Introduction

Since August 2020, the government of the People's Republic of China (PRC or China) has issued several new related policy measures to boost the development of its semiconductor and software industries. In August 2020, China's State Council issued the Notice on Several Policies to Promote the High-quality Development of the Integrated Circuit Industry and Software Industry in the New Era, which provides a broad framework.¹ In March 2021, the Chinese government issued several implementing measures that include criteria companies must meet to qualify for government preferences, as well as tax and tariff provisions (See Table 1 and Appendix). The Chinese government is expected to issue lists with more details about specific companies, projects, technologies, raw materials, and components that are to be encouraged by the state.

China's new policies encourage U.S. and foreign semiconductor companies—including those from Taiwan, Hong Kong, and Macau—to transfer certain technology, intellectual property (IP), talent, and research and development (R&D) to operations in China. These policies target capabilities across the semiconductor value chain, including integrated circuit (IC) design, fabrication, equipment, software design and tools, packaging and testing, and materials. These policies offer preferential terms over the next ten years—including tax, tariff, financing, and IP protection—for firms willing to establish capabilities, including production facilities, in China. These policies require companies to transfer certain IP—including a specific number of invention patents, depending on the subsector—to ownership by a China-based business that is legally separate from its corporate parent, potentially giving the Chinese government greater control over certain technologies, including through the use of China's new export control law.²

A semiconductor (also known simply as an integrated circuit, a microelectronic chip, or a computer chip) is a tiny electronic device (based primarily on silicon or germanium) composed of billions of components that store, move, and process data. Semiconductors are a uniquely important enabling technology. They are fundamental to nearly all modern industrial and national security activities, and they are essential building blocks of other emerging technologies, such as artificial intelligence, autonomous systems, 5G communications, and quantum computing. For more than six decades, consistent growth in semiconductor capabilities and performance and concurrent cost reductions have boosted U.S. economic output and productivity and enabled new products, services, and industries.³

Many Members of Congress and U.S. policymakers are concerned that China's state-led semiconductor policies, if successful, could lead to the loss of U.S. technological leadership and significantly shift global semiconductor production and related design and research capabilities to China. Chinese semiconductor competencies could support a range of technology advancements, including military applications. Although some countries, including the United States, support their domestic semiconductor industry, the scope and scale of China's state-led efforts are unprecedented when considering the amount of state funding involved, the Chinese government's ambitions to lead across the entire semiconductor value chain, the targeting of U.S. and foreign capabilities, and the particular methods that China is using, which appear to challenge current global rules and norms.⁴

U.S.-China Phase One Trade Deal Commitments

These new measures build on China's existing state-led semiconductor initiatives by providing new specific technology requirements tied to preferential market treatment and economic benefits.⁵ In establishing a direct quid pro quo link between technology transfer and qualifications for particular government incentives, China appears to be pursuing trade practices—that previously were detailed in USTR's Section 301 report from March 2018—of concern to the U.S. government and many in Congress.⁶ Specifically, China's new semiconductor policies may violate provisions in the January 2020, U.S.-China Phase One Trade Deal, particularly in Chapter 2 of the agreement that addressed some aspects of China's technology transfer policies and practices.⁷ Among related commitments, in Article 2.3 of the agreement, China agreed it would not require or pressure firms to transfer technology in relation to investment transactions, or as a condition for parties to receive or continue to receive any advantages conferred by China.⁸ In late March 2021, China's planning agency, the National Development and Reform Commission, issued further guidance on the new policies; the guidance clarifies that the Chinese government will require the relevant patents and IP mandated under its measures to be owned by a legally distinct and independent business in China, and cannot be simultaneously owned or controlled outside of China.⁹ According to these policies, patents and related IP submitted to the Chinese government for review will require government authorization, which creates an opening for the Chinese government to determine and require the specific know-how that companies must transfer to China to meet the policy requirements.

