Global reset – Technology decoupling (Part 2: Decoupling race and scenarios)
Phuah Eng Chye (26 March 2022)
What is the appropriate analogy to describe technology decoupling? I think it resembles a marathon in which US and China have to jump over hurdles to reinforce their leadership and expand their “spheres” of countries and MNCs. In this regard, both countries are formidable with large domestic markets and leading-edge capabilities but are tied together by interdependencies. in relation to these interdependencies, they have different strengths and weaknesses. The US is the incumbent with advantages in the openness and vibrancy of its private sector, research and educational ecosystem. But there are glaring gaps in several technology segments where the US lacks corporate representatives and domestic manufacturing capacity. China has a large industrial production and internet user base, an abundant supply of engineers and an unparalleled top-down ability to experiment, execute and scale at a rapid pace. The government is aggressive in promoting technology deployment and disrupting legacy. But China has huge dependencies in critical and advanced technologies and its “authoritarian” environment can be antithetical to basic research, innovation and entrepreneurship.
From a cultural perspective, Matt Sheehan describes it as a “race in which each side is hobbled by a core weakness: Silicon Valley’s egocentrism and China’s ethnocentrism”. He explains “Silicon Valley is great at absorbing people from around the globe, but is far less eager to absorb ideas from other places…blog posts by floundering Silicon Valley founders get plenty of attention, but major product announcements out of China are often ignored entirely. That’s partly due to a relative lack of quality English-language coverage of Chinese tech trends and innovations, but also, frankly, to an egocentrism that sees the Valley as the fount of all meaningful product innovation. In this mindset, successful companies from the developing world are dismissed offhand as copycats that survive due to their national governments’ protectionism”.
“In China, the situation is reversed. China and its leading companies do little to attract or accommodate non-Chinese engineers, so they limit themselves to one (albeit very large) talent pool. As in many sectors of Chinese society, it’s simply assumed that foreigners can’t really understand what’s going on in China, and so they are rarely integrated into core product roles. But when it comes to studying and adapting innovations from abroad, Chinese entrepreneurs eagerly devour the ideas bubbling up out of Silicon Valley. The demand for real-time knowledge of the Valley is fed by Chinese folks with a foot in both worlds, as well as a cottage industry of blogs, social media accounts, and podcasts. The ideas conveyed by these media outlets are not simply copied, but instead become what Sequoia chairman Michael Moritz calls fuel for the creative and imaginative entrepreneurial fires that are blazing in China and beyond”.
Matt Sheehan thinks “correcting these blind spots is hard because of how deeply embedded they are in each ecosystem’s culture. But both sides are taking steps to remedy them. Quality examinations of Chinese tech trends are gaining an audience in Silicon Valley, and both Baidu and Tencent have set up AI research labs in America, partly to draw on local talent”.
Matt Sheehan argues the new equilibrium where “companies remain trapped within the scope and span of their home countries” create a problem for the American government and industrial policymakers: “A diffusion of decision-making power and a move away from Washington. As the ultimate arbiter of access to the Chinese market, the Chinese Communist Party can…drive a policy wedge between America’s Internet companies and their government in Washington. White House officials may oppose China’s push to normalize cyber sovereignty, but the key US players are in Silicon Valley. So as long as Facebook, LinkedIn and other firms are willing to build alternate versions of their products for China, cyber sovereignty will become de facto policy in the world’s leading Internet markets…Chinese markets may remain impenetrable, but the innovations brewing there are a rich resource when developing products for the next billion users: mobile-first, population-dense, low-wage markets in Southeast Asia and India. American technology companies need to have their ear to the ground in China if it hopes to win these markets”.
Matt Sheehan points out “American policymakers face a tougher task. Trying to force reciprocal access through punitive actions – such as denying Chinese tech companies access to American markets – would almost certainly backfire. Chinese leaders would most likely embrace the moral equivalence of both countries walling off their markets, rather than acquiesce and open up the market to global information platforms…an explanation for why restricting access probably won’t lead to reciprocal openings. The US government’s tools for whipping its own companies into line are also relatively weak: tech CEOs can be shamed at Congressional hearings, but that tactic won’t be so effective when weighed against potentially selling to one billion new users in China and beyond. Policymakers could also try to force good behavior on tech companies through a new digital rights-equivalent of the Foreign Corrupt Practices Act. But while legislating morality may sound appealing, it would be tremendously complicated, dragging in everything from Europe’s Right to be Forgotten to the US government’s surveillance programs. In the end, the best approach for policymakers may be a posture of patient confidence. The United States has been the global epicenter of technical innovation and commercial creativity for decades, a distinction due in large part to a culture of openness. Given the lack of good policy levers to pull, the country is better off doubling down on its enduring strength than frantically devising ad hoc solutions to our weaknesses”.
Technology decoupling race
In the technology decoupling race, each country runs on separate tracks and hurdles. For the US, the main hurdles are its dependence on China’s industrial and raw material supplies, and the relative lack of US semiconductor manufacturers and 5G players. For China, the main hurdle is its dependence on critical Western technologies.
The US strategies can be broken down into three parts: blocking moves, driving the relocation of production facilities to outside China, and expanding its geographical sphere of influence. The strategies are supported by initiatives to thwart the flow of critical components, new technologies, know-how and capital into China; block Chinese acquisition of foreign technology (firms, patents); and to oust or bar Chinese infrastructure (and telco operators) and technology in as many countries as possible.
