Washington's Semiconductor Sanctions Won't Slow China's Military Build-Up

In October, the U.S. introduced a ban on exports to China of cutting-edge semiconductor chips, the advanced equipment needed to manufacture them and semiconductor expertise. The export controls are Washington’s most serious attempt to undermine China’s military modernisation and the most damaging measures U.S. President Joe Biden has taken against China.

China will probably struggle to maintain its rapid advances in artificial intelligence, quantum and cloud computing without access to U.S. technology and expertise. Chipmakers like the Semiconductor Manufacturing International Corporation—China’s largest logic chip producer—will lose access to machine maintenance and equipment replacement under the new controls.

U.S. chip equipment suppliers like Lam Research, Applied Materials and KLA Corporation have suspended sales and services to Chinese chipmakers, while ASML Holding, a Netherlands-based supplier, told its U.S. staff to stop servicing Chinese customers until further notice.

Despite the bleak short-term outlook, it is wrong to assume that U.S. controls will hobble China for years. In the case of nuclear weapons, significant resources were poured into acquiring bomb technology once political leaders decided that they were essential for national defence. That effort inevitably starved other sectors, but more often than not successfully delivered nuclear weapons programs.

Now that advanced semiconductors are seen as essential to national defence, Beijing is adopting a ‘whole of the nation’ approach and investing national resources into the industry. Many engineers and computer scientists are likely to be assigned to semiconductor design and manufacture, assisted by espionage against U.S., South Korean, Taiwanese, Japanese and European chip firms.

The export controls won’t cripple the Chinese military. According to a recent RAND Corporation report, China’s military systems rely on older, less sophisticated chips made in China on which U.S. export controls will have no effect. If China needs more advanced chips for AI-driven weapons systems, it can likely produce them, albeit at a very high cost. Many semiconductor industry experts agree that China has the technical capability to produce cutting-edge chips yet lacks the commercial capability to scale up production. This means that the U.S. ban will have less effect on weapons systems, instead delaying the rollout of civilian applications such as autonomous vehicles.

Nor will U.S. semiconductor firms emerge from the sanctions unscathed, given that many have China as their largest market. China accounts for 27% of sales at Intel, 31% at Lam Research and 33% at Applied Materials. Both Applied Materials and Nvidia expect the new export controls to cut U.S.$400 million (6% and 7%, respectively) from next quarter’s sales. Lam Research—one of Yangtze Memory Technologies Corp’s largest suppliers—expects the controls to cut a whopping U.S.$2.5 billion (15%) from 2023 sales.

These dramatic cuts come at a particularly difficult time for the U.S. semiconductor industry, which is experiencing falling revenue and increased input costs. By one estimate, the damage U.S. sanctions inflict on research and development and capital investment in the Western semiconductor industry ‘will exceed Washington’s modest subsidies for the chip industry by a factor of five or more’.

Tit-for-tat retaliation against the U.S. is not an option for China, given its heavy reliance on foreign technology. Any reciprocal measure would inflict more damage on China itself. Punishing U.S. companies with big exposure in China—like Nike or Apple—would harm the Chinese labour market since those firms employ many Chinese citizens. Other foreign supply chains and Chinese businesses supplying Nike and Apple would also suffer.

Imposing export controls on products China dominates, like rare earths or pharmaceutical ingredients, would accelerate the U.S. movement to ‘reshore’, onshore and ‘friend-shore’ manufacturing of those products, as was the case with Japan in 2012.

Instead of overt retaliation, China will probably seek alternatives to U.S. chip technology. But since alternatives are decades away, intellectual property theft and the nationalisation of foreign semiconductor firms could spike.

Whether U.S. chip controls represent a stand-alone policy or foreshadow sanctions across a wider range of high-technology sectors is unclear. In the run-up to the 2024 U.S. presidential election, many Republicans will call for harsher controls. At his recent meeting with Chinese President Xi Jinping at the G20 summit, Biden sought to tamp down U.S.–China hostilities. But unless he resists calls from the U.S. ‘China hawks’, Biden could find himself dragged into a second cold war.

Gary Clyde Hufbauer is a non-resident senior fellow at the Peterson Institute of International Economics and Megan Hogan is a junior fellow at the Peterson Institute for International Economics. A version of this article was published on East Asia Forum.

This article appeared originally at The Strategist (ASPI).