America’s ‘once unthinkable’ chip export restrictions will hobble China’s semiconductor ambitions

China’s ambitions to boost its domestic chip industry has likely become magnitudes more difficult and costly after the U.S. launched some of its most wide-ranging export controls related to technology against Beijing.

On Friday, the U.S. Department of Commerce introduced sweeping rules aimed at cutting China off from obtaining or manufacturing key chips and components for supercomputers, in what is seen as a huge escalation in tensions between Beijing and Washington in the technology sphere.

America argues that such advanced semiconductors can be used by China for advanced military capabilities.

“There is no going back to the way things were,” Abishur Prakash, co-founder of the Center for Innovating the Future, an advisory firm, told CNBC.

“With the latest action, the chasm between the U.S. and China has now expanded to the point of no return.”

Here are some of the highlights of the new U.S. rules:

• Companies require licenses to export high-performance chips, usually designed for artificial intelligence applications, to China.
• Even foreign-made chips related to AI and supercomputing, that use American tools and software in the design and manufacturing process, will require a license to be exported to China.
• U.S. companies will be heavily restricted in exporting machinery to Chinese companies that are manufacturing chips of a certain sophistication.

“The latest chip rules are a sign that Washington is not trying to rebuild relations with Beijing. Instead, the U.S. is making it clear that it’s taking this competition more seriously than it ever has, and is willing to take steps that were once unthinkable,” Prakash said.

Semiconductors are some of the most important technology products. They go into everything from smartphones to cars and refrigerators. But they’re also seen as key to military applications and advancing artificial intelligence.

As geopolitical tensions between China and the U.S. have ramped up in the past few years, technology, and in particular sensitive areas like chips, have been dragged into the battle.

Artificial intelligence, quantum computing and semiconductors are all areas China has identified as “frontier” technologies it wants to boost its domestic capabilities in. But the new U.S. rules will make that extremely hard, particularly in the area of chips.

“The U.S. has formally shifted its goal from outpacing China in the semiconductor industry to actively denying it access to advanced chips,” Pranay Kotasthane, chairperson of the high tech geopolitics program at the Takshashila Institution, told CNBC.

“China’s homegrown chip sector will be hobbled by these extensive controls.”

The reason why the U.S.’s export controls could be so effective is how they could touch several parts of the semiconductor supply chain, even those not directly based in America or controlled by American firms.

That comes down to the global nature of the chip supply chain but also how power and expertise is controlled by very few companies.

The United States, while strong in many areas of the market, has lost its dominance in manufacturing. Over the last 15 years or so, Taiwan’s TSMC and South Korea’s Samsung have come to dominate the manufacturing of the world’s most advanced semiconductors. Intel, the United States’ largest chipmaker, fell far behind.

Taiwan and South Korea make up about 80% of the global foundry market. Foundries are facilities that manufacture chips that other companies design.

The U.S., however, still boasts strong companies in the area of design tools, many of which are used by other companies in the supply chain. For example, it’s unlikely that advanced chips manufactured by TSMC won’t have used American tools somewhere along the way. In this instance, the U.S. export restrictions to China will apply.

Washington has used this so-called foreign direct product rule before on the poster child of the Trump-era U.S.-China tech tensions — Huawei. Under those rules, Huawei was cut off from the most advanced chips that TSMC was manufacturing and that were designed for its smartphones. Huawei, which was once the number one player in the smartphone market, saw its handset business crippled.

But never has such a rule been used so widely by the U.S.

Meanwhile, other countries could be under pressure to not ship certain pieces of equipment to China. For example, the latest rules mean companies will need to get licenses to ship machinery to Chinese foundries if those facilities are making certain memory chips or logic semiconductors of 16 nanometer, 14 nanometer or below.

The nanometer figure refers to the size of each individual transistor on a chip. The smaller the transistor, the more of them can be packed onto a single semiconductor. Typically, a reduction in nanometer size can yield more powerful and efficient chips.

China’s most advanced chipmaker, Semiconductor Manufacturing International Co. or SMIC, is currently making 7nm chips, but not on a huge scale. It is generations behind the likes of TSMC and Samsung which have a roadmap to make 2nm chips.

But to make chips of this sophistication on a large scale, with lower costs and more reliability, SMIC and other Chinese foundries will need to get their hands on a specific piece of kit called an extreme ultraviolet lithography machine. The Dutch firm ASML is the only company in the world capable of making this critical piece of machinery.

If it falls under the U.S.’s export restrictions or comes under pressure from Washington not to sell to Chinese companies, this could hamper progress among the country’s chipmakers.

ASML underscores the complexities of the semiconductor supply chain.

“Semiconductor production is a hyper globalised supply chain. Being cut off from this engine will mean that Chinese companies must ‘reinvent the wheel’ domestically. China’s semiconductor industry will need much higher capital and talent infusion to absorb this shock,” Kotasthane said.

But this will be an uphill climb.

Kotasthane said that China will be able to make advanced chips even without ASML’s machinery “but the yield will be far lower, meaning higher costs and lower reliability.”

Meanwhile, Chinese firms will have to rely on “lower-end” domestic alternatives for design tools, Kotasthane said, which they would typically have gotten from American and Japanese firms.

Washington’s latest rules also require any “U.S. persons” to obtain a license if they want to support the development or production of semiconductors at certain China-based manufacturing facilities. This effectively cuts off a key pipeline of American talent to China.

“Reinventing the wheel will be far more costly now,” Kotasthane said.