Terrible News: U.S. Sanctions Against Chinese Semiconductor Firms May Be Working… for Now
U.S. sanctions forbidding China from buying elite semiconductor devices, or the equipment to make them, is forcing the breakup of a global semiconductor ecosystem that overwhelmingly benefited both nations.
As the globe’s largest buyer of semiconductor devices and equipment, China provided hundreds of billions of dollars in revenue to U.S. chipmakers, effectively funding the ongoing R&D of great U.S. companies such as Qualcomm (NASDAQ: COM), Intel (NASDAQ: INTC), Nvidia (NASDAQ: NVDA), Advanced Micro Devices (NASDQ: AMD), Apple (NASDAQ: AAPL), Broadcom (NASDAQ: AVGO), Micron Technology (NASDAQ: MU), Texas Instruments (NASDAQ: TXN), and more.
China, in turn, rode into modernity on the back of accessible, affordable, and excellent microelectronics. Moreover, and little appreciated, the process spawned a generation of America-loving Chinese entrepreneurs with growing influence in what is still called the Communist Party of China, despite a growing dearth of Communists. (Chairman Xi, alas, is something of a throwback, though weakening for that very reason.)
More recently, China has been contributing powerfully to fundamental advances in semiconductor technology that could enrich both nations. The era in which we were always the teachers and the Chinese always the learners is rapidly slipping away. The collaboration between Georgia Tech and the University of Tianjin to create the first wafer-scale graphene semiconductor is only one example, if an especially dramatic one.
We have long argued that one effect of the sanctions would be not to retard the Chinese semiconductor industry but to push it forward and make it more competitive with the United States. The sanctions forbidding sales of elite chips to China make it imperative that the Chinese learn to make them at home. Complicating that effort is the ban on selling elite chip-making equipment to China, making it harder for them to compete.
Even so, the Chinese have made notable progress since the sanctions. The most conspicuous prohibition was against Chinese companies buying “extreme ultraviolet” (EUV) photolithography machines from ASML, the only company in the world that makes them. These are currently the only machines capable of inscribing the extraordinarily fine small circuits used in today’s most elite chips, using the so-called “7nm”, “5nm”, “4nm,” and “3nm” processes. Essentially, all practical AI chips, for instance, and all elite mobile phone chipsets use one of these processes, with the smallest, “3nm,” increasingly dominant.
Thus, it was quite a surprise when Huawei, using China’s leading chip manufacturer Semiconductor Manufacturing International (SMIC), was able to produce a “7nm” “equivalent” device to power its latest smartphone and eat into Apple’s share of the Chinese market. (Though he modestly omits to mention it, this coup was first revealed by my new colleague, Dr. Robert Castellano, via his Information Network–GG)
Despite such remarkable successes, however, on balance the sanctions are, for now, seriously hampering Chinese chips. Especially suffering are “fabless” Chinese chip firms, which design chips but outsource their manufacturing. Just like Nvidia, Qualcomm, Apple, AMD and elite chipmakers around the world, these firms want to outsource to TSMC, using its most demanding “3nm” and “4nm” nodes. That option is now foreclosed as TSMC, under U.S. pressure, has ceased production of leading-edge chips for Chinese clients.
The sanctions have hit HiSilicon, the chip design arm of Huawei, particularly hard. Before the restrictions, HiSilicon partnered with TSMC to produce its flagship Kirin chips. The inclusion of Huawei on the U.S. Entity List stopped that. As noted, HiSilicon turned to SMIC, China’s leading foundry, to produce the Kirin 9000S on that “7nm-equivalent” process. Though a technological coup for SMIC to achieve this without EUV equipment, SMIC still lags half a decade behind TSMC, crippling HiSilicon in premium markets.
In the near-term, hobbling China will help some non-Chinese companies, including Taiwan’s MediaTek and America’s Qualcomm, both of which are holdings in our Paradigm Portfolio. MediaTek, which exclusively partners with TSMC for its Dimensity series, has gained market share in midrange and high-end segments once dominated by Huawei. Qualcomm, although limited by export restrictions on certain high-end chips, remains a dominant supplier to Chinese smartphone makers, particularly for Android-based devices.
U.S. sanctions stifle innovation in Chinese-designed processors and increase costs for domestic smartphone makers, who must either rely on lesser local foundries such as SMIC or shift to foreign suppliers such as MediaTek or Qualcomm. Either course puts Chinese smartphone makers at a significant disadvantage, particularly in the high-end market, where performance and power efficiency are critical.
The sanctions, for now, keep wide the technological gap between Chinese and Western companies. SMIC, while making strides, remains several years behind global leaders in its fabrication capabilities. Without access to EUV lithography tools, SMIC’s progress is constrained to what can be achieved with older-generation DUV technology.
The very success of the sanctions, however, is ultimately bad news for the U.S. semiconductor industry. The Chinese government is investing all the more heavily in developing a self-sufficient semiconductor supply chain. Eventually, it may succeed, either by mastering EUV technology itself, or quite possibly replacing it.
ASML’s current state-of-the-art machines can cost more than $352 million. The next-gen version is predicted to cost more than twice as much. EUV is a technology demanding to be disrupted from below, an honor for which half a dozen technologies are competing even now. Given the incentives, China is at least as likely as the United States to do the deed. If the Chinese do replace EUV with better and cheaper technology, the question arises, will they allow us to buy it?
Thus, the real danger of the sanctions is the rage they inspire. We think little about the reaction of other nations to our national strategies. But denying China access to the world’s economically crucial technologies is at least as provocative as, say, the Arabs trying to cut off our oil in 1973, and probably more so as it is far easier to replace a barrel of oil than a Nvidia superchip. We might have to go back to the Opium Wars to find an example of Western bullying more infuriating to the Chinese. The difference this time round is that China can fight back.