US chip sanctions are hurting China. They cover not only direct sales from American and European companies. They extend to foreign-made products that use US software and technology.  China is reeling – and striking back.

But beware. Democracies – Japan, Europe, and the US – need to ensure that additional moves designed to hurt Beijing do not “boomerang” and end up hurting their own industries.

Let’s look first at the impact on China. The Netherlands’ ASML agreed in 2018 to supply leading Chinese foundry SMIC with EUV lithography equipment. Under US pressure, the Dutch government has now ruled that this contract now will never be fulfilled.

Chinese lithography maker Shanghai Microelectronics Equipment Company (SMEE) will have to source key components locally. That will be difficult. No.1 Chinese foundry, SMIC, will need seven years to catch up with today’s technology leaders, according to IDTechX analyst Yu-Huan Chang.

Chinese companies face shrinking bottom lines. Memory-maker YMTC has downgraded projected growth from 60% year-on-year to a 7% decline. SMIC suffered a 5% quarterly revenue drop – the first in three years.

Both Chinese companies blame a global chip glut – and yet they are announcing plans to build four new domestic chip manufacturing plants. Chinese manufacturers Grace Semiconductor (originally founded to access US markets) and Hua Hong are investing in a giant $6.7 billion new facility to meet strong demand – with support from Chinese investors and the local municipality.

Not only are Chinese chip makers hurting, but the break from China is also hurting Western semiconductor makers. NVIDIA, for example, claims it could lose $400 million of sales in one quarter because of the ban on selling its AI chips. ASML earns 15% of its revenues in China – this will now diminish as it cannot sell its latest equipment to China, and legacy equipment is likely to be sourced locally.

China is counterattacking. On July 3, it announced restrictions on exports of gallium and germanium, metals widely used in the semiconductor industry. It has already banned chips from US manufacturer Micron Technology, claiming, without evidence, that the US chips failed a “network security review.” The Micron ban was announced just a day after a G7 Summit in Japan, where democratic leaders agreed to reduce dependence on China. That’s not a coincidence. Micron makes 10% of its revenue from the China market – revenue which is now under threat.

Even so, Micron says it remains committed to building a plant in China. This move may be dangerous, depending on what concessions the US chipmaker must make. In the past, Beijing has used the cover of “joint ventures” to steal Western assets, as demonstrated by UK-Japanese chip designer ARM’s unhappy experience.

It’s not only Western chipmakers that face Chinese retaliation. Beijing is hitting out at Western companies from wood pulp to telecoms equipment – confirming its actions are political. 

Expect hostilities to escalate. The Netherlands imposed new export controls at the end of June, restricting the sale of Dutch manufacturer ASML’s advanced chips machinery to China. The Biden administration is considering additional restrictions on exports of artificial intelligence chips, which could stop the shipments of chips made by NVIDIA and other chip makers to Chinese customers. After the first round of US restrictions, NVIDIA stopped selling its most advanced A100 chips to China and made a lower-performance version called A800 for the Chinese markets. The new restrictions could ban the sale of even A800 chips without a license. Chinese AI stocks fell almost 4% on the news.

Importantly, Western democracies seem ready to coordinate their sanctions and their own plans to boost chip research and production. At a recent conference in Belgium, Japanese, American, and European policymakers outlined how they hope to make their plans complementary, not competitive.

Western sanctions and export controls have clearly had negative impacts on both Chinese and Western semiconductor companies. They look sure to slow China down in the short term. But will Chinese tech, especially AI, just become more independent, less under Western control, and hence more dangerous in the long term?

Remember the atomic bomb. Once the US unleashed it, the Soviet Union raced to catch up. It succeeded, thanks in no small part to spying – setting off the dangerous nuclear arms race. Will we now face a counterproductive chip race?

Christopher Cytera is a Non-resident senior fellow with the Digital Innovation Initiative at the Center for European Policy Analysis and a technology business executive with more than 30 years of experience in semiconductors, electronics, communications, video, and imaging.

Bandwidth is CEPA’s online journal dedicated to advancing transatlantic cooperation on tech policy. All opinions are those of the author and do not necessarily represent the position or views of the institutions they represent or the Center for European Policy Analysis.

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