ARGUMENT: Chip warWill China Retaliate Against U.S. Chip Sanctions?

Semiconductors, the core of the digital economy, are now a central point of geopolitical contention. Semiconductors, or chips, are the thumbnail-size devices which enable every electronic application on the planet—from cell phones and automobiles to aircraft and satellites. Both the United States and the People’s Republic of China (PRC) see the industry as critical to economic growth, global competitiveness, and national security. Recent automobile manufacturing shutdowns, driven by a shortage in the availability of semiconductors, have pushed the industry into the headlines and under a microscope.

Terry Daly and Jordan Schneider write in Lawfare that over the past few years, the United States has slowly tightened restrictions around key semiconductor players in China. “Beijing, however, has largely held its nose, content to pour billions into building its own chip ecosystem while refraining from lashing out at foreign firms,” they write.

Many analysts presumed that trade tensions pervading the semiconductor industry would improve with a change in U.S. administrations. This has proved to be unfounded. If anything, there is a stronger bipartisan consensus now on the dangers from an ascendant China than at any point since Richard Nixon reopened the relationship between the two countries in 1972. Indeed, the Biden administration just doubled down on the Trump strategy with an expansion of the Entity List, preventing U.S. companies from doing business with companies on the list without government approval. The U.S. and China are likely to continue the current path unless something triggers Beijing’s leadership to modify its approach to human rights, its increasingly aggressive military buildup and hegemonic goals, and its abrogation of trade practice obligations taken under the World Trade Organization (WTO).

In response to a series of Chinese trade infractions (intellectual property theft, forced technology transfers, cyber espionage, and WTO violations), the U.S. government implemented a sanctions regime that has inflicted increasing pain on China’s semiconductor industry and the future competitiveness of its commercial and defense customers.

To date, China has retaliated with tariffs and chip import restrictions, saber-rattled with respect to Taiwan, and passed legislation that nominally allows extraterritorial jurisdiction against entities that pose a threat to China’s national security. But otherwise, China has kept its powder dry. In response to the U.S.’s recent moves, what additional levers does China have? How can China pressure companies in the global semiconductor industry? The U.S. sanctions sword is double-edged and cuts both ways.

There are several measures China could take for retaliating against the United States, among them. Squeeze global supply chains via global OSAT (outsource package, assembly and test) share; frustrating industry merger and acquisition deals; ration rare Earth and critical materials where China retains commanding market positions; denying access to China’s market; or invade Taiwan.

“The prudent course in a period of uncertainty is risk mitigation. This applies to countries and companies alike,” Daly and Schneider write.

The U.S. and its allies must pursue strategies that rebalance geographic sources of supply away from today’s overconcentration in Asia. This is the type of industrial policy envisioned in the Creating Helpful Incentives to Produce Semiconductors (CHIPS) for America Act (still pending the appropriation of funding). The U.S. government should focus on seeding capacity investments not only in leading-edge fabs but also in emerging chip technologies such as gallium nitride and silicon carbide, as well as in segments such as advanced packaging-assembly-test, rare earth mining and refinement, and critical materials.

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The semiconductor industry yearns to regain its model of open markets, free trade, intellectual property protection, full leverage of geographic competencies, innovation by a multicultural workforce, global collaboration in research and standards, and funding by global capital markets. From the industry’s perspective, the case for deescalation is clear. While it would be heartening to see the U.S. and China walk back from the precipice and call a truce on chips and other bilateral flashpoints, the current reality is likely to be with us for some time. In the interim, global semiconductor firms should develop risk mitigation strategies and hold contingency plans for execution close at hand.