China Is Losing the Chip War

In an April phone conversation, Chinese leader Xi Jinping issued a stern admonition to President Joe Biden. Washington’s ban on the export of American advanced microchips and other sanctions designed “to suppress China’s trade and technology development” are “creating risks.” If Biden “is adamant on containing China’s high-tech development,” the official Chinese readout went on, Beijing “is not going to sit back and watch.”

Biden has been robust in his response. The ban, he told Xi, was necessary to protect American national security. “He said, ‘Why?’” Biden recently recounted. “I said, ‘Because you use it for all the wrong reasons, so you’re not going to get those advanced computer chips.’”

Imagine for a moment how humiliating that exchange must have been for Xi Jinping. Xi is not supposed to suffer such indignities. His propaganda machine portrays him as an all-knowing sage who will lead China to a new era of global greatness. His word is practically law, and such a warning as he gave Biden would have induced fear and obedience among his compatriots. Yet the American leader not only stood firm; he even went on to lecture the Chinese dictator.

Xi is only too aware that the United States stands in the way of his grand ambitions for Chinese hegemony. His desperate desire to break free from American global power motivates much of his policy: his partnership with Russian President Vladimir Putin, his campaign for economic self-reliance, the expansion of China’s nuclear arsenal. As yet, though, China can’t shake off Washington’s sway. China still needs the dollar, American capital, and the U.S. global-security system to sustain its own rise.

And perhaps nothing encapsulates Xi’s predicament better than the microchip. Xi needs the smallest and fastest chips to fulfill his dream of transforming China into a technology powerhouse. But China doesn’t make them. Nor does China make the immensely complex equipment needed to manufacture them. For that, Xi must rely on the U.S. and its allies—and their willingness to share the technology.

But those nations are no longer willing. Amid intensifying competition, Biden exploited American dominance in semiconductors to gain an advantage and hold back China’s technological and economic progress. The chip tells us a lot about the true balance of power between the U.S. and China, and the difficulties Xi faces in his efforts to tip that balance his way.

Xi gambled that he could partner with Russia and Iran, undermine the U.S.-led global order, and build a military designed to challenge American power—do all that and still benefit from the U.S. technology the Chinese economy needs to advance his ambitions. Perhaps he believed that capitalist greed would override national-security concerns, or thought he could rely on inaction from a divided and preoccupied Washington. Perhaps, too, he underestimated the complexities of the semiconductor industry and what it would take to develop the chips China needs.

Whatever Xi’s assumptions, he picked a chip war with a superior power before he had the armory to wage it.

[Michael Schuman: China has gotten the trade war it deserves]

China has been catching up with the U.S. and other advanced economies in many sectors, including telecommunications, green energy, and high-speed trains. In semiconductors, however, China still lags. American companies command half of the global chip market compared with China’s 7 percent, according to the Washington-based Semiconductor Industry Association in 2023.

The U.S. advantage is most pronounced at the technology’s frontier: the powerful chips that drive the industries of the future, such as artificial intelligence. The newest AI chip developed by the U.S. giant Nvidia is 16 times faster than the one currently sold by the Chinese telecom company Huawei Technologies.

The lead held by the U.S. and its partners over China is even wider in the equipment needed to manufacture advanced chips. The best machinery a Chinese company can produce makes chips that are 28 nanometers wide; the industry’s cutting-edge equipment can make 2-nanometer chips.

Closing this gap was always going to be tough for China. Semiconductors are very challenging to manufacture, which is why only a handful of companies around the world excel at doing so. Biden made the task even more onerous. In 2022, his administration barred U.S. companies from selling the most advanced chips and chip-making equipment to China without a special license, effectively isolating the Chinese tech sector. Biden also persuaded its allies Japan and the Netherlands—the two other leading sources of semiconductor machinery—to introduce their own bans. The Biden controls also prevent other foreign chip-making firms that use U.S. technology, such as the industry leader Taiwan Semiconductor Manufacturing Co., from producing advanced chips for Chinese firms.

The export controls “target all segments of the semiconductor value chain simultaneously,” Gregory Allen, the director of the Wadhwani Center for AI and Advanced Technologies at the Center for Strategic and International Studies, told me. That’s why Xi will find Biden’s policy “extremely difficult to overcome.”

The White House stresses that the controls are meant not to impede Chinese economic development but to ensure American security. Advanced chips can be used to upgrade Chinese military capabilities, which is obviously contrary to Washington’s interests. But the controls will also have a wider, potentially damaging effect on China’s tech sector, and thus the country’s economic future. They could, for instance, hamper progress in AI by depriving Chinese firms of the fastest chips.

Xi’s warning to Biden was merely his latest attempt to get the controls lifted. His government has protested them as unjust and tried to make their removal a condition for improved relations. A day after the ban was announced, China’s foreign ministry accused Washington of “abusing export-control measures to wantonly block and hobble Chinese enterprises.” The spokesperson went on to argue that “by politicizing tech and trade issues and using them as a tool and weapon,” the U.S. “will only hurt and isolate itself when its action backfires.”

Biden’s response was to place even tighter restrictions on the sale of AI chips to China last October. The Chinese can keep protesting, but “there is nothing they can say that will make a difference,” Allen told me. “These export controls are not designed to be part of some tit-for-tat horse trading.” Instead, he said, “they are designed to work.”

And they do. The restrictions on chip-making equipment have very likely prevented Chinese companies from producing super-small semiconductors for the immediate future. The loss of American AI chips is probably also slowing the advance of large language models and other AI development in China.

The longer these controls remain in place, the more painful they will become. As the U.S. chips and equipment that China does have become obsolete and cannot be replaced, its companies will have an even harder time competing with American rivals for the fastest and best technology.

