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Influential Washington policymakers have concluded, slowly and reluctantly, that the United States cannot win a tech war against China by merely blocking Chinese companies’ access to technology on national security grounds.

Instead, they believe, the US must shift towards restoring America’s fading edge in key technologies.

The shift in sentiment can be discerned in small but symbolic regulatory changes—including this week’s Commerce Department decision to allow US firms to work with China’s Huawei to set certain 5G standards—as well as a series of Congressional initiatives to fund high-tech industries and new influential think tank policy proposals.

A sign of the changing times is former National Security Adviser John Bolton’s tantrum against President Donald Trump in The Wall Street Journal, adopted from his forthcoming poison-pen memoir.

Bolton, the most ideological of the China Hawks to have served in the present administration, denounces his former boss for putting American economic interests, namely the export of US farm products to China, ahead of diplomatic retaliation for China’s long list of human rights violations.

The former official excoriates “panda-huggers like Treasury Secretary Steven Mnuchin” and “confirmed free-traders like National Economic Council Director Larry Kudlow,” complaining that Trump’s advisers are “fractured intellectually.”

Trump fired Bolton, as I reported in September 2019, to open the way to the “Phase One” trade agreement with China and de-escalate a tariff war that put US manufacturing into recession last year.

Among the many sources of Bolton’s rancor was Trump’s May 2018 decision to lift a ban on US exports of Qualcomm chips to China’s number two telecommunication equipment manufacturer ZTE, in exchange for a US$1.4 billion fine for violations of US sanctions on Iran.

ZTE virtually shut down for several weeks; the company’s stock was suspended and its survival in doubt. But Bolton didn’t mention that six months after the ZTE chip ban, Huawei rolled out its own top-of-the-line smartphone chipset, to the surprise of the semiconductor industry and the chagrin of the US government.

A ZTE promotional stand at the Mobile World Congress in Barcelona in February, 2020. Photo: Luis Gene/AFP

The definition of insanity, Albert Einstein is supposed to have said, is doing the same thing over and over and expecting different results. Huawei has been playing Road Runner and Coyote with the US Department of Commerce for the past two years, surprising the US side with its ability to work around obstacles.

Unable to stop China from designing its own silicon, and unable to dissuade most of its allies from buying Huawei gear, the US went all in: a May 15 pronouncement banning semiconductor sales to Huawei and ZTE from foreign chip foundries that use American equipment.

That, the US Commerce Department declared, was supposed to prevent Huawei from exploiting a “loophole” in American regulation—that is, designing its own chips rather than buying them from American firms.

Now, the US proposes to forbid companies from fabricating Huawei-designed chips, under pain of imprisonment for up to 20 years and fines of $1 million per violation. The US fabricates just 12% of the world’s semiconductors and none of the top-of-the-line products, which are made only in Taiwan and South Korea.

As I wrote on May 30, the US may not be able to count on South Korea to join the blockade against Huawei

The Commerce Department’s announcement was “not intended to benefit Huawei,” Secretary Wilbur Ross explained June 17. On the face of it, this exception to the Huawei boycott is a technical matter, permitting US companies to share technology with Huawei only for the purpose of specifying standards for 5G equipment.

Standard-setters in the International Telecommunications Union over 5G protocols gain commercial advantages, and the Commerce Department’s decision makes it easier for US companies to assert their position. But the action signaled that the US expects to face off against Huawei in the global rollout of 5G for the indefinite future.

That’s a significant reversal from predictions a month earlier that American regulation of chip sales “spells a death knell for Huawei’s global ambitions by freezing out the Chinese company from fundamental semiconductor technology,” as a giddy report at National Public Radio put it. Bloomberg News promptly dubbed this the “nuclear option to stop China’s rise,” citing industry analysts who predicted that Huawei no longer would be able to build and service 5G networks.

Media reports of Huawei’s death, as Mark Twain might have said, are premature. In anticipation of the US action, mooted in the press since December 2019, the world’s number two chip fabricator, Samsung, had built a prototype production line that could manufacture top-of-the-line 7-nanometer chips without any US equipment,  according to specialist media reports.

Taiwan Semiconductor Manufacturing 7-nanometer chips. Photo: Twitter

While not independently confirmed, it certainly is possible. European, Japanese, South Korean and Chinese equipment makers cover each of the dozen stages of semiconductor fabrication, although in many cases American equipment is superior.

On May 30, I cited industry sources in Asia Times who believed that Samsung might replace Taiwan Semiconductor Manufacturing Corp as Huawei’s lead chip fabricator. The story made the rounds of the South Korean and Taiwanese press, and on June 14 was picked up by the Chinese official English-language daily Global Times.

“As to media reports that Samsung and Huawei are considering a deal in which Samsung will help make 5G equipment semiconductor chips for Huawei, Chinese analysts said there is a 50-50 chance a deal could be reached,” the newspaper wrote.

