Name: Eastworld Spotlight: China’s ‘uphill battle’ to reach semiconductor self-sufficiency
Uploaded: 2020-09-10
Duration: 15 min 56 s
Description: Eurasia Group’s Paul Triolo on Huawei’s survivability and China’s challenges in the semiconductor industry

 CLAY CHANDLER: The measures against Huawei in particular are interesting because they seem to have really found a way to kind of tighten the noose around Huawei that perhaps earlier measures were not able to do. PAUL TRIOLO: The recent restrictions against Huawei, the so-called changes to the foreign direct product rule, basically have expanded US export controls overseas to affect virtually every semiconductor company. So the first action against Huawei in May of 2019 was using US export control laws in ways that they really hadn't been intended to be used, to go after supply chains of large, complex companies like Huawei. And so pretty quickly, though, the US companies figured out that there were loopholes or the limitations to those-- to that-- those export administrative regulations. So the China hawks have worked hard over the last year to plug those. And so that's what's really happened in May with an issuance of a very vague language around this foreign direct product rule. And then in August, we had a real tightening and expansion and clarification of the rules, which basically make any company using US technology to produce semiconductors on behalf of Huawei have to get a license with the presumption of denial. So whereas previously, it had just impacted US-based suppliers, for example, Intel, Microsoft, Broadcom, Qualcomm, now this new rule basically affects any company in the world that is producing semiconductors that may end up in the hands of Huawei or one of its affiliates, which are now, I think 158 of Huawei affiliates now are on this entity list. And so this really has sort of taken Huawei's supply chain from being restricted to be almost totally shut off in the area of particularly advanced semiconductors of the type that were being manufactured, for example, in Taiwan by TSMC and are now being manufactured in other places. Even in China, SMIC is now subject to this new limitation. So whereas Huawei, as you noted, Huawei was able to get around the May restrictions from 2019 by redesigning its base stations to basically design up US technology. Here, this action is hitting much more broadly in their supply chain, and then particularly hitting those advanced semiconductors that it had decided to design on its own. That was already happening with TSMC because in May, after the May rule, TSMC announced they would stop producing key semiconductors for Huawei. So that was already a pretty big hit. So you note that up until May, I think Ren Zhengfei and others at Huawei thought they could sort of weather the US restrictions. But after May, first TSMC announced that they would stop cooperating with Huawei. And then this August restriction is much broader and now hits really any company that's providing any kind of semiconductor assembly or product to Huawei. So I think it's a tough-- it's very tough now for them to work around us. CLAY CHANDLER: These high-speed chips that you mentioned are vital to both the telecom towers and smartphones that together account for about 80% of Huawei's revenue. And without these chips, Huawei can't really produce these products at all. We know that they have stockpiled quite a few chips, especially as the tensions heat up. But how long how can Huawei last before this really starts to bite and exhaust their supply? PAUL TRIOLO: On September 15th, which is next week, that's the deadline for basically the stopping of all shipment of semiconductors to Huawei under this May order. And so TSMC, for example, which was producing key advanced semiconductors, for all of Huawei's product lines-- so, as you mentioned, smartphones, the Kiran series, the series for their 5G base stations, for their cloud and AI side and for their enterprise, all those chip supplies coming from Taiwan will cease. And so their ability of Huawei to last with those stockpiles depends on the product line. So when you're talking about smartphones, for example, they were-- they were-- Huawei, at one point-- I believe last year was producing over 250 million smartphones per year. So they were using a lot of semiconductors that are the key to those advanced features in their smartphones. And so I think one estimate has that they'll only be able to produce 50 million phones next year. There's a huge drop. So that they'll run out of those advanced semiconductors probably in sometime early next year, because the volume is so high. For 5G base stations, they might be able to last a little bit longer because the volume there isn't as high. CLAY CHANDLER: Is there a risk that this is so disruptive that it could actually threaten Huawei's existences as a company? PAUL TRIOLO: I mean, as you say, the company has been able to get around this initially by redesigning out-- redesigning their base stations and some of their other products to design at US technology. But here, there's no-- there's no real alternative to go to once the US has basically restricted their ability to produce these cutting-edge semiconductors. The leading Chinese