Chip wars: US and China engage on the technology

The $54 billion CHIPS Act is designed to get companies to make semiconductors in the U.S., but the law can’t make chips cheap. How can the US turn the tide in the technology war it finds itself?

Last year, the United States rightfully increased its competition with China in the semiconductor industry. The CHIPS and Science Act, signed by the Biden administration in August, is a necessary industrial policy to ensure the United States maintains its technological edge and protects its supply chain.

China’s chip manufacturing industry, however, poses a significant threat to global security and is rife with intellectual property theft and unfair trade practices. The most extensive restrictions rolled out by the Biden administration in October are a justified response to China’s predatory behaviour in the sector. China’s efforts to train artificial intelligence at scale using advanced chips must be curbed, as the country’s unchecked growth in the technology sector poses a significant threat to global security.

Despite the sanctions, the Biden administration has failed to provide Beijing with a viable exit strategy to end the technology war. This is because the Chinese government has not demonstrated a willingness to improve its trade behaviours or respect intellectual property rights. The fact that China’s government has elevated supply chain security to its highest priority further illustrates its nefarious intentions in the semiconductor industry.

China’s 20th Party Congress report, released days after the United States’ announcement of the latest semiconductor export controls, demonstrates the Chinese Communist Party’s (CCP) determination to prioritise national security over market-based innovation. The report identifies the trade conflict with the United States as the “economic main battlefield” and vows to achieve “high-level technology self- strength and self-independence” by attacking technological bottlenecks and winning the war of conquering core technologies.

The CCP’s strategy is to buttress its leadership role in science and technology affairs, construct a new “national system” for scientific research, and strengthen the “national strategic technological force.” This approach, however, raises concerns about long-term economic distortions caused by economic planning based on security concerns rather than economic viability.

China’s Third Front construction campaign in the mid-1960s, launched in response to complicated security situations, serves as an example of these challenges. Mao Zedong’s fears of a war with Moscow and a U.S. attack on China’s industrial coastal region prompted the campaign to relocate China’s industrial base to the mountainous southwest. The campaign cost over 200 billion RMB and involved the relocation of more than 4 million people, highlighting the potential economic distortions caused by security-based economic planning.

The Chinese government’s current focus on promoting semiconductor production is reminiscent of the Maoist era’s Third Front construction campaign, which ultimately led to massive economic liabilities and long-lasting distortions. Despite mountains serving as natural shields against potential airstrikes, the prohibitive transportation costs associated with moving industrial bases to remote regions proved to be a significant burden for firms, particularly state-owned enterprises (SOEs). These SOEs could not keep up with their competitors and suffered from severe debt problems in the reform era, such as China Second Heavy Machinery Group in Deyang, Sichuan, which had accumulated over $2 billion in losses by 2015. However, local governments continued to prop up these zombie firms to avoid unemployment problems, leading to distorted economic conditions.

Similarly, China’s current semiconductor drive will likely result in similar distortions. Local officials are incentivized to prolong China’s investment-led economic model, which has resulted in various problems such as corruption, local debt, and real estate crises. President Xi Jinping’s efforts to regulate infrastructure investment and reduce debt have been bypassed by the push to build innovation parks, allowing local officials to double down on infrastructure construction. This approach prioritizes security concerns over economic viability and risks further distorting China’s economy in the long term.

The Chinese government operates a centralized system for distributing construction land quotas. The central government allocates quotas to provinces, which then distribute them to cities, and further down to counties. However, provinces retain some quotas for significant economic projects. Local governments can receive these special quotas and use them to construct innovation parks, which enable them to undertake more construction.

In addition to building scientific labs, local governments need to develop “complementary infrastructures” in the innovation parks, such as transportation, roads, and public facilities. This process is known as “making raw land ripe,” and it allows local governments to sell the property at much higher prices and keep all the revenue. Even if high-tech companies do not come to the innovation park, local officials can redevelop the supposed innovation zone into commercial areas and apartment buildings. This process provides opportunities for local officials to enrich themselves and reward their associates.

Furthermore, Chinese companies exploit the lack of accountability and take advantage of innovation subsidies.

Fraud is prevalent in the semiconductor industry in China due to several factors. The regulators overseeing the industry lack technical expertise, making them unable to detect fraudulent claims and wasteful projects. Moreover, the government’s national innovation drive creates incentives for local officials to attract high-tech investments, as this is considered a significant political achievement that can aid in their evaluation and promotion. As a result, companies like Hongxin exploit regulators’ eagerness to foster high-tech firms by making unrealistic commitments.