Witnesses Recommend Requiring Importers to Trace Origin of Chips in Products

The witnesses, some former Biden administration appointees working on supply chain issues, some from think tanks, testified at a U.S.-China Economic and Security Review Commission hearing June 5 on choke point vulnerabilities due to Chinese exports.

Commissioner Leland Miller said not confronting the dependencies risks national security. "China’s recent restrictions on U.S. access to gallium, germanium, antimony, graphite, certain rare earths, and other critical minerals demonstrate Beijing’s willingness to exercise its leverage. Tariffs may be a part of the solution, but a whole-of-government effort is needed to develop alternatives to these supply chain choke points."

Silverado Policy Accelerator CEO Sarah Stewart told the commission that China's subsidization and prioritization of production of lithium-ion batteries, solar panels and electric vehicles injured companies who made those products in other countries. She said that observers are "already seeing that in foundational semiconductors."

The think tank calls "foundational" what most call "legacy" or "mature" chips, to distinguish them from more advanced, newer technology chips. Stewart said they use that term to emphasize how crucial they are to modern life, and said they're used in missile guidance systems, not just cars and dishwashers.

The automotive factory furloughs in 2021 when carmakers couldn't get legacy chips in the quantity and time they needed show how critical the chips are. Those shortages weren't due to China weaponizing its strengths in the sector, but rather, that carmakers canceled orders when the COVID-19 pandemic was beginning, thinking demand for new cars would drop sharply. When carmakers realized their projections were wrong, that capacity had already been diverted to consumer electronics, where demand had been surging.

Stewart said census data on trade doesn't differentiate between node size, and that needs to be updated.

"Efforts to survey companies on legacy chips have shown that outside of census data, companies don’t even really know where their chips are coming from," she said. "We don’t know how many Chinese chips are in things we are buying, including our own government," Stewart said.

She said the Chinese Communist Party aims to have a 56% global market share by 2030, and to have 80% of its domestic manufacturing supplied by its own fabs.

If China were to throttle that supply in response to tariffs, that would be even more disruptive than what it's done with restricting exports of processed rare earths or rare earth magnets.

Stewart said that current policy on export controls is akin to blocking China's access to carbon fiber, while allowing it to corner the market on aluminum.

Commissioner Aaron Friedberg, who has previously discussed the need to track -- and tariff -- Chinese components in goods made elsewhere (see 2408200040), asked Stewart how difficult and costly would it be for importers to track where chips in finished goods come from.

Stewart replied, "We actually do this in many other areas," and gave seafood traceability as an example.

"The onus would be on the U.S. importer," she said. "It would be an extra burden than what we have now. But it is doable."

Stewart said the requirement could be deployed for certain products first, in a risk-based approach. She said importers could be told "you’ve got six months to figure out your supply chain for chips" if they import goods in the initial group of products.

She said that companies that find a chip is either designed or fabricated in China would need to report that. Then, she said, there could be a tariff on that chip, or an outright prohibition on importing it.

Former Office of the U.S. Trade Representative chief of staff Nora Todd also pointed to traceability as a weakness in a coherent trade policy. "One of the issues is that we don’t actually know all the legacy chips that are in the products ... we don’t know where they’re sourced from," she said.

"We don’t have a lot of requirements for traceability on imports," she said. "That may make it harder for us to impose tariffs that are effective," including what the USTR recommends for the Section 301 investigation on Chinese semiconductor production. Right now, they would be guessing which products contain chips that the U.S. wants to discourage sourcing of, she said.

She suggested that Congress write laws that require importers to provide information about chips; she also said there need to be trade law updates that get away from country of origin as the determinant of tariffs.

"Our trade tools were designed to address a product from a country," she said. "It won’t get at that product from Mexico that may be just as unfairly traded."

Todd also said that while Congress should pass Leveling the Playing Field Act 2.0, a rewrite of trade remedy laws, it doesn't go as far as is needed.

"Tests require serious harm or injury," she said, before trade remedies are authorized. "We should be looking to take action before the fact, not after the fact."

Monica Gorman, a former deputy assistant secretary of the Commerce Department for manufacturing and Biden adviser on manufacturing, agreed that the U.S. government doesn't understand upstream dependencies, noting CBP doesn't collect components, base materials and processing country of origin if those inputs are part of a larger component or finished good.

Gorman, who spent years at New Balance, American Eagle and The Gap before entering government, said companies don't want to share granular supply chain information with the government. She said the government has relatively little authority to compel them to do so.

"As soon as the crisis passes, everybody forgets and moves on to something else," she said, referring to how companies were more forthcoming during the pandemic supply chain crunch.

Stewart and Gorman also talked about carrots to encourage supply chain diversification, with Stewart saying any trade frameworks should include bonuses for U.S.-made chips, and Gorman endorsing the bipartisan Medical Supply Chain Resiliency Act, which aims to eliminate duties on medical goods in a multilateral trade agreement. Gorman said other sector-specific agreements could include incentives to promote upstream material and intermediate component sourcing within the group of signatories.

Witness Adam Wolfe, an emerging markets economist at Absolute Strategy Research, told the commission that China's push for dominance in strategic areas came about because it wanted to stop the U.S. from being able to exploit its own choke points to prevent technological advancement.

He also advised the commission to think clearly about what problem it's trying to solve. The hearing's title both covered choke points and non-market overcapacity.

He asked: "Is it the surge of Chinese exports that’s a problem or is it the choke point vulnerabilities? I think it’s the choke point vulnerabilities that’s a bigger problem for the U.S."

Friedberg asked if the U.S. could convince other importers from China to erect a "unified tariff wall" that prevents them from exporting manufactured goods.

Wolfe said that's not plausible. He said while other advanced economies may be troubled by China's rise in electric vehicles, for instance, the majority of China's exports go to other emerging markets. While those countries may levy trade remedies on Chinese textiles, or the low-value-added metal products they produce, they welcome cheaper capital goods, as well as Chinese investment in factories that allow Chinese companies to export with a different country of origin to get around U.S. tariffs. Even if final production is the lowest-value step, he said, integrating into the global market is inherently productive for these countries.

Wolfe cautioned policymakers over focusing too much on industrial subsidies, though he acknowledged that in hindsight, the U.S. should have kept capabilities in rare earth magnet production and rare earth processing.

"I do think trying to out-China is a losing strategy," he said. "America should play to its strengths."

He said the U.S. university system is the best in the world, and invests more than China in basic research. Commercial products are often invented from those discoveries, but scaling up production of those goods is done in China. "That doesn’t have to happen," he said.

But Wolfe said that many of America's advantages "are being undermined under the current administration."