Export Controls Are Only a Short-Term Solution to China’s Chip Progress

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On Aug. 29, 2023, during the latter half of Commerce Secretary Gina Raimondo’s four-day trip to Beijing and Shanghai, Huawei Technologies Co. quietly released a new phone called the Mate 60 Pro. Despite its inconspicuous introduction, the Mate 60 Pro proceeded to dominate the American news cycle the following week, after a bombshell teardown of the phone concluded that it was powered by a Kirin 9000s semiconductor chip fabricated in China by Semiconductor Manufacturing International Corporation— in other words, that China can produce 7-nanometer chips in spite of U.S. restrictions, and possibly on a massive scale.

This technological breakthrough sparked panic throughout Washington, leading many to conclude that U.S. efforts to constrain China’s semiconductor development were ineffective. In reality, though, the significance of the Semiconductor Manufacturing International Corporation breakthrough was greatly overstated: China was already well on its way to 7-nanometer chip fabrication.

Rather than discredit the Biden administration’s approach, the Huawei breakthrough should help to recalibrate it going forward. Even though the current “small yard, high fence” strategy is working, it is not infallible. China will continue its efforts to become self-reliant in semiconductor production. Its semiconductor supply chain can be reorganized over time, generating chokepoints in countries other than the United States, including China and its allies. As a result, winning the chip war with China requires retaining dominance in advanced semiconductors (chips of 8 nanometers or smaller) and reducing dependencies on Chinese “legacy chips” (those 28 nanometers or larger). Moreover, Washington should monitor and respond to China’s growing competitiveness in the legacy chip sector. And if policymakers decide to further tighten chip controls in the near term, they should ensure these measures do not threaten the success of American semiconductor firms.

 

 

How Did China Achieve Its “Breakthrough”?

Last year, in October 2022, the Biden administration imposed sweeping export controls on China, prohibiting the sale of certain advanced semiconductor chips, the sophisticated equipment required to manufacture them, and semiconductor expertise from the United States. U.S. export controls were meant to freeze China’s semiconductor suite at the 14-nanometer level. The controls specifically included a 14-nanometer threshold for logic chips and licenses for exports to 14-nanometer and sub-14-nanometer semiconductor fabrication plants in China, effectively prohibiting the sale of any U.S. goods or expertise to these facilities. This, however, was an unrealistic goal.

For a start, Semiconductor Manufacturing International Corporation achieved its 7-nanometer breakthrough months, if not a full year, before the Biden administration imposed export controls on China. In a July 2022 report, TechInsights, a Canadian semiconductor analysis firm, concluded that the company had been able to produce 7-nanometer chips since 2021. It further concluded that they took the technological leap from 14-nanometer to 7-nanometer chips in two years, faster than both Taiwan Semiconductor Manufacturing Company and Samsung. Such leapfrogging, while unusual, is certainly plausible. Semiconductor Manufacturing International Corporation’s co-CEO, Liang Mong Song, was previously an executive at Taiwan Semiconductor Manufacturing Company, the world’s largest contract manufacturer of semiconductor chips. There, Liang had been found guilty of leaking secrets to Samsung, including 28-nanometer process technology. Indeed, TechInsights said in its July 2022 report that “there are many similarities in process technologies, designs and innovations between Semiconductor Manufacturing International Corporation’s 7nm and TSMC’s 7nm.”

In general, semiconductor firms can use either extreme ultraviolet lithography machines or deep ultraviolet lithography machines to achieve sub-10-nanometer chip production. These machines are extremely expensive and highly sophisticated, with extreme ultraviolet lithography machines being the most advanced. The market for these technologies is also highly concentrated; Advanced Semiconductor Materials Lithography, the Dutch chip manufacturing equipment giant, has a monopoly over extreme ultraviolet lithography machines and a near monopoly over deep ultraviolet lithography machines. Semiconductor Manufacturing International Corporation manufactured its 7-nanometer chips using imported chipmaking equipment from abroad. However, the company has been prohibited from importing extreme ultraviolet lithography machines since December 2020, after it was placed on the U.S. Entity List. Instead, it was forced to rely on less-advanced deep ultraviolet lithography machines to achieve its breakthrough.

