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YL Blog #71 – China’s Pursuit of Semiconductor Independence: US Foreign Direct Product Rule (FDPR) in Effect

Written By

  • Patrick Kurniawan Researcher at the Habibie Center and a Research Associate at the Center for Southeast Asian Studies (CSEAS), National Chengchi University

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China’s largest semiconductor manufacturing firm, Semiconductor Manufacturing International Corporation (SMIC), has reportedly succeeded in producing 5-nanometer chips for Huawei without the use of extreme ultraviolet (EUV) lithography produced by the Dutch semiconductor processing equipment company, Advanced Semiconductor Materials Lithography (ASML). Last year, Huawei made a groundbreaking announcement unveiling its latest flagship smartphone: the Mate 60 Pro. This revelation not only sent shockwaves throughout the smartphone industry but also sparked significant political repercussions. Huawei demonstrated to the rest of the world that it has the capacity to produce a flagship-tier smartphone featuring components almost exclusively from Chinese companies. However, there are many questions surrounding SMIC’s 5-nanometer chips and Huawei’s upcoming Mate 70 Pro. Since the Trump administration, the US has been attempting to curb China’s technological advancement by restricting Chinese firms’ access to advanced chips from the U.S. and its close allies. So how do these Chinese enterprises manage to manufacture and produce advanced chips and gadgets without American technology?  

China’s pursuit of self-reliance in the technology sector has been a longstanding objective of the Chinese Communist Party (CCP) for over a decade. Perhaps the most prominent manifestation of this effort is the Made in China 2025 initiative which boasts an estimated budget of over $300 billion spanning a ten-year period. The National Integrated Circuit Industry Investment Fund, better known as the Big Fund, has been injecting funds for key Chinese tech enterprises amid an escalating technology race and sanctions by the US.

While the concept of self-reliance holds great appeal for Chinese tech enterprises, it poses challenges for the US, which has enjoyed global dominance in the tech sector for decades. To counter China’s tech ascendancy, I argue that the US has adopted a multifaceted approach that includes both domestic and international strategies, leveraging chokepoint effects. Domestically, measures have been employed to incentivize or outright prohibit American semiconductor firms from selling advanced chips to or investing in Chinese tech firms. While the domestic chokepoint effect has been discussed often, this article will focus more on the US’ international chokepoint strategies.

Gregory C. Allen, the Director of the AI Governance Project at the Center for Strategic and International Studies (CSIS), outlined this phenomenon best by stating that “America’s greatest competitive advantage over China is not wealth or weapons, but the fact that America has a lot of close friends, and China has none.” In the world of semiconductors, several US allies have a major role and significant geopolitical importance in the semiconductor value chain. 

Traditionally, we have often regarded Russia and Saudi Arabia as key players on the global energy stage due to their substantial contributions to the world’s oil production. In 2022, Russia produced 11% of the world’s oil and Saudi Arabia accounted for a little over 12%. However, U.S. allies like Taiwan manufacture more than 90% of global advanced computer chips while Dutch’s ASML holds 100% market share for EUV lithography, the most advanced lithography machines which are a key technology to manufacture advanced chips. South Korea’s Samsung Electronics and SK Hynix are the world’s key suppliers of memory chips. Japan also holds a strategic position in semiconductor chemicals, packaging materials, and tools. These countries are not just indispensable parts of the semiconductor supply chain; they are geopolitical levers. Furthermore, as U.S. allies, these countries’ dominance in semiconductor production can be weaponized to halt China’s technological rise

The US has effectively propelled these companies to the forefront of the US-China tech war by capitalizing on their pivotal positions, extending the chokepoint effect well beyond American semiconductor firms. This strategic maneuver was made possible through the application of the Foreign Direct Product Rule (FDPR), which was originally introduced in 1959. In essence, the FDPR can be succinctly summarized: if a product is manufactured using American technology, the US government possesses the authority to prohibit its sale, even if the product is manufactured in a foreign country. To halt the growth of the Chinese tech industry, the US successfully identified that almost all chip factories contain critical tools from US suppliers. Hence, in August 2020, the Bureau of Industry and Security (BIS) expanded the FDPR control trade of chips made using US technology or tools, effectively cutting off Huawei from even accessing chips made in factories outside of the US.

