Bargaining Chips: US Allies and Export Controls

A shift is occurring in U.S. policy on export controls, away from its “tall fence around a small yard” approach. The new strategy seeks a more expansive application of export controls more directly aimed at bringing about geopolitical objectives.

On October 7, 2022, the Bureau of Industry and Security (BIS) at the U.S. Department of Commerce unveiled two new export control rules aimed at degrading Chinese AI capabilities. Typically, such announcements would have garnered enthusiasm mostly among a small community of export control experts, but these controls have frustrated U.S. allies and sent shockwaves throughout the global high-tech economy. These controls, if maintained, enforced, and ultimately supported by allies, have the potential to reshape the world’s most consequential economic relationships, shuffle supply chains, and realign geoeconomic blocs.

The new restrictions on exports of advanced semiconductors to China are particularly unique because they represent a return to a broad-based designation of export controls. This reflects the U.S. assumption that it is no longer possible to distinguish between military and non-military end-users in China, a consequence of Beijing’s civil-military fusion doctrine.

The controls also invoke Foreign Direct Product (FDP) rules, which extraterritorially apply U.S. export controls to items that contain U.S. tools, inputs, or software. This means, for example, that Dutch enhanced ultraviolet (EUV) lithography equipment made with U.S. inputs is prohibited from being sold to China without a U.S. license – and the BIS has instituted a “presumption of denial” policy, effectively disallowing these sales.

Another feature of the controls is that they establish threshold limits, meaning that as technology advances and older technology becomes more generic, the scope of covered goods will necessarily increase.

Another conspicuous feature of the controls is that, unlike the substantial controls levied on Russia in recent years, which expanded after Russia invaded Ukraine, the United States failed to achieve allied buy-in to the rules prior to their release, even after extensively courting allies for months ahead of the announcement. Without the participation of other high-tech producing economies, such as the Netherlands and Japan, the controls are unlikely to succeed in the long run.

U.S. Semiconductor Investments

U.S. Secretary of Commerce Gina Raimondo has expressed optimism that key allies will “follow our lead.” Japan has begun consulting with industry to determine which types of restrictions it could viably implement, although Japanese officials are watching to see what the European Union and South Korea decide.

Observers noted that the immediate effect of the controls has come at the cost of U.S. industry. BIS Under Secretary Alan Estevez indicated, “We were willing to go this alone as a down payment and show that we had skin in the game while we’re having the discussions with our allies.”

Indeed, the controls are estimated to have a sizable impact on the U.S. private sector. Lam Research Corp anticipates a 2023 revenue drop of roughly $2.5 billion, (14.5 percent) and Applied Materials, the largest chip equipment producer in the United States, could lose between $250-550 million (up to 2.3 percent) for the quarter ending in October. KLA Corp., meanwhile, anticipates a revenue drop of nearly $900 million in 2023 (33 percent). The substantial revenue drops among U.S. firms are unlikely to reassure allies.

The United States hopes that its recent legislative package on chips spending will entice greater investment in the high-tech sector, a plan that appears to be succeeding. Micron recently announced a $100 billion investment in New York, while Intel and IBM will invest $20 billion each in Ohio and New York, respectively. Taiwan Semiconductor Manufacturing Company (TSMC), meanwhile, is slated to invest $40 billion in Arizona.

Unilateral Controls Have Limited Effectiveness

International collaboration is crucial for the longevity and ultimate impact of export controls. Foreign availability of similar products means that foreign competitors can “build out” U.S. design – that is, create supply chains free of U.S. inputs and design – to circumvent the controls and supply a key demand. Some private sector players have noted that the utility of the U.S. controls is likely to diminish over time and may cease completely within a year and a half without allied participation.

This explains why the Biden administration spent the better part of the past year attempting to build an allied consensus on export controls. The administration succeeded in achieving allied participation in the Russia context and helped the European Union fortify its own federal export control architecture. A key factor that facilitated such a unified response to the Russian invasion of Ukraine was the underlying philosophical agreement about the need to confront Russia and cripple its war machine.

In contrast with the Western consensus around Russia, the United States and its allies have much more variegated postures toward China. These differences largely mirror existing divergence in economic policies vis-à-vis China. After long regarding China as its “biggest customer,” the U.S. aperture is narrowing to focus on China less as a consumer base and more as an existential threat. Meanwhile, the European Union continues to regard China primarily as a customer for its exports, while acknowledging that business conditions are growing more arduous.