China’s access to foreign deep ultraviolet lithography machines is not in violation of current U.S. export controls. Though the United States struck a deal with Japan and the Netherlands in late January 2023 to restrict exports of advanced chip manufacturing equipment to China, the actual implementation of this agreement did not come until months later. Japan’s new export control rules were issued in May 2023 and took effect in July 2023, while the Netherlands’ new export control rules were issued in September 2023 and will not take effect until Jan. 1, 2024, almost a full year after the original agreement was made. To manufacture the 7-nanometer Kirin 9000s chips for Huawei, Semiconductor Manufacturing International Corporation could have therefore either manufactured the chips using foreign deep ultraviolet lithography machines legally procured prior to the October 2022 export controls (i.e., a “stockpile” scenario) or in the 9–10 months following the controls (in accordance with new Japanese and Dutch export controls, respectively).

A Win for the United States, Not China

Knowing that Semiconductor Manufacturing International Corporation could produce 7-nanometer chips in 2022 (if not 2021) using less sophisticated equipment, it was unrealistic to presume that imposing export controls (particularly export controls that were initially uncoordinated with allies) could cause the company to technologically regress. We should instead judge China’s domestic advancements in semiconductor production by how well they adhere to the objective of U.S. export controls — namely, by how well they are impeded.

By that criteria, the launch of the Huawei Mate 60 Pro phone cannot be considered an extraordinary win for China. While Semiconductor Manufacturing International Corporation is certainly capable of producing 7-nanometer chips, the likelihood that it can mass-produce these chips is low. The Mate 60 Pro sales themselves are evidence of this: The phone sold out almost immediately and seems only to have been available in limited quantities, suggesting limited inventory. Jeffries analysts believe that Semiconductor Manufacturing International Corporation can produce only a “very small” volume of 7-nanometer chips and that Huawei may be powering some Mate 60 Pros with Taiwan Semiconductor Manufacturing Company chips stockpiled prior to the 2022 U.S. export controls. The inclusion of these stockpiled chips is definitely possible: Some early users of the Mate 60 Pro reported it using NAND flash memory chips made by SK Hynix (a South Korean chipmaker that suspended chip sales to Huawei after the Chinese firm was hit by U.S. sanctions). SK Hynix has since opened an investigation into the use of its chips in the new Huawei phone.

For the chips that Semiconductor Manufacturing International Corporation did manufacture, analysts are currently trying to determine the “yield,” or efficiency, of China’s 7-nanometer chip production. Some research firms forecast the company’s manufacturing process yield rate at below 50 percent while TechInsights analysts predict above 50 percent, considering the good condition of the 7-nanometer chips they have examined. Compared to the industry norm of 90 percent or more, however, both yields are very low. As China did have the capacity to manufacture, but not mass produce, 7-nanometer chips prior to U.S. export controls, this implies that Semiconductor Manufacturing International Corporation was intent on improving its 7-nanometer yield at the time the controls were imposed. Evidence of minimal improvement in this area is a win for the United States, not for China.

In short, Huawei’s chip progress does not necessarily mean that U.S. export controls are failing. Semiconductor Manufacturing International Corporation’s ability to eventually scale 7-nanometer production was never guaranteed, but it was always a possibility. This is particularly true as the co-CEO has a history of leaking technology secrets and the company had relatively unfettered access to Japanese and Dutch chipmaking equipment for months following U.S. export controls in October 2022. Rather than bemoan the “defeat of U.S. chip sanctions,” U.S. lawmakers should be pleased that Semiconductor Manufacturing International Corporation is focused on trying to scale production at 7 nanometers and that China has asked Raimondo to ease export controls. It would be far more alarming if, for example, the company were pursuing 5-nanometer chip production today. And even if it is secretly pursuing 5-nanometer chip production now, 3-nanometer production is almost certainly out of reach because China is prohibited from purchasing extreme ultraviolet lithography machines from Advanced Semiconductor Materials Lithography, the world’s sole producer.

