A man examines a semiconductor wafer at the 2020 World Semiconductor Conference in Nanjing city. Photo: AFP

Wars happen because the opposing sides have different views of the likely outcome. In the Sino-American tech war, though, both Chinese and American tech company executives argued that America’s semiconductor giants would be the losers. The outlier is the Trump Administration, which appears to believe that it can beat China in a tech war.

Commenting on reports that the Trump Administration is weighing sanctions against Semiconductor Manufacturing International Corp (SMIC), China’s largest chip fabricator, an official at a big Chinese tech company said, “The scenario at the moment is that it’s just a matter of time before [the American chipmakers] don’t survive.” China will retaliate by putting massive resources behind a campaign to displace American chip designers, chip software developers, and chip equipment manufacturers, and drive them out of the market, the Chinese executive said.

Companies at risk include designers like Qualcomm and Nvidia, chip software developers like Cadence and Synopsis, and equipment makers like Applied Materials, Lam Research and KLA-Tencor. The Philadelphia Semiconductor Index lost 5.7%, or $100 billion of market capitalization, on Sept. 4 following news reports that China was about to launch a massive program to develop so-called third-generation semiconductors as part of a $1.4 trillion, five-year subsidy plan for tech industries.

An American bill to provide $25 billion in support for the semiconductor industry during the next five years circulated last June but appears lost in the shuffle of negotiations over economic stimulus.

The leak of a Trump Administration plan to deny US technology to SMIC may have been a response to reports of the Chinese semiconductor development plan. SMIC H-shares lost 23% in Hong Kong on Monday, and the company’s Shanghai-traded A-shares lost 13%.

Some American experts fear that the proposed sanctions against SMIC may push China into an all-out trade war against the United States. Measures that China might impose could include a ban on the Chinese activities of Apple and other big US companies, restrictions of exports of smartphones and computers, as well as a ban on shipments of rare earths.

Industry experts, though, believe that China will keep its powder dry until the shape of future US policy becomes clear following the November presidential elections.

SMIC is a badly chosen target, US industry sources argue. A report from the consulting firm SOS International first cited by the Wall Street Journal claims that “A series of PLA university and defense industrial complex researchers use SMIC processes and chips to conduct their research, indicating that this research is tailored to SMIC production specifications, making it impossible for them to manufacture their chips at another foundry.”

But a prominent semiconductor industry consultant argues, “The Chinese military doesn’t buy custom chips from SMIC. They get them from third parties on order from TSMC,” the world’s top chip foundry based in Taiwan. “Most of what the Chinese military uses is off the shelf generic chips, just like the Pentagon. It costs $500 million to design a custom chip. The Pentagon doesn’t have the budget for it. Neither does the PLA. So SMIC is not mainly for military applications. The WSJ and its sources have bad information.” The White House “isn’t looking at the facts,” the consultant added.

An expert at a Chinese semiconductor company says that the sourcing of chips to Chinese companies runs through an impenetrable maze of second- and third-party distributors, such that neither the PLA nor Chinese companies on the US Commerce Department’s “entity list” depend on SMIC. SMIC has just 3% of the world foundry market, and sells to Qualcomm and other American companies just as it does to Chinese customers.

Even if China can produce chips without US equipment, some industry experts argue, the Trump Administration’s boycott of software sales to Huawei and ZTE will prevent them from designing and testing the custom chips they need for smartphones as well as 5G base stations. This could effectively shut Huawei down and derail China’s planned rollout of 6 million 5G base stations by 2024, according to one evaluation. “It would take China ten years to reproduce what the top American companies are doing now,” an industry expert said.

But Chinese industry sources say that Washington’s sanctions against Huawei’s acquisition of design tools won’t work. Chinese local governments have become top customers of US makers of Electronic Design Automation (EDA) software, required for design and testing of high-end programmable chips. On June 10, Nikkei reported, “Cadence reported $83.8 million in sales to China during the January-March quarter, accounting for 13% of overall sales. That marks an 80% jump from the same quarter in 2018, the first year Cadence disclosed those figures, although the company has ceased trading with Huawei.”