In a recent interview, Dutch Minister of Economic Affairs Micky Adriaansens outlined some of these contours:

It is very bad to restrict trade with China in an untargeted way. Then we will lose an important export partner in both the Netherlands and the EU. Apart from the numbers; it is important that we work well together globally. There are many Dutch companies that successfully do business with China, many international students in the Netherlands, including Chinese ones. It is good for the next generations to live in a world where you are connected to each other. The softer values also play a role.

Dutch machine tool producer ASML has downplayed projections that it will be significantly affected by the U.S. controls. ASML CEO Peter Wennink said recently that if the company cannot sell its advanced lithography equipment to China, then it will seek revenues elsewhere. However, ASMI, another major Dutch semiconductor player, has argued that the new restrictions would affect 40 percent of their sales in China, which accounts for 16 percent of their overall revenue.

The Dutch government has also been reluctant to confirm that it will cave to U.S. export control demands. Dutch Foreign Trade Secretary Liesje Schreinemacher signaled that the Netherlands will not copy the U.S. export controls but rather “will likely introduce restrictions based on its own assessments.” Reports have emerged, however, indicating a deal between the Netherlands and United States may be close. Meanwhile, Chinese President Xi Jinping urged the Dutch to avoid “decoupling.”

Other countries, such as South Korea, are beginning to rethink the long-term implications of remaining so closely economically intertwined with China. As South Korean private sector experts have noted, South Korea sees China less through the national security prism and more through an economic competition and innovation lens. However, as Chinese firms have continued to steal Korean intellectual property and pursued other dominating policies that make it significantly more difficult for Korean firms to do business in China, the South Korean private sector has begun seeking alternative markets for their high-tech sector.

U.S. Efforts to Multilateralize Controls

The lack of a multilateral consensus for the application of controls on advanced semiconductor sales to China and a broader infusion of national security into economic and trade policy leaves the United States having to pursue aggressive bilateral and small plurilateral negotiations with partners.

The United States has recently tried to engage Japan on a mutual agreement that would promote investments in chips. The United States and South Korea also recently announced a new dual-use export controls working group. In May 2022, the United States and Japan held a ministerial of the Japan-U.S. Commercial and Industrial Partnership, which seeks greater alignment on semiconductor policies. Back-channel diplomatic efforts may have paid off for Japan and South Korea, both of which received waivers from the BIS to continue to operate in China; however, these one-year waivers started the clock ticking, and firms still face the inevitability that they will have to reshuffle their supply chains and consumer markets in the coming months.

Another example is the Chips 4 Alliance between the United States, Japan, South Korea, and Taiwan. The Chips 4 Alliance is intended to increase cooperation on building secure semiconductor supply chains by creating a more robust consultative process for designing and implementing export controls on national security critical technology transfers to China. The United States has also aggressively courted the Dutch, sending BIS Under Secretary Alan Estevez to the Netherlands along with Tarun Chhabra, who oversees technology policy on the White House National Security Council. The urgency of diplomatic efforts underscores the realization that without allied buy-in, U.S. firms will lose market share to foreign competitors while also reducing the likelihood that the United States achieves its strategic objectives.

Offering Incentives

The United States is left to design – and sell – a policy that will adequately compensate its partner countries if they join the controls. Japan has recently signaled a willingness to sign on to the U.S. controls, while the Netherlands is purportedly working on designing a similar legal tool. Reluctant to cave to extraterritorial U.S. trade policy, allies will likely expect concessions from the United States that are not only financial in nature, but that offer political cover to allies for joining.

What is less clear is whether U.S. allies will perceive these policies as incentives or sticks. If the latter, this signals that the United States is expending major diplomatic leverage when it is not clear that now is the most crucial time to do that. Convincing allies to join the current controls will cost the United States leverage if it seeks to build future export control regimes and will likely impact other high-tech diplomatic issues that have yet to surface.

Regardless, if the United States remains a magnet for foreign tech investment while also establishing expansive guardrails on international trade, this combination could fundamentally reshape the geoeconomic blocs of the 21st century.