How Trump's export curbs on semiconductors and equipment hurt the US technology sector

Chad P. Bown (PIIE)

September 28, 2020 5:00 AM
Image credit: 
REUTERS/Richard Chung

Hexuan Li provided outstanding data assistance, and Melina Kolb, William Melancon, and Oliver Ward assisted with graphics.

President Donald Trump’s much-touted “phase one” trade agreement with China is falling well short of its goal. Under the deal, Trump pledged that China would purchase an additional $200 billion of US exports over 2020 and 2021. With two-thirds of 2020 now in the books, China has imported less than one-third of the goods that Trump assured Americans it would buy this year. One rare exception are high-tech products like American semiconductors and chipmaking equipment, which have managed to maintain robust export sales despite the pandemic and anti-China rhetoric of a US election campaign.

That bright spot has suddenly dimmed, however, and not because of China. The Trump administration is remaking the US export control regime in a way that could lead to sharp cuts in foreign sales of both of these American industries. Elements of the new regime may be well-motivated, seeking to mitigate legitimate national security risks. Other links to national security are, at best, more tenuous and will certainly come at considerable economic cost to American companies.

The administration’s newest restrictions do more than shut off technology exports to China. The policy limits some American sales to third countries, even when they are US military allies. American semiconductor toolmakers cannot sell their equipment to major semiconductor manufacturers in South Korea or Taiwan, for example, if companies there want to use American tools to make anything to sell to Huawei, the Chinese telecommunications company targeted by the administration as a national security threat.

By restricting what foreign companies can do in their home countries, the administration is threatening allied governments’ national sovereignty, setting a dangerous precedent of unilateralism. The policy also creates new risks for American workers—both semiconductor equipment makers and those in the semiconductor manufacturing and software design industries.

On China, President Trump has said, “We lose billions of dollars and, if we didn’t do business with them, we wouldn’t lose billions of dollars. It’s called decoupling.” But Trump has it wrong. His decoupling policy here could mean losses of billions of dollars of American sales not only to China but to other countries as well. And the unilateral nature of his policy could open new areas of conflict with the very same allies that are essential to mitigating the national security threat.

Semiconductors, software, and equipment 101

Semiconductors are tiny chips—the ubiquitous integrated circuits and microprocessors—that drive everything from smartphones to telecommunications hardware, computers, automobiles, data centers, and weapons systems. From start to finish, chipmaking involves dozens of companies and interdependencies deeply woven into global supply chains. Three parts of that supply chain stand out—semiconductor design and manufacturing, software, and semiconductor manufacturing equipment (figure 1).[1]

Figure 1 Semiconductor manufacturing is a multi-stage process

In the first half of 2020, six of the top ten firms in semiconductor design and manufacturing sales—Intel, Micron, Broadcom, Qualcomm, Nvidia, and Texas Instruments—were headquartered in the United States.[2] The other four were Samsung and SK Hynix (South Korea), Taiwan Semiconductor Manufacturing Company (TSMC, Taiwan), and HiSilicon (China).

Semiconductors are often designed and manufactured in different locations. Broadcom, Qualcomm, Nvidia, and HiSilicon are “fabless”—i.e., they design, market, and sell chips but contract out the fabrication to foundries, like TSMC, which are often located in other countries. (Hence the term “fabless.”) The main business of TSMC, the Semiconductor Manufacturing International Corporation (SMIC, China), and GlobalFoundries (United States) is to produce chips for other firms.

Some companies, such as Intel and Samsung, design and manufacture their own chips in house. They are called integrated device manufacturers (IDMs).

A second important part of the semiconductor supply chain is software, or electronic design automation (EDA)—i.e., the companies that craft the software tools used to create integrated circuits and semiconductors. US-based companies like Synopsys, Cadence Design Systems, and Mentor Graphics make up 85 percent of the EDA market and sell or license critical software services to many American and foreign chipmakers.[3]

Third, to make semiconductors, manufacturers require access to sophisticated equipment and tools, which are also produced by only a handful of companies. Three based in California—Applied Materials, Lam Research, and KLA-Tencor—held more than 40 percent of global market share in this sector in 2018.[4] ASML (the Netherlands) and Tokyo Electron (Japan) combined held more than 30 percent.

The semiconductor industry is important to Trump’s phase one agreement with China

China is the largest buyer of both semiconductors and equipment; combined, global trade reached over $1 trillion in 2019.[5] Through the first eight months of 2020, the two sectors constituted nearly 25 percent of China’s total imports of goods covered by Trump’s agreement. They were even on pace to help China meet the misplaced metric of Trump’s estimated phase one purchase targets for the industry (figure 2).

