Biden Needs to Broaden Semiconductor Sanctions on China

In recent years, Washington has made historic strides in its semiconductor policy by recognizing that chips are perhaps the most important part of the United States’ techno-economic rivalry with China. These efforts culminated in October 2022’s export control rules, which have been widely and correctly praised for their effort to constrain China’s production of the world’s most advanced chips whose military uses and commercial significance are impossible to overstate. But the United States would benefit from going further.

Washington’s understandable desire to outcompete Beijing in manufacturing cutting-edge semiconductors (at 16 nanometers or smaller) appears to be blinding the United States to the enormous strategic and economic importance of so-called mature-node chips (larger than 16 nanometers). If U.S. policy does not shift to account for China’s existing capabilities and ambitions in these so-called legacy parts of the semiconductor sector, the United States and its allies could suffer grave commercial and strategic harm.

Smaller-node semiconductors are faster. Size is measured in nanometers for logic chips. Manufacturing these tiny devices is a difficult and resource-intensive industrial process that requires various machine tools to assist in production, the most important of which are called lithography systems. Dutch and Japanese firms are the key lithography machine makers.

The October 2022 export control rules restrict U.S. firms and engineers from assisting Chinese production of semiconductors that are 16 nanometers or smaller for logic chips and their equivalent for other semiconductors. The complementary Dutch and Japanese rules restrict sales of “at least some” lithography machines used for making advanced chips. By targeting sophisticated nodes, the Biden administration aims to make it impossible for China to produce chips for highly advanced uses such as data centers, smartphones, artificial intelligence, and machine learning.

But the new rules will do nothing to stop China from dominating production beyond the leading edge. Semiconductors aren’t just needed for dazzling uses such as artificial intelligence and supercomputing. Mid-range chips between 16 nanometers and 40 nanometers are key components for everyday products at the heart of U.S. economic life, such as cars, laptops, gaming consoles, and tablets.

And China is on course to produce more and more of these chips. Take the 28-nanometer node, for example. China’s chip giants currently account for a relatively small portion of global production of this size, but that will soon change. China’s premier logic chip producer, Semiconductor Manufacturing International Corporation (SMIC), is expanding its 28-nanometer chip production, with new facilities in Shanghai, Beijing, Tianjin, and Shenzhen all slated to come online in the next two years. Chinese producers could produce a plurality of the world’s 28-nanometer chips in just a few years.

China’s growing position at these nodes could endanger U.S. producers domestically despite generous CHIPS Act subsidies for U.S. companies. Beijing often pursues overcapacity in chosen sectors to crowd out international competitors with artificially low prices. This is how China became the global leader in solar panels, electric vehicle batteries, and rare-earth elements. The Chinese Communist Party could soon corner a segment of the global microelectronics industry.

That should keep Washington policymakers up at night. It means that China could wield its leverage over the U.S. economy to extract concessions on political issues such as the United States’ support of Taiwan or the alliance with Japan. Washington would have to worry at every turn about angering Beijing to avoid a “surprise” semiconductor supply crunch for tablets, automotive parts, or smartphones.

The difference between the United States and its allies is that Beijing doesn’t yet believe it has enough economic leverage over Washington to brazenly bully it.

Chinese strategists already appear to be suggesting doing just this, with one Peking University professor saying, “If China were to capture a major share of the world’s market for mature process chips, it would also gain a ‘bargaining position’: If the U.S. were to block 20 percent of advanced process products, we would reciprocate by blocking 80 percent of mature process products.”

This strategy suggests using China’s future leverage defensively, but it would be right out of Beijing’s playbook to use it offensively, too. Just look at China’s bullying of U.S. allies. In 2016, Beijing conveyed its displeasure toward Seoul for agreeing to host U.S. missile defense systems by squeezing South Korea’s economic reliance on China. Sales of Hyundai and Kia cars in China and the number of Chinese tourists visiting South Korea plunged to 52 percent and 66 percent, respectively, of the previous year’s numbers. China has followed the same script with Australia, Japan, Lithuania, and Norway, among others.

The difference between the United States and its allies is that Beijing doesn’t yet believe it has enough economic leverage over Washington to brazenly bully it. That could change if sales of the Ford F-150 relied on Beijing’s willingness to sell its semiconductors.

This new standard would put China’s semiconductor ambitions on warning. Nikkei Asia reported in November 2022 that SMIC could not build chips more advanced, or smaller, than 40 nanometers without U.S. technology. New rules would freeze many of China’s production expansion plans, forcing Beijing to pay billions more to develop the tools that only Western firms have mastered, if it can at all.

Halting China’s ambitions for mature chip dominance will set the stage for U.S. growth in that area. U.S. Commerce Secretary Gina Raimondo said in February that one goal of CHIPS Act investment would be to increase production of the “current-generation and mature-node chips most critical to our economic and national security” by 2030. U.S. manufacturers would have an easier time achieving this absent competition from Chinese firms that embrace state-backed predatory practices to get an unfair edge.

