The US Is Trying To Weaken China's Semiconductor Industry: Here's What China Is Doing To Fight Back In AI Race

In a bid to stymie China’s accelerating technological advancements, the U.S. government is considering stringent export restrictions on AI chips to China. The ban, potentially coming into effect as soon as next month, would require the likes of Nvidia Corporation NVDA and other chipmakers to obtain a license before shipping products to clients in China and other nations of concern.

With China and Hong Kong contributing about 25% or $7.1 billion to Nvidia's total sales in fiscal 2022, and an additional $8.5 billion in sales from Taiwan, the proposed restrictions could prove devastating for chipmakers.

The potential move is already causing waves in the industry, with the VanEck Semiconductor ETF SMH, Global X Robotics & Artificial Intelligence ETF BOTZ, and Pacer Data and Digital Revolution ETF TRFK expected to see volatility in the coming weeks.

The strategy isn't without controversy, either. Last month, Nvidia CEO Jensen Huang warned about the “enormous damage” such restrictions could cause the U.S. IT industry, pointing out that China could simply opt to build its own AI chips.

Read also: Nvidia, AMD Pull Back As Biden Administration Weighs Ban On AI Chip Exports To China: This Fund Tracks The Sector, Offers 3X Leverage

In fact, the restriction may be the catalyst China needs to bolster its own semiconductor industry, which it has been trying to do for some years.

What China Is Doing: As the largest consumer of semiconductors in the world, buying 53.7% of the global supply in 2020, China has thousands of semiconductor companies, according to The China Project. Yet it has struggled to dominate the industry due to its reliance on foreign suppliers and technologies for advanced semiconductors.

Amid escalating U.S. sanctions targeting advanced chipmaking, Beijing boosted its support for its domestic semiconductor industry, distributing more than 12.1 billion yuan ($1.75 billion) in subsidies to 190 locally listed semiconductor companies in 2022, according to South China Morning Post.

Significantly, the 10 largest recipients accounted for 45% of the payouts, receiving 5.46 billion yuan. Among them, China's largest foundry operator, Semiconductor Manufacturing International Corp (SMIC), was the leading beneficiary, with 1.95 billion yuan in subsidies.

Other recipients include Sanan Optoelectronics, a LED chip maker, which received 1.03 billion yuan, and Shaanxi-based chip packaging company Tianshui Huatian Technology, with subsidies totaling 467.1 million yuan.

Further, China established the National Integrated Circuit Industry Investment Fund, also known as the “Big Fund,” in 2014. The fund, which has invested in roughly 2,793 entities and holds a minority share in 74 companies, aims to make China a key player in the global industry.

What’s Next For China’s Chip Sector: Despite its efforts, China's share of the global chip design market is only expected to rise from 9% in 2020 to 23% by 2030, according to the Semiconductor Industry Association’s State of the Industry Report.

While China does have an advantage in packaging and testing, also known as outsourced semiconductor assembly and testing (OSAT), holding 38% of the global market in 2021, it has struggled to catch up in other areas, particularly in the wake of the U.S.’s campaign to curb sales of advanced technologies to China.

China's top five semiconductor firms — SMIC, HiSilicon, YMTC, UNISOC and Naura Technology Group — illustrate the country’s varying levels of success in the industry.

For instance, SMIC had been able to manufacture some 7-nanometer chips since 2021, a significant advance, according to The China Project. Yet with the imposition of U.S. export controls, SMIC will struggle to produce the chips at scale for several years.

Similarly, YMTC, China’s leading memory chip manufacturer, has faced ups and downs due to the export controls, despite having some initial success with its Xtacking technology.

The Last Word: While the future of China’s semiconductor industry is uncertain, the proposed restrictions by the U.S. may be the catalyst needed to spur China into developing its own advanced semiconductor technologies.

At the same time, investors should watch carefully for volatility in semiconductor ETFs with exposure to China.

Read next: Micron Technology, US Chipmakers Receive Invitation from Narendra Modi to Boost Semiconductor Production In India

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