“Huawei and Samsung were considering a deal in which the latter would make advanced chips for Huawei’s top 5G gear, while Huawei would cede a significant share of its smartphone market share to Samsung, the Asia Times reported,” the reports said.

The report went on to quote Ma Jihua, a veteran industry analyst and a close Huawei follower, saying that Samsung could “help” Huawei manufacture 5G-related chips, as Samsung may take the chance to grow rapidly amid the US government’s crackdown on Huawei, and there is a real possibility that Samsung could do Huawei a “favor.”

According to a semiconductor industry executive, the Global Times report was a Chinese government “trial balloon” to test the waters for such a deal. The unsubtle message of the article came in a quote from the same industry analyst Ma.

“Killing Huawei is probably not the real purpose of the US government, but it wants to contain China’s semiconductor industry growth by preventing Huawei from developing semiconductors,” Ma said, adding that the US will be happy to see that China will rely on Samsung semiconductors, which means that China’s semiconductors will keep lagging.

If China puts its vast resources behind its home semiconductor industry, the Chinese newspaper implied, the US eventually will face a Chinese competitor that can push American equipment makers out of the market.

The Dutch firm ASML is the only provider of ultra-sensitive lithography equipment that can etch microscopic lines on silicon to make the most powerful chips, and it is not likely that China will reproduce this technology any time soon. But there are 3,000 Taiwanese chip fabrication engineers now working on the Chinese mainland, and China has several options to work around the American ban.

Samsung and Huawei logos in a combination image. The two tech giants could make a pact to the chagrin of the US. Photo: Twitter

The prospect of a Huawei-Samsung accord occasioned an “Uh-oh” moment in Washington. South Korea’s exports to China are nearly double its exports to the US, and good relations with Beijing are critical to Seoul’s security. Samsung last year announced a $100 billion semiconductor investment program, an action that makes no business sense unless it was directed towards the Chinese market.

LAM Research, America’s top manufacturer of semiconductor fabrication gear, was among the Nasdaq 100’s top two performers on June 16 with a 6% gain, after the Commerce Department said it would allow US firms to work with Huawei on 5G standards development.

Investors read the decision as a harbinger of a more relaxed technology controls policy from Washington. LAM, Applied Materials and other US equipment makers are the biggest potential losers from the May 15 ruling, which encourages foreign chip fabricators to avoid American equipment.

South Korea had earlier remonstrated with Washington over what it called “unacceptable” assertion of extraterritorial controls over products made with American equipment. The Koreans are not the only American ally that resents being dragged into a tech war with China.

Australia, America’s partner in the Anglophone “Five Eyes” intelligence consortium and a close strategic ally, faces catastrophic damage to its R&D and future productivity, according to a new report by the University of Sydney’s US Studies Center.

Australia, the report says, excluded Huawei from its national broadband network and has worked loyally with the Five Eyes group. But America’s new assertion of extraterritorial controls over the use of American technology goes too far, according to the report.

“The regulatory divergence between the United States and China in terms of technology, scientific funding and supply chain security will go beyond actions Australia has taken so far to protect its own scientific and innovation base,” the report says.

“For Australia,” the University of Sydney wrote, “the expanded export control reform now being implemented by the US Commerce Department could have serious impact on universities, defense industry, business and government.”

It calls for a defense free-trade with the US and UK that will give Australia bargaining power to obtain exemptions from US controls. China, the report observes, recently overtook the US as Australia’s “leading international collaborator” in scientific papers published in peer-reviewed journals.

“Large parts of Australia’s R&D base, a source of strategic and economic strength, may not endure the fragmentation of the world’s innovation ecosystem, it warns. In effect, the University of Sydney concludes, Australia needs to find a way to persuade Washington to back down.

Washington isn’t getting much traction with its European allies, either. Although the German government hasn’t said the final word on Huawei’s involvement in its own 5G buildout, the country’s telecommunications industry is warning of dire consequences if the Chinese company is excluded.

US President Donald Trump continues to target Chinese telecom giant Huawei in a spiraling superpower tech war. Image: Facebook

The German daily Handelsblatt reported on June 16 that Deutsche Telekom, the country’s largest service provider, warned the government that replacing Huawei could cost 3 billion euros (US$3.4 billion) and take five years.

In February, the UK government spurned high-profile American remonstrations and agreed to allow Huawei a market share of 35% in its 5G buildout, approximately the same share that the Chinese company has now. The Boris Johnson government agreed to yet another review of Huawei’s participation and floated a possible compromise under which Huawei would be excluded after 2023.

“A cut-off date for installing new Huawei kit into the UK’s 5G networks is impractical and will force telecoms companies to spend nearly £1.5 billion (US$1.9 billion) on removing existing technology, experts have warned,” the Daily Telegraph reported on June 12.

The Trump Administration arguably has no more cards to play against China. The assertion of extraterritorial control over products made with American equipment after foreign manufacturers purchased it has no precedent in international law.

Whether the US has the right to impose such controls, though, probably is a moot issue, because foreign semiconductor equipment makers can provide substitutes across the entire complex process of chip manufacturing.

