Washington won’t chip away at China’s military with semiconductor sanctions

Authors: Gary Clyde Hufbauer and Megan Hogan, PIIE

In October 2022, the Biden administration imposed export controls on China, banning the sale of state-of-the-art semiconductor chips, the advanced equipment needed to manufacture them, and semiconductor expertise from the United States. The controls are the Biden administration’s most serious attempt to undermine China’s military modernization and the most damaging measures US President Joe Biden has taken against China.

Advanced semiconductors support everything from autonomous vehicles to hypersonic weapons systems. Chips are essential to the defense industry and technologies of the future. By targeting these critical inputs, the Biden administration aims to freeze China’s semiconductor suite at 2022 levels and hamper its military development.

China will likely struggle to maintain its rapid advances in artificial intelligence, quantum and cloud computing without access to American technology and expertise. Chipmakers such as the Semiconductor Manufacturing International Corporation – China’s largest logic chip maker – will lose access to machine maintenance and equipment replacement under the new controls.

US chip equipment suppliers such as Lam Research, Applied Materials and KLA Corporation suspended sales and services to Chinese chipmakers while ASML Holding, a supplier in the Netherlands, told its US staff to stop serving Chinese customers until further notice.

The new controls exploit China’s weaknesses in talent development and research. They require all U.S. citizens, residents and green card holders — including hundreds of ethnic Chinese educated and trained in the United States — to obtain permission from the U.S. Department of Commerce to work in Chinese manufacturing plants. Since such permission is unlikely, American citizens working at Chinese semiconductor companies will be forced to sacrifice their citizenship or their jobs. Most will have to give up their current jobs. Indeed, Yangtze Memory Technologies Corp has already asked core American staff to leave the company.

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

Now that advanced semiconductors are considered vital to national defense, Beijing is adopting the ‘whole nation’ approach and investing national resources in the industry. Many engineers and computer scientists will likely be assigned to semiconductor design and manufacturing, aided by espionage against American, South Korean, Taiwanese, Japanese, and European chip firms.

The export controls will not cripple the Chinese military. According to a 2022 RAND Corporation report, China’s military systems rely on older, less sophisticated chips made in China that U.S. export controls would have no effect on. If China needs more advanced chips for AI-driven weapons systems, it can probably produce them, albeit at a very high cost. Many experts in the semiconductor industry agree that China has the technical ability to produce the latest chips, but lacks the commercial capacity to scale up production. This means that the US ban will have less effect on weapons systems, instead delaying the rollout of civilian applications, such as autonomous vehicles.

American semiconductor firms will also not emerge unscathed from the sanctions, as many have China as their largest market. China accounts for 27 percent of sales at Intel, 31 percent at Lam Research and 33 percent at Applied Materials. Both Applied Materials and Nvidia expect the new export controls to shave US$400 million (6 percent and 7 percent, respectively) off next quarter’s sales. Lam Research – one of Yangtze Memory Technologies Corp’s biggest suppliers – expects the controls to cut a whopping US$2.5 billion (15 percent) from 2023 sales.

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

Retaliation against Washington is not an option for China, given its heavy reliance on foreign technology. Any reciprocal measure will cause more damage to China itself. Punishing American companies with large exposures in China — such as Nike or Apple — would hurt the Chinese labor market, since those firms employ many Chinese nationals. Other foreign supply chains and Chinese companies that supply Nike and Apple will also suffer.

The imposition of export controls on products that China dominates, such as rare earth metals or pharmaceutical ingredients, will accelerate the US movement to “re-land” those products, onshore and “friend-shore” manufacturing, as was the case with Japan in 2012.

Instead of overt retaliation, China is likely to seek alternatives to US chip technology. But as alternatives are decades away, intellectual property theft and the nationalization of foreign semiconductor firms may rise.

Whether US chip controls represent a stand-alone policy or presage sanctions across a wider range of high-tech sectors is unclear. In the run-up to the 2024 US presidential election, many Republicans will call for tighter controls. At his recent meeting with Chinese President Xi Jinping at the G20 summit, Biden sought to stem the animosity between the US and China. But unless he resists calls from US ‘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.