For its strategies to work, the US requires the cooperation of allies[1]. William Alan Reinsch and Emily Benson notes the US and EU formed the Trade and Technology Council (TTC) to formulate a common transatlantic approach to strengthen collaboration on investment screening in relation to transactions impacting security, best practices in risk analysis and mitigation, and policies related to sensitive technologies. The EU also aligned its FDI screening guidelines with the US Committee on Foreign Investment (CFIUS) and intends to strengthen information-sharing to ascertain the extent of foreign economic influence. The TTC would also be used as “a dedicated forum” to strengthen export control cooperation on dual-use technologies (on military and human rights concerns), emerging technologies, and “technology acquisition strategies, including economic coercive measures, and civil-military fusion policies of certain actors”. It would promote a multilateral approach by “conducting technological consultations on compliance and enforcement approaches, third country capacity-building efforts, and technological consultations”; although it acknowledged progress may be limited because export controls are “not formally within the remit of the European Commission”. They note the increasing attention paid to AI due to “growing transatlantic fears about China’s outsize influence in AI and data manipulation…will work more closely to develop responsible AI, including assessing risks and potential impacts on the future of work” and that while parties will strengthen domestic semiconductor ecosystems, they would work towards avoiding “a subsidy race that would crowd out private sector investments”.
The US has throttled expansion of controls for fear of adverse consequences. Matt Sheehan points out chip sale restrictions could have been “expanded to include some of China’s leading cloud providers such as Alibaba. In addition, US restrictions on SME exports are unilaterally expanded to cover most global sales of SME to China that use significant US components, as well as the servicing of existing equipment, effectively crippling production lines at Chinese fabs for a time. In the short term, these actions would constitute an enormous blow to China’s technology ambitions, one that would send the country’s ecosystem reeling. But over the medium and long term, they could also backfire on the United States if done unilaterally. Such a move would alienate key allies in Europe and Japan that produce SME, and incentivize all global SME companies to strip American components out of their own products to avoid US export controls. Replacing those US parts would be a slow process (experts estimate 5-10 years), but once completed it would effectively eliminate US influence over foreign SME suppliers and dramatically undercut the domestic US SME industry. In essence, this is a card that can only be played once, and in this case Washington chooses to do so during 2020-2023, giving the United States a one-off bump in technological competitiveness by temporarily cutting off Chinese access to advanced semiconductors. In doing so, the United States sacrifices its long-term leverage over China and its credibility with allies, while also hampering the ability of US semiconductor companies to innovate and compete”.
Thus, blocking moves buys time and creates favourable conditions for US and allies to establish new advanced semi-conductor plants. Initially, other countries and MNCs resisted being drawn into taking sides. But the US has had remarkable success in convincing Europe, Japan and India to collaborate in actions against Chinese products in their markets and to reduce their dependence on China. Once the new plants are onstream in the West, the US could maximise its advantage by producing competitive and innovative products. This would be followed by more hardline policies to convince the rest of the supply chain (upstream and downstream) to relocate out of China. Key questions remain over whether Western demand is sufficient to absorb the new output, and whether the West can speedily roll out a competitive 5G network and IOT ecosystem. Execution failures would stall progress and this could lead to defections among allies and MNCs to the Chinese ecosystem and risk damaging US leadership.
China’s main obstacle is the vulnerability of its supply lines[2] and its ability to maintain access to international markets. Opinions vary widely on China’s prospects. Emily Weinstein notes “Beijing’s reliance on imported technologies goes well beyond foreign-designed semiconductors. According to a 2018 article from the Ministry of Education, China relies on imports for 35 key technologies that it is unable to produce domestically in sufficient quality or quantity. These technologies include heavy-duty gas turbines, high-pressure piston pumps, steel for high-end bearings, photolithography machines, core industrial software, and more. With U.S.-China bilateral technology investment seeing a steep 96 percent decline since 2016, Beijing has been forced to look for new ways to source key technologies, turning to shell companies and intermediary agents to source foreign components, reagents, and other relevant equipment”. Matt Sheehan highlights potential implementation risks of costly “frictions, missteps, and waste” given the large role of “state-owned enterprises, companies not known for their nimbleness or innovation”.
Regardless, China has made dramatic progress in innovating and competing in international markets in recent years and its ability to surmount these hurdles should not be under-estimated. Cheng Ting-Fang and Lauly Li points out the US technology blockade “has spurred an aggressive effort by Beijing to identify and replace risky parts and suppliers…Dozens of Chinese companies, with specializations mirroring U.S. incumbents in key areas from ion implantation to etching, have sprung into prominence over the past few years, accelerating as the state realizes the enormity of the self-sufficiency project…the origin of everything that goes into its products, from production equipment and chemicals to the tiny lenses, screws, nuts and bearings in chipmaking machinery and production lines…suppliers are asked to provide corrective action reports to explain how they can together diversify procurement and find alternatives…everyone in the industry now has a mutual understanding that if anyone is building a new chip plant or expanding a semiconductor manufacturing line, at least 30% of production tools must be from local vendors.”
Cheng Ting-Fang and Lauly Li notes “every U.S. market leader in the computer chip industry now has a Chinese doppelganger that is being positioned to take its place as a vendor to the Chinese chip industry. Yangtze Memory Technologies Corp (YMTC)…is strikingly similar in its approach and strategy to Boise, Idaho-based Micron, while Beijing-based Naura Technology Group represents China’s hope to later challenge Applied Materials…Shanghai’s Advanced Micro-Fabrication Equipment (AMEC) is China’s version of Lam Research…Tianjin-based Hwatsing Technology produces cutting-edge chemical-mechanical planarization equipment and is set to break Applied Materials’ monopoly…These and dozens of other state and private companies have become the focus of an industrial policy known by the slogan secure and controllable.” “The trade disputes serve as the once-in-a-lifetime opportunity to grow business” with domestic champions having their technologies widely adopted by domestic customers and giving rise to full orderbooks and record profits.
The significance of the US grip on advanced tech components may be over-stated. Blanket coverage is not feasible as this means extending the sanctions to cover every Chinese firm, device, patent and app. However, narrowly-focused sanctions have limited reach and durability, and eventually Chinese players will find a way to “bypass what the enemy holds and hit them where they do not expect you”[3].
