China is fighting back in technology war with the US

TThe dates from 2022 are destined to reverberate in geopolitical history. The first, Russia’s invasion of Ukraine on February 24th, hardly needs further elaboration. Second, on October 7, 2022, the United States enacted a new set of export controls aimed at hindering China’s future advances in AI technology. Rather than targeting AI software, export controls cut off China’s access to the advanced (and almost exclusively U.S.-designed) computer chip hardware that powers AI. The next breakthrough in AI technology in more than a decade has convinced policymakers in both Beijing and Washington that leadership in AI technology is the foundation of their future economic and military power. On October 7, the US government pledged to prevent China from becoming an AI-powered authoritarian superpower.

In March 2023, Japan and the Netherlands also announced that they would introduce new export restrictions on advanced semiconductor manufacturing equipment, making the situation even tougher for China. Together, the United States, Japan, and the Netherlands supply about 90 percent of all the equipment used in computer chip factories around the world. Currently, all three countries have strict export controls on advanced semiconductor manufacturing equipment, which not only prevents China from purchasing American chips, but also prevents it from purchasing the equipment needed to manufacture Chinese alternatives.

In the months since October 7, the world has been watching to see how China will retaliate against the United States and its allies, as Chinese diplomats have constantly threatened. “This is not without consequences,” the Chinese ambassador said in March. “We’re not going to just swallow this.”

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The wait is now over. China launched a counterattack with three targeted moves.

First, China’s antitrust authorities effectively block all corporate mergers involving U.S. semiconductor companies operating in the Chinese market. While this is not as serious as export restrictions in the United States, the Netherlands, and Japan, it is more damaging to the U.S. semiconductor industry than it might seem at first glance. Mergers are essential for U.S. companies to acquire innovative technology and make strategic changes to their business models. Intel CEO Pat Gelsinger recently visited China to talk about Intel’s $5.4 billion acquisition of Tower Semiconductor, a deal that Intel executives believe is critical to the company’s future. He tried to persuade local officials to approve the project. Completion of the deal is six months behind schedule, with the August 2023 termination deadline rapidly approaching.

Second, China has launched a cybersecurity review of Micron, a major U.S. memory chip manufacturer. In late May, Chinese regulators banned the purchase of Micron chips in China’s critical infrastructure sector. Although Chinese regulators have publicly claimed that the decision was made solely for cybersecurity reasons, Chinese diplomats say it is certainly politically motivated retaliation for the October 7 export restrictions. This is unofficially acknowledged. So far, there is no indication that Micron has been banned from the Chinese market as a whole, but that could change in the future. Micron’s annual sales to China total $3.3 billion, so losing access to Chinese customers would be a blow.

Third, China announced that exports of two minerals, gallium and germanium, which are critical raw materials for electronics manufacturing, will be subject to export licensing requirements. China is the world’s dominant supplier of both materials, and the Chinese government can currently block exports at its discretion. Gallium in particular is important for many types of semiconductor technology. Although the Chinese government has not explicitly stated that the export restrictions are in response to October 7, there is no doubt that this is the Chinese government’s intention.

Gallium and germanium are not rare goods that the world would struggle to find substitutes for, even if China imposed a complete export ban. Both products are natural byproducts of mining other minerals such as aluminum and zinc, so if China tries to cut off supply, the U.S. and other non-Chinese mining companies could easily lose business selling germanium and gallium. You can participate in Many international semiconductor companies, including those specializing in gallium-based products, have said they do not expect any material impact on their business.

Therefore, the Chinese government likely intended this move as a warning shot to deter future actions by the United States and its allies. While the new export restrictions themselves are not particularly significant, China threatens to exercise control over the broader mineral supply chain. Most notably, China dominates the mining and refining of rare earth metals, controlling over 60 percent and 80 percent of the world’s production capacity, respectively.

A ban on rare earth exports would be far more damaging, but even in this case, the potential availability of non-Chinese alternatives, rather than technological feasibility or geographic availability, would be far more damaging. It’s a matter of political will. Rare earth deposits are available in many places, not just China. It is better for China to replace China in the mineral supply chain, even if it takes longer, if the US and its allies spend money (and speed up approval of regulatory permits). It’s much easier than replacing it. The United States and its allies in the semiconductor supply chain. China is decades behind the cutting-edge semiconductor manufacturing equipment achieved by the United States, Japan, and the Netherlands.

Furthermore, if China were to exercise its ability to limit the supply of rare earths, it would call into question reliance on China as a reliable supplier not only of critical minerals but also in all other sectors of the economy. While “decoupling” is an outdated policy term, “risk avoidance” and “diversification” have both figured prominently in recent economic security announcements from the Group of Seven (G7) and the European Union. Policymakers and business executives around the world are seeking to establish new and expanded trade relationships with partners who can offer viable alternatives to China, both as customers and suppliers. This is just an acceleration of a trend that was already underway. Samsung, for example, closed its last mobile phone factory in China in 2019 and moved production to countries such as Vietnam and India. Similarly, computer maker Dell announced plans to stop purchasing Chinese chips by 2024.

