International trade lawyers

After the trade talks with China broke down, the PRC government immediately announced measures designed to support the development of Chinese semiconductor manufacturing. On May 8, the State Council under the guidance of Li Keqiang announced it would extend a long standing series of Chinese government policies supporting the development of the domestic PRC chipmaking capabilities. This group of policies is just the type of Made in China 2025 subsidy measures that have been at the core of the U.S. dispute with China. In fact, it has been reported that failure to resolve the subsidy issue is the primary reason the trade agreement collapsed. See Trade talks face moment of truth as US pushes China on subsidies: Beijing’s state support for core industries remain as sticking point in negotiations. So in other words, in response to U.S. complaints, China decided immediately to report that it would go full speed ahead on a collision course with the U.S.

To clarify, chip promotion policies are typical of the Made in China 2025 program. There are three core elements, all of which critics of China deem unacceptable:

1. Chinese chipmakers receive a tax benefit. The basic plan for general chipmakers is no taxes for 2 years and a 50% reduction for 3 years. For chipmakers that can break the 9 nanometer barrier, there will be no taxes for 5 years and a 50% reduction for 5 more years. This plan was initiated in 2011 in the (国务院关于印发进一步鼓励软件产业和集成电路产业发展若干政策的通知) here. The State Council apparently plans to extend the benefits of this old plan.

2. Creation of the government controlled and funded China National Integrated Circuit Industry Investment Fund (国家集成电路产业投资基金) under the lead of CBD Capital, a wholly owned subsidiary of China Development Bank. The plan of the fund is to invest billions in chip manufacturing R&D and manufacturing capacity. This fund was created in 2014 and it did a second round of fundraising in 2018. See China invites overseas investors to propel local chip ambitions.

3. Overal planning and control exercised by the central government. This plan is outlined in the State Council Guideline for the Promotion of the Development of the National Integrated Circuit Industry which was issued in 2014.

As you can see, The PRC semiconductor program is a textbook case of all the U.S. finds objectionable with China’ high tech industrial policy: central government direction and control, subsidies in the form of tax breaks and funding from central government sources (funding with “strings attached”).

What this means is that in the face of the failure of the trade negotiations and the subsequent Huawei Entity List sales ban, the PRC has “doubled down” on its Made in China 2025 subsidy program. Not only will the PRC not back down on the subsidy program, the notice from the State Council makes clear China will in fact redouble its efforts to ensure that the program meets its intended goal. This basic policy position was made clear in a recent announcement from Wang Zhijun of the Ministry of Industry and Information Technology (MIIT). Wang announced that the Chinese government will continue its support of its domestic chip industry and will expand that support to software and the high tech sectors. Mr. Wang announced that China welcomes the Huawei ban as a push from the U.S. on reviving the chip design and production program: “To offset the possible implications of the ban, the ministry said it would this year introduce a two-year waiver on corporate tax payments for software developers and integrated circuit manufacturers, and reduce the rate on subsequent payments to 12.5 per cent over the next three years.”

As the South China Morning Post concluded after reporting the comments of Mr. Wang, “Beijing’s role within Chinese industry, in particular its financial support for the state sector, has been a major sticking point in the trade negotiations between the world’s two largest economies. Washington complains it puts US companies at a disadvantage, but Beijing says the matter is one of principle and it has no plans to change.”

We can draw two conclusions from the current situation that are commonly missed in the United States. First, China will not change its economic policies. China as a “systemic competitor” will not change. Second, those policies have failed and will continue to fail.

First, it has never been possible the PRC government would make any substantial changes to its technology support and subsidy programs. It has been reported that the U.S. negotiators included eliminating China’s subsidy programs as an integral feature of any trade agreement. It has been reported that the failure of the trade agreement was primarily based on China’s refusal to bend on this issue.

This shows that if the U.S. trade negotiators made a change in the fundamental structure of the Chinese system as a core condition, the trade negotiations were dead in the water from the start. It was never possible the PRC would back down on its subsidy policy. The three features I note above concerning the semiconductor plan are an integral part of the way it works in the PRC government and in the PRC economy.

This approach by the U.S. is a symptom of a fundamentally failed approach to China. The failed approach is the idea that after its accession to the WTO, the PRC would gradually transform into an open, market oriented system along the lines of the U.S., Europe and Japan. The policy is what the Germans (and much of the EU as well) call “change through trade.” See EU’s China policy is no longer just carrots. That policy failed. That failure is permanent. Ten years ago, many believed China would change. Few believe that now and that is why so many who have dealt with China for 10+ years are so frustrated. Fool me once….

The proper way to look at China is the approach taken by German industry in its recent report on China issued in January, 2019.  In the Report, China is identified as “systemic competitor” to the open market economies. As the Report states:

For a long time it looked as if China would gradually move towards the liberal, open market economies of the West by integrating into the world economy and reshaping its economic system. This theory of convergence is no longer tenable. China is no longer developing structurally in the direction of a market economy and liberalism but is in the process of consolidating its own political, economic and social model. At the same time, China as an emerging economic power is shaping other markets and the international economic order. The Chinese model of an economy marked by substantial state control thus enters into systemic competition with liberal market economies.

The Report concludes that China has developed an integrated set of policies in direct opposition to and competition with the liberal open market system. Countries with open market systems must deal with China’s policies as they are and without any hope those policies will change. This characterization of China a systemic threat is a remarkable change for German industry which had until 2019 been reluctant to speak out against the Chinese system. See Germany Industry Comes Clean on China  

Second, it is critical to note that the policies that have been “revived” by the China’s State Council and the MIIT are longstanding China policies that have been in place for more than 15 years. The tax breaks go back to 2011. The government development plan and the chip fund go back to 2014. These are not new policies. These are old policies being revived to face the same problems that existed back in 2011.

Stated bluntly, China is reviving a set of policies that completely failed. As James Lewis bluntly stated in a recent report, “despite 40 years of effort, investment, and espionage, China is unable to make advanced semiconductors.”(See China’s Pursuit of Semiconductor Independence. The tax breaks were a scam, as they always are in China. The chip fund investments, if they were made, were a waste of money. The brutal fact faced by the State Council and the MIIT is that China has made no meaningful progress on chip manufacturing over the past two decades. China makes cheap memory chips, but sophisticated chips still come from Taiwan. China has made little to no progress on chip design. Without design technology from ARM and testing technology from various U.S. companies, no Chinese entity (Huawei included) has any real hope of building a new advanced chip. China is stuck with bulk memory chips or copies of foreign designs. .

The whole policy has been a colossal failure and the Chinese authorities know this. The reports of revived and redoubled efforts are typical of the Chinese bureaucracy: don’t worry, we will do it right THIS TIME. But they won’t. So we should view the PRC for how Germany describes it and how pretty much everyone in the semiconductor industry sees it: a systemic competitor that cannot compete in the world of high technology. Low end, low margin, high volume manufacturing is the world from which China seeks to escape. Nothing from its recent announcements (or the realities on the ground) suggests this escape will ever occur. This means that as the U.S. accelerates cutting Chinese companies off from U.S. technology, the impacts will be far more severe than is generally understood. The Chinese authorities know this. But they are in a box from which there is No Exit.

Like it or not the Cold War between the United States and China (and soon Europe and China as well) is here and if you are not already looking to have your products made somewhere other than China — might we suggest Thailand or Vietnam or Taiwan or Mexico or the Philippines or Indonesia or wherever — you should start. See The US-China Cold War Starts Now: What You Must do to Prepare.