For example, in Huawei’s case, the expansion of its global 5G networks and smartphones business is temporarily halted by US sanctions. In response, Huawei is divesting affected businesses and licensing its hardware patents on smartphones and consumer devices (smartwatches, fitness tracker, tablets and smart TVs). In the meantime, Huawei has redirected focus to address gaps in infrastructure, operating system and software critical to its IOT ecosystem. It accelerated development of HarmonyOS and Huawei Cloud and tapped its strong domestic base and presence in developing economies[4] to roll out its cloud infrastructure, consumer, industrial and e-government services. Huawei’s strategies are aimed at plugging gaps in the software and IOT ecosystem and to create new designs to circumvent blueprints based on US-dependent technologies.
In any case, China’s current priority is not the manufacture of advanced components but ensuring adequate Chinese production of matured semi-conductors[5]. If they succeed, this would displace Western share of the matured technology market and reduce the profitability and ability of Western firms to invest in R&D.
In contrast to the arms-length approach of US and Europe, China’s biggest advantage is that technology and information is tightly integrated into nation-building[6]. Dylan Levi King explains “one of the key tenets of Xi Jinping Thought on Rule of Law, which states that China should: Make full use of big data, cloud computing, artificial intelligence and other modern technological means to comprehensively build a smart rule of law, and promote the digitalisation, networkisation, and intelligentisation of the rule of law in China. Optimize and integrate various information, data, and network platforms in the field of rule of law, and promote the construction of the nationwide rule of law informatization project”.
Dylan Levi King points out the central government is being set up as the hub for network surveillance and integrated big data analysis. “Algorithmic regulation will first augment human decision making, but the goal is for data-driven social governance technology to eventually put an end to corruption and a tighter leash on local experimentation by reducing reliance on human judgment”. Tu Zipei[7] calls the proposed Chinese model single-particle governance as it integrates data from government and commercial sources into individual master files that become the elementary particle. “This idea doesn’t come from Maoist egalitarian politics or Dengist market horizontality, but from online shopping and social media platforms. Fittingly, it will run on software developed by commercial digital technology firms, like Huawei, Tencent, and Alibaba. Such a system would fundamentally change the political culture. Horizontality requires not just individual autonomy, but also a sense that local communities or interests can be organized and exercise some kind of collective agency…The state can fulfill the interests and express the will of a broad population of abstracted social individuals without having to rely too much on the human judgments of local cadres at all. Despite the party’s centralism, it has always operated through a huge matrix of institutions: schools, planning committees, workers’ organizations, cultural groups, trade boards, and many others. A person’s political identity was linked in part to the collective bodies in which they participated. But with an urbanizing population that is increasingly integrated into service economies instead of life-long economic or social roles, the bases for these collective expressions of political identity are disappearing. As the population atomizes, the government seems intent on creating a stronger civic Chinese identity and wants its citizens to politically relate primarily to the national government…the new rhetoric about data-driven governance: it presumes a population where the individual is a data-generating automaton whose activities are input for the state to work with, with few or no intervening social structures. The logic of big data governance at its highest scale appears horizontal in flattening the inputs into decision making. It de-emphasizes the importance of political, economic, and intellectual elites but also of local government. It also increasingly removes the possibility of a cadre-managed collective autonomy in goals and decisions”.
In its 14th five-year plan for national informatization, the Central Commission for Cybersecurity and Informatization outlined “the breadth and depth of Internet + Government Services rapidly grew…The world’s first Internet court was established, and the national Internet + oversight system was preliminarily completed…digital technology played an important role in novel coronavirus pandemic prevention and control. Nationwide e-social security card issuance reached 360 million; long-distance healthcare cooperation networks cover over 24000 healthcare bodies in all districts and cities nationwide and all national-level poor counties’ county-level hospitals; and the nationwide Internet access rate for primary and secondary schools (including tuition points) reached 100%”.
“The 14th Five-Year Plan” period is an important period…accelerate the building of a digital China, forcefully develop the digital economy, promote the upgrading of the industrial base and the modernization of industry chains, promote the simultaneous development of new forms of industrialization, informatization, urbanization, and agricultural modernization…we must accelerate the building of a digital society, greatly enhance modernization levels of data-based national governance capabilities and transform the structural advantages of Socialism with Chinese Characteristics into powerful national governance abilities; it is a period for important breakthroughs in building a cyber superpower and a digital China and for enhancing international discursive power; we must vigorously advocate building a community of common destiny in cyberspace, vigorously participate in building a system of international norms for cyberspace, and promote that the development of the Internet enriches the peoples of the world”. Hence, “digital society building should advance steadily. A Party-led, service-oriented digital social governance structure with integrated resources, information support, and rule-of-law guarantees should be basically created. Social governance and public security systems should be perfected day by day, advance risk identification, early reporting and early warning capabilities should enhance notably, and capabilities to respond to sudden public incidents and emergencies should strengthen notably. The levels of informatization pushing up grass-roots governance levels should clearly rise. Novel smart cities should advance in a graded, categorized, and orderly manner; a digital countryside should be steadily built, urban and rural informatization coordination and development levels should notably increase”.
Overall, both sides will be held back by dependencies on each other. Hence, they are focused on unwinding these dependencies in preparation for the charge forward. The decoupling initiatives so far can be regarded as the start phase of a marathon race. Once US and China are able to reduce dependencies over the next three years, it is likely to be followed by an acceleration in the pace of technology fragmentation.
Assessing different scenarios
Where is decoupling headed? Consensus dismisses the complete decoupling scenario due to the high interdependencies. Cheng Ting-Fang and Lauly Li note “it is still hard to fully decouple the semiconductor supply, involving thousands of suppliers from around the world that have been tightly intertwined for decades. China can try to reduce its reliance on the U.S., but without American technology sources, it can hardly speed up its technological advancement. Neither is it practical for the U.S. to exclude China from all of its supply chains, as the country is still a big source of critical raw materials and rare-earth elements used in semiconductors and electronic components”. Hence, “most also believe that the doomsday scenario – a complete blockade of China’s tech and semiconductor industries – is not realistic, either. The world’s two largest economies are still interconnected, and they are also the two biggest semiconductor markets: China accounts for at least 25% of the sales of most U.S. chip companies…and few want to see that market disappear”.