China's Broader Semiconductor Industrial Plans

China's state-led efforts to develop an indigenous and vertically integrated semiconductor industry are unprecedented in scope and scale. In June 2014, the Chinese government published a plan, Guidelines to Promote National Integrated Circuit Industry Development, "with the goal of establishing a world-leading semiconductor industry in all areas of the integrated circuit supply chain by 2030." The document included measures to support an aggressive growth strategy, with the goal of meeting 70% of China's semiconductor demand with domestic production by 2025. In 2019, China revised the goal upward, setting an objective of expanding its domestic production of semiconductors (including from foreign firms in China) to meet 80% of domestic demand by 2030, as part of its Made in China 2025 industrial strategy.¹⁰ IC Insights estimate that integrated circuits produced in China accounted for approximately 16% of China's total market, valued at $143.3 billion.¹¹

China's policies feature a substantial and central role for the government in directing and financing Chinese businesses to obtain foreign IP related to semiconductors. The Chinese government uses production targets; subsidies; tax preferences; trade and investment barriers (including pressure to engage in joint ventures); and discriminatory antitrust, IP, procurement, and standards practices. The policies seek to leverage China's central role in global consumer electronics manufacturing and potential as a semiconductor production hub to incentivize and pressure foreign companies to localize production, share technology, and partner with the Chinese government and affiliated entities. To implement its semiconductor plan, China created a government fund—the China Integrated Circuit Investment Industry Fund (CICIIF)—to channel an estimated $150 billion in state funding in support of domestic industry, state-directed overseas acquisitions, and the purchase of foreign semiconductor equipment. In October 2019, China announced a second semiconductor fund with an estimated capitalization of $28.9 billion.¹²

Main Provisions of the New Measures

The Chinese government appears to be expanding and deepening a statist approach to developing technologies and sectors prioritized in its Made in China 2025 and other industrial plans.¹³ China's efforts to develop indigenous capabilities have often sought to first obtain the technologies and capabilities it needs from foreign firms. While China is advocating for technology independence in its new 14^th Five-Year Plan (2021-2025), details in the new measures show the government is still seeking specific foreign capabilities to fill critical gaps in advancing these goals of technology leadership and independence.¹⁴

Although aspects of the new measures show continuity in China's approach to obtain foreign capabilities, they also feature new lines of effort and areas of emphasis. China's current efforts appear to focus on U.S. and foreign technology collaboration that remains unrestricted by the United States and potential countermeasures that seek to work around current U.S. government restrictions on technology ties with China. Overall, the measures reflect a stronger emphasis on foreign R&D collaboration, the use of open source technology platforms, and the use of China's talent programs to attract foreign experts to work in China, all key themes in China's 14^th Five-Year Plan.¹⁵ The new preferences appear to be more specific to the types and levels of technology that the Chinese government is seeking in an effort to accelerate the development of these capabilities.¹⁶ In particular, the policies appear to target the following:

• Technological advancement. Preferences are set by level of technology and are calibrated dynamically as companies advance technologically. This could initially favor more advanced domestic firms while encouraging foreign firms to localize advanced capabilities. As has happened previously in semiconductors and other strategic industries prioritized by the Chinese government, the policies could motivate tactics of concern—such as joint venture terms that extract technology, IP theft, and talent poaching—as Chinese firms seek to fill gaps to meet the new requirements. In March 2021, for example, Taiwan authorities accused China's Bitmain of setting up front companies in Taiwan to recruit engineers from Taiwan Semiconductor Manufacturing Corporation (TSMC) and MediaTek.¹⁷
• Import financing and preferences. Only technologies and products that cannot be produced in China receive preferential tax and tariff treatment, in a potential violation of China's WTO obligations, while the policies encourage the development of domestic capabilities in these same areas. Some of the encouraged products—such as semiconductor production equipment, tools, software design, and materials—are key inputs that support the development of China's domestic production capabilities that appear to aim to displace imports of certain products, such as integrated circuits. Semiconductor equipment can constitute up to half of a foundry's capital expenditures, and China remains dependent on foreign semiconductor equipment, tools, and design software, many of which come from U.S. companies. The new government preferences supplement financing that the government already offers. The Sino IC Fund is set up as a leasing company that funds Chinese companies' purchase of foreign semiconductor equipment through a leasing arrangement. In 2017, for example, Semiconductor Manufacturing International Corporation (SMIC) and Sino IC Leasing signed an agreement under which Sino IC-Leasing provides $1.2 billion in state funds—through a series of leasing and buy back arrangements—to pay for SMIC's imports of foreign semiconductor production equipment.¹⁸
• Export Promotion. The new policies promote the export of Chinese ICs, software, and information technology services through specific government actions, financing, and insurance that could violate WTO rules on export subsidies.¹⁹ This new emphasis on China's targeted role as a major exporter provides another data point on the scope and scale of China's global ambitions.
• Chinese government funding. State financial support includes funding from government guidance funds; streamlined bond and equity listings; and, technology and IP insurance. The Chinese government has already channeled an estimated $150 billion to China's semiconductor industry and has allocated $1.4 trillion for strategic industries, including semiconductors, in its 14^th Five-Year Plan (2021-2025).²⁰ In March 2021, the Shenzhen government announced a $2.3 billion investment and a 23% stake in China's leading foundry, Semiconductor Manufacturing International Corporation.²¹ The new measures appear to widen the door for U.S. and foreign firms to obtain Chinese state funding and other financial preferences, including access to domestic capital and debt markets, if they meet the government's criteria and adhere to China's industrial policies.
• State direction and funds for foreign acquisitions. Chinese enterprise bids for foreign semiconductor firms are typically state-backed, as exemplified by the attempts by Tsinghua Unigroup—a member of CICIIF—to buy South Korea's SK Hynix, and U.S. companies Fairchild, Western Digital, and Micron.²² Recent developments show that the government is still directing funds toward acquisitions. In March 2021, a Chinese government-tied fund invested $1.4 billion in South Korea's Magnachip Semiconductor, a manufacturer of power chips and light-emitting diode (LED) drivers.²³
• U.S. and foreign research collaboration and partnerships. The new policies encourage research cooperation with foreign universities and companies, a priority in China's 14^th Five-Year Plan. With greater U.S. and foreign government scrutiny of Chinese acquisitions, China has sought other forms of cooperation, including joint ventures, technology licensing, and research partnerships. China's Huawei is reportedly investing $1.2 billion in an optoelectronics R&D and production center in Cambridge, England.²⁴ China is also turning to U.S.-led open source technology platforms—such as RISC-V, the Open Compute Project (OCP), and the ORAN Alliance—as a vehicle for technology collaboration. These platforms appear to have provided a way for Chinese and other entities—including state institutes and firms on the U.S. Department of Commerce's Entity List—to design semiconductor chips.²⁵
• Access to U.S. and foreign talent. The new policies emphasize the role of the government's talent programs and related government funds to develop expertise. Specific efforts include the use of talent platforms, such as the China Academy of Sciences' IC Personnel International Training Center.²⁶ The new policies' staffing criteria may necessitate foreign talent given reports of apparent talent shortfalls.²⁷ Semiconductor capabilities rely on decades of knowledge and expertise. In an effort to advance rapidly in the industry, China has deployed a set of policies to encourage the return of expatriates, the hiring of specialized industry talent (particularly from Taiwan), and cross-border exchanges of expertise through formal agreements and exchanges. Under these policies, Taiwan has reportedly lost an estimated 3,000 semiconductor engineers to China since 2015.²⁸ For example, the top executives of China's SMIC are the former Chief Operations Officer and R&D director at Taiwan's leading foundry, TSMC.²⁹
• Use of domestic regulatory tools. The IC policies call for the use of IP, standards, procurement, and competition authorities to advance China's semiconductor goals. China has used its antitrust authorities to impose terms on foreign semiconductor firms in ways that advance China's industrial policies. China's review of the Dutch firm NXP's acquisition of U.S. firm Freescale set terms that forced the sale of NXP's RF power transistor business to JAC Capital, a company controlled by China's State Council.³⁰ China imposed antitrust terms on Qualcomm in 2015 that not only required Qualcomm to pay a $975 million fine, but also required the company to license its essential 3G and 4G patents to Chinese companies, and enter into a joint venture with the Guizhou provincial government to jointly manufacture server chips in order for Qualcomm to access China's lucrative wireless market.³¹ In 2020, China reportedly leveraged its antitrust purview to complicate Applied Material's bid for Kokusai Electric and Nvidia's bid for Japan's SoftBank-controlled ARM.³²
• Use of litigation. In IP, Chinese semiconductor companies such as Fujian Jinhua and AMEC have used aggressive patent litigation tactics against their global competitors to challenge exclusive use of certain proprietary technologies, to pressure for better licensing terms, and to create counter pressures on U.S. court procedures by initiating copycat versions of U.S. cases in China's courts. These cases often rely on utility or use patents that are easier to create and harder to challenge.³³
• Strengthened ties with foreign industry associations. The policies call for strengthening ties with foreign industry associations. In March 2021, the China Semiconductor Industry Association (CSIA) announced a working group with the U.S.-based Semiconductor Industry Association (SIA) to share information about technology and trade restrictions and discuss industry countermeasures to U.S. restrictions.³⁴ CSIA, like many associations in China, is closely aligned with the government, provides direct policy input, and is tasked by the government to implement certain policies, including the application process for the new IC measures.³⁵ CSIA's leadership includes representatives of state research institutions and former senior officials.³⁶ Members include Chinese military firms and companies listed on the U.S. Department of Commerce's Entity List.³⁷

