the world into uncharted territory. Semiconductors drove the digital transformation of the world economy, and their design and manufacture combines technology from thousands of firms in dozens of countries.
The next shoe to drop will come from Beijing, which is mulling retaliatory sanctions against US companies like Apple, Qualcomm, Boeing and Cisco. Chinese leader Xi Jinping did not handle the initial phase of the epidemic well and suffered a significant loss of prestige. He cannot afford to be humiliated by the United States, and will respond in kind.
Washington’s after-the-fact assertion over extraterritorial rights over sales of products made by American equipment has no precedent. During the Cold War, foreign companies that bought American technology had to give assurances in advance that the products would not be sold on to the Soviet Union and its allies.
In this case, Taiwan Semiconductor and other fabricators bought American equipment to make products for Huawei and other Chinese companies. Huawei is now TSMC’s largest customer, overtaking Apple. The semiconductor industry around the world will scramble to remove as many American components as possible from the supply chain.
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It’s also unprecedented for the United States to try to stop the rollout of a key technology – in this case 5G broadband – rather than lead the rollout itself. If Huawei can’t source radio frequency devices from Taiwan, it will not fulfill its contracts to build 500,000 base stations.
It’s possible that Huawei’s 5G rollout in Europe will be set back by a year or more, giving Washington more time to think up an alternative. But it’s also possible that the US semiconductor industry will be the odd man out, as the rest of the world finds alternatives to US technology.
Washington is betting the farm on the hope that China and its partners won’t find a workaround in time. If they do, the new restrictions will be America’s last hurrah as a tech power. Ten years ago China would have been helpless. But during the past decade Chinese universities have muscled their way up to world class, thanks in large part to the return of tens of thousands of Chinese with doctorates from American universities.
China’s tech industry has the depth and breadth to attack the whole range of semiconductor production issues. Throughout the escalating Sino-American tech war, the Chinese have come up to speed faster than either Washington or the industry consensus expected.
The risk is that the US might lose the crown jewels – its leadership in semiconductor technology. That’s why the Trump Administration hesitated to impose a third-party export ban earlier.
At the urging of the US Defense Department, the White House rejected the nuclear option late in 2019, after America’s top tech designers warned that Chinese retaliation would shut them out of the Asian market. National Economic Council Chairman Larry Kudlow told the Wall Street Journal February 4: “We don’t want to put our great companies out of business.”
The president tweeted February 18: “The United States cannot, & will not, become such a difficult place to deal with in terms of foreign countries buying our product, including for the always used National Security excuse, that our companies will be forced to leave in order to remain competitive.”
Trump changed his mind after blaming China for the coronavirus epidemic. His trade adviser Peter Navarro declared last week, “We are at war with China,” and accused China of deliberately sending infected passengers on international flights from Wuhan to spread the virus.
Some observers attribute Washington’s increasingly hostile stance towards China to election rhetoric, but Trump didn’t have to throw a hand grenade into the semiconductor supply chain to get votes.
There is another, more ominous motivation. America faces a GDP decline of perhaps 10% during 2020, and an extremely uncertain recovery as it gradually reopens business activity without widespread testing or contact tracing.
The Asian economies – where the epidemic is largely under control– are coming back on line rapidly, and intra-Asian trade is booming.
Defense Secretary Mike Espers warned May 4 that China will use the pandemic to expand its footprint in Europe, “as a way to invest in critical industry and infrastructure, with effect on security in the long term.”
As a spinoff from its flagship 5G product, Huawei offers a series of artificial intelligence (AI) applications for healthcare, including diagnostic, telemedicine, and pharmaceutical research. China’s AI capacity played a key role in suppressing the epidemic, and hopes to lead in medical AI, possibly the 21st century’s biggest industry. China’s success in applying AI to epidemic control is an important selling point.
China meanwhile badly misplayed what should have been a strong hand. Navarro’s allegation that China deliberately spread the epidemic is inflammatory nonsense, and Secretary of State Mike Pompeo has yet to provide evidence that Covid-19 came from the Wuhan Virology Lab, as he alleged vociferously last week.
But China did prevaricate for weeks before admitting that an epidemic was underway – despite warnings from top Western virologists early in Januarythat the world might face a global pandemic.
Western scientists had an accurate picture of the risk by the first week in January, but with few exceptions failed to persuade their governments to act quickly. Beijing’s ham-handed attempts to buy influence through so-called face-mask diplomacy annoyed the Western countries most sympathetic to China.
Washington hopes that China’s loss of face through the epidemic will make it easier to impose controls on technology.
Retaliation against China through extraterritorial bans on chip sales is a high-risk response. LAM, Applied Materials and other American equipment makers dominate the present market, although Holland’s ASML has a monopoly on extreme ultraviolet lithography (EUV), the technology required to make the chips with the highest density of transistors.
Late last year the US persuaded the Dutch government to block the sale of a EUV machine to China. Last year the Chinese Academy of Sciences announced that it had developed its own EUV machine, but it is far away from application to large-scale production. If China puts its industry on a wartime footing with Manhattan-Project style resources, it might develop substitutes faster than the US expects.
According to Dr Handel Jones, the CEO of International Business Strategies, a prominent semiconductor consulting firm, “Blocking 5 and 7 nanometer sales to Huawei” from Taiwan Semiconductor and other fabricators “will have a major impact on the ability of Huawei to be competitive in smartphones.
Blocking radio frequency devices and other products to Huawei will stop the buildout of 5G in China, and that will not be tolerated. Even switching designs to [the mainland Chinese fabricator] Semiconductor Manufacturing International Corp at 14 nanometers would take a year.”
“It is both a very serious and volatile situation,” Dr Jones added. “There is a 120-day grace period where hopefully compromises will emerge.”
China meanwhile is considering its response. From the Chinese side of the board, elementary game theory indicates a maximalist response designed to inflict extreme damage on the already-weakened US economy.
The Chinese English-language daily wrote May 17: “Some industry analysts believed that a counterstrike against US companies like Qualcomm and Apple might prompt them to lobby against such restrictions as their interests in the Chinese market are important for maintaining their sustainable growth. For instance, 65% of Qualcomm’s total revenue lay in China, according to media reports in August 2019.”