A study for the German Federal Foreign Office notes “given the complexity of the industry, its capital intensity and the high degree of specialisation, it is unlikely that either China or the US will be able to achieve a decoupling of their production of the digital devices sectors. The US, in concert with its allies in Europe and East Asia, has effectively blocked the Chinese access to the most cutting-edge production technology which likely precludes it from advancing to the most high-tech fabrication. However, the US is not controlling the entire technology chain either, and it seems unlikely that it could replace the Chinese manufacturing of ICT devices in the near term”. In this context, “unlike the highly integrated supply chain of digital devices, the digital services running on them are fragmented between the West and China. China has isolated its digital sphere and blocked most foreign digital services from operating in its market. Information and communication in the Chinese digital sphere are censored by the government. The government also has the right to access all data held by Chinese companies. These policies created a parallel universe of digital services serving the local market”. In contrast, “the digital services companies dominating most markets outside of China, and in particular Europe and the US, are mostly of American origin”.
Enrique Duarte Melo, Iacob Koch-Weser, Michael McAdoo, Raj Varadarajan and Antonio Varas “see four potential scenarios for the US−China tech trade relationship”. Two are based on amicable relationships. Under the True Reciprocal Access scenario, US and China resolve key differences inhibiting technology trade such as improved terms on licensing US intellectual property; opening up digital services markets; liberalising cross-border tech M&A; and narrowing the scope of tariffs and other barriers). Under Managed Trade, US and China reach a bilateral trade agreement to roll back broad-based tariffs; leaving selective tariffs, export and investment restrictions, or market access barriers on a few strategic sectors and products while China retains some nontariff restrictions.
The latter two scenarios reflect stalemate and worsening relations respectively. Under Walls and Drawbridges, bilateral issues regarding IP, investment, licensing, and other nontariff matters are unresolved. It is possible the US may react by deepening and selectively broadening tariffs on Chinese imports but leaving popular consumer electronics products such as smartphones, laptops, and TVs untouched. “Uncertainty remains high for technology companies, with no clearly established framework to manage friction in areas such as IP, cross-border M&A, antitrust, and cybersecurity. Instead, each individual dispute becomes a bargaining chip in the geopolitical conflict between the two countries”. Under the Technology Cold War scenario, nontariff restrictions are expanded. Examples include additional US bans on high-tech exports, broadening tariffs or market access restrictions to cover all “valuable” electronics and possibly “every single networked electronic device imported from certain countries”. China could retaliate by restricting exports of rare earths, taking antitrust measures against US tech companies, and accelerating indigenous technology development efforts. Enrique Duarte Melo, Iacob Koch-Weser, Michael McAdoo, Raj Varadarajan and Antonio Varas suggest “this would effectively halt the bulk of bilateral technology trade and prompt a massive redefinition of global technology supply chains. It would also lead to fragmentation of global technology standards in areas such as telecommunications, computing architectures, and operating systems”.
Decoupling can be further analysed from product and geographical perspectives. Product-based scenarios such as the blockades on critical technology, supplies, networks and software were discussed earlier. However, there are questions as to whether product decoupling will extend across the entire chain and range. In other words, how far would component nationalism reach and to what extent will products (hardware, software, data) originating in one country be allowed to sold or used in the other? However, product-based scenarios only present a narrow perspective on decoupling outcomes.
Geographical-based scenarios perhaps better capture the global complexities of decoupling. In this view, the US and China are the competing centers for the evolution of separate technology spheres. It can be considered that victory perhaps belongs to the protagonist that is able to attract the most countries and MNCs to its sphere.
The US has the immediate advantage as the advanced economies (and India) are mainly on its side. But it has the uphill task because it needs to cover more ground to prevent defections, evasion of controls and impede China tech from spreading around the world. But the US face considerable challenges in maintaining a fully united front due to divergent national interests and concern among allies that they are bearing the brunt of decoupling costs. For example, the Europeans are suspicious of US policies and financing of ORAN as an alternative to Huawei for 5G networks. They are concerned that the US policies will unfairly advantage US companies and put European companies such as Ericsson and Nokia, current leaders in the RAN market, at a disadvantage.
Woon Wei Jong notes TSMC, which currently produces 92% of the world’s most advanced chips below 10nm, “continues to face calls by the US-Japan alliance to set up overseas factories to spread the risk, as well as political pressure to choose sides between the China and US markets”. While subsidies are being dangled as a carrot, TMSC needs to consider risks that “if TSMC doesn’t go in, the markets might be seized by Samsung and Intel.” Due to US restrictions, TSMC has little choice to manufacture for advanced process chips (14nm and below) outside of China. In addition, “once TSMC’s fabrication plant in the US is operational, it would benefit from the over 3,000 IC design companies in the US, and they would not just order chips from US companies, nor would they overtake TSMC’s production capacity”. But TSMC has hedged on mature process technologies preferring to “go where the orders are…Taiwan’s electronic product exports to mainland China have repeatedly hit record volumes”. It was observed TSMC has also “rapidly expanded its factories in Taiwan in the past two years, in order to establish a de facto reality…When TSMC’s factory in Arizona goes into production in 2024, that will actually be bad for Taiwan. Because when the US gains a chip supply, if war breaks out across the Taiwan Strait, the economic and technological impact to the US will be much less, and Taiwan will be of less use”.