Taiwan Semiconductor Manufacturing Company (TSMC) is one of these companies affected by the FDPR’s expansion; the world’s largest chip manufacturer made the difficult and costly decision to cease new orders from Huawei. This move was undoubtedly challenging, especially considering that Huawei ranks as TSMC’s second-largest customer. Foreign semiconductor firms like TSMC are now obligated to seek licenses, and any violations of the FDPR could expose these companies to significant penalties. Fortunately for TSMC, in 2022, the US granted a one-year license to allow the continuation of its market expansion in China. However, it’s important to note that this license does not provide TSMC with a waiver to assist its Chinese customers in producing advanced graphics and AI processors.

The situation involving ASML is notably more intricate than that of TSMC. The US has exercised its legal authority both in government-to-government relations and government-to-business interactions. Invoking the Wassenaar Arrangement of 1996, the US successfully convinced the Dutch government to suspend the export of EUV scanners. This action was justified on the grounds that these scanners were classified as dual-use goods and technologies. The US voiced concerns that China might exploit this technology for the production of advanced semiconductors with military and artificial intelligence applications.

From the government to the business side, ASML is also likely to be affected by the previously discussed FDPR. EUV lithography machines are at the top of the list of US government export bans against China considering the importance of this technology in the production of advanced chips. Earlier this year, the Dutch government partially revoked an export license for NXT:2050i and NXT:2100i lithography systems to China which prompted criticism from Beijing.

So how did China manage to acquire the technology to produce a flagship-tier smartphone in Huawei’s 60 Mate Pro? Well, this has been the subject of speculation. The new smartphone is powered by a new Kirin 9000s chip produced by SMIC. However, the production of such advanced technology relies on the use of cutting-edge EUV tools, which can only be obtained from ASML, as discussed earlier. ASML’s technology has been restricted because of the US FDPR bill.

Hence, this suggests two possibilities, each telling a completely different story about the current stage of the US-China tech war. In the first scenario, SMIC has either managed to manufacture advanced chips without EUV tools or created its working version of EUV tools. Fortunately for the West, this doesn’t seem to be the case. It is rumored that SMIC utilizes old deep ultraviolet (DUV) lithography machines, purchased before the sanctions, to produce 5-nanometer chips for Huawei. This method likely incurs higher manufacturing costs, making it tougher for Huawei to sell its Mate 70 series with a good margin, thereby they will struggle to compete with other smartphone manufacturers like Apple or Samsung. In most cases, such constraints would spell game over for a company, but Huawei stands in a unique position. It can leverage its access to a massive domestic market and substantial government subsidy packages to continue operating.

The second scenario however paints a different story, one that has been intensely advocated by Mike Gallagher, he states “This chip likely could not be produced without US technology and thus SMIC may have violated the Department of Commerce’s Foreign Direct Product Rule.” Gallagher does have a valid point considering China’s history with IP-related issues. If this scenario indeed proves to be accurate, I argue that the US FPDR policy has had a profound impact on China’s semiconductor industry. This impact has been significant enough to compel China to resort to underhanded strategies or to use outdated technology to circumvent trade restrictions amidst the ongoing US-China tech war.

That being said, I believe the US will seek to intensify its FDPR policy by further restricting access to other key American technologies. This could take the form of more stringent requirements for obtaining special licenses to sell to Chinese enterprises. Such measures will surely further isolate Chinese enterprises, ultimately affecting Beijing’s technological advancement and competitiveness.

Patrick Kurniawan is a Researcher at the Habibie Center and a Research Associate at the Center for Southeast Asian Studies (CSEAS), National Chengchi University

Disclaimer: All opinions in this article are solely those of the author and do not represent any organization.

Photo: The China and US flags on a processor unit. Source: iStock