US Chipping Away At Global Semiconductor Supply Chains – Analysis

William A Reinsch and Emily Benson

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On 7 October 2022, the US Bureau of Industry and Security issued new regulations on exports of semiconductors and certain semiconductor manufacturing equipment. The rules attempt to block Chinese access to high-end artificial intelligence chips through a combination of new controls on software, people, knowledge transfers, manufacturing equipment and US components integrated into foreign products.

The new rules are a significant shift in an export control policy that the United States has been pursuing for nearly 30 years. The previous policy was designed to keep adversaries, primarily China, one or two generations behind the United States technologically. Under this policy, the United States would raise the level of controls as new technology emerged, before releasing older generations for export.

In other words, the controls were a deliberate moving target. That had three effects. China was denied access to the most advanced technology. US companies were able to sell older technology to China and use the revenue generated for research and development. And the provision of older US technology to China reduced the incentive for the development of Chinese alternatives.

Deteriorating relations between the United States and China as well as the realisation that the third point above had diminishing returns — China embarked on its own path of independent technology development many years ago — led to the new US rules being implemented. The main difference in the new policy is the creation of a technological line of control that the current US administration does not intend to move.

The United States has shifted its policy from simply trying to keep China behind to actively seeking to degrade its military capabilities. Maintaining export controls at the same level regardless of future technology developments means that the universe of controlled items and technologies will become much larger over time. It also means that enforcement will become more difficult and the cost to US producers will increase.

The short-term impact of the new rules appears to be fairly small for chip makers, since a relatively small number of chips were directly affected. But it has been larger for the equipment manufacturers, who have a significant market in China. Assessing the long-term impact requires examining three questions. What will be the effect of the new rules on US company revenue? Will the new controls accelerate China’s policy of indigenous technology development? Will the new controls eventually lead to ‘designing out’, a scenario where other countries develop products that contain no US technology and are therefore outside the scope of US export controls?

Currently, these questions cannot be fully answered, but there are some hints at what might happen. With respect to US company revenue, the immediate impact is likely to be small on chip manufacturers and large on equipment makers. Over time, as the universe of controlled items grows, the negative revenue impact will also grow and US companies could find themselves strapped for capital. This will adversely affect their research and development expenditure on future generation technology to the competitive detriment of companies.

With respect to China’s policies, the new US rules will almost certainly accelerate China’s plans for indigenous technology development. Those were already underway, but the sweeping nature of the new rules will push China to move more quickly. A report to the 20th Party Congress in October 2022 included the mandate to ‘achieve greater self-reliance and strength in science and technology’. They may also increase Chinese overcapacity of legacy chips that would further reduce revenue for US firms.

The third question is harder to predict. We have seen the ‘design out’ phenomenon before — most notably in the case of commercial communications satellites in the late 1990s and early twenty-first century. In the short run, there do not appear to be any countries capable of developing chips or equipment entirely free of US technology, but the ‘short run’ in the semiconductor industry is a matter of a few years.

As US controls cover more and more items, the incentives to develop non-US alternatives will grow and we may see a repeat of the satellite episode, which saw the US satellite industry’s global market share shrink from 75 per cent to 25 per cent in a few years.

In the long term, the rules could present significant challenges to US companies in maintaining market share and revenue expectations. US companies will inevitably face more competition from China as it continues down its own path of independent development, and companies could also face new competition from other sources lured into the market by the US export constraints. That will not be an immediate issue since entry barriers in this industry are very high in terms of both capital and technological expertise. But the longer the controls stay the same or expand in scope, the more likely it is that competition will grow.

This situation presents opportunities for other Asian nations from two opposite directions. First, as existing companies seek to remove Chinese content from their supply chains, they will look for alternative locations for manufacturing. Southeast Asia is an obvious choice, though the opportunities vary in individual countries. Second, new entrants to the market seeking to develop products without US technology could look to Asia as a suitable location for parts of their new supply chains.

Several countries in the region have significant experience both in manufacturing chips and in other parts of the supply chain, including assembly, testing and packaging. Japan has already joined the United States in applying additional controls on semiconductor products, and others, such as South Korea and Taiwan, are under increasing pressure to join. As the United States considers the effects of the current and future controls, it must take into account not only the limitations and costs of the controls but also the political and economic costs it is asking allied countries to incur.