Europe and India, with their talent and markets, are potential game-changers that could swing the battle or even upset the current US-China dominance. These countries have jumped on the decoupling bandwagon because they see opportunities to pursue their own aspirations to achieve supply chain resilience and create national tech champions. The EU[8] is concerned about being squeezed by both sides and is developing strategies to achieve strategic autonomy and digital sovereignty. Europe launched its Chips Act to “ensure that the EU has the necessary tools, skills and technological capabilities to become a leader in this field beyond research and technology in design, manufacturing and packaging of advanced chips, to secure its supply of semiconductors and to reduce its dependencies”. “The EU Chips Act will build on Europe’s strengths – world-leading research and technology organisations and networks as well as host of pioneering equipment manufacturers – and address outstanding weaknesses. It will bring about a thriving semiconductor sector from research to production and a resilient supply chain. It will mobilise more than €43 billion euros of public and private investments and set measures to prevent, prepare, anticipate and swiftly respond to any future supply chains disruption, together with Member States and our international partners. It will enable the EU to reach its ambition to double its current market share to 20% in 2030”. India, with massive untapped potential, has decided its future lies with the US and has reduced Chinese access to its markets. However, India is more likely to adopt China-type policies to emerge as a major tech player in its own right.
John Lee adds “technologically advanced liberal democracies disagree among themselves over the extent and type of state control to be imposed on the internet. Divergence between the US and EU over regulation of data storage and transfers, platform businesses and other internet-based activities seems to be widening, despite continuing efforts to reconcile these differences. Leading technology firms from countries like Germany, Japan and South Korea are continuing to invest in China and work with Chinese partners”. “Despite much talk of coordinating technology and industry policy vis-a-vis China, in most countries there appears to be little appetite for extensive decoupling. And so far, governments are not providing resources sufficient to substitute for the opportunities offered by China’s emerging IoT ecosystem. At the same time, competition is rising between advanced economies for dominance of future technologies and markets…at the expense of US business interests”.
The future global tech landscape will thus be shaped by how the rest of the world react to US and China policies and achievements. If China is able to successfully replace Western components, the West will be left with a bigger share of their own market but a smaller share of global pie as it loses access to the Chinese sphere.
It is also difficult to impede China’s international expansion. John Lee points out “concerns about how China may exploit the IoT are driving moves to disconnect from Chinese networks, led by the US. But the reluctance of other countries to join a democratic internet coalition excluding China means that instead, the IoT will likely continue fragmenting into a variety of distinct cyber-spaces”. In John Lee’s view, “in pursuing selective decoupling, the US faces not just significant costs from eroding the global economies of scale that have supported ICT advances for decades, but also resistance in many nations to excluding Chinese technology. Many developing nations prioritize economic and technological development, and already have an extensive Chinese presence in their digital infrastructure and technology collaborations…on cybersecurity and capacity building…smart city projects with Chinese firms like Huawei…participate in their next-generation telecoms networks…This means that even if countries within a politically trusted community commit to purging their digital networks of Chinese technology, they can still expect to face its presence across large areas of the world. For example, foreign transport markets might still be populated with vehicles made in China and operated by AI platforms designed by Chinese firms, using networking standards co-developed with Chinese actors and telecoms infrastructure built by Chinese firms. And within such a trusted community, the cost of developing China-free technological ecosystems would rise significantly, due to reduced economies of scale”.
In this scenario, John Lee notes “the IoT will increasingly be shaped by the developing world. The global South now accounts for the vast majority of internet users and the lion’s share of economic growth worldwide”. The collaborative software development platform GitHub “estimates that by 2025 the US share of its users will halve compared to 2015, with an equivalent increase from developing nations. Many of these countries are now engaged in infrastructure and logistics projects involving Chinese actors and branded under Beijing’s digital silk road. This promotes integrated digital infrastructure solutions that build-in emerging technologies like AI and digital currencies, in which China is striving to lead”.
“As developing nations increasingly contribute to digital technological development, their preferences on design and governance of the IoT, and the systems built upon it, will need to be accommodated in an integrated global economy”. In this regard, “addressing such divergent attitudes outside Europe towards Chinese digital authoritarianism is crucial”. The dilemma is that “if Europe is to remain integrated in an internet-based economy global in scale, rather than confined to a relatively small group of like-minded states, it must find common ground with China and other emerging actors on the IoT’s design and regulation. This requires grappling with approaches to internet architecture and management that go beyond those inherited from the 1990s-2000s. At the same time, connection with Chinese networks implies significant risks that will expand in tandem with the IoT, requiring potentially costly mitigation measures and likely placing limits on the desirable extent of international connectivity”.
John Lee thinks “the prospect of the global internet splintering cleanly, into a liberal democratic internet on the one side and a Chinese-dominated cyberspace on the other, is unlikely. The world will instead probably see a continued and messy evolution towards a federation of networks, interconnected but increasingly divergent. The US continues to pursue technological decoupling with China, which for its part seeks reduced reliance on the US and its like-minded partners for core technologies. Third parties will likely continue pursuing their own paths in between these two poles, choosing elements and connections that suit them”.
Open-source scenarios present a formidable challenge to decoupling. Caroline Meinhardt notes “open-source research collaborations, in particular, are seen by China’s tech industry as a promising way to make up for US export controls. Amid fears that the US might permanently bar Chinese companies from access to its hard- and software, Chinese IT-industry officials think open-source projects will give them secure access to technologies because they are not controlled by any one foreign country…Examples include the open-source chip project RISC-V…Huawei’s open-source operating system, HarmonyOS, (to replace Android). Huawei is also planning to build China’s first open-source software community, by partnering with companies and software developers around the world. A competitive software ecosystem built on open source rather than commercial licenses would be a key step towards technological self-sufficiency”.