Figure 2 Without China’s purchases of US semiconductors and equipment, Trump’s phase one agreement is underperforming

 
From soybeans to lobster to energy, other US exports to China in 2020 are lagging. Through August, their combined year-to-date sales are 58 percent lower than Trump’s prorated targets. At the current pace, China would fall $89 billion short of its total purchase pledge for 2020.

The US national security concerns affecting the semiconductor industry

National security concerns are a main driver of the Trump administration’s new export control policy affecting American sales of semiconductors, software, and manufacturing equipment. The major worry involves Huawei, for reasons US officials have recently articulated.[6] Nevertheless, US government problems with Huawei are longstanding, dating back to at least the mid-2000s.[7]

Huawei is a Chinese national champion with similar revenues as Microsoft, according to Fortune’s Global 500 ranking for 2020. One of Huawei’s most important product lines is mobile phones.[8] With 20 percent of the global market, Huawei was the top supplier of smartphones in the second quarter of 2020, ahead of Samsung, Apple, and three other Chinese handset makers, Xiaomi, Oppo, and Vivo.[9]

Huawei’s other main business is telecommunications infrastructure equipment, providing hardware for many countries’ 5G (fifth generation wireless technology) networks—the critical infrastructure expected to further enable developments ranging from remote surgery and autonomous vehicles to the Internet of Things. Only four main suppliers dominate telecommunications hardware, with Huawei providing 27.5 percent of the global 5G base station market in 2019. The other major suppliers—Ericsson (30 percent, Sweden), Nokia (24.5 percent, Finland), and Samsung (6.5 percent, South Korea)—are also not American.[10]

The most clearly articulated government concerns over the threat Huawei poses to national security involve its supplying 5G infrastructure, like base stations.[11] There are worries that Huawei could install “backdoors” within its equipment’s networks, and that China’s national security law could compel the company to collect and turn over personal, corporate, government, or military information on foreigners to the Chinese government. (In one widely cited case, Huawei has been accused of facilitating spying on the African Union headquarters in Ethiopia.) Another concern is more technical and involves Huawei’s performance and reliability. A 2019 report to the UK government evaluating the Huawei equipment in use throughout the British telecom network stated, “Huawei’s development and support processes are not currently conducive to long-term security risk management and, at present, the Oversight Board has seen nothing to give confidence in Huawei’s capacity to fix this” (HCSEC Oversight Board 2019).

The US, UK, and Australian governments have decided against procuring Huawei equipment for their networks. Whether or not these concerns are overwrought, they involve tradeoffs that need to be clarified. There is also a question of whether the United States is using the most effective policy tools to address its concerns.

US export controls toward Huawei in 2019 targeted American semiconductors and software

The US Department of Justice indicted Huawei in January 2019 for stealing US technology, money laundering, and helping Iran avoid sanctions involving the proliferation of weapons of mass destruction. Huawei has denied the allegations.[12] In May and August 2019, the Department of Commerce added Huawei and its affiliates to the “Entity List” of foreign companies for which it is illegal for Americans to provide a good or service without a license. The government theory was that cutting off American-made inputs—of semiconductors to Huawei directly and of EDA tools to its subsidiary chip designer HiSilicon to shut off access indirectly—would cripple Huawei’s ability to produce leading edge telecom equipment, leaving the 5G market to more reliable gear made by Ericsson, Nokia, and Samsung.

But two problems arose with this approach. The initial US export controls in 2019 were both too narrow and too broad, overlooking some problems and creating others (figure 3).

Figure 3 The US is attempting to use export controls to cut off Huawei’s access to semiconductors

Export controls were too broad economically if they also restricted American sales to Huawei or HiSilicon of products that did not threaten US national security. If the concern derived only from the base stations for the telecom hardware sector, for example, cutting off American semiconductor industry exports for Huawei’s smartphones could be unnecessary and excessively costly.

At the same time, the initial US export controls were too narrow to protect national security. For example, fabless companies designing chips to be made at TSMC in Taiwan, or Samsung manufacturing semiconductors in South Korea, were outside the reach of the 2019 export controls. Indeed, a July 2020 report by the US-based Semiconductor Industry Association makes the counterintuitive argument that the Trump administration was actually giving the US semiconductor industry too much credit. Because most semiconductors needed for base stations are widely available from manufacturers outside of the United States, cutting off American sales was unlikely to prevent Huawei from procuring the technology elsewhere.[13] (See again figure 3.) The American industry essentially told the administration: “We’re great, but not that great; and we can be replaced.”

