On the ongoing US-China trade war

Someone recently asked my opinion about the ongoing US/China trade war and its implications for the automotive and chipset sectors. In this brief article, I provide an overview of the situation and my take on it.?

Introduction

Many leading car makers in Europe and the US are concerned about the economic threat of China-made electric vehicle (EV) imports to their future sales volumes or operating margins. Given that labour and material costs tend to be 20-30% cheaper in China, even when adding export shipment costs, this constitutes an unfair advantage for China. Yet the situation isn't that simple...

Some car brands and key players in the automotive supply chain (the so-called “tiers-1”), like the Volkswagen group, Valeo or Forvia and several other entities, have themselves taken advantage of this economic imbalance - which is both a threat and an opportunity - by establishing a strong manufacturing presence in China to both serve the domestic Chinese market and also to engineer and build products that serve their clients outside of China.

Many other car players that have not had a growth strategy in China are now seeking governmental support to protect their domestic market, which often resulted in a suggestion for more imposed tariffs to combat the effects of globalization and economic imbalances. For example, the Biden administration announced a tariff increase for Chinese EV imports from 75% to 100% (prolongating what Trump has started). However, even with ever-growing tariff penalties, other price-dumping practices are ongoing, and the US government seeks to address them bipartisanly.

The China-US trade war on chipset technologies differs from the automotive situation as it is more a matter of technology supremacy and national security than a cost advantage.

The automotive sector (~30M new cars are produced and sold yearly worldwide) is making extensive use of processors (there can be 100+ chipsets per car). The problem with the chipset sector is that (1) most of the advanced production know-how and capacity has gradually shifted to Asia, particularly Taiwan, which China is looking to take over, and (2) China is quickly ramping up domestic design capabilities.

In re 2), indeed, the US has so far led the "chipset design game" with companies like Intel, AMD, NVIDIA, Qualcomm, Texas Instruments, but most of these companies have been operating under a “fabless” strategy given the massive investments required to build microchip fabs that only a few companies like Samsung and TMSC can absorb, typically by sharing the production capabilities with several processor brands. "Fabless" also mean that the companies could focus on keeping an edge on the performance and features of processor technology versus competing to retain a production edge. NVIDIA is an interesting example of a global company whose brilliant founder, Jensen Huang, is a Taiwanese native, educated in the US at Stanford and whose company success is primarily bound to its relationship with the Taiwanese chipset fab "TSMC".

As I write in my book "Who says Tech is a long quiet river? ", the quiet transition of control over chipset production in favour of Asia started 15 years until COVID kicked in, causing a deficit in processor inventory (or now, the need to regulate what vendors are allowed to sell to a country in the case of the Ukrainian war). It was only 3 years ago that a realization happened that there is a need for more sovereignty in both the design and production aspects of chipsets, which is what the "CHIPS Act" intends to address.

In the next section, I detail how the automotive sector is planned to be protected from foreign regimes beyond tariffs, and then I cover the main aspects of the CHIPS Act.

Protective the automotive world (e.g.,"Leveling the Playing Field Act")?

Beyond tariff increases, more focused legal "bills" are being proposed, like the "Levelling the Playing Field Act," for US states particularly impacted by the US-China economic war in the automotive sector, such as Ohio or Michigan. These bills are interesting from my viewpoint because they go beyond the tariff sanctions with a focus on addressing tactics used to circumvent the payment of tariff measures, usually implemented using third-party companies:

• Ways to quickly detect repeating offenders, like governments subsidizing the production or export of goods imported to the US. The goal here is to detect indirect contributors to the exporting of products, even when tariff penalties are in place, for example, in the case of price-dumping practices aimed at gaining market share and selling products at costs even below domestic admitted prices.
• Expediting "entity swap" situations where a previous admitted case re-occurs with a different entity name (which I have personally witnessed in China)
• Using an intermediary shield company (like via Mexico) to avoid a direct US-China confrontation

The above examples show the limitation of direct tariff penalties and well-known circumventing tricks the US would like to address.

CHIPS' Act

The CHIPS Act ("Creating Helpful Incentives to Produce Semiconductors" - someone was certainly being creative when picking up this name) has several core objectives:

• Boost funding in direct contribution or tax credits for key companies to reestablish plants in the US. Intel alone received $8B dollars, which, BTW, only represents the cost of a new fab (between 10-20B$ given the latest miniaturization milestone of ~3nm per transistor)
• Boost R&D, notably in packaging technologies (I'll address that in an upcoming newsletter). This refers to how a processor "die", extracted from wafers, is encapsulated in a piece of electronic that can be used in mass production for example)
• Training of a new generation to address the gap with the kind of know-how Taiwan has accumulated. What's quite interesting here is that 2 of the leading tool processor manufacturers are US companies (LAM Research and Applied Materials). I'm sure the US government will block any Chinese attempt to acquire these companies moving forward.
• Supply chain and (smart) international collaboration to regain sovereignty and mitigate supply chain and geopolitical tensions

My take: while the CHIPS acts goals are sound, in practice, they are fairly limited in short-term impact, and, on the design part, China is off to train enough engineers to compete on future chipset features.

Also, the notion that the US government is willing to boost funding for its national brands (like Intel) could be seen as the same practice China uses to finance subsidies domestically.

Never underestimate China: the battery example.

China is not standing still in this economic war, and one must also appreciate the early planning effort that went into its strong market position. For example, in the electrical batteries sector, two raw materials are of prime importance: lithium and cobalt. Realizing that potential, China quietly and heavily invested in Africa, South Africa, Bolivia for lithium and Africa for Cobalt.

It is estimated that China will have secured 1/3 of the world's Lithium capacity by 2025 (report here ) and is now the world's third-largest lithium producer. More impressively, China now controls 70% of the global lithium refining capacity.

This allows them to control the EV market's cost structure, whether cars are produced in China or not, given that 20-30% of EV costs come from the battery pack. Given such supremacy, why wouldn't car makers be willing to implement technology transfers to help Chinese domestic car companies design cars in exchange for preferred battery pricing or guaranteed volumes in a market where demand exceeds production?

The car industry is a complex web of alliances, joint ventures, and bilateral agreements at different levels of the supply chain, which makes applying tariff penalties tricky and sometimes counterproductive. One must consider the overall picture of bilateral relations and its global implications, like US employment, where ~10M US workers are estimated to contribute to the automotive industry.

Conclusion

China needs access to the US market to maintain the profitability of its vast production capabilities and confirm return on investments in topics like batteries (perhaps even a bigger priority than exporting China-made EV vehicles into the US). In contrast, the US needs China to help lower the cost structure of some critical goods like battery packs, given their level of control.

This is why a US-imposed "Chinaxit," defined as a larger-scale version of the European "Brexit," could have significant consequences for the automotive sector.

The story's moral is that correcting commercial imbalances in our entangled world will be difficult and take time.

Yet, looking at the various worldwide political trends, societies seek more protectionism or evidence that current trade models will continue to make sense.

#US-Chinatradewar #CHIPS #LevelingthePlayField2.0

As always, feel free to contact me @ [email protected] if you have comments or questions about this article (I am open to providing consulting services).

More at www.lohier.com and also my book . You can subscribe to this free bi-weekly newsletter here and access former editions here .