John Lee suggests “one potential approach is to focus on global cooperation to protect the internet’s public core, meaning elements that facilitate international data transfers (such as the domain name system and networking protocols). Supporting the security and stability of this essential function as a global public good is already mandated by the EU’s Cybersecurity Act”. The public core” concept, which if accepted, “would require member-states to adopt policies related to sustaining the general availability and integrity of the public core of the open internet. This approach implies prioritizing international cooperation to maintain shared systems of common interest, potentially at some expense to propagation of political values. Western governments are already engaging in such limited compromises with greater frequency, as they diverge in regulatory practice from the widest conceptions of internet freedom.” “Prioritizing internet infrastructure also implies moving beyond the focus on content regulation, human rights and malicious cyber activity that still dominates debates over internet governance. Shared interests in the internet’s functionality as a global public good are readily identified. For example, managing network congestion requires international coordination; the alternative would be for each party to massively expand its own infrastructure and incur significant increases in costs”. “European decision makers need to closely follow China’s evolving approach to the IoT’s development on a global scale, and how this is shaping the politics of the interconnection of everything”.
However, the Russian invasion of Ukraine has given rise to the spectre of a “nuclear” tech decoupling. The Western sanctions on Russia was swift and comprehensive. Lara Williams notes TSMC and Samsung announced an immediate halt of semiconductor exports to Russia. Russia may be able to source low-end chips from China but its access to high-end chips have definitely been cut off. However, Russia could retaliate “by cutting off supplies of the neon gas required for the lasers used in lithographic chip-making equipment, notably to Dutch semiconductor company ASML” and the supply of palladium, used in chipmaking. The prospect for escalation is high if, for example, Chinese firms supply chips to Russia, or if cyber-attacks and sabotage occurs.
James Ballarchive notes “Facebook has been blocked entirely by Russian authorities, while Twitter is almost completely cut off. Many more companies have voluntarily withdrawn from the Russian market – including Apple, Microsoft, TikTok, Netflix, and others”. Russian content is also being censored or purged in the West”. These “moves have raised fears of a splinternet (or Balkanized internet), in which instead of the single global internet we have today, we have a number of national or regional networks that don’t speak to one another and perhaps even operate using incompatible technologies. That would spell the end of the internet as a single global communications technology – and perhaps not only temporarily…If such countries set up rival governance bodies and a rival network, only the mutual agreement of all the world’s major nations could rebuild it. The era of a connected world would be over”.
“There have been some moves toward this kind of action already. Last month the Ukrainian government called on ICANN, which oversees the internet’s domain name system, to suspend Russia’s access to the system – effectively removing .ru sites from the internet. ICANN, which was once an offshoot of the US Department of Commerce but now operates as a nongovernmental organization, roundly rejected the proposal…[T]he internet is a decentralized system. No one actor has the ability to control it or shut it down…ICANN has no power in law or statute over the domain-name system – its decisions are accepted voluntarily by all internet operators…The internet’s other governing bodies work in much the same way – they are independent international bodies that work by agreement, not by force…mean the internet is held together by little more than mutual voluntary agreement”.
James Ballarchive notes the development of technically incompatible protocol would not be catastrophic as “technologists would probably find a way to bridge the two protocols in short order”. It would be trickier to reverse a situation where rival organisations were set up to manage IP addresses and DNS. “Vested interests would form, wanting to stay with one or the other body, making the politics of reconnection almost impossible. The problem of reconnecting these disparate networks into one global internet would thus be a political one, not a technical one – but it’s often the political problems that are the most difficult to solve. There are also steps short of a full splintering of the internet that could still have a significant effect on hampering the global flow of information – or the proper functioning of the internet in a pariah state. Because of the nature of the internet to create monopolies, some services have a quasi-infrastructure type status. Amazon Web Services, for example, runs so much of the back end of the internet that banning it from a particular territory creates major headaches. Similarly, cutting off access to github repositories would paralyse a lot of services, at least temporarily. Russia has been seeking to mitigate this risk among official and public sites, trying to require them to repatriate their data, use .ru domains, and minimize the use of overseas service providers. For a time during the panic of the week, some took this to be an instruction to all Russian websites, even leading to alarmist (but so far unevidenced) articles suggesting that Russia planned to cut itself off from the internet entirely”.
James Ballarchive adds “other countries and groups have sought to mitigate the global nature of the internet – and not just autocracies. The EU has been seeking to require all data processed on its citizens to be processed within its borders, a move US tech giants have been fiercely resisting. Iran, meanwhile, has built up national connections between its key online institutions, enabling it to operate a sort of Iran-only functional internet should it either need to close itself off from the global network or if it got kicked off by an adversary. A splinternet remains very possible – driven by politics rather than technology – but for now, everyone seems keen to hold on and try to nudge the fragile status quo in their favor, not least because it seems that were the internet allowed to fracture, it could prove impossible to repair”.
In another development, Enrico Bonadio and Alina Trapova notes in March 2022, “the Russian government issued a decree saying that Russian companies are no longer obliged to compensate owners of patents, utility models and industrial designs from unfriendly countries…that have issued sanctions against Russia…This means that Russian businesses can use intellectual property, such as patented inventions or fashion designs, without having to pay or seek the consent of the rights holders. Affected companies cannot enforce their patents and designs against Russian imitators. This effectively legalises intellectual piracy in a country already known for failing to adequately protect intangible assets”. Russia’s recent counter-measure opens up another loophole for the evasion of US controls.
Economic costs
The economic costs of technology fragmentation are significant. At the macro level, Diego A. Cerdeiro, Johannes Eugster, Rui C. Mano, Dirk Muir and Shanaka J. Peiris estimate “technological fragmentation can lead to losses in the order of 5 percent of GDP for many economies”. Based on their analysis of its effects on global trade volumes, sectoral misallocation effects, and lower international knowledge diffusion, “China usually loses the most in each scenario reflecting very large effects through the trade and sectoral-misallocation channels. Generally, some countries can gain in the scenarios without preferential attachment, as those countries act as partial substitutes for a hub – for example, India can help replace China for the United States or Germany on the margin.”. A breakdown in the relationship between China, Japan and Korea could “lead to the largest losses for China”. They highlighted their models did not account for “the potential effects from changes in foreign investment policies, to trade in services, and to industrial policies aimed at mitigating the productivity impact of the loss of access to foreign technologies”.
