(May 29): For over two years now, the US and China have been at loggerheads over trade issues. In mid-January, the world’s two largest trading nations reached a truce. The Phase 1 agreement saw Beijing promising to purchase an additional US$200 billion ($283.3 billion) of American goods and services over the next two years while Washington agreed to slash tariffs on US$120 billion in Chinese products from 15% to 7.5%. In the aftermath of the coronavirus pandemic, however, there has been a marked escalation of the conflict, with the US upping the ante after China indicated it may not be able to buy most of the additional American products it had agreed to buy.
At the heart of the US-China trade war is the battle for global tech supremacy. Last week, Washington turned up the heat on the export of key semiconductors to China. The trade war which turned into a tech war 18 months ago, has morphed into a fierce chip war that threatens to permanently derail Beijing’s audacious plan to become a global technology powerhouse by 2025.
The US Department of Commerce is drafting a law that would require semiconductor makers around the world that use US technology or equipment, in addition to the existing curbs on US domestic firms, to obtain Washington’s approval to sell chips to Huawei Technologies, China’s homegrown tech champion. The move will potentially quash Huawei’s ability to make any telecommunications network equipment and smartphone handsets. Huawei is currently the world’s top network equipment maker and No 2 maker of smartphone handsets. “The objective of the US is to, at the very least, squash China’s ability to design and make advanced chipsets, thereby halting its tech progress,” says Edison Lee, telecoms analyst for Jefferies in Hong Kong. “The Trump administration’s aim is to help the US catch up with and then overtake China,” he says. With no access to sophisticated US semiconductor technology, China’s tech options could be limited, Lee argues.
5G race
Here is what you need to know about the upcoming chip war as well as why it matters and what happens if things get out of hand. China has been first off the gate with the next-generation 5G telecommunications network. 5G is not just a faster upgrade for your current 4G phone. It will be an enabler for things such as driverless cars, artificial intelligence, streaming virtual and augmented reality services, drones, smart cities, telemedicine such as remote robotic surgery by a doctor thousands of miles away as well as an Internet of Things-powered networked smart home.
No wonder there is a fierce race between the US and China to be in pole position. America’s No 1 target is Huawei, which makes telecom equipment such as networking gear and switches, mobile phones, as well as an array of other components. An affiliate, Hi Silicon, has ambitions to become the world’s largest chipmaker. Huawei may be first rolling out 5G worldwide but it relies heavily on US designed chips made on US or western equipment using mainly US software. For China, one key benefit of Huawei aggressively building a 5G network ahead of global peers is to make its local 5G chip supply chain more globally competitive, which might then help monetise Chinese 5G patents. Once China has the 5G patents and the know-how as well other telecoms-related intellectual property, it would be the tech powerhouse to beat.
So, it is not surprising that the Trump administration does not just want the US to remain the global tech supremo and dominate the 5G race, it also wants to kill Huawei or at least cripple it so that the latter becomes a mere shadow of its former self. By invoking the Foreign Direct Product Rule now, Washington is trying to prevent semiconductor companies around the world, including Shanghai-based, second-tier foundry Semiconductor Manufacturing International Corp (SMIC), from using American technology, equipment and software to produce chipsets designed by Huawei and its affiliates.
For now, the rule does not prevent semiconductor equipment makers from selling to Chinese chip foundries like SMIC and Hua Hong Semiconductor as long as they do not use them to make chipsets for Huawei. But Lee says that Dutch semiconductor equipment maker ASML has, in recent months, failed to obtain an export licence to ship extreme ultraviolet lithography (EUV) machines to SMIC, reportedly due to US pressure. EUV machines, he says, are critical for the Chinese foundry giant to upscale to 7 nanometre (nm) transistors or even more sophisticated 5nm ones, which 5G smartphones require. SMIC currently produces mostly lower-end 14nm chips used in 3G and 4G phones.
America, Lee notes, “remains gravely concerned about the security of Huawei’s and (other) Chinese telecoms products” including network equipment and smartphones. The Jefferies analyst doubts if the US would be placated if Huawei could utilise a non-Chinese-designed chipset to continue building 5G smartphones. It is possible for Huawei to quietly switch to the 5G chipsets of Taiwanese chip design firm MediaTek. But the Trump administration is likely to plug that loophole quickly. “The Direct Product Rule could be effective in hampering Huawei’s ability to produce 5G baseband chipsets, since there are no non-US companies that have produced a general baseband chipset for 5G that Huawei could use,” he argues.
However, for smartphones’ 5G baseband chipsets, there are alternative designers in the markets such as MediaTek and China’s Unisoc. “Allowing Huawei to use 5G chipsets designed by MediaTek and Unisoc that are then made by Taiwan Semiconductor Manufacturing Corp, or TSMC, and continue to produce 5G smartphones does not seem to be consistent with the US’s objective,” Lee notes. Without US software and American designed chips chips, “Huawei would look much more like a simple “brainless” box maker,” says Mark Li, an analyst for Bernstein & Co.
