Huawei’s U.S. Restrictions Expose a High-Tech Achilles’ Heel for China

China is heavily reliant on imported computer chips, despite efforts to develop its own semiconductor industry.

By Raymond Zhong

A Huawei store in Beijing. The company had stockpiled computer chips for emergencies like the trade restrictions announced last week by the United States.

BEIJING — For all of China’s efforts to become a global force in high technology rivaling the United States, it has mostly failed to produce top-flight contenders in one crucial area: the industry that gave Silicon Valley its name.
Last year, China imported more than $300 billion worth of computer chips, the backbone of all digital products. 

That is more than it spent on crude oil from abroad.
Washington has now turned China’s reliance on American microchips against Huawei, the Chinese telecommunications giant that is labeled a national security threat. 

The Commerce Department last week restricted American firms from selling components and technology to the company, essentially cutting Huawei off from Google software, Qualcomm chips and more.
The department said Monday that it would allow Huawei to continue doing business with American suppliers for 90 days to prevent disruption to mobile networks that use the company’s equipment. 

Yet Washington’s move still strikes at a national soft spot for China that has weighed on the minds of the country’s leaders for decades.
Desperate to reduce the dependence on imports, the authorities in China have pledged tens of billions of dollars to help foster homegrown chip champions. 

The country’s dreams of semiconductor hegemony have added to the trade tensions with the United States, which wants Beijing to scale back what it considers unfair government support for Chinese firms.
Washington has found reason to directly punish one state-backed chip maker, Fujian Jinhua Integrated Circuit Company. 

After Micron Technology, an American rival, accused the Chinese company of pilfering chip designs, the Commerce Department blocked it from buying American components.

Last year, China imported more than $300 billion worth of computer chips, the backbone of all digital products. That is more than it spent on crude oil from abroad.

The fruits of China’s chip drive have been mixed at best. 

Chinese firms’ market share remains modest in most areas of semiconductor production. 

Nearly all of the most complex chips must still be imported. 

Several Chinese state-backed makers of memory chips, which store data, have announced big production plans. 

But the global market for such chips is currently saturated, suggesting grim prospects for turning a profit.
On the whole, government support has helped the Chinese industry, said Gu Wenjun, chief analyst at ICwise, a semiconductor market research firm in Shanghai. 

“But now that the market has become overheated and fickle, the negative effects are increasingly apparent,” he said.
Local governments in China “don’t understand the industry,” Mr. Gu said. 

They are merely using up resources that private companies know how to spend more effectively, he added.
China’s role as the world’s leading assembler of electronics, and its vast consumer market for electronics, has convinced some observers that given enough time, the country would inevitably attract or foster the knowledge for producing advanced chips. 

If China could catch up in making toys and then in producing cellphones, the thinking goes, then why not in semiconductors someday?
For now, surviving without American chips promises to be the ultimate test for Huawei, despite the company’s recent strides in developing its own processors.
In an interview with Chinese media on Tuesday, Huawei’s founder and chief executive, Ren Zhengfei, said that in “peaceful times,” half of Huawei’s chips came from American companies, and the other half it developed itself. 

Huawei has stockpiled chips for emergencies like this, Mr. Ren said.
But the company could never entirely reject American technology, he said. 

Even members of his own family, he said, are iPhone users.
“We will not recklessly get rid of American chips,” Mr. Ren said. 

“We need to grow together.”
Beijing’s angst over foreign semiconductors has a long pedigree.
As Japan, South Korea and Taiwan emerged with formidable chip industries in the 1980s and ’90s, China experimented with various forms of state planning to develop its own abilities. 

In 2014, Beijing set a goal of becoming a global leader in all segments of the chip industry by 2030, and national and local government semiconductor investment funds began springing up across the country.
The results of those efforts are hard to spot, however, in the innards of leading Chinese tech companies’ products.
To crack open one of Huawei’s smartphones or cellular base stations is to see the extent to which advanced technology is a truly globalized endeavor, even as Beijing and Washington have come to distrust each other’s tech providers.
In Huawei’s new P30 Pro flagship phone, for example, American firms supply a number of key components, including parts that help process the radio signals that carry calls and data through the air, according to an analysis by System Plus Consulting, a research firm in France.
The P30 Pro’s memory chips are from Micron and the Japanese company Toshiba. 

The camera technology is from Sony of Japan. 

The processor, the brains of the phone, was developed by Huawei itself.
Huawei’s semiconductor division, HiSilicon, has surprised industry observers with the progress it has made in developing processors and baseband chips, which connect phones to data networks. 

Yet even HiSilicon may be affected by the Commerce Department’s restriction. 

Many of the leading providers of chip design software are American.
For other kinds of components, Huawei should not have much trouble finding non-American substitutes if it is fully cut off from American suppliers. 

In memory chips, for instance, Micron is a leading global supplier, but so are Samsung and SK Hynix of South Korea.
In general, the more advanced the silicon, the more likely it is that Huawei will have to compromise on quality to avoid American providers like Broadcom, which supplies specialized chips for Huawei’s data centers, and Nvidia, which makes high-end graphics processors for Huawei’s laptops.
The company’s options may also be limited when it comes to the critical components that help smartphones process radio signals. 

