Talking chips (Part 3)
China, US sanctions and Nvidia
TL;DR
This newsletter is about the semiconductor industry and AI development, and is the third on a three-part analysis of this topic. This part looks at the geopolitical aspects of the computer chips, in particular the US sanctions against China.
Here are the key takeaways:
US concerns regarding China's role in the semiconductor value chain began during the Obama administration in 2015. It viewed China's massive state subsidies to its tech companies and its dominant position in electronics manufacturing as a threat to the US economy and national security.
This eventually led to sanctions being placed against China to weaken its position in semiconductors and more broadly. This included restrictions on the sale of certain hardware and equipment from US companies to Chinese companies, such as Huawei.
However, despite these sanctions, China has still managed to produce semiconductors that are not far behind the US. This was made evident in August 2023, with Huawei's launch of its new smartphone, the Mate 60 Pro which featured a 7-nanometer chip.
Additionally, Nvidia has found a way to continue its Chinese sales despite the restrictions imposed by US sanctions. Its H20 GPUs, though less powerful than its flagship products, remain popular with Chinese customers, generating billions of dollars for the US company.
The national security risk of China
The current state of the semiconductor industry has partly been formed by the growing tensions between the US and China over the past few years. This may also play a big part in the future of US-China relations.
It was in 2015 that US government's perception of Chinese tech companies as a national security risk began to intensify. Regarding semiconductors in particular, there was a growing realisation that US companies had become so reliant on countries in Asia.
Intel was one of the first US tech companies to highlight this concern when Brian Kraznich, the company's former CEO and the previous chairman of the Semiconductor Industry Association, raised concerns with the US government about China's strong position in the semiconductor industry. This was due both to the massive state subsidies provided to its own companies and that "China was a crucial market for almost every U.S. semiconductor firm, either because these firms sold directly to Chinese customers or because their chips were assembled into smartphones or computers in China."1
The US has found itself in this vulnerable position due to its assumption that a laissez faire market approach would be optimal for growth and market share for American firms. Instead, the semiconductor supply chain has become very complex and global, with certain critical aspects becoming monopolised by a handful of irreplaceable companies outside of the US:
America's technological lead in fabrication, lithography, and other fields had dissipated because Washington convinced itself that companies should compete but that governments should simply provide a level playing field. A laissez-faire system works if every country agrees to it. Many governments, especially in Asia, were deeply involved in supporting their chip industries. However, U.S. officials found it easier to ignore other countries' efforts to grab valuable chunks of the chip industry, instead choosing to parrot platitudes about free trade and open competition. Meanwhile, America's position was eroding.2
Additionally, since semiconductors power several other industries, including AI, such vulnerabilities extend to huge swaths of the US economy. Accordingly, recognising this problem as raised by Intel and others, in 2015 the US government started to develop its policy with respect to semiconductors and China:
The government's trade negotiations saw China's chip subsidies as a flagrant violation of international agreements. The Pentagon nervously watched China's efforts to apply computing power to new weapons systems. The intelligence agencies and Justice Department unearthed more evidence of collusion between China's government and its industries to push out America chip firms.3
This then led to the official stance being announced by the Obama administration in 2016: it is "imperative that semiconductor technology remains a central feature of American ingenuity and a driver of our economic growth. We cannot afford to cede our leadership."4 China was identified as the primary challenger in this regard with its unfair trade practices and extensive state intervention.
But the concerns around China have not just been limited to trade. The intelligence and security community have also been raising red flags about the Chinese Communist Party (CCP) and the companies that they use to further their agenda.
US agencies have been increasingly worried about China's position as the world's factory, presenting the opportunity to build backdoors into the electronics used in the US. This includes the semiconductors designed for military weapons.
