It was a well-rehearsed scene as yet another company made its debut on Shanghai’s STAR market, China’s answer to the tech-heavy Nasdaq. The executives huddled together to strike the gong, confetti erupted over the red carpet and strobe lights danced around the hall.

But this celebration — for SMIC, China’s biggest manufacturer of semiconductors — was different. Semiconductors have emerged as a flashpoint in the increasingly tense U.S.-China relationship, and SMIC’s initial public offering (IPO) was as much an assertion of China’s techno-nationalism as it was a stock offering.

Just one month before, Huawei was sanctioned by the U.S. and cut off from its supply of semiconductor chips.¹Huawei was SMIC’s biggest customer SMIC’s July IPO provided an unexpected lift. It was China’s biggest listing in a decade, raising $7.6 billion. And many of its shares were sold to state firms and patriotic retail investors, determined to support China’s homegrown chip efforts.

On the first day of trading, its shares jumped 245 percent.

Semiconductors, the wafer thin chips that power just about every electronic device today, from refrigerators to cell phones to servers, are crucial to Beijing’s long term goals of achieving technological self sufficiency. Although China is a leading manufacturer of the gadgets that require these chips, it imports 80 percent of its semiconductors, mostly from the U.S. and its allies. The country, in fact, spends $300 billion a year on imports of foreign chips, more than it does on oil.²Of course, many of the chips China imports from overseas it re-exports after assembling them in phones, computers and other gadgets.

While SMIC lags far behind the top international chip makers, the company has long been considered China’s best hope to catch up. It has manufactured chips for industry stalwarts like Qualcomm and Samsung, and boasts the country’s most advanced chip making facilities, or fabs. No other Chinese firm comes close.

In the wake of the Huawei sanctions, which left the telecom giant literally cramming as many chips as it could onto chartered planes before the sanctions went into effect, China had no real choice but to go all in on SMIC. Although SMIC is not a state-owned enterprise, it gets enormous support from the Communist Party. Its largest shareholders are state entities, including Beijing’s “Big Fund,” a $29 billion pool of assets earmarked for the development of an advanced semiconductor industry.

“U.S. sanctions have created more incentive for the Chinese government to support domestic firms to produce domestic Chinese technology,” says Matthew Bryson, a Chinese tech analyst at Wedbush.³It is worth noting that state support for SMIC and other Chinese firms predate the trade war initiated by the Trump administration.  

But the gong had barely stopped reverberating from SMIC’s IPO before the U.S. government turned its sights on the Shanghai-based company. In September, the Commerce Department announced that U.S. exports to SMIC posed an “unacceptable risk” of being diverted to “military end use,” followed soon thereafter by the Department of Defense placing SMIC on a blacklist of “Communist Chinese military companies.”

Then came a White House executive order banning Americans from investing in Chinese military-related companies. And just this week, MSCI — one of the world’s largest stock index providers — announced that it was removing SMIC and nine other Chinese companies from its global indices, apparently because of their designation by Washington as military firms.

Shares of SMIC have plummeted nearly 50 percent since its IPO last July.

The drumbeat of bad news continued Friday, when the Commerce Department officially placed SMIC on an export blacklist known as the “Entity List,” alongside dozens of other Chinese firms.⁴Note, the sanctions imposed against Huawei were more stringent than those imposed on SMIC; Huawei is subject to a rule that also affects US manufacturing equipment made overseas. For SMIC, which relies on myriad American components and IP, it is a significant blow to advancing its product line.

“SMIC perfectly illustrates the risks of China’s leverage of U.S. technology to support its military modernization,” Commerce Secretary Wilbur Ross said Friday, calling SMIC China’s “national champion.”

The company, which did not respond to requests for interviews, has stated publicly that it “has no relationship with the Chinese military and does not manufacture for military end-users or end-uses.”

