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Silicon or Soy? Targets of the U.S.-China Trade War

President Trump Meets With Vice Premier Of China At The White HousePresident Trump Meets With Vice Premier Of China At The White House
President Trump met with China Vice Premier Liu He to discuss trade this week.Chip Somodevilla—Getty Images

On Wednesday the U.S. Semiconductor Industry Association (SIA), an industry group that includes Intel, Micron Technology and Nvidia among its members, released a report no doubt designed to capture the imagination of President Donald Trump. It came out a day before the president met with China Vice Premier Liu He to discuss trade and was called “Winning the Future”—a very Trumpian sentiment.

The report sets out the challenge of securing America’s leadership in the semiconductor space—where the U.S. has dominated ever since the industry was created.

Semiconductors are vital to all the next great tech advances, including 5G, AI, and quantum computing. However, as the report explains, Silicon Valley’s supremacy is “under threat from [foreign] government policies that seek to localize supply chains and build state-backed national champions to compete abroad.”

In case it isn’t obvious: they’re talking about China.

We’ve mentioned before how last year’s blockade on U.S. companies exporting microchips to Chinese telecom manufacturer ZTE was a wake-up call for Beijing, demonstrating how many of China’s tech champions are dangerously dependent on supplies from the U.S.

In fact, Beijing became wary of China’s crippling silicon addiction years before. The government released the National Guideline for the Development of the Semiconductor Industry in 2014 and established a $22 billion fund, nicknamed the Big Fund, to invest in domestic chip makers. The incident with ZTE only made Beijing realize it had to double-down its efforts.

China’s private tech companies have promptly answered the call. Baidu released its smart chip, Kunlun, last July; Huawei unveiled the world’s first 7nm microchip in August; Alibaba launched its semiconductor division Pingtouge last September; and this week smart phone maker Xiaomi announced it will reorganize its microprocessor subsidiary as part of a $1.5 billion AI strategy.

It’s the age of AI that might give China a chance to excel in the semiconductor business. AI chips are a different class from semiconductors of old so China is starting (relatively) fresh, rather than playing catch up. China’s huge data pools also give it an advantage when it comes to testing and improving AI chipsets.

The problem for China, and the saving grace for the U.S., is that Chinese companies are designing chips too sophisticated for domestic foundries to manufacture. For example, Huawei had to outsource the manufacturing of its groundbreaking 7nm chip to the Taiwan Semiconductor Manufacturer Company (TSMC).

But that won’t be the case forever. Chinese foundries currently meet 30% of domestic demand. Beijing wants to boost that number to 40% by next year and is flooding the sector with subsidies to do so.

To keep an American hand in the lucrative silicon trade, the SIA recommends the government does three things: first, triple federal funding for industry research to $5 billion a year; second, scrap immigration caps on qualified STEM candidates; and third, protect intellectual property.

That last point is something the U.S. has a real chance to do now, as Chinese negotiators engaged in discussions on forced tech transfers last week for the first time since the Trade war began nearly a year ago. Hopefully, negotiators will be able to keep focus on this space and away from less important objectives, such as reducing the trade deficit and increasing sales of soy.

This story originally appeared in Fortune’s CEO Daily newsletter. Subscribe here.