December 27, 2024
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A New Trade Investigation Into Chinese Semiconductors
The list of strategic U.S. industries is growing longer.
By: Geopolitical Futures
By Chris Siepmann
On Dec. 23, the United States launched an investigation under Section 301 of the Trade Act of 1974 scrutinizing China’s policies regarding its foundational semiconductor industry.
Over the past decade, much of Washington’s focus in its economic competition with China has been on advanced logic semiconductors. These are the chips at the heart of the newest cell phones, laptops and advanced AI processors. Foundational semiconductors, meanwhile, were largely ignored, lost in the concerns over China winning the race for smaller node sizes and more advanced architectures. Foundational chips are used for applications where low cost is more important than bandwidth or processing power. To keep costs down, they are produced using mature process nodes – i.e., larger, less-advanced chips manufactured using previous-generation technologies. Whereas advanced node semiconductors are typically reserved for specialized applications, foundational semiconductors are used in a dizzying array of consumer, industrial and defense applications – everything from toys and smart appliances to laser guidance systems for missiles and night vision goggles.
However, China’s manufacturing aspirations were never limited to advanced chips. Its “Made in China 2025” industrial policy, first announced in 2015, does not differentiate between advanced and legacy chips in its top-line goals. It calls for China to produce 70 percent of the semiconductors it consumes by 2025 and 80 percent by 2030 – which, according to a report issued by the U.S. International Trade Commission, would result in China capturing 57 percent of the global semiconductor market and displacing production in the United States, Europe and Japan.
China will fail to meet its 2025 goal; it presently lags behind Taiwan, Japan, South Korea, Europe and the United States in advanced chip production. However, according to Taiwanese semiconductor market research firm TrendForce, China will more than double its chip manufacturing capacity within the next five years, the vast majority of which will be for legacy chips. Between current and planned fabrication projects, Beijing is on track to capture more than half of the global semiconductor market by 2029, potentially fulfilling the Chinese Communist Party’s long-term vision.
To accomplish this, China’s main policy tool has been a sustained torrent of targeted government subsidies. According to U.S. Secretary of Commerce Gina Raimondo, “[w]e know there’s a massive subsidization of that industry on behalf of the Chinese government, which could lead to huge market distortion," resulting in China capturing 60 percent of the global foundational semiconductor market in the “next handful of years.” Just one of these subsidy programs, the IC Investment Fund, is valued at $150 billion. For comparison, America’s CHIPS Act allocated a mere $53 billion to new domestic semiconductor investments.
The Section 301 initiation notice highlighted that China’s policies have led to “significant capacity expansion, artificially and unsustainably lower domestic and global prices, a protected domestic market, and emerging overconcentration of production capacity in the PRC.” Indeed, analysts have projected that China’s subsidized investments in foundational semiconductor production between 2022 and 2027 are likely to result in supplies more than doubling global demand. U.S. policymakers believe this would allow China to manipulate supply chains, undercut prices and suffocate the manufacturing base for these “boring” but critical chips in rival nations.
In addition to systemic overcapacity, the Section 301 initiation notice offers a long list of additional grievances, arguing that “the PRC pursues its targeting of the semiconductor industry through an extensive range of anticompetitive and non-market means, including through Chinese Communist Party guidance, directives, and control within state and private enterprises; activities of state-owned or state-controlled enterprises; market access restrictions; opaque regulatory preferences and discrimination; wage-suppressing labor practices; massive and persistent state financial support of industry, including government guidance funds; and forced technology transfer, including state-directed cyber intrusions and cybertheft of intellectual property.”
In other words, an increasing number of U.S. policymakers now realize that focusing mainly on advanced chips was myopic. They now see China’s potential dominance of legacy chip manufacturing as a national security threat on par with its potential dominance of advanced chip manufacturing. The “small yard and high fence” strategy of selectively restricting China’s access to leading-edge technologies was intended to minimize unintended economic harm to the U.S. and its allies, but was too clever for its own good due to its granular complexity. Chinese companies, with limitless time and motivation to find loopholes, were slowed but not prevented from accessing restricted chips and equipment, and U.S. companies designed advanced AI chips for the lucrative Chinese market falling just outside the government’s specifications. The tightening regulatory noose both failed to halt China’s development of its indigenous semiconductor supply chain and steeled party leaders’ resolve to accelerate it. And while advanced node semiconductors are critical to maintaining the lead in the AI race and other economic battlegrounds, they comprise a small percentage of total semiconductor production. By turning a blind eye to mature process node semiconductors, the U.S. appeared to be ceding most of the global semiconductor market to China.
Any attempt to remedy this situation with tariffs must confront the reality that most foundational semiconductors entering the U.S. do so as part of another finished product, such as a toaster, a television or a car. International customs conventions (the so-called “rules of origin”) permit tariffs based only on the classification of finished goods, not the parts contained therein. However, to be effective, any remedy resulting from the Section 301 investigation must somehow either target previously incorporated semiconductors (using a demand-side barrier such as tariffs) or the means to produce them (using a supply-side barrier such as export controls).
This may lead to “ends justify the means” countermeasures that ignore rules of origin to accomplish policy goals. In addition to further undermining international trade agreements and bodies such as the World Trade Organization, tariffs on incorporated components would also be extremely disruptive for manufacturers and importers, who would be forced to account for the provenance of every chip soldered into their products. Some influential think tanks and policy voices have already advocated for “see-through” tariffs on integrated components for which importers would bear the burden of accurately declaring the presence of Chinese chips.
The new Section 301 investigation is just one of many policy changes that could result from legacy chips’ accession to policymakers’ lists of strategic industries. Use of export control tools, such as the foreign direct product rule, could be broadened beyond AI-related chips and high-bandwidth memory to restrict Chinese access to a broader range of semiconductor equipment, including equipment for manufacturing legacy semiconductors. Other policy proposals, such as Sen. Marco Rubio’s “Stopping Adversarial Tariff Evasion Act,” would apply Section 301 China tariffs to legacy chips produced by Chinese-owned manufacturers even when not produced in mainland China.
President-elect Donald Trump’s first term in office inaugurated a new era of U.S. trade policy, with broad tariffs and new export control rules that were maintained and expanded by President Joe Biden. During Trump’s second term, expect a whole-of-government approach to further economic decoupling from China, starting with industries deemed critical to national security (a list that will continue to grow). This decoupling will employ tariffs, sanctions, export controls and other enforcement levers to block China’s access to the buyers, knowledge, equipment and tools needed for its strategy of subsidized, systematic industrial overcapacity, while leaning on allies to follow suit. At the same time, expect a resurgence of U.S. industrial policy aimed at resurrecting previously hollowed-out U.S. manufacturing capabilities and developing new initiatives in strategic sectors. In the words of Chinese President Xi Jinping, “[t]echnological revolution is intertwined with the wrestling of superpowers, with the high-tech sector becoming the main battlefield.” Trump has already proved that he’s not afraid of causing disruption if it helps him win.
Chris Siepmann is the managing director at Weller James, an advisory firm helping organizations navigate geopolitical and policy changes, reduce risk exposure, forecast future outcomes and build organizational resiliency. Previously, he served as director for trade enforcement at the Office of the U.S. Trade Representative during the Trump and Biden administrations, where he advised on and helped administer tariffs and exclusions under the first China Section 301 action, along with a variety of other issues. You can contact him at inquiries@wellerjames.com.