Still, the new restrictions have exposed cracks in its corporate edifice. Last Wednesday, SMIC’s co-CEO, Liang Mong-song, abruptly resigned, reportedly in protest of the hiring of Chiang Shang-yi, a 74-year-old former executive at the Taiwan Semiconductor Manufacturing Corporation (TSMC). Liang’s expertise is in a less sensitive area than the extreme ultraviolet lithography (EUV) technology SMIC was pursuing under Song. Chiang’s hiring and Liang’s exit suggest the company may have to shift course.⁵The U.S. sanctions now place pressure on the Dutch, who dominate EUV technology, to restrict access to SMIC.

The U.S. decision to blacklist SMIC is almost certain to slow China’s ambitions in advanced chip-making, though some analysts warn that the sanctions could backfire, creating even greater incentives for Beijing to build its own technological capabilities, at any cost, and perhaps some day turn the tables on American firms.

“In some ways, the restrictions the United States has imposed on China have created a new focus for the Chinese and their own domestic innovation around the semiconductor space,” says Jacob Parker, the senior vice president at the US-China Business Council. Chinese semiconductor firms “now operate on 24-hour a day, 7-day a week research and development cycles — literally three shifts a day — to be able to fill some of these gaps. When you’re operating like that, you are able to achieve breakthroughs at a faster pace.”

For SMIC, this is the ultimate test of its 20-year existence: can it overcome the economic sanctions and find another path to advanced chip-making, or will it settle for making lower-end chips for things like television sets? And will investors, after feasting on one of the hottest stock offerings in a decade, accept the latter?

THE CHIP WIZARD

Before it was Beijing’s golden child, SMIC was a scrappy firm started by a foreigner with allegedly pilfered IP. In fact, the recent executive shakeup is not SMIC’s first kerfuffle involving TSMC, Taiwan’s big chipmaker.

The company was founded in 2000 by a Taiwanese-American chip wizard named Richard Chang, who had sold his first chip company to TSMC for $5 billion. The next year, Chang departed Taiwan for mainland China in order to start the Semiconductor Manufacturing International Corporation (SMIC).

Chang was welcomed on the mainland. Up to that point, China’s foray into chipmaking had been a series of spectacularly expensive duds. After the Cultural Revolution promptly put an end to China’s first semiconductor attempt — the government-funded project Wuxing Factory No. 742 — Beijing stepped back into the ring with the 908 Project (so called because of its start in August 1990) and then the 909 Project. Beijing invested more than $1.25 billion in the projects, but by 2001, the 909 Project’s semiconductor firm, the Huahong Group, was bleeding losses.

Neither project led to any breakthroughs. 

Beijing was wiping out on the breakneck speed of the semiconductor industry. The field has long progressed according to the principles of Moore’s Law, which stipulates that the number of transistors that can fit onto a chip doubles every two years, increasing processing speeds exponentially. In the 2000s, for instance, the best chips were close to 130 nanometers. Transistors on the most advanced chips today, by contrast, are five nanometers — which means you would have to line up 60 million of them side-by-side to reach a foot. It is an industry that requires massive R&D expenditures, and survives on innovation. Like a paused shark, if a chip firm stops innovating, it dies.

So while money is crucial — starting an advanced logic foundry today could cost as much as $20 billion — it is not enough, as China can attest. The country’s statist ventures floundered as the West and its neighbors flourished in the fiery alchemy of capitalist competition.

Then came Richard Chang. 

Chang had studied in the United States and worked at Texas Instruments (TI) with the Nobel Prize-winning physicist Jack Kilby, who in 1958⁶Kilby worked with Robert Noyce on the integrated circuit and won the Nobel Prize in 2000. He died in 2005. helped invent the Integrated Circuit (IC) — another name for a computer chip. Innovative American companies like TI, Intel and Qualcomm devoured the design-side of the semiconductor market, acquiring patents like squirrels do nuts. Their success has been a backbone of the American economy.

“This is the most important industry in the world,” says Stephen Ezell, who follows Chinese semiconductors for the Information Technology and Innovation Foundation. “This is the industry that is driving innovation in every other sector of the economy, from exploring new drugs to aerospace.”

