On July 3rd 2023, China’s Ministry of Commerce announced it will be controlling Chinese exports of gallium and germanium effective August 1st, 2023. With this new licensing regime, China is responding to the US government’s (USG) weaponizing of semiconductor patents by weaponizing its own hold on rare elements and minerals. The nominal pretext, to “safeguard China’s national security and interests”, is taken straight from the US Bureau of Industry of Security (BIS) playbook.
Why gallium and germanium in particular?
In its Mineral Commodity Summary, the US Geological Survey found that China produced 98% of the total world output of elemental gallium in 2022 (540 out of 550 metric tons), an industrial “chokepoint” if there ever was one.
The US consumed 18 tons of gallium in 2022, importing ~10 tons from China,~5 tons from Germany and Japan, and the rest from other sources. Pure gallium metal is used to derive compounds like gallium-nitride (GaN) and gallium arsenide (GaA). These chemical compounds are used in various industries, notably, semiconductor wafer and microelectronics fabrication.
China has a looser but still significant hold on germanium production compared to gallium. Germanium cannot be considered a real chokepoint, however, because the US also refines germanium in Canada and maintain stockpiles for the Defense Industrial Base (DIB) under the Defense Logistics Agency (DLA). Second, the US Geological Survey notes that germanium is more readily substitutable and easier to recycle than gallium. The economic valuation of this proposition remains to be tested.
Can China choke the industrial supply chain?
The effectiveness of these market interventions can only be measured against a stated goal. Many have pointed out that the Chinese Commerce Ministry’s announcement a day before US Independence Day was symbolically motivated. More importantly, the announcement was reported to be part of a negotiation tactic before the US Secretary of the Treasury, Janet Yellen’s visit to China on July 9th.
The negotiation hypothesis must be considered in light of recent USG restrictions on China. Those include the expanded semiconductor restrictions of October 2022, the upcoming Dutch export restrictions (via US pressure) of Extreme Ultraviolet Lithography (EUVs) machines, and the rumored restrictions on Chinese access to US cloud computing services.
In effect, China may be hoping to deter the USG by punishment i.e., blocking access to precious materials, if the US does not relax its weaponization of the technology supply. The Chinese Ministry of Commerce could also escalate to include many other precious commodities under its jurisdictional control that are needed for the manufacture of electric vehicles.
China is no stranger to this style of aggressive mercantile diplomacy. In 2010, China blocked rare earth exports to Japan after the extended detention of a Chinese fishing boat captain. More recently, China also started curbing graphite exports to Sweden, a necessary input to the production of lithium-ion batteries. But this latest action, while expected, reinforces Washington’s theory that China’s leverage is likely overstated because it comes at a higher cost for China.
On the military side, American Defense Industrial Base firms especially those on China’s ‘undesirable entity list’ are likely expecting a presumption of denial. But on the economic side, a commodity ban is a broad hammer that will hit consumers globally and domestic producers in China harshly. Unlike targeted restrictions on Extreme Ultraviolet Lithographic equipment (EUVs), commodities can be substituted for by ramping up production in another jurisdiction or innovating around them. It will be slow and costly but inevitable.
While China’s controls will certainly impact but not choke industrial supply chains, the real question is, under what conditions will global manufacturers of semiconductor wafers be granted a license? I suspect the Chinese Communist Party (CCP) will likely end up erring on the side of saving face, and favor spiting Washington over making money. Authoritarian regimes cannot afford to look defenseless in the face of US hegemony, but if this really is a negotiation tactic, it will not succeed. The USG has too much institutional inertia, lobbying, and bipartisanship around the deeply misguided US high-tech containment strategy.
If the CCP is betting on making Chinese chips more competitive in the long run it is fundamentally misunderstanding what it takes to be competitive in high-tech manufacturing. The more China’s economy closes off, the more the talent and capital needed to stay competitive will flee. China’s latest crackdowns make for an unstable business environment. The market only cares about a clear roadmap for compliance and seems to have penalized the Chinese market for it. According to a recent report by Rhodium Group, foreign direct investment in China fell by 80% this quarter compared to last year. But even if investment outflows ended up temporarily outweighing those flowing in, China has a $3 trillion in reserves (minus gold) insurance policy.
After Russia’s invasion of Ukraine, the US has shown an increased willingness to weaponize the dollar. In a race to the bottom, China knows the US could sanction any global firm that trades with a would-be blacklisted Chinese semiconductor firm. This unfortunate scenario will likely depend on how quickly the high-tech trade war escalates or whether future negotiations somehow prevail. Everybody loses in a zero-sum game, but it seems China may lose more. It will take new US leadership and a significant rethink of US foreign policy to expect this momentum to change.
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Source: Internet Governance Forum