Even as the world is in the grip of the coronavirus pandemic, the US and China are locked in an escalating race to control the technologies of the future. This new environment has inspired a philosophy I have described as “techno-nationalism”: mercantilist-like policies, such as export controls, that link a nation’s tech innovation and enterprises directly to its economic prosperity, national security, and social stability.

While governments are trying to lock down technology, tech multinationals are looking for ways to sidestep onerous export controls and restrictions to continue selling to key customers such as Huawei. As I document in a recent report published by the Hinrich Foundation, businesses are doing this by exploiting legal loopholes and restructuring global supply chains.

Alex Capri is Visiting Senior Fellow at the National University of Singapore, in the Business School. He writes extensively on trade, technology, and geopolitics.

Going forward, loopholes in existing export controls could prompt stricter measures from Washington, which will come at higher costs for tech companies and continue to disrupt global value chains (GVCs).

For US and other foreign companies, this means two things: first, the US government could close export control loopholes, in particular the so-called de minimis rule; second, the Feds are likely to increase pressure on key suppliers and governments to stop selling controlled technologies to Chinese companies.

Export controls’ impact on value chains

An export control is a regulation put in place to protect national security, promote foreign or domestic policy, and, in some instances, control the export of items in short supply. By itself, an export control is not an export ban, and does not mean that the product in question can never be exported.

Export controls do, however, often mean that you have to ask a government for permission before selling, transferring, or transporting a product to a foreign market. Whether or not a license is required will depend on where the final buyer is located, who the buyer is, and how the controlled item will be used.

A key driver of export controls is the concept of “dual-use,” meaning that a commercial technology could be used for military purposes. In the US, for example, the US Department of Commerce has created an extensive list of dual-use technologies which can be found on the Controlled Commodity List (CCL).

Everything on the CCL is subject to “export controls,” but an actual export license will only be required based on the above “who,” “where,” “what,” and “why” criteria, for each unique instance. For example, the same item exported to China, Japan, and South Korea might only require an export license for China.

The US Export Control Reform Act of 2018 will expand the number of dual-use technologies on the CCL, targeting “emerging and foundational technology” and putting most, if not all, US-China technology transfers at risk of being subject to more export controls and license requirements. This would include things like machine learning, robotics, autonomous vehicles, and additive manufacturing (3D printing), among others.

This means that everything on Beijing’s “Made in China 2025” list will fall under the dual-use umbrella.

Export licenses add a layer of uncertainty to GVCs, and the denial of a license can turn a long-time supplier into an unreliable supplier literally overnight. Export controls also mean that a company’s supply chains will be examined under the proverbial regulatory compliance microscope, adding compliance costs, delays, and risks to previously routine business.

Read more: A Chinese view of AI export controls

Efforts to de-Americanize

Export controls are already costing US firms and businesses. Since being placed on the restricted entity list in May 2019, Huawei claims to have jettisoned all US technology from its P30 Mate smartphone, including radio frequency chips (made by Skyworks Solutions and Qorvo), memory (Micron), and design software and operating systems (Synopsis, Mentor Graphics, and Android).

According to a report by Bloomberg, Huawei has also eliminated US technology from the first 50,000 units of its next generation 5G base stations, turning instead to fabless design subsidiary HiSilicon. Bloomberg reported that this impacted US suppliers Intel and Xilinx.

The ramping up of US export controls—and Chinese companies’ subsequent efforts to decouple from US suppliers—has placed US companies in a precarious position, given their sizable revenues from the Chinese market. Huawei alone purchased approximately $11 billion worth of semiconductors from US firms in 2018.

To put this into perspective, more than 60% of Qualcomm’s revenue came from China in the first four months of 2018; for Micron, over 50%; for Broadcom, about 45%. Broadcom has revised its 2019 revenue estimate down by $2 billion because of the Huawei ban, and overall market uncertainty from the US-China tech war.

It is no surprise, then, that American companies are fighting to maintain their market share.

Two very compelling long-term fears make it very hard for, say, semiconductor firms to write off their Chinese customers . First, once a company loses market share, it becomes nearly impossible to recapture it if foreign competitors can step in to replace them. This is due to the very high switch-over costs and complexities involving semiconductor B2B relationships. A well-ensconced competitor in the semiconductor space is very difficult to supplant. Second, in a sector that must commit ever-increasing resources to innovation, revenue from existing business must be ploughed back into critical R&D activities. Losing that revenue damages future competitiveness.

US firms have therefore been lobbying the US government, through organizations like the Semiconductor Industry Association (SIA), to delay an all-out ban on tech sales to Huawei and other Chinese firms, and to convince the US Department of Commerce to quietly approve export license applications—so far, there have been virtually no accounts of denied export license applications for Huawei.

‘American’ technology

Even though current export controls are hurting US businesses, these rules are not that hard for many suppliers to dodge. In many cases, all it takes is a little creativity with the legal definition of “US technology.”

US export controls apply only to US technology—and whether technology is US is determined by so-called “de minimis” thresholds set out in US Export Administration Regulations. What matters is how much of the value of the product is made up of US “controlled technology.” These thresholds are currently set at 10% and 25% of a product’s overall fair market value, depending on the technology in question.

If a company wants to sell to Huawei, all it has to do is manipulate its supply chain to cut the value of the US content, or to increase the value of non-US made components. This can be done a lot of ways—none of which help US workers or suppliers.

To manipulate the value of non-US inputs, for example, companies can increase the costs of foreign labour, overhead, IP license fees, or the costs of materials. For a product near the threshold, this can be as easy as paying EU factory staff a bit more to raise the value of non-US components.

The de minimis loophole is incentivizing US companies to move operations overseas and has led the US government to consider reducing the thresholds, or eliminating them all together.

So far this has not happened, due to opposition from US companies and trade associations. However, this issue may yet re-emerge.

The next phase

Going forward, the US government could take a much tougher stance on export controls, which could have high costs for many firms. For starters, it could close the de minimis loophole, reducing the threshold to 5% or even zero. This would make it difficult or impossible for some firms to reshuffle their GVCs.

Another increasingly plausible scenario is that the US government will try to exert leverage over third-country companies to cut off sales to restricted entities such as Huawei.

Senior officials at the White House have agreed to new measures to increase pressure on the Taiwan Semiconductor Manufacturing Company (TSMC), the Taiwanese semiconductor foundry which produces microchips for Huawei’s HiSilicon. Under a new proposed rule, foreign firms that use US-made chip-making equipment would have to obtain an export license to sell certain micro-chips to Huawei.

Only a small handful of companies make the manufacturing machines that enable everyone else to produce high-yield microchips in commercial quantities, including TSMC. American companies, such as Applied Materials, Lam Research, and KLA-Tencor, dominate this space. Two other firms, ASML (Netherlands) and TEL (Japan), round out this small, exclusive club. However, because ASML and TEL come from countries with strong historical alliances with the US, Washington has the power to get them to acquiesce to its techno-nationalist agenda.

An uncertain future for export controls

Chinese companies will accelerate their efforts to de-Americanize their supply chains, no matter what happens to US export control policies.

The rise of techno-nationalism will push companies to decouple, ring-fence, and realign their value chains, in some cases pre-emptively and in other cases because of new government constraints.

The US-China technology rivalry, thus, will continue to present tech companies with increased risks and uncertainty well into the foreseeable future.

Alex Capri

Alex Capri is Visiting Senior Fellow at the National University of Singapore, in the Business School. He writes extensively on trade, technology, and geopolitics.