Despite the risk stemming from China’s ambitions in mature-node chips, the Biden administration’s current policy is limited to cutting-edge chips likely because of misguided timing considerations. Biden officials would likely argue that the United States only needs to lock China out of the technological commanding heights now to win the chip competition once those sub-16 nanometer chips become the industry standard, in five to eight years.

But with a real risk of war over Taiwan in the coming years, Washington cannot afford to place its bets on winning an edge by 2030—it must act decisively now. U.S. policy should be to prevent China from building the chips its military needs for a war over Taiwan. Western machine tools and engineers cannot be allowed to contribute to the factories that will become crucial for China’s war machine.

A tougher approach would raise several concerns worth considering.

First, some will suggest this policy would ask too much of Japan and the Netherlands and run the risk of allied firms removing U.S. technology from their supply chains. This overstates how much Washington would be asking of its allies. China accounted for only 15 percent of the Dutch company ASML’s revenue in 2021. Immersion lithography machines are just one tool among many that the company sells to China, so banning sales of this technology would be tenable. And Nikon, Japan’s lithography firm, represents a much smaller part of the market for lithography machines than ASML.

Washington has leverage in these negotiations because of ASML and Nikon’s reliance on U.S. technology that would hover over any additional negotiations. The United States could, for example, threaten to prohibit sales of U.S. technology that ASML requires. The Biden administration reportedly did this to get the allies to cooperate with its October 2022 rules. America could also offer economic carrots to smooth over negotiations. Washington could get creative; one idea could be to offer access to green energy incentives from the Inflation Reduction Act contingent on cooperation with export controls.

In any case, the allies may be less resistant to the policy in principle than some believe, following a careful explanation of the stakes by the United States. Both the Netherlands and Japan have demonstrated that they’re taking the United States’ side on Chinese export controls. In a recent op-ed that coincided with news of his country’s cooperation on export controls, Dutch Prime Minister Mark Rutte wrote: “I cannot see how this will be China’s century, as is often said. The 21st century will be the century of democracy and thus the century of America.” Japan, for its part, is aware of the role technology plays in competition with China and has privileged export controls in its strategy since Russian President Vladimir Putin’s renewed invasion of Ukraine last year.

Second, critics will warn this move would risk the profits of U.S. machine tool producers such as KLA Corporation, Lam Research, and Applied Materials. This is a real concern in the short term, but it is likely to be offset by global semiconductor demand and CHIPS Act subsidies that will drive construction of new facilities outside of China requiring U.S. technology. Lam’s chief financial officer even said in November 2022 that Lam’s “manufacturing capacity is fairly fungible” to argue it could divert lost Chinese sales from the export control rules to Western customers. This applies to allied firms too.

Third, many will warn that the United States should shelve this policy to avoid an aggressive Chinese response, such as Beijing cutting off sales of rare-earth minerals to Washington. But Chinese leader Xi Jinping has already recently begun depicting existing U.S. policy as “containment,” “encirclement,” and “suppression.” If China wanted to take aggressive steps, it has the pretext to do so. Also, China’s economic ambitions still rely on U.S. technology and capital. Washington maintains many punitive economic options of its own if Beijing turns to rare earth minerals. China may think twice before provoking a more significant reaction from the United States. This may help explain Xi’s missing counteraction to Biden’s export control rules. China could react that way again.

By blocking China’s route to self-sufficiency in chip consumption, the United States could ensure that China remains dependent on Taiwanese-made chips.

Fourth, detractors might argue that expanding export controls would incentivize China to invade Taiwan to secure Taipei’s valuable semiconductor manufacturing facilities. But China covets Taiwan primarily for ideological and geostrategic reasons, not commercial ones. To the extent that Taiwan’s semiconductors factor into Xi’s invasion calculus, this policy could reduce the odds of war. By blocking China’s route to self-sufficiency in chip consumption, the United States could ensure that China remains dependent on Taiwanese-made chips.

Taiwan famously produces more than 90 percent of the world’s semiconductors measuring 10 nanometers or below. It also is an important producer of 28- and 40-nanometer chips. War would likely neuter Taiwan’s chip manufacturing capabilities, either from the destruction of those facilities or from Taiwan’s loss of critical international inputs it needs to function. Continued Chinese reliance on Taiwan would therefore keep the economic costs of war high for the Chinese Communist Party.

These challenges are real, but U.S. policy would be well served by raising the China export control standard from 16 nanometers to 40 nanometers. Doing so would zero in on the threat Beijing’s mid-range semiconductor ambitions pose to Washington’s economic security. Fortunately for the United States, semiconductor manufacturing is perhaps the most complicated and expensive industrial process in the world, so China will struggle to master chip production without Western inputs. This new policy will help set the conditions for the United States and its allies to win the techno-economic competition with China and help deter a Chinese invasion of Taiwan.