Outlook and Considerations for Congress

Recent congressional initiatives to support the U.S. semiconductor industry stem in part from the challenge that China poses. Issues before Congress include what should be the appropriate role of U.S. government in assisting U.S. industry; how best to focus federal financial assistance; the amount of funding proposed activities would need to accomplish goals for sustaining U.S. semiconductor competitiveness; and how to coordinate and integrate federal activities internally and with initiatives of the U.S. semiconductor and related industries. Legislation was introduced in the 116^th Congress (S. 4130 and S. 3933/H.R. 7178), and reintroduced in the 117^th Congress (H.R. 7178), to increase federal funding for semiconductor research and development efforts; collaboration between government, industry, and academic partners; and tax credits, grants, and other incentives to spur U.S. production.³⁸

Within these broad considerations for Congress are underlying and overarching questions about how to address China's ambitious industrial plans, trade practices of concern, and the role of U.S. firms and capital in developing China's emerging semiconductor market. China appears to be reinforcing its statist approach to developing its semiconductor industry and is continuing to target U.S. and foreign capabilities in semiconductors and other critical and emerging technologies. In response, Congress might consider whether additional domestic and global measures are needed that would seek to more specifically protect and advance U.S. capabilities and interests vis-a-vis China. Specifically, Congress might consider

• Whether additional conditions and protections are needed as part of any broad or specific funding outlays should Congress decide to increase federal government investments in semiconductors, including R&D and operations. Such provisions might consider the entire semiconductor supply chain, the life and use of a particular technology that the government funds, and any potential touchpoints for China to access or obtain the know-how through the entire lifecycle of a technology, from the initial research stage through commercialization.
• Relatedly, Congress might consider assessing whether China's targeting of U.S. R&D capabilities and open source technologies merits additional government oversight and controls over U.S. basic and applied research, as well as the technical expertise that U.S. industry shares with China over open source technology platforms.
• Congress might explore whether additional conditions or controls are needed on the export of U.S. semiconductor equipment, tools, and software, which play a critical role in advancing China's fabrication capabilities. U.S. sales of these items to China have increased three-fold since 2014 when the Chinese government launched its national semiconductor policy.
• Congress might consider whether new global trade rules or arrangements are needed. Congress might consider whether to encourage the Biden Administration to accelerate efforts with Japan and the EU to develop new plurilateral rules to counter Chinese state subsidies and other practices of concern. Congress might consider whether to press the Administration for joint action and collaboration on R&D and export controls among allies and like-minded countries as part of efforts to foster resiliency in critical U.S. supply chains.

Appendix.