Tackling the Chinese offensive

Tackling the Chinese offensive

by Pininvest Analysis

Semiconductor Industry on pininvest.com

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Pin-insights

In the top tier of US exports, semiconductors are at the heart of the on-again, off-again trade negotiations between the US and China

Commitments to global trade, stated by China’s highest authorities, and from which the country benefits vastly, do not square with semi-conductor policies aiming at self-sufficiency over time

The disruption of the international supply chains for semi-conductors serving the Chinese electronic industry today stirs a hornest nest - from the protection of intellectual property to fair competition in China to issues of national security

These issues may not be settled any time soon and could destabilize Chinese relations with its trading partners in the medium term

 

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The semiconductor industry has proven to be a model of reinvention – where successive technological breakthroughs and manufacturing technologies have been financed by vast capital expenditures

By positing the ultimate goal of domestic self-reliance, China deprives the semi-conductor majors of any long-lasting confidence in sharing Intellectual Property (IP)  and technological know-how 

The semi-conductor majors are not solely of interest as economic entities – dual civilian/military applications bring wide-ranging national security stakes in play

 

Locking horns

At face value, the two countries have little to agree on

For America, semiconductors manufacturing, concentrated by the US firms for almost half their facilities on the domestic market, is a matter of soft power, technological leadership as well as national security

In 2018, according to the Semiconductor Industry Association (SIA), U.S. semiconductor exports in 2018 totaled $44 billion, topping US exports after aircraft and oil, with surpluses with its major trading partners (China, Mexico, Canada, and South Korea) and an overall trading surplus

In China, the size of semiconductor imports is a perennial bugbear of the country’s industrial planners, surpassing oil imports in 2017 at $260 billion

Source Credit Suisse -  China's Integrated Circuits (IC) Import - Export

 

A mission statement

"Leveraging on global resources, build a world class industry base for memory chips, where China has full control at its sole discretion"

The commitment of holding company YRST (Tsinghua Unigroup) aligns with China’s industrial policy as discussed in our Silicon Hearts note

Since 2016, national (‘Big Fund’) and provincial funds, complemented by State-owned and private companies (China Tobacco, China Mobile China Development Bank and the leading technological firms from Huawei to Tencent and Alibaba) coordinated their support of memory manufacturing (DRAM and NAND projects)

As a strategic gambit, the focus on domestic manufacturing of semiconductors was entirely predictable, although the size of the investment – financing multiple facilities estimated at $6-7 billion each since 2017 – could have impressed

But there has never been any doubt about China’s determination to free its global exporters of technological hardware (smartphones, PCs, drones, video security...) from their dependence on imported semiconductors

Further shrouded in distrust, the China-US negotiations remain indispensable and destabilizing

 

Indispensable negotiations

Negotiations have iterated confusingly between a ‘hard’ number of additional exports – presumably marked as a ‘win’ – and the respect of fundamental principles of international trade (to which China committed formerly)

Playing the numbers, China proposed in February to increase U.S. semiconductor sales to $200 billion over six years (about a fivefold increase over current exports) 

The proposal went down to a $30 billion commitment over six years in March, leaving the uncomfortable feeling of aiming for a volume mix of imports without affecting the underlying industrial policies

Improbable as China expands its own semiconductor manufacturing base, quota planning of the industry by the Chinese authorities was roundly rejected by the US semi-conductor firms (paywall)

 

Fundamental principles however remain at bay

In their fullest expression, foreign firms call for fair competition on the Chinese market, which would deprive industrial policy of its subsidies-driven toolbox – an improbable goal

Focusing on key segments of trade, the US expectations are no less controversial in China for areas such as

  • cloud computing where local champions (Alibaba and Tencent) are supported (and foreign providers discriminated, according to the US negotiators)
  • overseas data transfers (constrained) and local storage of company data (required)

The long list of rules circumventing WTO principles, reviewed in our 'CFIUS, Mission impossible' and aiming at transfer of intellectual property under various guises, may or may not be under consideration in the discussions today

 

Destabilizing confrontations

For lack of middle ground on most central issues of trade between the two countries, and – as some should be arguing – for giving Chinese behavior a pass for so long – the closing arguments of a ‘deal’ could be vindictive – and destabilizing

Chinese rejection of arbitration proceedings, another request of the US negotiating team, will lead to court involvement – each country rejecting predictably the conclusions of the other party's judiciary

Next to the well-publicized blockade of Huawei telecommunications specialist (and ZTE in its time), semiconductors disputes already give early warnings of future skirmishes

Fujian Jinhua Integrated Circuit was indicted in December 2017 of illegally obtaining trade secrets from US semiconductor firm Micron Technology for the production of DRAM chips, following criminal charges filed by Taiwanese authorities against Fujian and its Taiwanese partner United Microelectronics

By deciding to add the Chinese firm to the list of entities facing restrictions in October ’18, the US Commerce department implied that national security was at risk

By escalating a dispute regarding intellectual property, the American Administration has cut off chipmaker from U.S. equipment suppliers, barring the export, re-export or transfer of U.S.-origin technology, commodities or software

Aggressively preventing Fujian from selling its chips in overseas markets, a US civil lawsuit extends to any devices made by third parties that include chips made by the company and its partner UMC

By moving aggressively, the US are signaling willingness to block Chinese chipmakers from buying manufacturing equipment from the uniquely small group of providers, Japan’s Tokyo Electron, the Netherlands’ ASML Holding , US-based Applied Materials , Lam Research and KLA-Tencor

Without access to ‘foundational’ equipment, China’s ambitions may be delayed for a number of years – the Fujian plant, which benefitted from a $5.7 billion provincial subsidy, left idle by the departing American (and Dutch) equipment firms, is bound to remain a sore point, calling for forceful assertion of China's sovereignty

In response, it can only be expected that the Chinese authorities will double down on their determined efforts to secure autonomy of the technological supply chain, for civilian as well as military purposes, and to achieve their purpose by any means

 

American legal roadblocks may be an effective tactic in the short run and, more significantly, if the Chinese negotiators were induced to make major concessions by loosening the grip of the State on industrial policy

As we know, this outcome is fading away and face-saving trade agreements will be no more than a distraction in a drawn-out and bumpy confrontation between the US and China

 

All of this is certainly destabilizing in a globalized world as the stock markets may recognize over time