The industry found itself caught in the crosshairs of Trump’s policy. Nearly one quarter, or $49 billion, of the American semiconductor industry’s total annual revenues derived from sales to Huawei and other Chinese companies.[14] Yet, despite the strong export performance of the industry in 2020, it supplied only 5 percent of China’s imports of semiconductors (figure 4). Geographically, chips from Taiwan and South Korea made up China’s largest sources of foreign supply.

Figure 4 Taiwan and South Korea are China’s top foreign suppliers of semiconductors

Export controls do little to protect national security if the foreign target can simply acquire the technology from third countries instead. As a US legal matter, the Export Control Reform Act of 2018 recognizes this situation by observing: “Export controls that are multilateral are most effective…. Export controls applied unilaterally to items widely available from foreign sources generally are less effective in preventing end-users from acquiring those items.” [15] The 2019 controls were a potentially worrisome and costly case study.

US export controls toward Huawei’s semiconductor suppliers in 2020 target American semiconductor manufacturing equipment

Limiting US semiconductor exports in 2019 that turned out to be “widely available” from other countries presented the Trump administration with a dilemma. It could recognize that its unilateral restrictions were ineffective in protecting national security and remove them. Or it could make them more effective by working with other governments to also limit exports of chips from their plants.

The Trump administration chose neither approach. Instead, it went with a previously untried option: directly coercing companies in foreign countries that manufacture semiconductors using US software or technology to stop selling them to Huawei. To do so, the Department of Commerce implemented additional rounds of export controls in May and August 2020. Under the foreign-produced direct product (FDP) rule, the Commerce Department effectively put new limits on sales by American companies of a new part of the semiconductor supply chain—manufacturing equipmentto chipmakers overseas (see figure 3).

The idea was to present foreign manufactures like TSMC and Samsung with a choice. To access American-made tools used to fabricate semiconductors, those companies would need to agree not to sell to Huawei. If they wanted to keep Huawei as a customer, TSMC and Samsung would have to find other, non-US manufacturing equipment. The Trump administration was betting these foreign chipmakers would continue to buy the American equipment.

American toolmakers like Applied Materials, Lam Research, and KLA-Tencor are at the frontier of this highly concentrated industry. But like American chipmakers, the semiconductor equipment makers also have a “We’re great, but not that great” concern. Substitutes from the world’s other major equipment providers are currently available from other countries that are not subject to controls (figure 5; see again figure 3), and others may be in the pipeline.

Figure 5 American companies face stiff global competition in semiconductor manufacturing equipment

Unable to head off the new policy, SEMI, the semiconductor design and manufacturing industry association, raised these concerns by noting that the May 2020 export controls had “already resulted in $17 million lost sales of U.S.-origin items to firms unrelated to Huawei” (emphasis added),  further predicting that the new (August 2020) “restrictions will also fuel a perception that the supply of U.S. technology is unreliable and lead non-U.S. customers to call for the design-out of U.S. technology.”[16]

The August action is unlikely to be Trump’s last set of export controls. On September 26, it was reported  that the US Department of Commerce was adding SMIC, the Chinese foundry, to the Entity List, shutting off its access to American-made tools, semiconductor designs, and software.

Six implications of the new US export control regime

Through its broad and unilateral export controls, the Trump administration has issued sudden ultimatums on American companies as well as foreign firms in allied countries. This peremptory action is not only a substantial policy shift but also a big gamble. There will be considerable costs to American industry. And even if the approach successfully mitigates the national security risk related to Huawei’s 5G infrastructure, using threats rather than cooperation with allied governments may backfire.

First, companies now face pressure to avoid setting up semiconductor, software, or toolmaking facilities in the United States. Even firms currently manufacturing in the United States may explore moving production and activities offshore to escape US export controls.

Second, foundries in foreign countries have new incentives to “design out” and avoid purchasing American semiconductor manufacturing equipment, lest such purchases get targeted and disrupted in the future. Japanese or Dutch suppliers of competing equipment suddenly look more attractive to these companies.

Third, Huawei may do more than stop its future purchases of American-designed semiconductors. If it fails financially, or even if it sees no future relationship with American companies, Huawei may halt payment of billions of dollars in license fees it owes to American firms for use of earlier technologies.