Antonio Varas, Raj Varadarajan, Jimmy Goodrich and Falan Yinug considered “two scenarios – one where each region pursues complete semiconductor self-sufficiency compared to more nimble, targeted investments aimed at filling strategic high-risk gaps to improve resilience in the overall global supply chain…a hypothetical extreme scenario, where each major region in the world looks to build up semiconductor self-sufficiency in a strict sense, across all layers of the supply chain”. “Aside from any considerations of execution feasibility, we estimate that at a global level such extreme scenario of regional autarchy would require a staggering $900 to $1,225 billion in upfront investment to cover each region’s 2019 consumption levels…amount is equivalent to about 6 times the combined R&D investment and capital expenditure of the total semiconductor value chain in 2019. In addition…the industry would incur $45 to $125 billion in incremental recurrent annual operational costs…In total, the new capacity that would have to be built in this extreme scenario is equivalent to 40% of the total existing global capacity – which suggests that the industry would face a situation of massive global overcapacity…fabs are very complex specialized facilities that typically take 2-4 years to build and put into commercial production, and require 3,000 to 6,000 staff to operate, mostly skilled technicians that need to be recruited and trained…replicate its own competitive domestic supplier for each of the over 30 types of semiconductors…replicate domestically its own EDA and core IP, as well as its own manufacturing equipment. We estimate that this will add $130-400 billion of upfront investment to cover between 5 and 15 years of start-up period R&D to develop the local technology prior to commercialization. These figures do not take into account any potential failed investments, such as companies that start R&D but do not succeed in developing a commercially viable product. In addition, the new local firms involved in these activities would face $33-105 billion in incremental annual operating costs – mainly in recurrent R&D…This total estimated $900-1,225 billion in upfront investment and $45-125 billion in incremental annual operating cost to build a series of fully domestic supply across each major region would all but wipe out the profits of the industry, which amounted to $126 billion across the entire value chain in 2019. Therefore at least a portion of the incremental costs would necessarily have to be passed on to device makers in the form of higher prices for the semiconductors they purchase. If fully charged to customers, it would amount to an average increase of 35-65% in the price of semiconductors. This may result in higher prices of the electronic devices for end users. Furthermore, it is also likely that siloed domestic industries shielded from foreign competition and deprived of global scale would lose in efficiency and ability to innovate. Ultimately, it would reverse the decades-long trend of making increasingly powerful and more affordable electronic devices accessible for consumers around the world. In conclusion, complete autarchy or full semiconductor self-sufficiency appears to be more a theoretical concept rather than an attainable policy goal”.
Antonio Varas, Raj Varadarajan, Jimmy Goodrich and Falan Yinug also project “that during the next decade China will add about 40% of the new capacity and become the largest semiconductor manufacturing location in the world…the key factor behind this trend is economics: the total ten-year cost of ownership of Ying a new fab located in the US is approximately 25- 50% higher than in Asia, and 40-70% of that difference is attributable directly to government incentives”. They estimate “a $20 billion to $50 billion federal government program of additional grants and tax incentives for new state-of-the-art fabs built in the next decade would be effective in beginning to reverse the declining trend in US semiconductor manufacturing of the last 30 years. For example, we estimate that a $50 billion incentive program would enable the construction of 19 fabs in the US over the next ten years, doubling the number expected if no action is taken. In contrast, a goal of complete self-sufficiency to cover the total US semiconductor consumption by 2030 with onshore capacity would require more than $400 billion in government incentives”.
In contrast, Antonio Varas, Raj Varadarajan, Jimmy Goodrich and Falan Yinug suggest a “market-driven, targeted $20-50 billion government incentive package would…enable the US to maintain minimum viable capacity for advanced logic chips, essential for national security and supply chain resilience” is a more attainable policy goal. “Covering just 9% of the total US semiconductor consumption, such targeted intervention is far removed from a large-scale industrial policy aimed at building a self-sufficient local semiconductor supply chain. We estimate that covering the expected domestic consumption of advanced logic chips for critical infrastructure applications by 2030 would require building just 2-3 new state-of-the-art fabs in the US – assuming new fabs with capacity between 20,000 and 35,000 wafers per month. This capacity addition is well aligned with market needs…less than 5% of the new advanced logic capacity that needs to be added globally to keep up with the expected demand growth in the next ten years. The presence in the US of existing advanced manufacturing infrastructure and most of the world’s leaders in design of advanced logic chips, which account for a large share of foundry revenues, is also a relevant factor that contributes to the viability of such investment. The new $20-50 billion government incentive program mentioned above would be critical to make the economics of such new advanced logic fabs in the US competitive with alternative available locations in Asia. We estimate that these fabs would require a $40-45 billion of private sector investment to build and operate over a 10-year period, together with $15-20 billion of government incentives – of which $9-10 billion would need to come from the new federal incentive program. The remaining new federal incentives would be applied to spur investment in new US capacity in other important areas besides advanced logic, including memories, analog and advanced packaging”.
The harmful economic effects of technology decoupling will be amplified by demand and supply dislocations. Alicia Garcia-Herrero notes “there are cyclical and structural reasons for the sharp increase in the demand for semiconductors. Cyclically, with so much labor and education shifting online, the pandemic has unleashed strong pent-up demand for electronic products. The stockpiling that we saw in 2021 has also resulted in transportation bottlenecks. Structurally, electrification, such as the mass production of electric vehicles, and digitalization need semiconductors, mostly of the high-end variety that can only be produced by the most advanced semiconductor foundries, which happen to be concentrated in Taiwan”.