domestic foundry, for example, SMIC, is just not at the same level. They're two or three generations behind leaders, like TSMC, Samsung, and Intel. And the US has also acted to cut off their ability to acquire advanced lithography equipment, for example, so they can move to those more advanced nodes in semiconductor manufacturing. So Huawei has nowhere to turn here, right? There's no domestic champion that's going to come to Huawei's rescue on the semiconductor side. So that's existential to them. I mean, their company-- my sense is they're going to have to reorganize, potentially spin off parts of the company. They're still competitive, of course, in things like software, cloud services. But all those things still require semiconductors at some level. So all parts of their business are eventually going to be affected. CLAY CHANDLER: Boy, the stakes here are enormous. It's almost like sort of the nuclear option for the US to exploit that technological monopoly that it has and threaten the existence of-- Huawei's a $100 billion company. It's enormous. It's the largest chip manufacturer. Again, this is a multibillion-dollar business that is not only important for the functioning of China's economy, but there are a lot of issues of national pride and face at stake here. For policymakers in Beijing, what are the-- what are the options? I mean, are there tools in-- weapons in their arsenal that they can deploy as well against American firms that would act as a deterrent? PAUL TRIOLO: Beijing's policy response, I think, has been evolving over the last year, as they have sort of come to grips with the fact that the US is really, and seems to be intent on eroding Huawei's ability to continue to function in the way it had been as a company. So I think on the one hand, Beijing wants to-- senior leaders in Beijing are sort of trying to run the clock out, you get the sense, on this administration, hoping that if they got a change of administration in November that some of these policies would be re-examined under a Biden administration. So they're being very careful and disciplined in responding to this, to sort of directly to the Huawei actions. On the other hand, of course, they're taking a lot of steps domestically to shore up the industry. Already, of course, there's a huge national [? ICU ?] development fund, investment fund, which has been providing a lot of subsidies to Chinese semiconductor companies. In May, there was a big announcement of the new infrastructure initiative, which is designed to focus on 5G and mobile edge computing and try to encourage, again, domestic companies to take part in that, and a lot of subsidies involved with that. And then, of course, they've been beefing up the stock market, the STAR Market in Shanghai, the high-tech market, encouraging semiconductor companies to list on the market, changing some of the IPO requirements, and trying to get companies in China to raise funding through both the STAR Market and the Hong Kong Stock Exchange, as you know. So there's sort of a two-fisted policy here. One is try to, as much as possible, channel capital to the domestic industry, hoping that their semiconductor industry will get better. The problem is these are tough technologies to master. And so in some sense, the semiconductor industry domestically has unlimited capital available to it. I mean, there's so much funding out there. But it's not really a function so much of funding as it is of talent and sort of technology know-how. And that's going to take time. Certainly, China has come a long way since-- for the last five years, even, in terms of design and manufacturing of semiconductors. But this is a global industry that's taken 20 or 30 years to develop some of the division of labour. And it's just really hard for China and Chinese companies to recreate these global value chains that took so long to develop and are really cutting-edge kinds of things in the software services side or in the semiconductor manufacturing side. And so it's a real-- China faces a real uphill battle. But, again, very capable companies and very capable industrial planners in Beijing. But if they're really going to-- if they're really going to try to recreate the whole semiconductor industry in China, that's going to take a decade or more. So there'll be places where they can make progress. But it's going to be a long struggle if they're going to really wean themselves off of US technology in that arena. It's going to take a long time. CLAY CHANDLER: You talk in your report about the emergence of a red chain and a blue chain in the global supply chain. Can you say a little bit more about that and what that means? PAUL TRIOLO: Yeah. I think what we're seeing as a result of particularly the recent series of US government policies here is an attempt to really-- to force countries and companies to try to choose sides in this conflict. So we've seen this very clearly, for example, with this new Clean Initiative that the Trump administration is pursuing. Secretary Pompeo has been [INAUDIBLE] us. And again, in August, he announced an expansion of this, the so-called clean network, which really includes things like 5G, includes cloud services now, it includes application-- mobile application