The alternative is to enhance America’s technological edge. The White House has offered no plan, apart from a vague commitment to include 5G wireless in a $2 trillion infrastructure spending program that the administration reportedly is preparing.

Some tentative initiatives are coming from Congress, of which the most ambitious is the Endless Frontiers Act co-sponsored by Senate Minority Leader Charles Schumer (D-NY) and Senator Todd Young (R-IN). Congressman Mike Gallagher (R-MI), a member of the Congressional China Task Force and an influential voice among young Republican leaders, joined Schumer, Young and California Democrat R. O. Khanna to announce the new bill on May 27.

The alliance of liberal East and West Coast Democrats and Republican conservatives illustrates the evolution of a new national consensus.

“The bill’s name, The Endless Frontiers Act, invokes the title of the seminal 1945 report by presidential science adviser Vannevar Bush that made the case for federal support of academic research and led to NSF’s creation in 1950. But the “Stay Ahead of China Act” might be a more accurate moniker,” Jeffrey Mervis wrote in Science Magazine May 26.

“The legislation would provide the visible, focused, and sustained funding and approach that the US urgently needs to meet the challenge posed by China’s increasing capabilities,” says [MIT President Rafael] Reif, one of several academic leaders whom Schumer has consulted over the past year in drafting the legislation, according to the same report.

US Congressman Mike Gallagher, a member of the Congressional China Task Force, is a co-sponsor of the Endless Frontier bill. Photo: US Congress

On June 10, Republicans and Democrats in the House and Senate proposed $25 billion of funding and tax credits to support the domestic production of computer chips and counter Chinese competition.

The Semiconductor Industry Association is an avid supporter of the legislation. Its chairman, Keith Jackson, said in a statement endorsing the bill, “Semiconductors were invented in America and US companies still lead the world in chip technology today, but as a result of substantial government investments from global competitors, the US today accounts for only 12% of global semiconductor manufacturing capacity.”

To put these numbers in context, the US at the peak of the Cold War spent 1.4% of gross domestic product (GDP) on federal R&D, channeled mostly through the Defense Advanced Projects Research Agency and the National Aeronautics and Space Administration.

That’s the equivalent of about $300 billion a year in today’s dollars. The Schumer-Young bill, in contrast, would add just $20 billion a year to National Science Foundation funding.

The Endless Frontiers bill, moreover, would channel money into university research departments. During the 1970s and 1980s, the Defense Department worked mainly with corporate laboratories at the Bell System, IBM, General Electric and RCA, which integrated the efforts of top scientists with engineers and line production managers. This allowed for rapid testing and commercialization of discoveries.

The Establishment consensus, reflected in a December 2019 report on US competitiveness from the Council on Foreign Relations, favors more funding for R&D.

“By combining strategic planning, government-led investment, large pools of data, and a growing number of STEM talents, China aims to surpass the United States to become the world’s leading technological superpower,” the Council on Foreign Relations wrote. “Given these challenges to the United States’ technological leadership, the US government and the private sector must undertake a comprehensive and urgent response.”  

America’s big tech companies, however, show little interest in competing with Asia. On the contrary, the explosion of equity valuations in the US stock market came largely from software companies with low capital investment requirements.

America doesn’t invest in hardware; Asia does its investing for it. As a result, the capital intensity of the US stock market (the ratio of assets to pre-tax income) is half that of the Shanghai Composite Index or Korea’s KOSPI Index. In 2005, the three markets were roughly on par.

Persuading American companies to return to high-tech manufacturing is the subject of a new report by the American Compass foundation, for which I wrote the introduction. “America’s effort to suppress Chinese dominance in the next generation of mobile broadband revealed the lack of American hardware manufacturing—or even design—as a strategic weakness,” I argued.

US tech companies’ answer to Huawei’s leadership in 5G broadband is to ask for government subsidies for software. In theory, the dedicated hardware produced by Huawei as well as Sweden’s Ericsson can be replaced by cheap generic hardware programmed to route calls and distribute broadband.

Researchers from University of Science and Technology of China check on the operation of a quantum computer at a lab in Shanghai. Photo: Xinhua

That hasn’t worked well in the past; the custom-built, special-purpose chips that Huawei installs in its 5G base stations are more reliable than general-purpose logic chips programmed for 5G functions. Finland’s Nokia got into trouble using programmable chips from Intel, which proved to be unstable.

Software companies, to be sure, prefer subsidies for software. The US tech industry’s vehicle for soliciting software subsidies is the Open Radio Access Network Alliance (O-Ran), lavishly praised in an industry-subsidized report published last week by the Center for Strategic and International Studies.

If it works, the attempt to combine sophisticated programming with off-the-shelf hardware will take years, by which time China will have installed a national 5G network and made important strides towards realizing its productivity potential in manufacturing, transportation, medicine and other fields, making China the leader in the Fourth Industrial Revolution.