Such concerns fuelled the hostility towards companies like Huawei as the US government started to become more paranoid about its links with the CCP and the associated national security risks. However, while these worries started during the Obama administration, more aggressive policy decisions, including those around trade and national security, were not enacted until the Trump administration in 2016-2020:
The China hawks on the National Security Council concluded that America's semiconductor industry needed to be saved from itself. Left to the whim of their shareholders and to market forces, chip firms would slowly transfer staff, technology, and intellectual property to China until Silicon Valley was hollowed out. The U.S. needed a stronger export control regime, the China hawks believed. They thought Washington's discussion about export controls had been hijacked by the industry, letting Chinese firms acquire too much advanced chipmaking design and machinery. Administration official cited the revolving door between the Commerce Department and law firms who worked for the chip industry and lobbied against export controls, though these officials were also among the few people in the government who understood the complexity of semiconductor supply chains. Because of this revolving door, Trump administration officials believed, regulations allowed too much technological leakage, weakening America's position relative to China.5
The US sanctions against China
With this backdrop, the US has placed a number of sanctions against China to weaken its position in semiconductors and more broadly.
In May 2020, the US restricted any goods made with US-produced technology from being sold to Huawei as well as banning the sale of goods to Huawei directly. This essentially prevented Huawei from accessing the vast majority of chips, including those made with US manufacturing equipment and software that Huawei and others rely on.
The Biden administration then strengthened these sanctions in October 2022, the purpose of which was to "forcefully [decouple] the entire advanced technology supply chain before China insources it." In fact, it was thought that these sanctions would result in Chinese companies and universitie losing access to several large companies across the supply chain and significantly shift the tech industry and beyond.
There are two main elements to the Biden 2022 sanctions. The first is the introduction of the the 'unverified' list and the second is the export controls for advanced computing, semiconductor manufacturing, and the general semiconductor supply chain.
Regarding the unverified list, there are to two important things to understand:
The entity list
The unverified list
The legal basis for the entity list and the unverified list is the Export Administration Regulations (EAR). This law regulates the export of goods and technologies for national security and foreign policy purposes.
The entity list, which is controlled by the Bureau of Industry and Security (BIS) of the US Department of Commerce, essentially lists those entities that act against the interests of the US. If a company is placed on the entity list, with Huawei being a prominent example , then those companies are "prohibited from receiving some or all items subject to the EAR unless the exporter secures a license."
Separately, the unverified list is a list of parties that are "ineligible to receive items subject to the Export Administration Regulations (EAR) by means of a license exception." It is for foreign parties receiving EAR items whom the BIS has not yet made a determination.
The unverified list can be thought of as a precursor to the entity list:
The entity list is used on people and companies supporting or engaging in terror acts...The unverified list is a pre-cursor because it is for persons and companies that the US cannot verify as having broken the rules.
The Biden 2022 sanctions made two changes to EAR:
The BIS imposed "additional export controls on certain advanced computing semiconductor chips (chips, advanced computing chips, integrated circuits, or ICs), transactions for supercomputer end-uses, and transactions involving certain entities on the Entity List."
The BIS adopted "additional controls on certain semiconductor manufacturing items and on transactions for certain IC end use."
In essence, the changes cover "all advanced chips that could be used for AI and supercomputing [and]...equipment that can be used to manufacture them."
The rationale for the first change (regarding controls on semiconductors):
...advanced AI surveillance tools, enabled by efficient processing of huge amounts of data, are being used by the PRC without regard for basic human rights to monitor, track, and surveil citizens, among other purposes. With this rule, BIS seeks to protect U.S. national security and foreign policy interests by restricting the PRC’s access to advanced computing for its military modernization, including nuclear weapons development, facilitation of advanced intelligence collection and analysis, and for surveillance. BIS intends to impose controls on items subject to the EAR and U.S. person activities to limit the PRC’s ability to obtain advanced computing chips or further develop AI and “supercomputer” capabilities for uses that are contrary to U.S. national security and foreign policy interests.
The rationale for the second change (regarding controls on equipment for manufacturing semiconductors):
...semiconductor manufacturing equipment can also be used to produce various ICs (packaged or unpackaged) for WMD or other military applications, as well as applications that enable human rights violations or abuses, including but not limited to the advanced systems and “supercomputers” described above. Similar to their use in commercial products, the use of semiconductors has become vital in the “production” of military systems, particularly for advanced military systems, and may be used for purposes that are contrary to U.S. national security and foreign policy interests. The PRC government expends extensive resources to eliminate barriers between China’s civilian research and commercial sectors, and its military and defense industrial sectors. It also is developing and producing advanced integrated circuits (packaged or unpackaged) for use in weapons systems.