Fourth, major foreign consumers of US-made semiconductors—including other Chinese smartphone suppliers like Vivo, Oppo, and Xiaomi—may look elsewhere in the future, concerned that their supplies will get cut off, even if they make products that do not pose a national security risk.

Fifth, this type of export control regime requires a new US bureaucracy, creating concerns over cronyism, nontransparency, and discrimination. Because the prior US approach to export controls was so narrowly targeted, there was little need for a process to consider exceptions. The Trump administration has chosen a regime that is overly expansive by design, with the possibility that government officials could decide exceptions, arising from company petitions, on a case-by-case basis. In addition to American firms, foreign chipmakers like Samsung and TSMC are also likely to request exemptions.[17] Some may be accepted, others may be denied, but the secrecy demanded by national security raises the perception that US government decisions will be based on favoritism, and not risk, generating conflict with allied governments in South Korea and Taiwan worried about their high-tech firms.

Sixth, foreign governments are likely to retaliate, imposing new costs on American companies. On September 19, China announced it was creating its own “unreliable entity list” of foreign firms that might be cut off from China’s consumer market. There is already speculation that, at some point, Beijing could add American companies like Apple, Cisco, and Qualcomm to the list.

But even allied governments—displeased with how the sudden and unilateral American policy has constrained their companies’ sales to China—may respond with their own export controls. As a hypothetical example, take the bilateral dispute in which Japan threatened export controls on semiconductor materials that its companies ship to South Korea.[18] What is to prevent the Japanese government from extending its ban to American chipmakers, instructing them not to use semiconductor materials from Japan for any products they want to sell to customers in South Korea?

One more reason why Trump’s trade policy is not good US policy

The Trump administration has invoked national security as a rationale for its new export control regime, but its actions have opened another Pandora’s box for US trade policy, with potentially dangerous damage to the US semiconductor industry—a backbone of its high-tech economy—and to US trading partners.

Cutting off an important revenue source for American chipmakers, software designers, and toolmakers jeopardizes the research and development (R&D) that supports tens of thousands of American jobs. Less R&D also means less American innovation, including for weapons systems of the future. An overly -restrictive US export regime therefore creates a new national security risk. Lastly, in a time of scarce government resources owing to a pandemic and crippling recession, the new policy is also forcing the industry to demand tens of billions of dollars of new federal subsidies as compensation.

More immediately, these export controls sharply identify one more fundamental inconsistency of the Trump administration’s own trade policy. There are many reasons to criticize the president’s phase one trade agreement with China. To Trump, however, the deal was “historic” because of his promise that China would suddenly purchase $200 billion more of US goods and services. But because of his own administration’s export restrictions, he is now likely to break even this promise.

References

Bown, Chad P. 2020. Export Controls: America's Other National Security Threat. Duke Journal of Comparative and International Law 30, no. 2: 283-308.

Ford, Christopher A. 2019. Huawei and Its Siblings, the Chinese Tech Giants: National Security and Foreign Policy Implications. Remarks at Multilateral Action On Sensitive Technologies (MAST) Conference, September 11.

Ford, Christopher A. 2020a. U.S. National Security Export Controls and Huawei: The Strategic Context in Three Framings. US Department of State, Bureau of International Security and Nonproliferation, Arms Control and International Security Paper #8, May 22.

Ford, Christopher A. 2020b. Export Controls and National Security Strategy in the 21st Century. US Department of State, Bureau of International Security and Nonproliferation, Arms Control and International Security Paper #16, August 19.

Goodman, Samuel M., Dan Kim, and John VerWey. 2019. The South Korea-Japan Trade Dispute in Context: Semiconductor Manufacturing, Chemicals, and Concentrated Supply Chains. USITC Office of Industries Working Paper ID-062, October.

HCSEC (Huawei Cyber Security Evaluation Centre) Oversight Board. 2019. Annual Report: A report to the National Security Adviser of the United Kingdom, March.

SIA (Semiconductor Industry Association). 2016. Beyond Borders: The Global Semiconductor Value Chain, May.

SIA (Semiconductor Industry Association). 2020. 5G Wireless Infrastructure Semiconductor Analysis, July 1.

USTR (US Trade Representative). 2018. Findings of the Investigation into China’s Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation Under Section 301 Of The Trade Act Of 1974, March 22.

Varas, Antonio, and Raj Varadarajan. 2020. How Restrictions to Trade with China Could End US Leadership in Semiconductors. Boston Consulting Group, March.