Chang, who later became a U.S. citizen, helped TI build semiconductor fabs as far afield as Singapore, Thailand, Italy and Japan. But in the 1990s, he returned to Taiwan to build his own fab, contributing to the rise of East Asian “tigers” — Samsung (South Korea), TSMC (Taiwan) and numerous Japanese firms — eating up some of the American behemoths’ revenue.

Douglas Fuller, the author of Paper Tigers, Hidden Dragons: Firms and the Political Economy of China’s Technological Development, says Chang “has a fetish for fab-building,” and he is “much better at building fabs than running them.” So when TSMC acquired his Taiwanese fab, the opportunity to build a new one in Shanghai was too good to pass up.

At SMIC’s founding, only 400 of Chang’s 1,000-plus team had grown up in mainland China. Many, like Chang himself, who was born in Nanjing before his family fled to Taiwan, were overseas returnees, eager to contribute to China’s patriotic cause of self-reliance, or 自力更生 (ziligengsheng), which dates to the earliest days of Communist Party lore. 

“Everywhere you went at that time in China, it was, ‘Rah, rah, China has to catch up. We’re building up China,’” recalls Clyde V. Prestowitz Jr., who interviewed Chang in Shanghai at the time, while working on his book, Three Billion New Capitalists. 

It’s not just in chip production [China wants] to be self-sufficient in. They want to be self-sufficient in everything from the tools to the materials to the foundries to the packaging. Everything.

Jimmy Goodrich, vice president for global policy at the Semiconductor Industry Association

Chang, of course, was attracted to mainland China by its growth potential and an array of generous incentives and tax breaks — enticements the Chinese authorities hoped would help offset efforts by other governments, including the U.S. and Taiwan, to restrict the flow of talent or the export of advanced manufacturing techniques to China.

And yet it wasn’t just China that was eager to see Chang establish a foundry in Shanghai. With China set to join the WTO, an array of American and global investors and venture capital firms were eager to finance the operation, including Goldman Sachs, New Enterprise Associates and H&Q Asia Pacific. Motorola, which was getting out of the fab business, even sold its plant in Tianjin, in north China, to SMIC, a deal that made Motorola a major shareholder at the time of SMIC’s first initial public offering, on the Hong Kong Stock Exchange, in 2004.⁷Motorola sold its stake after the lockup period.

Still, the company’s development was rocky, to say the least. It struggled to pay for its massive capital expenditures, was torn by management strife and bad luck (one of its CEOs even died in office), and the company racked up losses, year after year. More importantly, despite some technological advances, the company failed to significantly close the gap with its foreign rivals, leaving it several generations behind the world’s leading fabs, even to this day.

To survive, SMIC has focused on producing the basic chips that power simpler gadgets, like garage door openers and TVs. Such commonplace chips account for 90 percent of its revenue. While the leading fabs are working on 7 and 5 nanometer nodes, SMIC began producing 14 nanometer chips late last year — leaving the company about a decade, or two generations behind its rivals, analysts say.

“SMIC, historically, has been a producer of chips that are a couple nodes back and that continues to be a major business for them. Their struggle has been getting to the most advanced technologies,” says Willy Shih, a professor at Harvard Business School. “I don’t know that they have invested enough in basic process R&D to assume the mantle of leadership that the country wants them to.”

SMIC has fought to close the gap. But it’s been accused and repeatedly sued for trying to do so unfairly, including poaching talent from its Taiwanese rival, TSMC.

In 2003, Taiwan’s TSMC sued SMIC for stealing its intellectual property. With over 100 ex-TSMC employees then working at SMIC, it was likely there had been some spill over. TSMC had even supposedly discovered a SMIC mole in its ranks.

“The relationship is not at all friendly,” says Handel Jones, a consultant with extensive experience in Chinese semiconductors. “TSMC basically wants to control the supply in China.”