Implications for the United States

What should be of concern to U.S. lawmakers is China’s significant investments in legacy chip manufacturing. The majority of China’s manufacturing capacity today is concentrated in “legacy chips” — chips of 28 nanometers or larger. Over the next 3 to 5 years, China is expected to add “nearly as much new 50-180 nanometer wafer capacity as the rest of the world” as well as construct 26 fabrication plants through 2026 that use 200-millimeter and 300-millimeter wafers — 10 more plants than in the Americas. China’s ambition to dominate global legacy chip production poses a grave economic and national security threat to the United States, as legacy chips underpin everything from dishwashers to military weapons systems. Just as it did with solar, China could box out foreign competitors through dumping, rendering the United States — and the rest of the world — dependent on China for mature chips.

There is also China’s increasing self-reliance in chip production. TechInsights found that, in addition to the 7-nanometer chip, half to two thirds of the silicon used in the new Huawei phones was produced domestically in China. Previously, this amount was only one third. Similarly, four of the eight central processing units, the graphics processing unit, and the neural processing unit of the Mate 60 Pro’s “system on a chip” were designed and adapted by Huawei. Previously, all of these components relied entirely on designs by Arm, a British semiconductor and software design company. China is clearly becoming increasingly self-reliant in developing its own chipmaking capacity, and at a very rapid pace. But the extent to which China is sacrificing performance and cost efficiency to be self-reliant is unclear.

Though the new Huawei phones seem to show that the Biden administration’s “small yard, high fence” approach is working, it is wrong to assume that U.S. export controls will effectively hobble China’s semiconductor ambitions for years. China has launched a whole-of-nation plan to become self-reliant in semiconductor production, and U.S. export controls are merely supercharging this development. It is true that current export controls make it very difficult for China to advance in chip technology, but the Semiconductor Manufacturing International Corporation breakthrough is evidence that Chinese chip foundries can produce better semiconductors with older tools. Further, as time progresses and China’s stockpile of chips, chipmaking equipment, and spare parts runs low, industrial espionage will become increasingly important to the success of China’s whole-of-nation mission. It is reasonable to assume that American technology is at risk of being stolen or replicated.

The U.S. Department of Commerce issued updated implementing rules for chip export controls on Oct. 17, 2023, slightly over one year after the original controls were first announced. The updated rules largely build on the originals, adding firms to the Entity List and strengthening restrictions on both select advanced semiconductors and semiconductor manufacturing equipment to correct for unexpected loopholes and address leakage. If the United States decides to impose even more chip restrictions on China over the coming year, it needs to be careful not to cut off its nose to spite its face. Some lawmakers, notably Rep. Mike Gallagher (chair of the House select committee on China), has called for an end to all U.S. technology exports to Huawei and Semiconductor Manufacturing International Corporation. While there is nothing wrong with investigating whether the Huawei phone bypassed U.S. sanctions, if the United States wants to win the chip war with China, it cannot just cripple China’s semiconductor sector — it needs to also ensure the success of American semiconductor companies. Placing very extreme, blanket restrictions on China would do the opposite of that.

Moreover, the further export controls get from the cutting edge of semiconductor manufacturing equipment, the less indispensable U.S. semiconductor technology becomes. This means that new controls will be less effective because China can simply import controlled technologies from producers other than the United States. Though the United States has so far been able to align its controls with the Netherlands and Japan, this alignment was not without considerable delay, and similar alignments are not guaranteed going forward. Issuing additional export controls on less indispensable U.S. technology also means that U.S. semiconductor companies miss out on revenue in the near term, even if they enjoy an initial revenue spike from China stockpiling equipment. Whereas companies could theoretically divert chip sales to countries other than China to make up for lost sales, in reality these sales are unlikely to match massive Chinese market demand. Today, the COVID-19 semiconductor boom has faded, as higher interest rates have dampened purchases of products that use semiconductors. The U.S. government should therefore have strong justification before cutting off these companies’ main source of revenue at a time when they are bracing for uncertainty.

 

 

Megan Hogan is the Eranda Rothschild Foundation Junior Fellow at the Peterson Institute for International Economics. She works on international trade issues, including digital trade, semiconductor export controls, and U.S.-Chinese relations. She is also the founder of DisinfoLab, a student-led disinformation research lab based at the College of William & Mary’s Global Research Institute.

Image: Wikimedia

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