stores. And clean means really free of Chinese technology. And so we saw this initially with Huawei, which was-- which was a path that the US followed over the last two years, which is to convince allies, particularly in Europe and in Asia, to exclude Huawei from their 5G network rollouts. And initially, that looked like it wasn't going to gain a lot of traction. But over the last two years-- over the last year in particular, it's really gotten traction, in part because the US has also implemented these other restrictions on Huawei, casting doubt over the ability of that company to go forward, to succeed in those markets going forward. And so the Clean Initiative has really now been expanded into just about every part of the technology stack. And so that really is an attempt to sort of force the world into either the blue supply chain, which is the US and other Western democracies, Europe and in Asia, and a red supply chain, which would be one that China would lead. And right now, countries, for example, in Africa, Latin America are still using Chinese equipment and would probably not sign up to any kind of effort to exclude Chinese companies from operating in their markets. So that sort of red chain-- red supply chain, blue supply chain paradigm, I think, is definitely operative, particularly with this-- in the latter days of this administration. CLAY CHANDLER: That's so interesting, because the way the US-China conflict is often positioned in these discussions is that it's a clash of rival superpowers. But in the technology sphere, it's not clear in every area that China really is a superpower, or even perhaps ever will be. PAUL TRIOLO: Well, yeah, again, I think you have to take each sector separately. I think, as you mentioned, there are really two main areas where China has historically been behind the US, and that's semiconductors and semiconductor manufacturing and in software, sort of operating systems, enterprise software. So if you look at the top 10 companies in the world in enterprise software, there aren't any Chinese companies there. So those two areas have been-- have been a known source of concern in Beijing for a long time. Right, they talk about as core technologies are in the hands of others. This is what you hear from Chinese officials all the time. And again, as I said, it's sort of this continuum. They've made tremendous progress in all of these areas in the last 10 years. If you go 20 years ago, there was no Chinese semiconductor industry imagined. There was no Chinese software industry. So now they're farther along. But in a sense, the US-China tech Cold War has come at a really bad time, where the dependence of key Chinese companies on US technology remains very high. And the US has been willing to use this, as you said, this sort of nuclear option to cut off Chinese companies selectively from having access to key parts of the US technology supply chain. So China is gonna-- is gonna have to really sort of alter course and try to reproduce those global value chains within China. Now, the advantage China has is it's a huge market, right? So China's 5G market is bigger than most of the rest of the world combined. So they have the advantage of a really big captive domestic market. But those areas that I mentioned, like technology and sort of trained personnel who know how to run an advanced fabrication facility, like TSMC, those are things you can't change overnight. But based on the progress that they've made so far, I think that given a five-year timeframe, it's possible that China and Chinese companies could still make major, major gains, even if they're focused domestically. But again, it's an uneven-- it's also an uneven-- a little bit of an uneven field. ZTE, for example, is not subject to any of these export control regulations. So they're still able to acquire US technology. Now in AI, I think, China has a big advantage, because there, it's not so-- if you get access to the hardware, which China has been able to do [INAUDIBLE] Chinese companies-- it hasn't been as restricted as in some other areas, except for companies involved in [INAUDIBLE],, ironically. Then there's-- it's more software. As you say, it's more-- they're very good at leveraging AI for commercial and consumer-facing kinds of applications. And they're doing much better basic research on AI. So China, no matter what happens, I think, in the hardware side, China will be very competitive. Chinese companies will be very competitive in using AI and AI applications. So each of these areas sort of has a different-- there's a different level of dependence and a different sort of trajectory for Chinese companies to go to also to reduce their dependence on the US. I think that's going to be the general trajectory at this point. I mean, I think we are going to see a real strong move domestically to just keep reducing dependence on foreign technology, and particularly US technology. 

Eastworld Spotlight: China’s ‘uphill battle’ to reach semiconductor self-sufficiency

International

Can Huawei survive challenges in the semiconductor industry?

China’s struggle to reach semiconductor self-sufficiency

Eurasia Group’s Paul Triolo on Huawei’s survivability and China’s challenges in the semiconductor industry