What will happen if Washington moves to implement the Direct Product Rule quickly? For one thing, the global 5G rollout is likely to be delayed, notes Warren Lau, senior tech analyst at Aletheia Capital in Hong Kong. Huawei has aggressively sought and won 5G infrastructure contracts globally, with Asia and Europe being key targets. By deftly undercutting competitors such as Samsung Electronics and Ericsson, Huawei won over 60 5G contracts globally. The US has long argued that China uses Huawei 5G chips to install a backdoor through which it spies on overseas networks. Earlier this year, US Secretary of State Mike Pompeo said America was “putting allies and partners on notice about the massive security and privacy risks connected to letting Huawei construct their 5G networks” inside of their countries. Several countries, including the UK, have indicated that they might revoke Huawei contracts.
For now, though, Huawei’s problem is sourcing chips and components. “If it is unable to secure sufficient key components for 5G base stations, the company may be unable to support its overseas customers in the build-out of 5G infrastructure,” notes Lau, who believes Huawei is still on track to build 600,000 to 800,000 5G base stations in China this year and probably has secured ample inventory for 1.2 million units of 5G basebands for 2021 projects in China. Longer term though, “Huawei is in deep trouble,” says Pierre Ferragu, an analyst for New Street Research in New York. Without access to state-of-the-art US technology, “Huawei has just 12 months left to live,” he argues.
Who gains from Huawei’s pains?
With Huawei out of the picture, Lau reckons Ericsson, Samsung and others are likely to gain market share. “Customers who have signed up with Huawei on 5G gears may face delays and could look for alternative solutions to avoid delays in the rollout of 5G networks,” the Aletheia Capital analyst says. A big beneficiary of the chip war, over the long run, is likely to be TSMC, the world’s largest foundry, which contract manufactures customised chips for fabless (those without a wafer fab or factory) chip designers like baseband chip designer Qualcomm, broadband chip firm Broadcom and graphics chip giant Nvidia. Smartphone behemoth Apple, which designs many of its own smartphone chips but relies on foundries like TSMC to manufacture them, is another big customer of TSMC.
In the interim though, TSMC will lose since Huawei accounts for 14% of its total sales. Lau believes TSMC could lose nearly 2% of its revenues to Samsung should Qualcomm’s smartphone customers gain share at the expense of Huawei because the baseband giant uses the Korean chipmaker as its production partner. Ericsson and Samsung, which make 5G base station chips for Xilinx and Marvell Technology, will also gain at the expense of TSMC.
But TSMC will win big over the long run as it sides with the US in the battle over chip supremacy. On May 15, TSMC announced it would spend US$12 billion to build a factory to make 5nm chips in Arizona. The giant foundry operator has the support of Washington as well as the state. President Donald Trump has been eager to jump-start the development of new chip factories in the US to allay fears about the US’ reliance on China, South Korea and Taiwan to produce chips. Construction will begin next year, with production likely to begin in 2024. By building a plant in the US, TSMC is making a statement, says veteran tech analyst Ben Thompson, who writes the Stratechery blog. “When it comes to the US and China, ambiguously sitting in the middle, selling to both, is no longer an option,” he says.
There are now two distinct tech powers, each with its own ecosystem. “At some point, every tech company is going to have to make a choice between the US and China,” Thompson says. “It is tempting to blame the tension be- tween the two countries on President Trump, but the truth is that China, particularly under [President] Xi Jinping, has been significantly hardening its rhetoric and actions since be- fore Trump was elected, and has been commit- ted to not just catching, but surpassing, the US in technology for years,” he notes. “There is a fundamental clash of values between the West and China, and it is clear that China is only interested in exporting theirs.”
As Huawei loses market share in smartphones, Chinese rivals Xiaomi, Oppo and Vivo have gained at least locally and in emerging markets such as India, Africa and Latin America. Another winner is SMIC, which Beijing is grooming as the homegrown chip foundry alternative to TSMC. South China Morning Post reported last week that China will inject US$2.2 billion into SMIC to help it move into next generation chip manufacturing.
Lee expects China to retaliate if the US tries to neutralise Huawei by choking off its supply of components. “The risk of a ‘super’ Cold War is mounting, and China’s patience as it waits for a peaceful unification with Taiwan may be running thin,” he says. Though the bigger picture remains foggy, “it all looks like the beginning of a new Cold War,” notes Ferragu who says “fog is exactly what a war needs to get started.” Others believe Trump will back down if China makes concessions and reins in Huawei ahead of the elections in November. If Trump loses his re-election bid, the incoming president Joe Biden might seek to de-escalate tensions with China. Yet it may be wise not to bet on Huawei getting a reprieve under a new administration because a vast majority of Americans now widely see it as a national security threat.
Assif Shameen is a technology and business writer based in North America
