WPenner's Blog

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THREAD: The US government's new export controls are wreaking havoc on China's chip industry.

New rules around "US persons" are driving an "industry-wide decapitation."

— Jordan Schneider (@jordanschnyc) October 14, 2022

I heard about this first from Peter Zeihan on October 12, but couldn't find the source he was quoting, so didn't want to believe it was true.
On Friday, that changed dramatically. A second Biden's executive order shutting down Chinese use of US chip technology is having immediate impacts, with many executives being pulled out of the country.

Biden's order forces Americans working in China to "pick between quitting their jobs and losing American citizenship."
The mass resignation of top American talent in the country has reportedly reduced the semiconductor manufacturing industry to "zero overnight. Complete collapse. No chance of survival."

There is a perception that China supplies the world's semiconductors, but according to Zeihan¹ their semiconductor capacity remains dependent on foreign countries for innovation, tech discovery, research, and investment. Design of advanced chips continues to come from the West (mostly the US) but also the primary production components and technologies like lasers. One or two companies in the US, the Netherlands/EU, or Japan and South Korea hold the patents for key technologies. While China produces a lot of chips, they are at the low end of the technology spectrum.

I'm told that a key mental model for understanding business in China is the idea of Fengkou (follow the tailwinds). ² The idea is that only being in the right time and place matters, no matter how talented a person is. Thus, market timing, not visionary individuals, create opportunities. With a stroke of a pen, Biden has turned semiconductors just turned from a tailwind into a headwind in China.

Of course, mental models can be as much of a trap as a help. One reason for the success of the West is that instead of following tailwinds, people routinely buck trends and set out in divergent directions. The motivations for this kind of response to the world stems from a wide range of causes, including conservatism, anti-authoritarianism, progressivism, and the pleasure of being contrarian. This rebelliousness turns out to be unprofitable most times (see the business failure rate, for example), but when it works, it drives the economy, and sometimes, the economy of the world.

Coming back to Zeihan for a moment, he points out that lacking foreign help with even basic things like run fabrication factories (fabs), China cannot continue the industrial output they have become accustomed to. Coupled with the inability to purchase high-end chips directly, many of the advances made in recent years and expected to be the foundation for the next 5-year plan, will either slow or stop. This includes areas like Internet of Thing (IoT), AI, supercomputing, supersonic flight, telecommunications, space exploration, and many others. Because Europe and Japan are cooperating with this ban, circumstances will lead China begging others for help, from South Korea and Taiwan in particular.³

China has followed the semiconductor tailwinds set by Western countries and companies for so long they seem unable to support themselves when the wind shifts. So rather than waiting to get swept along b y a favourable trend that can turn capriciously into headwind, it's a good day to get swept up in the effort of creating a new trend.