American companies, including Skyworks and Qorvo, lead the market for these “radio frequency” parts, which are technologically demanding to produce.
“It’s just very difficult unless this is your bread and butter,” Liam K. Griffin, Skyworks’s president and chief executive, said on a conference call this month with analysts. 

“We have years and years of experience here working with this.”

Chinese Peril

Decoding President Trump’s Plan to Rein In China
By SUI-LEE WEE

President Trump introducing the White House’s national security report in Washington on Monday. The report included details of China’s rising technological prowess.

BEIJING — It isn’t just about missiles and militaries anymore.
President Trump’s national security blueprint released on Monday lumped economic challenges posed by the United States’ foreign rivals, particularly China, with the sort of traditional notions of national security that have long driven American policy.
Much of the document focused on brewing disputes between Beijing and Washington over emerging industries of the future — and who will control them.
Trade disputes between China and the United States are nothing new.
But couched in the technical terminology and bureaucratic jargon is a fight over the new ideas that could shape industries and economies for decades to come.
Here’s how to read Mr. Trump’s national security plan, and what it means.

Intellectual Property Is King
“Every year, competitors such as China steal U.S. intellectual property valued at hundreds of billions of dollars. Stealing proprietary technology and early-stage ideas allows competitors to unfairly tap into the innovation of free societies.”

For years, the United States battled China over pirated movies and counterfeit sneakers.
Today, the stakes are bigger.
Businesses and Trump administration officials are expressing increasing concern about China’s efforts to buy up technologies and ideas abroad. 
China’s hope is to become largely self-sufficient in crucial technologies like semiconductors, artificial intelligence and electric cars, both to upgrade its economy and to free itself from technological dependence on the West.
To get there, Beijing has unveiled its “Made in China 2025” program, an ambitious plan to foment homegrown firms that will compete with American companies with the help of state support and cheap loans.
Western businesses complain that, to do business in China, they are required to form joint ventures with Chinese companies, or to otherwise share technology with Chinese partners who may someday become rivals. 
And the Pentagon has warned that China is taking stakes in innovative American start-ups.

Deals Get a Closer Look
“While maintaining an investor-friendly climate, this Administration will work with the Congress to strengthen the Committee on Foreign Investment in the United States (CFIUS) to ensure it addresses current and future national security risks. The United States will prioritize counterintelligence and law enforcement activities to curtail intellectual property theft by all sources and will explore new legal and regulatory mechanisms to prevent and prosecute violations.”

The Committee on Foreign Investment in the United States is a panel that reviews proposed deals between an American company and a foreign buyer on the grounds of national security and makes recommendations to the president.
But critics say the panel should extend its mandate and assess deals based on economic security concerns.
In its annual report to Congress this year, for example, the US-China Economic and Security Review Commission, a group created by Congress to monitor relations between the countries, said that Washington should block Chinese state-owned enterprises from acquiring American companies.
One particular sector that has been in China’s sights is the semiconductor industry, a linchpin of Made in China 2025.
For years, Chinese companies have tried and failed to buy stakes in or to acquire entire American semiconductor companies, such as Fairchild Semiconductor, Micron Technology and Lattice Semiconductor. 

Watching Its Citizens
“China combines data and the use of AI to rate the loyalty of its citizens to the state and uses these ratings to determine jobs and more. Jihadist terrorist groups continue to wage ideological information campaigns to establish and legitimize their narrative of hate, using sophisticated communications tools to attract recruits and encourage attacks against Americans and our partners.”

First unveiled a decade ago, China aims to roll out a nationwide social credit system by 2020 that aims to reward trustworthy individuals but put perceived miscreants on a blacklist.
By giving each citizen a credit score based on a range of behaviors such as abiding by traffic laws and paying fines, the government aims to “create an honest and faithful society”.
As part of the plan, which has been introduced in several cities, China’s top court maintains an online blacklist of people who are unable to pay their debts.
People on the list are barred from taking flights, trains or making big purchases.
Human rights groups have criticized the system, saying it has been used unfairly on rights lawyers and investigative journalists and that the penalties are arbitrary.

Globalization 2.0
“Although the United States seeks to continue to cooperate with China, China is using economic inducements and penalties, influence operations, and implied military threats to persuade other states to heed its political and security agenda. China's infrastructure investments and trade strategies reinforce its geopolitical aspirations.”

China’s “Belt and Road Initiative” is a central part of Xi Jinping’s economic and geopolitical strategy to increase the country’s sway by building infrastructure projects such as railways and ports across Africa, Asia and Europe.
Beijing has pledged to support $1 trillion in infrastructure projects that would span 60 countries.
In so doing, Xi is trying to rewrite the global economic order — an adviser to the government called the plan “the new globalization 2.0” — drawing companies and countries into Beijing’s embrace.
The plan has left some countries increasingly concerned about becoming too dependent on China. The United States and many of its major Asian and European allies have taken a cautious approach to the project, wary of becoming too beholden to China’s strategic goals.
Some, like Australia, have turned down Beijing’s overtures to sign up for the plan.

