August 16, 2023 | The Messenger

How the US Can Get Its Chips’ Worth With China

August 16, 2023 | The Messenger

How the US Can Get Its Chips’ Worth With China

The passage of the CHIPS and Science Act one year ago this month was heralded as a monumental step in U.S. efforts to compete with China in the tech domain. “We need our government and our economy to rely on chips made right here in America,” proclaimed Senate Majority Leader Chuck Schumer (D-N.Y.) last fall. The CHIPS Act was the way to do so. A corresponding White House news release declared that the “CHIPS and Science Act will lower costs, create jobs, strengthen supply chains, and counter China.”

There has been much ballyhoo since. Proposals have been floated by IntelTSMC and others. But real progress has been stymied. Several weeks ago, for example, TSMC announced a delay in its plans to get a new facility in Arizona up and running.

And as the U.S. effort stalls, China is building. Over the past year, SMIC, a Chinese semiconductor foundry company, has increased its market share of the global legacy chip marketplace, including with growth in sales to U.S.-based customers. The importance of the U.S. market to SMIC — and the company’s confidence that it will continue to take advantage of that market — is reflected in its May 2023 opening of a new office in Irvine, Calif. (For context: the CHIPS Act had passed nine months earlier and SMIC is on the Department of Commerce’s Entity List.)

YMTC, China’s flash memory chip champion, is on the Entity List, too. It is expanding operations thanks to a flush of cash from China’s Big Fund and successfully increasing prices for its 128-layer NAND flash chip. CXMT, China’s DRAM chip champion, is ramping up for an IPO on the mainland. Chinese tech companies, intent to keep pace in processing and data demands from the current wave of artificial intelligence excitement, have been increasing their orders for Nvidia’s cutting-edge chips, which are seen as core to the tech stack for current and next-generation AI applications.

Even Huawei, the Chinese tech champion most severely targeted by U.S. regulatory action, has expanded its role in new semiconductor materials and production. Huawei’s HiSilicon subsidiary, for example, is preparing to put into operation a more than 2 million-square-foot optical chip factory in Wuhan. And Huawei is actively investing to operationalize China’s strategy of controlling the global market for key next-generation semiconductor materials, such as gallium and indium phosphide.

Examples abound; their point is clear: China is further along in competing for semiconductor dominance than the West and the U.S. collectively have recognized — and current, defensive policies are not keeping pace. None of this is because China is out-innovating American enterprises or researchers. It’s because China is building. China has enduring strengths in market share of legacy segments and supply chain control; Beijing is willing to apply those for commercial and geopolitical leverage. And Chinese and global capital markets value that.

American promises are just promises until they’re built. American defenses are hollow until they’re enforced.

The corollary of this dynamic: A tit-for-tat of escalating, incremental Whac-A-Mole moves does not favor the United States. China holds significant points of leverage all along the semiconductor value chain. Those range from dominance of upstream semiconductor materials to downstream pressures derived from control of packaging and testing steps in the chip value chain. Moreover, China remains the world’s workshop. That means Chinese sub-component and component manufacturers are key customers for even the most cutting-edge and innovative U.S. and allied companies. Our crown jewels lack value if they don’t have use cases and markets outside of China in which to grow.

U.S. strategy and policy — ranging from CHIPS Act funding to export restrictions — need to recognize that the U.S.-China tech competition is all-encompassing, that it’s an industrial competition first, and that both of those realities lend China an under-appreciated advantage.  

U.S. policy needs to continue to defend against China’s semiconductor champions and value chain control — and to do so more effectively. At the same time, U.S. policy needs to incentivize real, proactive investment by industry.

What does this mean?

The U.S. needs more strategically to target its defensive tools. China’s semiconductor ecosystem is a latticed web of financial and operating entities buttressed by Chinese Communist Party industrial policy. The core forces behind that web can be identified and, political will willing, restricted from accessing U.S. markets, technology and capital. But those core forces need to be identified and targeted. The Commerce Department needs to develop and enforce broad-based restrictions of technology flows to this web — and limit waivers and exemptions from existing restrictions. 

Congress can increase pressure on China’s core semiconductor nodes with moves like expanding Section 889 enforcement to more Chinese champions. Both inbound and outbound investment screening need high-fidelity intelligence to cue expansions of reviews of potentially relevant covered transactions.

And the U.S. and allied private sectors need to be motivated to build. That, too, will require additional regulatory prods. Domestic content requirements and prohibitions against Chinese and Chinese-dependent goods should be expanded. Capital markets need more clarity in assessing China risks across the semiconductor value chain and the downstream markets that depend upon it. The allure of the Chinese market, for cost reductions and for revenue gains, may be a short-term boon for a wide variety of publicly listed companies. It’s also clearly a long-term losing proposition. Transparency should be required in capital markets to make this reality, and related exposure, clear to investors all along the capital stack. With added transparency, capital markets can be expected to impose costs on those players who elect to play both sides in this strategic showdown.

The chips are on the table. The only way to win is with smarter offense and defense that target the core of China’s strategy.

Nathan Picarsic and Emily de La Bruyère are senior fellows at the Foundation for Defense of Democracies and co-founders of Horizon Advisory. FDD is a Washington, DC-based, nonpartisan research institute focusing on national security and foreign policy.


China Cyber