• May 12, 2023

De-Americanise: How China is redefining its chip industry

De-Americanise: How China is redefining its chip industry

US-China tech trade war accelerates China’s self-reliant semiconductor push, investing in mature chips less affected by US controls.

Last October, construction plans for a hulking semiconductor factory owned by a major state-backed company in central China fell into disarray. The Biden administration had escalated the trade war over technology, severing China’s access to the Western tools and skilled workers it needed to build the most advanced semiconductors, according to a detailed news report on the Economic Times website.

Some employees with U.S. citizenship departed the company. Three U.S. equipment suppliers almost immediately halted their shipments and services, and Europe and Japan are expected to do the same soon.

The facility belonged to Yangtze Memory Technologies Corp., or YMTC, a memory chip company that Xi Jinping, China’s president, has extolled as a flagbearer in China’s race toward self-reliance. Now, the chipmaker and its peers are hurriedly overhauling supply chains and rewriting business plans.

Nearly seven months later, the U.S. trade barriers have accelerated China’s push for a more independent chip sector. Western technology and money have pulled out, but state funding is flooding in to cultivate homegrown alternatives to produce less advanced but still lucrative semiconductors. And China has not given up on making high-end chips: Manufacturers are attempting to work with older parts from abroad not blocked by the U.S. sanctions, as well as less advanced equipment at home.

The tough U.S. restrictions stemmed from alarm over what officials in Washington viewed as the threat posed by China’s use of its technology companies to upgrade its military arsenal. Jake Sullivan, the national security adviser, recently characterised the sentiment as part of a “new consensus” in Washington that decades of economic integration with China was not wholly successful, adding that the new controls were “carefully tailored” to go after China’s most cutting-edge semiconductors.

Under the October rules, American enterprises and citizens may no longer aid any Chinese companies building chip technology that meets a certain threshold of sophistication. The controls went beyond Trump administration trade curbs that went after specific companies like the Chinese telecom giant Huawei.

During those earlier trade tensions, Beijing mobilised vast sums to cultivate homegrown alternatives to Western chipmakers. But foreign components were readily available and of higher quality, leaving many Chinese firms unwilling to make the switch.

Those reservations about using materials from China appear to be easing. Chinese tech companies up and down the supply chain are assessing how to replace Western chips and related components, even those unaffected by U.S. controls. Guangzhou Automobile Group, a state-owned electric vehicle manufacturer, said in February that it aimed to eventually purchase all of its roughly 1,000 chips in its cars from Chinese providers. It currently buys 90% of its chips from overseas.

“The goal now in China in a lot of areas is to de-Americanise supply chains,” said Paul Triolo, the senior vice president for China at Albright Stonebridge Group, a strategy firm.

Dozens of Chinese chip companies are finalising plans to raise money through initial public offerings this year. They include China’s second-largest chip manufacturer, Hua Hong Semiconductor, as well as a chip toolmaker backed by Huawei.

The technology disputes between the world’s two largest economies show no signs of abating. The Biden administration has drafted, but not yet released, new rules that would restrict American venture capital investments in advanced chip companies in China. Foreign investment into China’s semiconductor sector this year has already tumbled to $600 million, its lowest point since 2020, according to data from PitchBook, which tracks private financing. And officials are mulling tighter controls on technologies like quantum computing or chip manufacturing equipment.

U.S. restrictions have caused Beijing to activate a state fund that had been dormant because of waste and graft: The government’s “Big Fund” injected roughly $1.9 billion into YMTC in February to bolster its response to the U.S. restrictions. The fund has also recently put money into chip equipment and material suppliers, according to state media reports.

The new subsidies aim to remove Western components from China’s supply chains. The southern city of Guangzhou has earmarked more than $21 billion this year for semiconductor and other projects, including those that attempt to replace Western chip equipment suppliers. Purchase orders for Chinese-made equipment have spiked in recent months, according to corporate reports and press statements.

Xi has been outspoken about what he sees as an effort by Western countries to enforce an “all-around containment” of China. During an important legislative meeting in March, the Chinese president interrupted remarks by a delegate from a Chinese crane manufacturer. The exchange was widely reported by state media: “The chips inside your cranes, are they locally sourced?” Xi asked. Yes, the delegate said.

So far, less than 1% of all semiconductors in China are at the industry’s top end that are subject to U.S. controls, according to estimates from Yole Group, a market research firm. The rest are less advanced, or “mature,” semiconductors, found in everyday consumer electronics and cars, and are “the vast majority of the business,” said Jean-Christophe Eloy, the CEO of Yole Group. Those chips, largely untouched by the Biden administration’s October controls, are now seeing a surge of investment, he added.

China’s two largest chip manufacturers, the state-backed Semiconductor Manufacturing International Corp. and Hua Hong Semiconductor, have each announced billions of dollars this year to expand production into mature chips, according to public announcements.

Yet over the long term, China’s lack of access to world-class tools needed to make chips could stymie its progress in many advanced industries like artificial intelligence and aerospace, according to Handel Jones, the CEO of International Business Strategies, a consulting firm.

In August, YMTC had targeted a threefold increase in its share of global chip production to 13% by 2027, challenging chip incumbents like U.S.-based Micron Technology, according to Yole Group’s estimates. Facing trouble building out its second factory, the Chinese memory chipmaker’s production is set to decline, sliding to just 3% of the market in 2027.

International companies that had previously invested in China’s semiconductor industry are diverting their investments elsewhere. Korea and Taiwan’s leading chip manufacturers, Samsung and Taiwan Semiconductor Manufacturing Co., are investing billions of dollars into new production in the United States. The Taiwanese chipmaker is applying for U.S. subsidies for its Arizona factory that force it to cap its investment into China for a decade.

At the same time, experts said, the weakening of foreign influence over China’s chip sector is creating opportunity for domestic companies. Last month, a semiconductor equipment manufacturer went public in Shanghai. Shares of the company, Crystal Growth & Energy Equipment, have climbed 30% since its debut.

“It’s because of the sanctions that there’s now space in the market,” said Xiang Ligang, a director of a Beijing-based technology consortium who has advised the Chinese government on technology issues. “Now we have a chance to develop.”

The recent burst of state cash could supercharge China’s share of global production in lower-end chips. In the next decade, China could account for roughly half of the world’s production capacity for a class of mature semiconductors, according to a jointly written report by Rhodium Group, a consulting firm, and Stiftung Neue Verantwortung, a think tank in Berlin.

That could create new supply chain vulnerabilities for foreign companies, said Jan-Peter Kleinhans, a co-author of the report.

“Putting all of your eggs in one basket is a stupid idea,” he explained. “This is a choke point that can be exploited.”

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