Eventually, SMIC agreed to pay TSMC $175 million over six years. (During this time, Chang reportedly renounced his Taiwanese citizenship after he was fined $160,000 by the Taiwanese government for making illegal investments in the People’s Republic.) But in 2005, TSMC sued again, claiming SMIC had breached the agreement. The dispute, which took place in American courts, was resolved after TSMC was awarded a 9 percent stake in SMIC. On the day the resolution was announced, Chang stepped down from the company. This was widely believed to be a condition of the deal with his old rival.

Chang’s management of the firm had always been “less than stellar,” says Fuller, and with Chang out, SMIC’s revenue and profitability have improved over the past decade. 

But its fortunes are closely tied to China’s ambitions. In 2014, Xi Jinping again evoked ziligengsheng in a call for China to reduce its dependence on foreign technology. He launched a semiconductor Big Fund: $22 billion of government financing to help China meet a goal of manufacturing 70 percent of its semiconductors in-country, by 2030. 

Given the complexities of advanced chip manufacturing, reaching that level of independence is a momentous undertaking, but China has proven its ability to produce domestic alternatives for important technologies. In the face of U.S. export controls on space-grade microchips, for example, China embarked on a successful campaign to produce its own. It has developed sophisticated rockets, despite U.S. sanctions. And last year, it completed its answer to the U.S. Global Positioning System, or GPS: the BeiDou Navigation Satellite constellation. 

In semiconductors, the country is similarly motivated: The Big Fund has since been increased to $29 billion, and it is SMIC’s largest shareholder. 

“It’s not just in chip production they want to be self-sufficient in,” says Jimmy Goodrich, vice president for global policy at the Semiconductor Industry Association. “They want to be self-sufficient in everything from the tools to the materials to the foundries to the packaging. Everything.” 

With strong state backing and an increasingly sophisticated product line, SMIC’s prospects were looking bright through the 2010s. Then came MAGA.⁸Make America Great Again 

MAKING OF A TECH WAR

To be fair, Washington’s issue with China’s semiconductor industry precedes Trump and his trade war. In its final years, the Obama administration sought to block Chinese attempts to acquire Western chip firms, after having caught on to the fact that the rash of acquisitions were linked to Chinese state policy. 

“The red lights started flashing that these acquisitions were getting out of control,” says Goodrich, at the Semiconductor Industry Association. 

A warning came in late 2016, when Penny Pritzker, Obama’s Commerce Secretary said, “The U.S. government will make clear to China’s leaders at every opportunity that we will not accept a $150-billion industrial policy designed to appropriate this industry.” 

Then-Commerce Secretary Penny Pritzker gave a major speech on semiconductors in November 2016.

But Beijing doubled down on state support for its high tech firms. Indeed, measured as a percentage of company revenue, Chinese government support to SMIC and Tsinghua Unigroup, another major Chinese chip maker, exceeded 30 percent of their revenue. U.S. government support for Qualcomm and Intel, by contrast, was below 5 percent, according to a 2019 report published by the Organisation for Economic Cooperation and Development.

After Trump took office, the U.S. unleashed not just a trade war but a full scale blitz against Beijing over its industrial policies, its overseas investments in U.S. tech firms and its military buildup, arguing that they are a threat to America’s national security. To push back, the administration turned to a key lever: the chip industry. 

Under President Trump, the U.S. has imposed economic sanctions on scores of Chinese firms by placing them on the so-called U.S. Entity List, which restricts American firms from shipping goods to the designated entity. For Huawei and SMIC, two of China’s national champions, that has meant blocking access to vital supplies of chips and chip-making equipment.

Still, while intended to protect national security, the sanctions have not exactly been popular with American technology firms, since it has severely restricted sales to their biggest market — China. Google, Intel, Microsoft and Qualcomm have all been affected.

“American companies lose that revenue in the short term and that limits their ability to make profit which then is reinvested into the research and development of the technologies for the future,” says Parker, at the US-China Business Council. “What you end up seeing is a very slow burn reduction and dilution of American competitiveness over time that may only become apparent in about a decade.” 

