The US may tighten export controls on European and Asian companies to prevent China from leveraging old chip technology. It is a bad idea.

The post No Carrots, Just Sticks: US Bullying Allies on China Chips appeared first on CEPA.

It is a stark ultimatum to two close US allies: stop selling and servicing your chipmaking technology in China or we will cripple your industry.

Unless Japan and the Netherlands restrict China’s access to previous-generation machines, the US reportedly could enforce existing — but so far unused — export controls that bar the sale of goods containing even minuscule amounts of American technology. The threat represents the latest effort to harden US restrictions aimed at kneecapping Beijing’s ability to modernize its military by producing or purchasing chip tech.

But Washington may be overplaying its hand. A new export control crackdown could give a body blow to the already strained global chip industry. It would undercut US diplomatic efforts to mobilize allies to confront China — a steep price for policies that are already showing signs of backfiring.

The mere suggestion that Washington was prepared to enforce the foreign direct product rule sent semiconductor stocks reeling. Shares in US chip firm AMD dropped more than 10%. US chip equipment maker Applied Materials stock plunged by 7.8%. Shares in high-flying NVIDIA dropped 6.6%.

US attention is focused on two companies: ASML and Japan’s Tokyo Electron. Both build cutting-edge machines that manufacture advanced semiconductors. In 2023, both the Netherlands and Japan acquiesced to US pressure and updated their export controls to align with US rules.

But gaps allowed China to stockpile massive amounts of equipment before the controls went into effect. ASML and Tokyo Electron continue to sell and service low-end tools in China. Washington views this as exploiting its export controls and believes that Amsterdam and Tokyo are moving too slowly. After Bloomberg reported that the US was considering toughening up its export controls against the two companies, shares in Tokyo Electron dropped 7.5% and ASML plunged 11% — shaving off $46.7 billion of ASML’s market value, the Dutch firm’s worst trading day since March 2020.

China is beating controls by acquiring last-generation tech from Tokyo Electron and ASML through intermediaries and using it to make high-end chips, according to US officials. Tightened export controls aim to keep China from making logic chips below the “advanced” threshold of 14 nanometers. SMIC, China’s chip manufacturing champion, used the old tools to make seven-nanometer chips and claims it can go further to five nanometers. Although that still would be a generation behind the cutting-edge of three nanometers, it would build the US case that the controls are too weak.

Admittedly, the current export controls have slowed China’s chip progress. Huawei and SMIC face severe production limitations. Roughly 80% of the AI chips have defects. Replacement parts for old, faulty equipment are hard to find — as are engineers willing to risk US sanctions to service the tech. Chinese AI firms are also bogged down by switching their AI models to Huawei’s tech, as most were built using NVIDIA’s.

For advocates of the US restrictions: this means mission accomplished. The export controls are making it harder for Beijing to catch up with the Western firms racing ahead in AI innovation.

But Chinese chip firms are not the only ones hurting. So are Western semiconductor leaders. Since 2022, the US controls have wiped out $130 billion in market capitalization for US chip companies. The restrictions deter foreign firms from making deals with US companies, encourage them to not use US tech, and deprive them of capital crucial to R&D. They are bifurcating the global tech industry, forcing firms to split their US and Chinese supply chains.

American chip firms feel they are being punished while others — particularly ASML and Tokyo Electron — fill the gaps. ASML earned nearly 50% of its second-quarter revenue of $5.2 billion in China this year, up from historical levels of 15 to 20%. China drove over 40% of Tokyo Electron’s FY2024 sales of almost $12 billion.

Both the Dutch and Japanese are furious about potential reinforced controls. In an unprecedented move, unnamed Japanese officials are publicly bucking the US, saying they will not comply. In order to protect ASML, the Netherlands could push the EU to impose countermeasures like tariffs or intellectual property restrictions on the US through an untested law passed in response to Trump-era tariffs on steel.

Amsterdam and Tokyo worry that the US tone has toughened. Before, the two countries believed that the US only targeted specific cutting-edge technology. Now they fear Washington is hellbent on forcing ASML and Tokyo Electron completely out of China.

If the US acts unilaterally, it risks reinforcing the narrative that the US is a “bully” over-reliant on extraterritorial measures and intent on decoupling rather than derisking from China.

The US cannot counter China alone. Cooperation with the Netherlands, Japan, South Korea, Taiwan, and others is critical. When the US imposes export controls without convincing its partners, it gives China time to exploit loopholes: stockpiling older machines, accessing restricted tech through middlemen, improving smuggling routes, and developing domestic production. Piecemeal export controls force the US to play whack-a-mole and infuriate allies with constant rule changes.

China also could counterattack. Beijing dominates global supply chains for raw materials, electric vehicles, solar panels, and less-advanced chips. It also has deeper coffers to offset costs. Beijing so far has refrained from weaponizing this leverage — but that may not last.

Europe and Asia have attempted to walk a fine line between access to the Chinese market and US innovation. The US is trying to push them off the fence with tightened export controls. The hardline risks hurting everyone.

Matthew Eitel is Special Assistant to the President & CEO at the Center for European Policy Analysis (CEPA).

Bandwidth is CEPA’s online journal dedicated to advancing transatlantic cooperation on tech policy. All opinions are those of the author and do not necessarily represent the position or views of the institutions they represent or the Center for European Policy Analysis.

The post No Carrots, Just Sticks: US Bullying Allies on China Chips appeared first on CEPA.