The US-China Tech War Entered a New Phase

Last October, US Secretary of State Anthony Blinken declared: “We are at an inflection point. The post-Cold War world has come to an end, and there is an intense competition underway to shape what comes next.  And at the heart of that competition is technology.” ¹ In other words, Mr Blinken announced that a new cold war with China has started.

At the core of the conflict is a rivalry over technological dominance. Leadership in AI technology is critical to the future of military and economic power. In 2015, China launched the ‘Made in China 2025’ strategy; the Chinese government announced that it would invest 150 billion dollars over the next ten years to build a domestic semiconductor industry and increase local content in semiconductor chips to 40% by 2020 and 70% by 2025.² China’s announcement sent shockwaves through the American defense establishment. In a few decades, Chinese firms may be able to produce more advanced microchips than those made in the U.S.. As a result, China may develop the most advanced missile, laser, or air defense systems worldwide, and possibly threaten U.S. national security.

To contain the Chinese advancement in this field, the U.S. is eager to use all kinds of economic pressure. However, the Chinese economy has become too large for the U.S. to impose traditional sanctions. In particular, financial sanctions would almost certainly backfire. Therefore, the U.S. has concentrated its efforts on the development of its technology sector.³

From Defense to Offense: A New China Containment Strategy

In fact, the Biden administration introduced strategies such as the CHIPS Act, expanding the ‘Made in America’ program, and lately announced unprecedented measures to cut off Chinese companies from advanced semiconductors made anywhere in the world with American equipment or know-how. As a result, the tech war between the two superpowers has now entered a new phase.⁴

With the new China containment strategy, the U.S. is departing from its free-market principles to mimic the same Chinese economic approach.

However, the Chinese approach has been far from successful. For example, the ‘Made in China 2025’ expands on prior government initiatives to promote innovation and relies on heavy government support for public and private investments in research and innovation and targets for local manufacturing content. Subsidizing and backing key industries and businesses distorts the market allocation of factors of production, prevents capital accumulation and destroys valuable resources. Developed economies are built on extremely complex and interconnected production processes, and China’s protectionist industrial strategy has resulted in lower imports of machinery and technology.

The US semiconductor industry does not require subsidies or trade protection. The US continues to lead the world in semiconductor sales and controls the top end of the whole supply chain.⁵ It was able to exert overall market domination over semiconductors because it specialized in ventures that are R&D intensive and profitable, like chip design and machinery. By contrast, Asian rivals to the US specialize mostly in labor- and capital-intensive stages of the value chain. In 2020, American businesses invested roughly $44 billion in R&D, more than any other nation’s semiconductor industry as a percentage of sales. By these standards, it cannot be argued that the US chip business is an ‘infant industry’ that requires protection from foreign competition. Rather, export controls to China would probably hurt their earnings, ability to innovate sustain long-term global leadership.⁶

Although China has reduced its tech gap with the West, it still lags behind. Chinese companies are technologically at least a decade behind their main competitors from Taiwan, the US, and Korea.⁷ President Xi’s aggressive intervention in the nation’s IT sector is stifling creativity and entrepreneurship, and the government’s use of resources to foster domestic innovation has been ineffective.

The costs of the U.S-China Tech War

China’s actions and its use of commercial advantage for geopolitical goals are definitely causing justifiable concern, which justifies some limitations on China’s access to cutting-edge Western technology. Nevertheless, strict regulations may have significant unexpected consequences. American companies will lose a profitable market. As a result, they might become more reliant on government handouts, making them less dynamic and innovative. To copy Chinese policies threaten to change the US industry to resemble China’s.

Furthermore, it would be very costly to entirely re-shore chip manufacturing in the United States. According to an estimate, fully self-sufficient local supply chains would require at least $1 trillion in upfront investment, $45 to $125 billion in additional recurrent yearly operational costs for the whole sector, and result in a 35 to 65 percent increase in chip pricing.⁸ It will get even worse if other allied states duplicate it, which is already happening with the European Union’s latest announcement to pass the EU Chips Act this year. The International Monetary Fund estimates that trade disruption, technological decoupling, and economic conflicts might cause a 5% decline in global GDP.⁹

Internal and international labor division and specialization are more advantageous than the protectionist approach. Interfering with international specialization in innovation and trade by the government will eventually lower capital accumulation, productivity, and living standards. Because of this, the US-China tech war can have no winners, but many losers.