Varas, Antonio, Raj Varadarajan, Jimmy Goodrich, and Falan Yinug. 2020. Government Incentives and US Competitiveness in Semiconductor Manufacturing. Boston Consulting Group and Semiconductor Industry Association, September.

VerWey, John. 2019. The Health and Competitiveness of the U.S. Semiconductor Manufacturing Equipment Industry. USITC Office of Industries Working Paper ID-058, July.

Notes

1. See Semiconductor Industry Association (SIA 2016) and VerWey (2019). Other important elements of the global semiconductor supply chain—including raw materials—are not yet subject to US export controls and are not discussed here.

2. IC Insights, China-Based HiSilicon's Time in the Top-10 Ranking May be Short Lived, IC Insights Research Bulletin, August 11, 2020.

3. See Varas et al. (2020, p. 6). Though Siemens acquired Mentor Graphics in 2017, Mentor continues to list its headquarters as Oregon. The EDA firms’ industry association is the Electronic System Design Alliance.

4. Thomas Alsop, Semiconductor equipment manufacturers' market share worldwide 1Q'17 to 2018, Statista, March 2, 2020.

5. In 2019, China’s imports were $359 billion (34 percent) and Hong Kong’s imports were $167 billion (16 percent) of the $1.055 trillion world imports of semiconductors ($969.7 billion of products classified under Harmonized System (HS) Codes 8541 and 8542) and semiconductor manufacturing equipment ($85.6 billion of products under HS 8486). Because semiconductors cross borders multiple times before being implemented in final products, they can be double counted, making total trade larger than value added. (According to the Semiconductor Industry Association, worldwide semiconductor sales were $412 billion in 2019.) Due to lack of sufficiently disaggregated data, amounts of cross-border EDA services trade are not presented here. For reporting on the impact of the export controls on American firms providing EDA services to Huawei, see Dan Strumpf, Yoko Kubota, and Wenxin Fan, Silicon Valley Will Feel Sting of Export Restrictions Against Huawei, Wall Street Journal, May 16, 2019.

6. For a recent US government perspective on the risks posed by Huawei, see Assistant Secretary of State Christopher A. Ford (2019, 2020a, 2020b).

7. Steven R. Weisman, Sale of 3Com to Huawei is derailed by U.S. security concerns, New York Times, February 21, 2008. See also House Intelligence Committee, Investigative Report on the U.S. National Security Issues Posed by Chinese Telecommunications Companies Huawei and ZTE, Washington, DC, October 8, 2012, and USTR (2018).

8. According to Huawei’s 2019 Annual Report (p. 22), 35 percent of its revenue derived from its ICT “Carrier business” and 54 percent from its “Consumer business,” highlighted by more than 240 million smartphones shipped in 2019 (p. 52).

9. S. O’Dea, Smartphone market share worldwide by vendor 2009-2020, Statista, August 20, 2020.

10. Kelly Hsieh, Competition in Mobile Base Station Market to Intensify as Global 5G Development Enters Upswing, Says TrendForce, Trendforce, August 3, 2020.

11. There are separate policy concerns related to Huawei receiving unfair subsidies from the Chinese government, including those voiced by the European Commission. See Shawn Donnan and Christian Oliver, EU Commissioner Attacks China’s Telecoms Subsidies, Financial Times, March 27, 2014.

12. Huawei’s response to the Department of Justice charges on January 28, 2019, was: “We deny that we or our subsidiaries or affiliates have committed any of the asserted violations of U.S. law set forth in each of the indictments. We are not aware of any wrongdoing by Ms. Meng, and we believe the U.S. courts will ultimately reach the same conclusion.”

13. The report concluded “substitutes for U.S. components exist for nearly every semiconductor product family required to build a complete RAN infrastructure. In fact, our analysis indicates that of the more than fifty critical semiconductor elements necessary to design, manufacture, and sell a competitive 5G RAN network, only 3 components could face supply constraints outside the United States in the event of an export restriction. For each of those three components, we have further concluded that alternatives are currently being deployed or under active development, especially within China by Huawei’s semiconductor design arm, HiSilicon” (SIA 2020).

14. Varas and Varadarajan (2020, p. 13).

15. For a discussion, see Bown (2020).

16. See SEMI Statement on New U.S. Export Control Regulations,” press release, August 24, 2020.

17. Samsung and MediaTek (Taiwan) have reportedly already applied for licenses to sell to Huawei.

18. See Goodman, Kim, and VerWey (2019).

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