Cheng Ting-Fang and Lauly Li notes “this new push by China has already begun to make waves in the global semiconductor industry, threatening to disrupt the delicate equilibrium between supply and demand. A global chip shortage has swept many industries partly due to panic buying by Chinese companies, spooked by the risk of U.S. sanctions…At the same time as they brace for shortages, however, the global chip industry is simultaneously making preparations for a massive glut of chips as Chinese companies like YMTC…double its monthly output of memory chips to 100,000 wafers by the second half of 2021, giving it 7% of the global NAND flash memory market…expect YMTC will start to affect the overall NAND flash market price by next year and the market may also face some oversupply issues.”
The Semiconductor Industry Association (SIA) estimates China’s semiconductor industry grew by 30.6% to reach annual sales of $39.8 billion or 9% of the global semiconductor market in 2020. This puts China ahead of Taiwan and only slightly behind Japan and EU, each with 10% market share. If China’s semiconductor can maintain 30% CAGR over the next three years, then SIA projects China’s annual revenue could rise to $116 billion by 2024. Its global market share would rise to 17.4% of global market share, placing China behind only the United States and South Korea.
SIA also notes “nearly 15,000 Chinese firms registered as semiconductor enterprises in 2020. A large number of these new firms are fabless start-ups…are developing advanced chips, designing and taping out devices on bleeding-edge process nodes. Sales of Chinese high-end logic devices are also accelerating, with the combined revenue of China’s CPU, GPU, and FPGA sectors growing at an annual rate of 128% to nearly $1 billion in revenue in 2020, up from a meager $60 million in 2015”. “SIA analysis further shows that in 2020, China held an impressive 16% market share in the global fabless semiconductor segment, ranking third after the U.S. and Taiwan, and up from 10% in 2015”. According to SIA, “China also maintains robust growth in building out its semiconductor manufacturing supply chain, with 28 additional fab construction projects totaling $26 billion in new planned funding announced in 2021”.
In addition, Caixin Global notes the global chip shortage, coupled with the race to deliver smarter services and products…more newcomers seek to gain a foothold in advanced chips to power new technologies – including the internet giants and device makers…The rising tide of in-house chip development poses threats to major chipmakers…Tech giants will focus only on certain types of chips that are most important to them, while more products will still rely on partnerships with chipmakers,
Alicia Garcia-Herrero notes “Taiwan Semiconductor Manufacturing Co. (TSMC) is raising its capital expenditure from $30 billion in 2021 to up to $44 billion in 2022”. Total Chinese investment to support indigenous innovation in the semiconductor industry “already stands at around $50 billion. This is bound to have an impact on chip supply down the road but very possibly only for less advanced semiconductors. Together with similarly large packages approved by the U.S. and the EU to support their own semiconductor industries, this may indeed result in long term oversupply, especially at the lower end of the industry”. Electronics contract manufacturing giant Foxconn has announced plans to invest in India to produce chips. At the higher end, “TSMC has announced its plan to further investment in the U.S. and Japan, and potentially Germany and the Czech Republic in the future”. “All in all, chip shortages will ease slightly in 2022 with more production in Asia, but a massive wave of new supply will be on stream in 2023. Given that the bulk of that production will only be for mature node semiconductors, only higher-end chips will face shortages…This means that the largest sector of the semiconductor industry may end up saddled with overcapacity. Instead, those producers shifting operations toward the higher end of the market, such as TSMC, will see their margins increase as demand continues to outstrip supply”. Overall, the current supply shortages are likely to be followed by over-supply when new plants come onstream. It remains to be seen how many of these plants, lured by government incentives, will be favour able to come onstream and achieve commercial viability.
Conclusions
Geopolitical tensions show no sign of easing. Instead, with the extension of technology export controls on Russia following its invasion of Ukraine, there are risks of escalation in the severity and scope of decoupling policies. There is no historical precedence, and therefore no guardrails, for tech decoupling. All seem fair in the quest for technological leadership and sphere fragmentation. In this tech obstacle race, advantage will likely change hands many times in a marathon without a visible finishing line and where no one can quite describe what the prize looks like except that is likely to be a lose-lose proposition for most.
There are many open-ended questions to consider on tech decoupling. Will spheres be walled off to the point where access and interoperability is minimal or porous to the point where controls are superfluous? How will the rules (including on intellectual property) and standards differ within a sphere and between spheres? How much room do tech companies and MNCs have to re-organise themselves to operate in both spheres? What would a technological détente look like?
At the end of the day, the fault is in treating technology leadership as a zero-sum game. This is absurd because the benefit of technology is that it creates abundance – a bigger pie that the world could share; and fairly if abundance was equitably managed. Decoupling or splitting the world into separate tech spheres will turn technology into a geopolitical contest to control information space that is more likely to create rather than solve problems.
References
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[1] See Mathieu Duchâtel “Technology transfers: The case for an EU-Japan-US cooperation framework”.
[2] See Mathieu Duchâtel “The weak links in China’s drive for semiconductors”. Institut Montaigne.
[3] From Sun Tzu’s Art of War.
[4] See Muhammad Zulfikar Rakhmat and Yeta Purnama on the benefits of Huawei’s digital talent programme in Indonesia.
[5] According to the Semiconductor Industry Association, from September 2020 to November 2021, Chinese wafer manufacturers added nearly 500K wafer per month capacities in trailing nodes (>=14nm), and only an additional 10K in capacity for advanced nodes. China’s wafer capacity increase alone accounted for 26% of the worldwide total. See “Global reset – Technology decoupling (Part 1: Challenges, checkpoints, chokepoints and IOT)”.
[6] See Rogier Creemers, Johanna Costigan, Graham Webster for a translation of Xi Jinping’s speech.
[7] Former Alibaba executive and theorist of social governance.
[8] See Tim Rühlig and Mathieu Duchâtel “Semiconductors in Europe: The return of industrial policy”.