‘The US government is run by idiots who don’t understand the industry,” one of the founding fathers of America’s semiconductor industry told me after the Biden administration announced sweeping curbs on Chinese purchases of US high-end chips, fabrication equipment, and design tools. The Biden measures also forbid American citizens or residents from working in China’s chip industry.

“Washington has brought a knife to a gunfight.”

America is in a full-scale economic war with China, but Washington has brought a knife to a gunfight. China’s subsidies to its nascent chip industry are four times the Biden administration’s proposed support for American manufacturers. That doesn’t augur well for American victory.

This isn’t a drill. After the Trump administration banned high-end chip sales to China’s Huawei in 2020 and shut down its 5G smartphone business, Harvard guru Graham Allison asked, “Could the US attempt to enforce that ban become a 21st-century equivalent of the oil embargo the United States imposed on Japan in August 1941?” The latest Biden measures extend the Huawei ban and more to the whole of Chinese industry. I don’t think China will respond by seizing Taiwan’s state-of-the-art chip fabrication plants, which make 70 percent of the world’s advanced semiconductors. Instead, China will dig in for an economic war of attrition that it may well win.

Every manufactured product, from toasters and automobiles to ballistic missiles, runs on computer chips. The United States invented the integrated circuit but now fabricates just 12 percent of the world’s chips, and none of the most advanced versions.

What is it the Biden administration doesn’t understand? The nature of the industry—specifically, its constant hunger for capital expenditures.

Semiconductor sales in 2021 were roughly $600 billion, and the industry planned $200 billion—an eye-popping one-third of total sales—in capital spending. The Taiwan-based TSMC and Intel together planned to spend $220 billion over the next three years. Industry analysts slashed that estimate to $160 billion last month, and the Biden chip war probably will shrink it even more. But compare this to the global automobile industry, which sold $2.8 trillion worth of cars and trucks in 2020 but only devoted $200 billion, or one-fourteenth of total sales, to capital expenditures.

The semiconductor industry lives and dies on innovation. The latest chips that power 5G smartphones as well as Artificial Intelligence applications pack 10 billion or more impossibly small transistors of 3 to 5 nanometers into a chip the size of a fingernail. A state-of-the-art chip plant costs $20 billion to $30 billion and will be obsolete in three to five years. It needs lithography from laser light shrunk through an impossibly complex system of mirrors using machines that only one Dutch company can manufacture, as well as 700 different inputs ranging from specialty metals in valves that contain corrosive chemicals to machines that can purify solvents to one particle per trillion drops.

In good times, profit margins are impossibly high. Nvidia, perhaps the world’s most advanced designer of AI chips, last year made $20 billion of gross profit on $30 billion of sales. But its stock price fell to $112 on Oct. 14, from a 2021 high of $346, a loss of two-thirds of its market value, as the slowing world economy reduced demand and the Biden administration cut off its Chinese market, or 26 percent of its world revenue.

China last year bought slightly more than half of the world’s computer chips and a vast amount of chip-manufacturing equipment. ASML, the Dutch company with a monopoly on high-end lithography, made 15 percent of its 2021 revenue in China. LAM Research, the top US maker of chip fabricating equipment, depended on China for 35 percent of sales that year. The China ban will punch an enormous hole in the revenues of America’s remaining pockets of tech leadership.

What does the Biden administration have to offer in return? The $50 billion CHIPS Act passed this year offers up to $8 billion a year in subsidies for chip manufacturing. That’s barely 5 percent of the industry’s global budget. It also envisions an $11 billion chip research center, while Samsung alone spends $16 billion on research and development. Meanwhile, the White House estimates that it will spend $30 billion a year on student-loan forgiveness.

This looks like America’s Cold War measures against the Soviet Union, but the resemblance is threadbare. Under the Reagan administration, the federal development budget, spent on building prototypes of new technology, ran to 1 percent of GDP, or about $230 billion in current dollars. Now it’s about 0.3 percent of GDP. With its huge population and vast talent pool, China is a far bigger challenge than Russia ever was, yet the United States spends a small fraction of our 1980s commitment relative to the size of the American economy.

National security demands that the United States protect its chip supply. It’s easy to hide the logical equipment of a time bomb among the billions of transistors of a modern chip, which means that chips used for America’s military and critical infrastructure should be produced at secure facilities at home.

But it’s one thing to protect the US chip supply, something I have advocated for years, and quite another to try to stop China from building its own chip industry. China has thrown vast amounts of money into semiconductors, with mixed results. It now has a $221 billion fund for its domestic industry. As always, China’s top-down approach suffers from inefficiency and corruption. In August, the chief of its semiconductor investment fund was arrested for alleged misuse of funds.

But it would be foolhardy to underestimate China, which now graduates seven times as many engineers annually as the United States, and has 20 of the world’s 50 top-rated engineering schools, according to the US News ranking. The United States has 70 years of expertise in the industry, but it has lost many of the manufacturing skills and infrastructure on which innovation depends. China has a vast advantage in human capital. It can’t buy high-end chips from Taiwan, but it has hired more than 10 percent of Taiwan’s chip-fabrication engineers. It also has support from South Korea’s top chipmakers, Samsung and Hynix. So intertwined are China’s and South Korea's high-tech industries that the Biden administration had no choice but to grant a reprieve for the South Koreans to continue investing in China’s chip industry.

The Biden administration claimed that its chip ban was aimed at China’s military, but that doesn’t wash. The overwhelming majority of military applications use older chips that China can make at home, as a 2022 RAND Corporation report explains. AI applications like autonomous vehicles need more modern chips, and the Biden ban will slow China’s attempt to digitize its economy. The Middle Kingdom will have to shift investments toward reinventing what others can do better, and that will be a drag on its growth.

It will take China at least five to 10 years to match the raw computing power of the ultra-dense 3- to 7-nanometer chips now produced by TSMC and Samsung. But there are a lot of workarounds in the meantime. Some Chinese firms claim to get 5-nanometer AI performance out of 14-nanometer chips with smart software. The Biden administration says it wants to stop China from making supercomputers that can design advanced weapons, but China built one of the world’s top supercomputers with 14-nanometer chips running in parallel.

The likeliest outcome of the chip war is the creation of a separate Chinese semiconductor industry, with years of global over-capacity financial distress for non-Chinese firms that depend on high profit margins to sustain capital expenditure and R&D. China will try to amortize its vast semiconductor subsidies by flooding the world market with cheaper products and putting Western companies out of business.

We have two choices. We can accept a Chinese presence within the global division of labor in semiconductors, or we can spend what it takes to keep China out of the running. As it stands, we are doing neither. We can expect the worst of all possible outcomes.

David P. Goldman is deputy editor of Asia Times and a fellow of the Claremont Institute’s Center for the American Way of Life.

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