Xi’s strategy in the US-China chip war

By Chris Miller, Associate Professor of International History at The Fletcher School

In January 2017, Chinese leader Xi Jinping promised “win-win outcomes” via a “dynamic, innovation-driven growth model.” Yet only several months prior, Xi had struck a different tone in a speech to an audience that included Huawei founder Ren Zhengfei, Alibaba CEO Jack Ma, high-profile People’s Liberation Army researchers, and most of China’s political elite. China must focus on “gaining breakthroughs in core technology as quickly as possible,” Xi declared, referring above all to semiconductors, the tiny chips that provide the computing power in everything from smartphones to dishwashers to autonomous drones.

How did Xi envision China advancing its semiconductor capabilities?

“We must promote strong alliances and attack strategic passes in a coordinated manner. We must assault the fortifications of core technology research and development,” he declared. “We must not only call forth the assault — we must also sound the call for assembly, which means that we must concentrate the most powerful forces to act together, compose shock brigades and special forces to storm the passes.” Former President Donald Trump was known for his “trade war” with China. But the mixing of martial metaphors with economic policy started in Beijing. Today, amid an escalating chip war, America’s semiconductor industry faces an organized assault by the world’s second-largest economy and the one-party state that rules it.

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China’s leaders are counting on a mix of market and military methods to develop advanced chips at home. Today, China is hugely reliant on foreign technology to build semiconductors. It spends more money importing chips each year than it spends buying oil. As China’s tech firms push further into spheres such as cloud computing, autonomous vehicles, and artificial intelligence, their demand for semiconductors will only grow. Xi’s call to “compose shock brigades and special forces to storm the passes” seemed urgent. China’s government has set out a plan called “Made in China 2025,” which envisions reducing China’s imported share of its chip production from 85% in 2015 to 30% by 2025.

Since 2014, Beijing has emphasized semiconductor subsidies, launching what became known as the “Big Fund” to back a new leap forward in chips. Key “investors” in the fund include China’s Ministry of Finance, the state-owned China Development Bank, and a variety of other government-owned firms, including China Tobacco and investment vehicles of the Beijing, Shanghai, and Wuhan municipal governments. Some analysts hailed this as a new “venture capital” model of state support, but the decision to force China’s state-owned cigarette company to fund integrated circuits is about as far from the operating model of Silicon Valley venture capital as could be.

If China only wanted a bigger part in the world’s chipmaking ecosystem, its ambitions could’ve been accommodated. However, Beijing isn’t looking for a better position in a system dominated by America and its friends. Xi’s call to “assault the fortifications” wasn’t a request for a slightly higher market share. It was about remaking the world’s semiconductor industry, not integrating with it. Some economic policymakers and semiconductor industry executives in China might have preferred a strategy of deeper integration, yet leaders in Beijing, who thought more about security than efficiency, saw interdependence as a threat. The Made in China 2025 plan doesn’t advocate economic integration but the opposite. It calls for slashing China’s dependence on imported chips. The primary target of the Made in China 2025 plan is to reduce the share of foreign chips used in China.

This revolutionary economic vision threatens to transform trade flows and the global economy. Trade in chips helped build the globalized economy. The dollar values at stake in China’s vision of reworking semiconductor supply chains are staggering. China’s import of chips, $260 billion in 2017, was far larger than Saudi Arabia’s export of oil or Germany’s export of cars. China spends more money buying chips each year than the global trade in aircraft. No product is more central to international trade than semiconductors.

It isn’t only Silicon Valley’s profits that are at risk. If China’s drive for self-sufficiency in semiconductors succeeds, its neighbors, most of whom have export-dependent economies, would suffer even more. Integrated circuits make up 15% of South Korea’s exports, 13% of Singapore’s, 27% of Malaysia’s, 23% of the Philippines’s, and 43% of Taiwan’s. Made in China 2025 calls all this into question. At stake is the world’s most dense network of supply chains and trade flows, the electronics supply chains that have undergirded Asia’s economic growth and political stability over the past half-century.

Made in China 2025 is just a plan, of course. Governments often have plans that fail abjectly. Yet the tools China has brought to bear, including vast government subsidies, state-backed theft of trade secrets, and the ability to use access to the world’s second-largest consumer market to force foreign firms to follow its writ, give Beijing unparalleled power to shape the future of the chip industry. If any country can pull off such an ambitious transformation of trade flows, it is China. Unless the United States continues to take steps to support the chip industry in the face of Chinese subsidies, it is easy to imagine semiconductors could be the next victim of China’s tactics in the “chip war.”

This piece is republished from the Washington Examiner.