Chinese Peril

Obama left a departing gift Trump actually might want: a road map for countering China's plans to dominate the semiconductor business.
By William McConnell
A big part of President Donald Trump's economic message during the campaign was his promise to get tough on China, which he singled out for drawing jobs from the U.S. with the lure of cheap workers and generous government subsidies and for erecting trade barriers that favor exports from that country over imports.
If he wants to fend off threats, he might send his White House staff searching for a Jan. 6 report issued by Barack Obama's White House science officers. 

The web link to the report, which recommended steps U.S. officials can take to protect the U.S. semiconductor industry, no longer works, no doubt because of the new president's zeal to scrub all things Obama from the White House's communications outreach. 

A link to copy from The Deal, owned by The Street, is here.
But Trump would likely be receptive to the report's theme: that China's industrial policy designed to quash the U.S. lead in the global semiconductor market and place itself in that role is a threat to U.S. economic and national security and the U.S. should counteract those efforts.
Regulators' wariness of semiconductor sector acquisitions by buyers with Chinese ties already has killed many recent deals. 

But, typically, the challenges are targeted at only deals involving products sold to the military or that are critical to the U.S. telecommunications infrastructure. 

Fujian Grand Chip Investment Fund LP on Dec. 8 dropped its €670 million ($717.5 million) bid for German chipmaking equipment supplier Aixtron SE after Obama said he would block the Chinese investment fund from acquiring the Aixtron's U.S assets. 

Lam Research Corp. and KLA-Tencor Corp. spiked their $10.6 billion merger in October due to an extended investigation by the Committee on Foreign Investment in the U.S. 

In January 2016, Royal Philips NV backed out of its $3.3 billion agreement to sell its Lumileds lighting components business to a Sino-U.S. consortium, citing opposition by Cfius. 

Others deals halted under U.S. government threat include Fairchild Semiconductor International Inc.'s $2.46 billion takeover offer from China Resources Microelectronics and Hua Capital Management, China's Unisplendour Corp. Ltd planned investment in Western Digital Corp., and Tokyo Electron Ltd.'s 2015 effort to acquire Applied Materials Inc. for $9.4 billion.
It's not as if semiconductor deals involving Chinese buyers can't get done. 

In December 2015, GlobalWafers Co., Ltd. was cleared for its $683 million acquisition of SunEdison Semiconductor Limited, and three other semiconductor-related deals involving Chinese and other foreign buyers were approved in 2015: Globalfoundries Inc.'s acquisition of IBM Corp.'s microelectronics business, NXP Semiconductors N.V.'s $1.8 billion sale of its RF Power unit to Jianguang Asset Management Co. Ltd. and Integrated Silicon Solution Inc.'s acquisition by Uphill Investment Co.
According to the report, economic threats should be added to the list of national security concerns that could result in an acquisition of U.S. assets by foreign buyers being blocked by Cfius, particularly if the buyer's home country (China) is violating international trade agreements. 

Under the Obama administration's plan, the U.S. would only expand the definition of national security threat to take much more widespread action blocking deals involving China when the negotiated rules have been violated. 

The report hinted that China's noncooperation on economic and trade issues would provide more proof of a national security threat. 

Trump's only real reservation about the plan might be to quibble with the some of the steps Obama's team recommended as being too plodding and requiring naive faith in China's willingness to negotiate and follow a set of rules governing such issues as each countries' import restrictions and use of government subsidies.
China has stated that it intends to have "advanced world-level" semiconductor capability in all segments of the industry by 2030. 

Its government has committed $150 billion over 10 years to subsidize investment and acquisition and also conditions access to its market on local production and technology transfer.
Coupled with these initiatives, China's gambit is timed to take advantage of the fading phenomenon of Moore's Law, the expectation that the semiconductor industry will double the number of transistors on a chip every 18 to 24 months. 

That pace is much harder to keep up today as industry R&D is spread across more numerous types of products. 

Because semiconductor technology is advancing more slowly, it is now easier for China to narrow the gap in its capabilities, according to the report.
Anne Salladin of Stroock & Stroock & Lavan LLP said the report could launch an important conversation within the Trump administration.
"Cfius is intended to deal with acquisitions on a transaction-by-transaction basis," she said. 

"This is an inexact tool for dealing with repeated purchases by a determined government like those we have seen over the past year," she said. 

While the CFIUS process is designed to prevent deals that could put a specific military or telecom technology in the hands of a hostile government, the statutory criteria it relies on to challenge a transaction were not designed to prevent a string of acquisitions that could supplant U.S. economic leadership bit by bit.
Trump, however, is unlikely to adopt the report without making major revisions, particularly to recommendations urging U.S. and Chinese officials to engage first in dialogue to agree in principle to measures that are reasonable for protecting national security. 

Under the Obama administration report, if China fails to adhere to these agreed-upon norms, one way that the U.S. could respond would be to allow China's policy to affect national security threat assessments of Chinese acquisitions. 

"On its face, it seems as if the report's goals would be aligned with President Trump's, but certain recommendations in the report are not necessarily a blueprint for action. These recommendations rely on norms agreed to by the two countries," Salladin said. 

"That process could take time to put in place and would not immediately apply higher scrutiny to deals."