“Export controls are like throwing a wrench in the gears of China’s chip industry,” Jimmy Goodrich, a senior adviser to the Rand Corporation on technology and China, told me. Over time, China will encounter “more and more challenges in maintaining the pace of innovation,” he said, “and with the rest of the world moving quickly on the innovation ladder, there will be a larger and larger gap” between the Chinese and American tech sectors.

[Read: The U.S. has a microchip problem. Safeguarding Taiwan is the solution.]

Xi’s only way to slip Washington’s grip is for China to manufacture the technology itself. A decade ago, he launched a campaign to replace chips brought from American companies by developing a homegrown semiconductor industry, and his government has spent hundreds of billions of dollars to make that happen.

Yet Xi has fallen short. In 2015, he set a target of making China 70 percent self-sufficient in chips by 2025, a goal he probably won’t come close to meeting. The usually boastful Communist Party–run news outlet Global Times projected that self-sufficiency reached 30 percent last year.

Production targets alone are almost meaningless; the bigger question is whether China can manufacture cutting-edge chips. On that, Beijing has made progress. For the first time, Huawei this year caught the wary eye of Nvidia, which designated the Shenzhen-based company a “competitor.” And last September, Huawei created a stir by unveiling a new smartphone, the Mate 60 Pro, that has an advanced, 7-nanometer chip—a breakthrough for China. The Chinese public, egged on by state-controlled media, heralded the phone as a nationalist triumph. An image of U.S. Commerce Secretary Gina Raimondo (who is responsible for implementing the export controls) doctored to show her as a Huawei brand ambassador was passed around on Chinese social media.

In fact, the Huawei chip demonstrated how effective Washington’s sanctions are. The 7-nanometer chip still trails the global industry. Taiwan’s TSMC is already mass-producing a 3-nanometer chip. Huawei’s touted triumph was even a step backwards. Five years ago, the company, which has been under U.S. sanctions that came into effect in 2019, was getting a 5-nanometer chip from a partnership with TSMC.

But now cut off from TSMC’s services, Huawei has been forced to produce inferior chips in Chinese foundries that are unable to manufacture more advanced chips. In response to my questions, the company did not comment on the specifics of its chip operations but acknowledged that “we still have serious challenges ahead,” and it noted that “technology restrictions and trade barriers continue to have an impact on the world.”

Facing this technology deficit, Xi’s state-heavy methods offer no guarantee of breakthroughs. One of the main investment programs, known as the Big Fund, has been embroiled in corruption scandals—several of its managers are subject to a highly embarrassing anti-graft investigation. In addition, the subsidies have encouraged Chinese companies to build factories that manufacture legacy chips, using older technology, and has led to fears that China could flood the global market, leading Biden to announce in May that the U.S. will double the tariff on imported Chinese semiconductors from 25 to 50 percent by next year.

Perhaps the most damaging error of Xi’s preference for state control is to undermine innovation in China’s private sector. In his quest to consolidate power, Xi has harassed prominent tech companies and entrepreneurs, including Alibaba founder Jack Ma. That hostile environment in Xi’s China is competing with a talent-rich, firmly established, and well-remunerated ecosystem in the U.S., where innovation is driven by entrepreneurial zeal.

Xi has instead fostered a business climate in which “you don’t want to be too successful,” Andrew Harris, the deputy chief economist at the U.K.-based research firm Fathom Financial Consulting, told me. “There is always this implicit option that the state can requisition your technology,” and that acts as “a massive disincentive” to be creative.

China may never match, let alone surpass, the United States in chips. By the time Chinese companies reach one goal, their foreign competitors have moved further ahead. “That’s constantly a struggle that any latecomer has to deal with,” Rand’s Goodrich told me. “You’re trying to close the gap, but the gap is constantly moving forward.”

A recent report by the Semiconductor Industry Association and Boston Consulting Group forecasts that China will manufacture domestically only 2 percent of the world’s advanced chips in 2032. “Ten years ago, they were two generations behind. Five years ago, they were two generations behind, and now they’re still two generations behind,” G. Dan Hutcheson, the vice-chair of the research firm TechInsights, told me. “The harder they run, they just stay in place.”

[Michael Schuman: Why Biden’s block on chips to China is a big deal]

In Beijing’s telling, Washington’s actions are those of a rich hegemon keeping its boot on the throat of a poorer nation pursuing its own development. But the reality Xi faces is that the U.S. has no obligation to share its technology with other countries—and that’s especially true of China, which has become a more and more adversarial competitor.

Now China faces the daunting task of building a single-nation chip supply chain in an otherwise highly globalized industry. That the Chinese economy can excel at every link of that chain seems highly improbable. Goodrich believes that the cost of trying to do so could run to $1 trillion. Lacking their competitors’ equipment and experience, domestic producers would operate at higher cost and less efficiency, and so could export only with continued, heavy state subvention. Already, Hutcheson estimates that advanced chips cost as much as five times more to make in China as those manufactured by Taiwan’s TSMC.

Xi’s strategy has little economic rationale—in fact, he has made China’s economic progress harder than it had to be. “The sense it makes is from a national-security perspective,” Hutcheson said. But that’s true only because Xi’s premise is that cooperation with the U.S. is contrary to China’s national interests. The evidence available so far from the chip war suggests that China’s continued ascent would have been better served if Xi had maintained a partnership with Washington.

Instead, China must bear the immense financial burden of re-creating at home what it could have acquired abroad—and even then, it is not likely to benefit as much as it could have from emerging technology compared with other major economies with access to the best the world has to offer. Xi not only has hampered Beijing’s attainment of great-power status, but has actually achieved the reverse: By choosing a China hostile to the U.S., he now leads a weaker China.