The local governments provide the chip design software to a host of startups. “This is a form of parallel processing,” one Chinese executive explained. “Instead of doing chip design centrally at (Huawei’s design subsidiary HiSilicon), the same engineers take jobs at startups and distribute the same task across a group of hundreds of small companies.”

An executive at a Chinese design company said, “Design tools make it really easy to design chips and test them. That makes them efficient. Is there anything efficient in China? Is the Chinese government worried about efficiencies? They can send 10,000 engineers to design one component.”

China probably can’t manufacture the top-of-the-line smartphone chips with extremely small (7 nanometers or less) transistor gate widths that power high-end smartphones, but it doesn’t require those for 5G base stations. The most efficient chip foundries in the world – owned by the duopoly of Taiwan Semiconductor Manufacturing Corporation (TSMC) and Samsung – need the Extreme Ultra-Violet lithography machines made exclusively by Holland’s ASML and US equipment for several other applications to achieve commercial efficiency. But China makes enough of its own semiconductor equipment and can buy enough machines from South Korea and Japan, to produce rough-and-ready substitutes.

China’s access to Japanese equipment is a matter of industry speculation. The largest Japanese provider, Tokyo Electron, “has toed the American line in the past,” said one industry source. China made up 22% of Tokyo Electron’s revenues last year, compared to 23% for Taiwan and 14% for Japan. China was also the largest market in 2019 for Hynix, South Korea’s leading producer of semiconductor manufacturing equipment, comprising 46% of the company’s total sales.

During 2019 China reportedly hired 3,000 Taiwanese chip fabrication engineers to build out its domestic production. And Chinese industry sources say that the actual count of Taiwanese working in the mainland’s chip fabrication industry is several times larger than the reported number.

China is the world’s largest market for semiconductors and semiconductor equipment. 56% of Synopsis’ sales and 55% of Cadence’s sales were to foreign purchasers as of the second quarter of 2020. In the case of chip designers, 92% of Nvidia’s sales and 89% of Qualcomm’s sales were overseas. China imports $200 billion of semiconductors a year, most of which directly or indirectly contribute to revenues of US designers, software developers and equipment makers.

The American semiconductor industry can’t earn enough without Chinese revenues to maintain the level of R&D required for market leadership. At the beginning of 2020, the US Department of Defense vetoed an early proposal to slap export controls on US semiconductor technology, arguing that it would deplete the revenue of American market leaders and force cuts in R&D. The White House originally followed the Defense Department’s reasoning, but reversed course in May.

Now the US companies face the scenario that the Defense Department warned about. A Chinese executive comments, “The best case scenario for the Americans is an agreement on market share [in China], in which case the US companies survive. “The scenario at the moment is that it’s just a matter of time before they don’t. China doesn’t have to export – they just have to produce for their own consumption and that wipes out the US companies.”

Writing in the Chinese news website guancha.cn, Chinese economist Chen Jing wrote, “In the long run, China’s independent chip production plan may indeed affect the income of the relevant US companies… Take the lithography machine as an example. The semi-automatic lithography machine with a 5-micron process was first developed by China in 1978, and is only 5 to 7 years behind the United States and Japan.”

Chen concluded, “Advanced chip manufacturing is extremely difficult and combines the most advanced technologies in many fields. The lithography machine is the jewel in the crown of the industry. It should not be expected that China’s independent technology can break through to the most advanced manufacturing process in a short period of time. It may take as long as 10 years. But more significant is independent chip design and manufacturing technology that is applied in the market on a large scale. If many companies participate in the formation of a closed loop of fully independent design, manufacturing, application, and capital recovery, even if it is not the most advanced, it is of great significance, and it can bring about the failure of the US chip offensive.”