At the time of their imposition, it was believed that the sanctions would significantly cripple China's position in the semiconductor industry. In particular, it was hoped that the sanctions would weaken the country's ability to develop its own advanced semiconductors and to keep this technology out of the hands of the CCP.
But despite the Biden sanctions, China still looks capable of producing semiconductors that are not far behind the US. This was made evident in August 2023, with Huawei's launch of its new smartphone, the Mate 60 Pro, as Bloomberg reported at the time:
The reason the Chinese nationalists saw the phone as such a blow to...the US was its main processor, a component designed and manufactured in China that uses 7-nanometer chip technology...The Mate 60's Kirin chip isn't as advanced as the 3nm chips that power Apple Inc.'s most advanced new iPhones. But the export controls were aimed at keeping China's tech capabilities 8 to 10 years behind the US, and the phone demonstrated that Huawei's chipmaking partner, Shanghai's Semiconductor Manufacturing International Corp (SMIC), may be only four years behind.
Accordingly, the US is still trying to close the loopholes that has enabled China to continue developing advanced semiconductors. For example, the development of Kirin involved the use of manufacturing equipment that was supposed to be restricted from Chinese use.
Nvidia and US sanctions on chips
Nvidia is one company that has been particularly impacted by this chip war between the US and China.
With the sanctions, Nvidia is prevented from selling its most advanced chips to Chinese companies. However, the company so far managed to take advantage of loopholes to continue sales to China, which remains an important market for the company:
[Despite the US sanctions]...Nvidia still found a way to ship high performance GPUs into China with their upcoming H20, L20, and L2 GPUs. Nvidia already has product samples for these GPUs and they will go into mass production within the next month, yet again showing their supply chain mastery.
In July 2024, Nvidia still managed to make tens of billions of dollars worth of chip sales to China, although the equipment sold was less advanced than Nvidia's flagship products. In fact, the H20 GPUs are "proving popular with Chinese customers, despite its downgraded performance compared with the chips Nvidia can sell in the US."
But Huang, Nvidia's CEO, has consistency warned that cutting China out would be to the detriment of the US tech sector:
"If we are deprived of the Chinese market, we don't have a contingency for that. There is no other China, there is only one China," Huang said, adding that there would be "enormous damage to American companies" if they were unable to trade with Beijing.
Huang added that blocking the US tech industry's access to China would "cut the Chips Act off at the knee", referring to the Biden administration's $52bn funding package to encourage construction of more semiconductor manufacturing facilities...in the US.
"If the American tech industry requires one-third less capacity [due to the loss of the Chinese market], no one is going to need American fabs, we will be swimming in fabs," he said. "If they're not thoughtful on regulations, they will hurt the tech industry."
Furthermore, the sanctions may encourage companies to start hoarding chips in anticipation of a severe slowdown. For example, ByteDance, the company behind TikTok, ordered "around $1 billion worth of Nvidia GPUs in 2023...which amounts to around 100,000 units split between Nvidia's A100 (ordered before the US government told Nvidia to stop selling its top-performing HPC cards to China, back in August 2022) and H800 cards".
Ultimately however, at least in the short-term, it is expected that the US sanctions will "hit the ability of Chinese tech groups such as ByteDance, Tencent and Alibaba to compete with US-based OpenAI, Microsoft, Meta and Google in a technology that is reshaping the industry."
Chris Miller, Chip War: The Fight for the World’s Most Critical Technology (Simon & Schuster 2022), 295.
Chris Miller, Chip War: The Fight for the World’s Most Critical Technology (Simon & Schuster 2022), 298.
Chris Miller, Chip War: The Fight for the World’s Most Critical Technology (Simon & Schuster 2022), 296.
Chris Miller, Chip War: The Fight for the World’s Most Critical Technology (Simon & Schuster 2022), 296.
Chris Miller, Chip War: The Fight for the World’s Most Critical Technology (Simon & Schuster 2022), 301-302.