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The Tech War On China Continues
Peter T. Treadway

Throwing Down The Ladder by Which They Rose.’ Thomas Nast, 1870 (Image: The New York Public Library Digital Collections / CC0 1.0)

 It seems that not a day goes by that the Trump team does not heap a new insult and/or sanction on China. If this is part of a reelection campaign, it is a very dangerous strategy. The banning of WeChat, the proposed expropriation without compensation of TicTok, the closing of the Chinese consulate in Houston, the sanctioning of Hong Kong officials and a gaggle of Chinese companies, the sending high ranking officials to Taiwan—the list grows exponentially. Presumably until the election. If it stops then.

     Trump has managed to convince the majority of Americans that China poses some kind of existential threat to the United States and that punitive measures must be taken against China. He and his pugnacious Secretary of State appeal to specious mercantilist arguments regarding trade and old cold war bugaboos about Soviet style communism. Now he blames China for his own failings in protecting the US against Covid 19. ( Admittedly China shares some blame on Covid). 

     Most offensively he appeals to the historical American racial prejudice against Asian people. Many Americans might deny that they harbor prejudices but the historical record is one of significant and continued American domestic discrimination against Asians and one atrocity after the other in foreign affairs (e.g. Vietnam 3-5million dead, country still suffering from American chemicals and left behind ordinance) To cite just one(of many) domestic examples, the 1790 Naturalization Act specified that to qualify for American citizenship an immigrant had to be white. That law was not repealed until 1952.

      At any rate no measures, fair or foul, must be spared in inflicting pain on China. According to Trump advisor Peter Navarro, the US must make China poor.

Semiconductor Manufacturing International—A Juicy Target 

     To put things simply, China lacks the ability to manufacture semiconductors, especially those that are most advanced. China must depend on US or US controlled suppliers (like Taiwan Semiconductor). Market and political forces in China are working to create this semiconductor ability. But the US is determined to stop them. 

     Semiconductor Manufacturing International Corp (SMIC) is the leading Chinese semiconductor fab. Fabs manufacture semiconductors but don’t design them. SMIC has a long way to go to catch up with Taiwan Semiconductor and Samsung in terms of capacity and state of the art sophistication. It recently raised the equivalent of billions of dollars in as offering on Shanghai’s new STAR Exchange. The stock did well. But now the US has indicated that it may put SMIC on its Entity list which means exports of US made equipment to SMIC will be restricted if not eliminated. SMIC depends on US equipment. 

     On Monday, in reaction to this news of a possible US action, SMIC’s Hong Kong stock dropped 23%. You might wonder why the market was surprised. Like a train rumbling towards you a mile away, anyone with a minimal knowledge of semiconductors and US politics could see this coming. Didn’t anyone ask SMIC on their pre IPO presentations what they would do if the US put a knife in their back? Surely this US action if it happens should not come as a surprise. SMIC argues it has rigorously complied with US regulations. The US says it suspects SMIC of supplying the Chinese military which SMIC denies.

     It doesn’t matter what SMIC says or does nor what the truth is. The real reason the US may put SMIC on the Entity List is that the US cannot tolerate the rise of a non-Caucasian rival in the key tech area. The US has a reputation for fairness but under Trump the US doesn’t play fair. This is a tech war or a race war—call it what you want.

     If the US enacts an embargo on semiconductor equipment exports to China, China isn’t the only lose. This is bad news for American semiconductor equipment companies like Lam Research, Applied Materials, KLA-Tencor and ASML( a Dutch company but under the US thumb). They will lose their largest customer. 

     The US has achieved almost total dominance in semiconductors in a world of globalized competition where China was a major participant. With embargoes on Huawei and now perhaps on SIMC, the US is retarding global economic progress and throwing a wrench into further progress by US semiconductor equipment companies. It is also turning its back against its own free market ideology.

      I recommend an AsiaTimes article by author David P. Goldman entitled “Huawei Sanctions Will Destroy US Chip Industry”. The title says it all. Except now it’s Huawei and SMIC sanctions.  Worse. The article references the US Semiconductor Manufacturing Association which warned in a July 14 memo to the US Commerce Department that restrictions on chip sales to China would throttle the revenues of American firms and force them to reduce R&D. Except nobody in the Commerce Department will be listening. Collateral damage to American tech companies is to be accepted.

     The long run would seem to favor China. The big driver of the semiconductor industry and the entire computer revolution is brains. And China apparently is winning the brain contest. According to Forbes, in 2016 China graduated 4.7 million in STEM subjects vs 568,000 for the US. Throw in another 561,000  STEM graduates in Russia which is partnering with China in technology. Throw in the fact that Chinese comprise a significant part of the STEM students in US universities, at least until Trump started cutting off Chinese student visas. Throw in the fact that China is vacuuming in ethnic Chinese engineers from Taiwan and around the world. According to the Goldman article, China is hiring thousands of Taiwan’s chip manufacturing engineers to work on the mainland at double pay. Finally, throw in the fact that the Trump Administration has made immigration so difficult. Historically, talented foreigners have founded and staffed American tech companies.

     Anyone with an introductory course in economics can predict what will happen eventually. The huge China market will produce a demand for semiconductors. This will provide an incentive for the creation of a non-American supply chain servicing China and eventually the rest of the world in competition with the American companies. Global economic progress will slow as this duplicative supply chain structure takes time and resources to become a reality. The introduction of 5G for example will be slowed everywhere. (Huawei by the way is the number one patent holder for 5G) To offset the loss of the China market Congress is cooking up handouts for the semiconductor industry. The American companies will have to settle for that to replace their lost Chinese business. How long it will take for the Chinese supply chain to fully get up to speed is the only question.

     You have to wonder how the Chinese allowed themselves to get in this state of dependency on the Americans for semiconductors. 

Reshoring Is a Bad Word for an Economist

     Both American political parties seem to have outdone themselves in advocating the so-called rebuilding of American manufacturing sector. Nothing like political unanimity behind a total mistake. The manufacturing sector doesn’t need rebuilding. I quote from a recent report from the Cato Institute:

A President Joe Biden [or Trump] does not need to ‘rebuild manufacturing in the US’. The myth that never dies. The United States manufacturing sector is not dead. Just last year, before being devastated by the pandemic, US manufacturing output set a record high. And the sector once again proved itself an attractive destination for investment in 2018 when FDI stock in American manufacturing rose by 10% to $1.77 trillion. Decline in American manufacturing employment, however, has long been a story of American progress, as the sector has stayed competitive by learning to do more with less. Using the decline in employment to tell a story of sectoral decline, not progress, is a mistake…

     It’s output not employment that determines the success or failure of the manufacturing sector. People forget. In 1900 40% of Americans worked on farms. Power was supplied by animals and humans. Tractors and farm machinery then took their place. Agricultural output soared but agricultural employment declined. American agriculture has fed the world but with fewer and fewer people. Similarly, the American manufacturing sector is something America should be proud of.

     Globalization—a much maligned word nowadays—along with technology driven productivity improvements, is responsible for the “good” low inflation we have enjoyed in recent years along with the low interest rates. Reshoring, i.e. bring manufacturing back to the US, will drive up prices and reducing economic efficiency. The Fed should take note.