Foundry and loathing

Taiwan Semiconductor Manufacturing Company spent the end of this week being both courted and cornered by the same government. Late on 14 May, American time, the world’s biggest contract chipmaker said it would build a factory in Arizona: 5-nanometre chips, 20,000 wafers a month, about $12bn of spending between 2021 and 2029 and more than 1,600 jobs.^{2TSMCTSMC Announces Intention to Build and Operate an Advanced Semiconductor Fab in the United States15 May 2020} A few hours later the Commerce Department told it, in effect, that one of its customers was off limits.^{1US Department of CommerceCommerce Addresses Huawei's Efforts to Undermine Entity List, Restricts Products Designed and Produced with U.S. Technologies15 May 2020} The carrot and the stick arrived by the same post.

The stick is aimed at Huawei. The Chinese firm and its affiliates have sat on America’s Entity List, a trade blacklist, since May 2019. That stopped American firms selling it parts. It did not stop HiSilicon, Huawei’s chip-design arm, from drawing chips on American design software and having TSMC make them on American machines. Wilbur Ross, the commerce secretary, said Huawei and its foreign affiliates had made “stepped-up efforts to undermine these national security-based restrictions.”^{1US Department of CommerceCommerce Addresses Huawei's Efforts to Undermine Entity List, Restricts Products Designed and Produced with U.S. Technologies15 May 2020} The rule, in short, was aimed at closing the loophole that let a blacklisted firm get chips made abroad on American tools.^{1US Department of CommerceCommerce Addresses Huawei's Efforts to Undermine Entity List, Restricts Products Designed and Produced with U.S. Technologies15 May 2020}

Phone home. Huawei revenue by business, 2019, CNY bn

	Revenue
Consumer	467.3
Carrier	296.7
Enterprise	89.7

Source: Huawei 2019 annual report⁴

The fix is a tweak to an obscure provision, the foreign-produced direct product rule. A chip made abroad for Huawei now falls under American export law if it comes out of American software or technology.^{5Federal RegisterExport Administration Regulations: Amendments to General Prohibition Three (Foreign-Produced Direct Product Rule) and the Entity List19 May 2020} Foundries using American chipmaking tools will need a licence to supply Huawei. Items that began production before 15 May may still be shipped until 14 September.^{5Federal RegisterExport Administration Regulations: Amendments to General Prohibition Three (Foreign-Produced Direct Product Rule) and the Entity List19 May 2020} Since nearly every advanced fab on earth runs on kit from Applied Materials, Lam Research and KLA, the rule could pinch the entire contract-chipmaking business, not just one Taiwanese firm.^{3Bloomberg LawU.S. Tightens Rules to Crack Down on Huawei's Chip Supply15 May 2020}

The stakes for Huawei are large. Its 2019 annual report shows revenue of CNY858.8bn ($123bn), up 19.1%.^{4HuaweiHuawei Releases 2019 Annual Report31 Mar 2020} The fastest-growing part is not the 5G network gear that alarms Western spies. It is consumer devices, which brought in CNY467.3bn, up 34%.^{4HuaweiHuawei Releases 2019 Annual Report31 Mar 2020} Those phones run on HiSilicon’s Kirin chips, and Kirin chips come from TSMC. Eric Xu, one of Huawei’s rotating chairmen, warned on 31 March that “the Chinese government will not just stand by and watch Huawei be slaughtered on the chopping board.”^{6HuaweiHuawei 2019 Annual Report Press Conference Q&A31 Mar 2020}

Credit where it is due. As economic warfare goes, this is elegant. America has stopped shouting about tariffs and found a choke point: design software and fabrication tools, where its firms remain hard to replace. It hits one company, not a whole trade relationship. Commerce says the rule is meant to “narrowly and strategically target Huawei’s acquisition of semiconductors”,^{1US Department of CommerceCommerce Addresses Huawei's Efforts to Undermine Entity List, Restricts Products Designed and Produced with U.S. Technologies15 May 2020} and on this point it has a case.

But a choke point is an asset that loses value each time it is squeezed. Before Friday a fab manager in Shanghai, Seoul or Hsinchu could buy an American etching machine and treat it as a machine. After Friday it comes with a leash, and Washington decides who holds the other end. Each such use gives China, and anyone else who fears being next, a reason to pay a premium for tools and software with no American content. That will not happen fast; the expertise in these machines took decades to build up. Still, the industry’s long-run bet on American kit as neutral plumbing was a quiet subsidy to American toolmakers, and the rule draws it down.

Beijing’s reaction is the thing to watch. Mr Xu’s warning came before the rule and was a response to the threat of it. Now the threat has arrived, and TSMC sits between its biggest market and the source of its equipment.

The strongest case for the rule is that Huawei is not an ordinary rival. If a firm that Washington considers a security risk can get around a blacklist by renting a foreign factory, the blacklist means nothing, and America has spent a year lobbying allies to keep Huawei out of their 5G networks. Closing the gap is the minimum needed to make the original policy mean something. We accept that. A loophole this large is an invitation, and governments should not issue sanctions they cannot enforce.

The answer is to treat the rule as a scalpel that wears down with use. Keep it pointed at named firms with clear security grounds, not at whichever Chinese champion is doing well this quarter. And put more weight on the carrot that arrived alongside it. A leading-edge TSMC fab in Arizona does more for American chip security than any number of licence requirements, because it adds capacity instead of denying it. Making America the easy place to build fabs, with sensible permits, steady incentives and visas for the engineers who run them, is slower work than drafting a rule. It also cannot be routed around.

Leashes work best when nobody notices them. This one has been noticed.