There are also experts who warn that U.S. sanctions could backfire, and eventually aid China by giving Beijing greater incentives to unseat the U.S. in vital technologies. But Prestowitz dismisses such talk. “There is this argument that if we try to limit supply to China, that’ll only make the Chinese more dedicated to becoming self-sufficient,” he says. “But anything you do is not going to make them more dedicated. They are dedicated.”

China isn’t wasting time. Beijing has criticized Washington’s use of sanctions and vowed to create its own Entity List, which it calls the “Unreliable Entity List.” Beijing has also aided some firms hit by U.S. sanctions, including the telecom giants Huawei and ZTE. And in August, Beijing announced a trove of tax incentives for domestic chip makers, prompting thousands of Chinese firms to try their hand at the business.

Even Richard Chang, the “father of the Chinese semiconductor” and now aged 72, continues to stoke his “fab-building fetish.” Since leaving SMIC, he has started two firms. His current $2 billion venture, SiEn, based in northeast Chinese city of Qingdao, relies on a Communal Integrated Device Manufacturer (CIDM) model, which involves individual firms collaborating in chip design and manufacturing, a novel method for the Chinese chip industry.

For its part, SMIC will have to find its own path forward. The company’s management team is in turmoil after the departure of the co-CEO, and there are said to be conflicts over whether the firm should focus on its core business of selling lower-end chips, or invest more in R&D to build a more advanced operation, as Beijing would like.

But in a highly globalized industry dominated by American IP and components, trying to stay competitive without access to those resources is a challenge.

“At this point, it’s very difficult, if not impossible, to be a foundry that is not supported by U.S. [IP or components],” says Bryson of Wedbush. “It makes it a whole lot harder for them to continue to progress up to the technology curve, where they’ve been gaining on their international peers. It’s just hard to see how they do that now.” 

There is this argument that if we try to limit supply to China, that’ll only make the Chinese more dedicated to becoming self-sufficient. But anything you do is not going to make them more dedicated. They are dedicated.

Clyde Prestowitz, author of Three Billion New Capitalists

Chad P. Bown, an economist and senior fellow at the Peterson Institute for International Economics, says this melding of trade policy and national security has not been seen before. “The last time we saw anything like this was during the Cold War, where they were really trying to keep sensitive technology away from the Soviet Union and Warsaw Pact countries,” he says.

The incoming Biden administration could lift the sanctions on SMIC and take it off the Entity List, a possibility fueled by reports that Biden could appoint someone close to the U.S. semiconductor industry to the Department of Commerce’s Bureau of Industry and Security, which controls the entity list, according to Fuller.

But doing so would not be easy, since there is a growing bipartisan consensus that America needs to remain tough on China in the corporate and military arena. The Senate recently passed a 2021 defense policy bill that would, if approved, allocate $3 billion in government subsidies for semiconductor firms looking to build fabs in America, an unprecedented sum. The U.S. currently accounts for only 12 percent of worldwide fab capacity — down from 37 percent in 1990. China, meanwhile, has jumped from 3 percent in 2000, when SMIC opened, to 15 percent in 2020.

“While I don’t think the Biden administration will use the Entity List the way Trump has, I doubt he will remove companies from it very quickly, if at all,” says William A. Reinsch, a former Commerce Department official now at the Center for Strategic and International Studies in Washington. “He will be under bipartisan pressure from Congress not to do that, and removing companies from the list allows his Republican critics to say he is soft on China. So I think those listed, stay listed.”

And yet while China remains years, if not a decade, behind the most sophisticated chip makers, and U.S. pressure does seem to be destabilizing firms like SMIC — at least temporarily — experts say it would be unwise to doubt that China can catch up.

“You know, China is in the process of recovering a drilling sample from the moon and bringing it back to earth,” says Shih at Harvard Business School. “So can they do this? In my view, it’s just a question of how much money and how much time you are going to spend. We’ve given them all the motivation to do it now.” 

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