US security concerns about Chinese tech could push research offshore
Hardliners in the US see Chinese tech firms like Huawei as a security threat, but others worry that restrictions could damage US’ technological pre-eminence
The Trump administration declared war last year against Chinese technology firms, all in the name of US national security.
But in the many months that have followed, Washington is doing more head-scratching than regulating. It turns out that protecting the US telecoms infrastructure from foreign threats is a lot harder – and more complicated – than expected, especially when it pits that priority against the competing objective of maintaining the US’ technological pre-eminence.
In May, US President Donald Trump signed an executive order to prohibit US infrastructure from using Chinese products and services. But the Commerce Department has yet to complete the detailed regulations. The deadline of October 12 has come and gone, with no sign when those regulations will be published.
“There is a struggle within the US government to develop and implement expanded export control policies,” said Harry Clark, who leads Orrick, Herrington & Sutcliffe’s international trade & compliance team advising some US suppliers to Huawei Technologies. In all, American firms make more than US$14 billion in sales of semiconductor chips and other components to the Chinese telecommunications giant.
“It is difficult for the government to decide which technologies should be restricted when the technologies are obscure and evolving so quickly. These decisions can be momentous, potentially shutting US companies out of supply chains.”
As technology has become the most contentious aspect of the US-China relationship, the race to dominate next-generation technologies – 5G networks, robotics and artificial intelligence – has become critical for the US to maintain its global leadership.
Some US officials, along with many in the tech industries, caution that sweeping restrictions could push tech research offshore and cripple the sector that gave rise to America’s technological superiority in the first place.
China hardliners in Washington, however, say Beijing remains a security threat that must be addressed.
“The new China Internet Security Law basically says the Chinese government, without permission, now has the ability to vacuum up anything that crosses the Chinese network,” said Michael Brown, director of the defence innovation unit at the Pentagon. “It doesn’t matter who the end user is, it’s all available to the Chinese government, and therefore, the People’s Liberation Army.”
Some believe Huawei, which has risen to global leadership in 5G development, is caught in the crosshairs of the US-China trade war and is likely to be used as a bargaining chip in negotiations.
Separate from Trump’s executive order, the Commerce Department in the same month also placed Huawei and dozens of its affiliates on a so-called Entity List that banned US suppliers from selling components to them without government approval.
American companies could seek waivers, and Commerce Secretary Wilbur Ross pledged in June to deal with applications for those licences “within the next few weeks.”
Five months later, no licences have been issued.
Eileen Albanese, who leads the Office of National Security and Technology Transfer Controls at the Commerce Department’s Bureau of Industry and Security, on Tuesday could only say: “Huawei licences that we have received continue to be in process. I have no estimate as to when a resolution will happen.”
Albanese’s team is also in charge of drafting a list of “emerging technologies” and “foundational technologies” that will require national security reviews in case of foreign investments. Congress passed a law last year requiring expanded controls on such technologies – but deciding which technologies should be regulated has taken longer than anticipated.
Speaking at the Center for Strategic and International Studies in Washington, Albanese made clear just how hard it is to determine where to draw the line.
“We obviously have to look at foundational and emerging technologies to see how that might impact our national security, but is there a slice in between where export controls can be useful in providing the tools that would perhaps delay the indigenization in China?” she asked.
“We need to take a very balanced approach, but not to the point where it is a sledge hammer, because it will only result in perhaps [research] going offshore,” she said.
Clark, of the Orrick firm, noted that “there is great frustration for the industry because of that uncertainty.”
A spokesperson for the Commerce Department did not respond to a request seeking comment.
Restrictions on selling to Huawei will cost its US suppliers billions of dollars a year. Huawei’s top 19 US suppliers had a combined US$14.2 billion in revenue from their Chinese business partner last year.
One leading provider, Micron Technology, the Boise, Idaho-based memory chip maker, generated 12 per cent of its revenue in its fiscal 2019 – about US$2.8 billion. Yet it had to suspend most of its shipments after the blacklist.
For the three months starting June, Micron’s revenue dropped 42 per cent from a year earlier. Revenue for the year was down 23 per cent.
“We are unable to predict the duration of the export restrictions imposed with respect to Huawei, whether any licences will be issued, or the long-term effects on our business,” Micron management wrote in the company’s annual report two week ago.
NeoPhotonics, a semiconductor company in San Jose, California, has perhaps the biggest exposure to Huawei-related risks. In 2018, its sales to Huawei accounted for 46 per cent of its total revenue.
Blacklisting Huawei “is expected to have a material impact on the forecasted revenue and profitability,” NeoPhotonics said in August.
Beyond the drop it has already seen in sales, the US semiconductor industry is worried that the restrictions could encourage Huawei to seek alternatives from competitors in other countries – a shift that seems already in progress.
A spokesperson for Huawei, which drew nearly US$7 billion in revenue from the Americas last year, said the company managed to swap out all US components for its 5G infrastructure products in its most recent quarter.
“US semiconductors should absolutely be worried. Chinese tech firms do not want to use US products given what’s going on. What Trump did has made China move faster to be technologically independent,” said Bradley Gastwirth, chief technology strategist at Wedbush Securities. “The pain isn’t fully realized. In the medium term, it’s going to get a lot worse.”
Huawei’s largest segment – consumer devices – seems to be alive and well. Its smartphone sales are estimated to reach 270 million in shipment in 2019, taking up a whopping 42 per cent market share in China and dwarfing Apple’s iPhone sales.
But Ren Zhengfei, the company’s founder and chief executive, acknowledged that the US blacklist could cost Huawei up to US$10 billion in lost revenue annually.
“After this crisis, we marched faster along the road of innovation,” Ren told CNBC last month. “We are paying more attention to hire young talent and we are more capable to make progress than in the past.”
While the world is still grappling with installing the 5G next-generation communications infrastructure, Ren said that Huawei had begun development of 6G technology five years ago and that he was confident it would lead developing that technology worldwide.
The US tech industry is facing more uncertainty. This week, the Federal Communications Commission sought to apply more restrictions on Huawei and ZTE, the Chinese telecoms equipment maker.
The commission plans to vote on November 19 on a proposal to prohibit US companies that receive subsidies from a US$8.5 billion government programme called the Universal Service Fund from purchasing equipment or services from Chinese tech companies.
The commission will also consider another proposal to remove and replace Chinese equipment used by rural wireless networks.
Letting Chinese equipment into 5G wireless networks in the US “would open the door to censorship, surveillance, espionage and other harms,” FCC Chairman Ajit Pai argued in an op-ed in The Wall Street Journal this week.
For US tech firms, it feels like Washington is just piling on.
“If all these restrictions hold up, the US companies are the net net losers,” said Wedbush’s Gastwirth. “And that’s something we’ve done to ourselves.”