This is the fundamental reason why the Biden administration has calculated that it has an escalation advantage when it comes to technology export controls. There are some key technologies that China simply cannot do (at least for now) that companies from the United States and its allies can do. Therefore, whenever China wants to inflict pain on the United States or its allies, it can do so, but only by further harming itself.

Since October 7, analysis and speculation about China’s retaliation has dominated the news coverage. But retaliation is not the most important element of China’s strategy. His four parts of China’s newly updated semiconductor strategy are really important.

First, China is trying to circumvent chip export restrictions by smuggling advanced AI chips and other technologies to continue its AI development efforts. The U.S. Department of Commerce’s Bureau of Industry and Security (BIS) is the agency tasked with enforcing export controls not only on semiconductors destined for China, but also on all dual-use exports controlled by the United States worldwide. To carry out the task of monitoring trillions of dollars of economic activity, BIS has fewer than 600 employees and a relatively small budget of just under $200 million. China is betting that a network of smugglers and shell companies can detect leaks in BIS export control enforcement barriers. As long as Congress continues to ignore BIS, which is woefully under-resourced relative to the size and importance of its mission, China may be right.

Second, China seeks to divide the United States from its allies. In the case of the Netherlands and Japan, China has already been unsuccessful in dissuading them from imposing new export controls. But that doesn’t mean China is giving up, it’s just turning its attention not only to South Korea but also to other European countries. China may be decades behind the United States, Japan and the Netherlands in semiconductor manufacturing equipment, but Germany and South Korea are not. The combination of Germany and South Korea’s technological expertise and China’s financial and engineering capabilities would pose a serious threat.

Third, China is stepping up its existing industrial espionage and recruitment efforts. During the Cold War, the U.S. Central Intelligence Agency (CIA) concluded that Soviet efforts to illegally obtain semiconductor manufacturing equipment and operating know-how dwarfed all other Soviet industrial espionage activities. The situation is similar in China, which has drastically stepped up its use of cyber espionage tools and recruitment of human resources. ASML, one of the world’s leading semiconductor equipment manufacturers, faces thousands of cybersecurity incidents each year, alleging that Chinese employees and partners steal proprietary engineering data and illegally sell it to Chinese government-backed companies. He said the problem has repeatedly plagued him. Semiconductor companies in the United States, Japan, South Korea, and Taiwan all face similar challenges.

Fourth, and most importantly, China is investing hundreds of billions of dollars to build an all-Chinese supply chain that eliminates dependence on foreign technology suppliers. The Biden administration’s export restrictions did not cause this. It has been going on for over 10 years already. China’s “Made in China 2025” The policy (originally announced in 2015) included “replacing imported products with Chinese-made products” among its goals for China’s semiconductor industry. Diplomatic backlash caused China to stop talking openly about ~. Made in China 2025, but that policy never went away. Indeed, China’s leaders have further reinforced China’s fundamental goal of “self-reliance.” Made in China 2025 Following the Trump administration’s trade war and export restrictions on Chinese tech companies ZTE and Huawei. China’s State Council’s July 2020 semiconductor policy (adopted almost a year before President Biden took office) states that imports of foreign semiconductor manufacturing equipment are prohibited until Chinese companies have made enough progress to displace their foreign competitors. He said it was a “temporary” need.

These are unacceptable conditions as the basis for any trade relationship between China and the United States. The Biden administration’s efforts have been regularly (and falsely) attacked as a decoupling strategy. But in reality, Chinese policy is much closer to decoupling than US policy. The October 7 export ban did not change China’s strategy, but it made it more difficult for China to succeed by cutting off access to chip manufacturing equipment.

Therefore, German and South Korean companies that may be attracted to the short-term benefits of transferring technology to Chinese competitors, but which do not foresee a meaningful long-term role for their Chinese It’s good to remember that you’re contributing to building the future. Companies outside China. Quarterly and annual profits will likely be large. The results five or ten years from now will be disastrous. Some hope that governments will take this into account as they consider introducing new export controls similar to those in the United States, Netherlands and Japan.

China’s retaliatory efforts are aimed at scaring the United States and its allies, and in that sense they are probably working. Fear of retaliation continues to dominate news cycles and looms large in the minds of policymakers, especially in countries that have erected major fences, such as Germany and South Korea. But even though China’s targeted companies are inflicting real pain, the more strategically important issue is China’s decades-long policy of excluding foreign companies from its technology supply chains. , the threat of authoritarian superpowers controlling the future of AI. The United States and its allies will probably never succeed in persuading China to give up these goals, but if the two countries stand united and strong, they can ensure that China’s strategy fails.

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