Monthly Note - February 2024

Written By Nathan Picarsic

A public service announcement up front: 

This is the Chip Risk Monitor’s latest monthly installment, brought to you by Horizon Advisory’s team of supply chain and geopolitical intelligence analysts. The goal with the Chip Risk Monitor is to highlight the hidden risks buried in semiconductor dependencies on China and to move from awareness of those risks to solutions – ranging from updated US government and allied regulations that accurately target core risks to proactive supply chain vendor vetting, like that provided by the Horizon Advisory team, across critical value chains relevant to emerging value chains impacted by geopolitical competition.

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Back in December 2023, for those keeping score at home, the US Commerce Department published its Assessment of the Status of the Microelectronics Industrial Base in the United States report. The report covers a lot of ground and lays out key pillars of work to be done to restore balance against China’s dominance of global chip supply chains. 

The report highlights at various points the need to protect US intellectual property as a part of building a diverse semiconductor industrial base and advancing America’s technological superiority. That is an important consideration. But, on balance, the report reflects faulty assumptions that imperil US strategy in competition with China across technology areas. Namely, the assumption that this geopolitical tussle will play out as a series of innovation races across a litany of fronts. The Commerce report reflects that faulty assumption, among other ways, via an over emphasis on promote lines of effort and an under emphasis on protect lines of effort; also via a general focus on cutting-edge advance rather upstream dependencies and foundational industrial and technological capacity. This imbalance is all the more striking given the fact that Commerce BIS issued the report. BIS is the US government’s lead authority on protecting through export controls on critical and emerging tech. 

This bias toward promote – and the faulty assumption that it reflects – are risky for government in general, and especially dangerous in the US-China semiconductor competition. 

The sad reality is that dynamism and innovative capacity alone will not win today’s tech battle or the long-term peacetime competition of which it is a part. This battle is as much about supply chains, relative upstream dependencies, and the revenue and security returns offered by market share metrics in legacy fields as it is about the cutting-edge and winning in patents and performance stats. 

Regardless, the US government is a much more reliable steward of protect rather than promote lines of effort (see: Solyndra). The US federal government needs to ratchet up its regulatory reach to combat China’s non-market tack – even if that runs afoul of short-term corporate interests.  

That reality matters for how semiconductor companies engage with the US government – and with the Chinese market – for a couple reasons over the long-run: 

  • First, the usual US corporate tack of touting a cutting-edge protect line while shipping legacy materials to Beijing will eventually no longer work with regulators. The latest from BIS suggests it may still work for a bit longer but eventually, the underlying logic of China’s approach will erode that playbook. 

  • Secondly, as broader geopolitical competition rages on and bleeds beyond the contours of limited, economic warfare tools (e.g., whack-a-mole sanctions and export restrictions) the metrics that will matter in managing the US-China competition – and keeping that competition below the threshold of outright, direct kinetic conflict – will increasingly map onto generating an actual, credible military deterrent vis-à-vis China’s political leadership.  

A credible military deterrent demands relatively independent supply lines that China cannot disrupt. Beijing has learned from its leverage over rare earths and semiconductor materials that it may have “assassin’s maces” to balance against US export restrictions. Chinese strategists also see those tools as relevant for undermining America’s military deterrent. 2022 brought a timely and sharp example with Lockheed Martin’s F-35 supply chain coming under scrutiny for the use of Chinese alloys, which caused a temporary delay in deliveries of the next-generation fighter that is core to the US force structure in the Indo-Pacific.

Enforcement by Report

Then there is an even bigger problem: Enforcement – and with it resolve. Curiously, the Commerce Department’s December 2023 magnum opus is light on specifics for how the Department’s role in defending through “targeted use of export controls” can be calibrated for China’s approach and keep up with new evasion tactic. The report weighs in at a healthy 107 pages and features 168 footnotes. The word “enforcement” appears in the report only twice. Surely, that owes in part to the nature of the report’s methodology, which is primarily an exercise in drawing on survey responses from US industry respondents. But one can’t help but read and wonder if there should be concern about foxes guarding the henhouse.  

The House Foreign Affairs Committee would likely agree. That Committee also just released a report of its own: The Bureau of Industry and Security: 90-Day Review Report under the leadership of Committee Chairman Representative Michael McCaul. By comparison with the Commerce report, in this tome, the word “enforcement” shows up 22 times. Harrowing examples from the report help to prove the point of today’s challenge:

BIS enforcement actions have at times been slow. Seagate Technology—a mass data storage company—provides an instructive example. In September 2020, Seagate said it continued to sell hard drives to Huawei and did not believe it needed a BIS license, despite its competitor, Western Digital, pausing all shipments to Huawei. In October 2021, the Senate Committee on Commerce, Science, & Transportation issued a report alleging that Seagate violated export controls prohibiting shipment to Huawei. Nearly a full year later, on August 29, 2022, Seagate disclosed in SEC filings that it received a proposed charging letter from BIS alleging violations of the Export Administration Regulations. 

(The Bureau of Industry and Security: 90-Day Review Report)

The punitive effect of BIS enforcement was certainly felt in that case with a $300 million administrative penalty against Seagate eventually levied last year. But in an era defined by emerging technology development, stockpiling, and productive capacity moving at a fast pace, a multi-year lag on enforcement actions is demoralizing – and potentially destructive to those commercial players who do play by the rules. And that’s against a relatively easy target in Huawei, which has been a focal point in US scrutiny of China’s tech ambitions for some time. As the Chinese government, its industrial policy program, and its panoply of semiconductor champions begins more deliberately to evade and circumvent US restriction

More Reporting by Report

The Commerce Department has announced an industry survey to follow on their broader December 2023 effort that will more specifically investigate “mature-node” or legacy chips. An update to that survey was posted by Commerce on January 18th to offer more detail on the scope and intent of the investigation:

This analysis will inform U.S. policy to bolster the semiconductor supply chain, promote a level playing field for legacy chip production, and reduce national security risks posed by the People’s Republic of China (PRC). The data will also support preparation for the implementation of Section 5949 of the James M. Inhofe National Defense Authorization Act for Fiscal Year 2023 

This development is a welcome one for the aforementioned relevance of semiconductors to the defense industrial base. And, in theory, should go a long way toward better clarifying risks associated with the reach into critical US supply chains of players like SMIC, which has reportedly continued its growth in the US market over the past few years despite scoring the full gamut of US government designations as a risk factor.

Spotlight

Last month, the Chip Risk Monitor published an essay covering Tencent’s cloud business and its ties to the international RISC-V consortium. 

Apart from the open-source chip tech bet covered in that update, it’s worth flagging how exemplary Tencent is among China’s tech champions in its plans to evade and overcome export restrictions from the United States. For instance, Tencent leadership in a November 2023 analyst call declared that their stockpiling of Nvidia chips now restricted for export to China would be sufficient to support multiple generations of tech development. Tencent President Martin Lau was direct:

Right now, we actually have one of the largest inventories of AI chips in China among all the players … We were the first to put in orders for H800 and that allows us to have a pretty good inventory of H800 chips. So, we have enough chips to continue our development.  

Not great, Bob.

What’s Next

Over the next month, Chip Risk Monitor’s newest in-depth review will cover TSMC, the linchpin and largest semiconductor champion in the world. 

The weeks to follow will bring refreshed looks across the set of monitored Chinese semiconductor champions and deep dives into their global business footprints, their ties to overseas markets, and trends in supply chains exposed to the risks these players carry. Follow along and subscribe to our newsletter at: www.chipriskmonitor.com/subscribe.

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Nathan Picarsic
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Monthly Note - January 2024