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PC: Hive Ventures

Context

Following the 2024 US presidential election, new high tariffs on AI hardware might drastically alter global supply chains that underpin artificial intelligence (AI) research.

What is the Tariff War on AI Supply? 

A Tariff War on AI Supply refers to a trade conflict where countries, particularly the U.S. and its trading partners like China, impose high import duties on critical components and technologies used in Artificial Intelligence (AI) systems. This is a part of broader economic and strategic competition over control of emerging technologies.

Recent Advances in Tariff Wars and AI

• US-China Technology Tensions:  The US has continued to pursue China's access to advanced AI processors, most recently focusing on Huawei's Ascend chips.  While a temporary 90-day tariff de-escalation agreement for broader items was announced on May 12, 2025, the underlying tech competition, particularly in semiconductors critical to AI, remains a basic national security objective for both countries.  The US Commerce Department pushed back the "AI Diffusion Rule" (issued by the previous administration) to protect American chips while also warning against using US-built AI chips to train Chinese AI models, indicating a targeted strategy.
• EU Strategic Autonomy: The European Union, under its "AI Continent Action Plan" launched in April 2025, is actively pursuing strategic autonomy in artificial intelligence. This initiative, in conjunction with the "Chips Act 2.0" study, seeks to accelerate AI development and adoption by improving computing infrastructure, data, skills, and regulatory simplification. In the midst of global trade tensions, the EU recognizes the importance of robust access to semiconductors and aspires to double its share of the global semiconductor industry to 20% by 2030, focusing on collaboration while growing local capacity.
• Increased Hardware Costs: Tariffs of up to 27% on crucial AI components are considerably increasing the cost of AI infrastructure in nations such as the United States. Companies are reconsidering their data center sites and perhaps shifting operations to lower-cost nations, including, strangely, China.

U.S. CHIPS Act 2.0  While the original CHIPS and Science Act of 2022 allocated $52.7 billion to bolster domestic semiconductor manufacturing and research, discussions are underway for a potential CHIPS Act 2.0 to address emerging challenges and expand upon initial efforts. Key Considerations: Expanded Funding: Additional investments to support advanced semiconductor technologies and infrastructure. Workforce Development: Initiatives to train and retain skilled professionals in the semiconductor sector. Supply Chain Resilience: Measures to secure and diversify supply chains for critical components. Research and Innovation: Enhanced support for R&D in cutting-edge semiconductor technologies. These considerations aim to ensure the U.S. remains competitive in the global semiconductor landscape and addresses vulnerabilities exposed by recent supply chain disruptions.

Impact of 2024 U.S. Tariffs on AI Supply Chains and Costs

• The 2024 U.S. tariffs have imposed import duties of up to 27% on critical AI hardware components, leading to a significant rise in AI infrastructure costs.
  
  
• These tariffs affect over $200 billion worth of data processing machines imported from nations such as China, Taiwan, Vietnam, and Mexico, making it costlier to build and operate AI systems in the U.S.
  
  
• As a result, companies are experiencing a disruption of global supply chains, forcing them to relocate or delay data center construction due to elevated U.S. costs.
  
  
• Ironically, some firms are shifting operations to China, which was one of the main targets of the tariff policy.
  
  
• The tariff environment is also impacting the pace of technological advancement by causing a reduction in innovation and investment.
  
  
• Higher costs and uncertain trade environments discourage long-term capital investment and lead to fragmented supply chains.
  
  
• Empirical studies suggest that a standard deviation increase in tariffs may lead to a 0.4% reduction in output growth over five years, indicating long-term economic consequences.

What are the various tariffs and their types?

Tariffs are levied by the government on imported goods. They perform a variety of functions, including protecting domestic industry, producing money, and resolving trade imbalances. The primary forms of tariffs include:

• Protective tariffs are designed to protect native sectors from foreign competition by raising the cost of imported goods.
• Revenue tariffs: Designed to generate revenue for the government without necessarily safeguarding domestic businesses.
• Anti-dumping tariffs: These are imposed to prohibit foreign corporations from selling goods below market value in order to undercut domestic producers.
• Countervailing tariffs are levied to offset the subsidies offered by foreign governments to its exporters.
• Retaliatory Tariffs: Imposed in retaliation to tariffs imposed by other countries, frequently as a form of negotiation or protest.

India as a Third Option in U.S.-China Tech Rivalry

• Strategic Geopolitical Position:
  
  
• India is seen as a neutral and reliable alternative amidst rising U.S.-China tensions.
  
  
• Example: Global firms are increasingly selecting India for data centers and AI collaborations to reduce dependence on China.
  
  
• Growing Tech and AI Sector:
  
  
• India’s AI and digital engineering sectors are among the fastest-growing within its IT industry.
  
  
• Example: IT exports have grown at 3.3% to 5.1% annually, driven by demand for AI services.
  
  
• Skilled Workforce:
  
  
• India produces around 1.5 million engineering graduates annually, many with AI and software skills.
  
  
• Example: This talent pool supports global R&D, especially in software development and algorithm design.
  
  
• Policy Support and Investment:
  
  
• The Indian government is promoting growth in semiconductors and AI infrastructure.
  
  
• Example: AMD’s $400 million design campus in Bengaluru and multi-billion-dollar fab proposals highlight this effort.
  
  
• Comparative Cost Advantage:
  
  
• India offers lower labor costs and a rapidly expanding tech ecosystem.
  
  
• Example: Companies find India more cost-effective than both the U.S. and China for tech operations.
  
  

Influence of Tariffs on AI Innovation and Efficiency

• Disruption of Global Supply Chains:
  
  
• Tariffs raise costs of essential AI components, slowing access to new technologies.
  
  
• Example: A 27% tariff on AI chips (2025) made the U.S. a costlier place to build AI infrastructure.
  
  
• Shift Toward Efficiency:
  
  
• Rising hardware costs force a pivot toward algorithmic efficiency and model compression.
  
  
• Example: AI usage costs dropped ~40x/year through optimization rather than hardware scaling.
  
  
• Deadweight Loss and Productivity Decline:
  
  
• Tariffs reduce trade volume, creating inefficiencies that harm both producers and consumers.
  
  
• Example: A 1 SD rise in tariffs can cut output growth by 0.4% over five years.

What are the challenges facing India?

• India's reliance on imported semiconductor components renders its AI ambitions vulnerable to global supply chain disruptions and tariffs. Tariffs on AI devices, for example, can raise costs and hinder the growth of India's AI infrastructure.
• Limited Semiconductor Manufacturing Capacity: India currently lacks domestic chip manufacturing facilities, making it difficult to compete against established producers such as Taiwan and China. For example, India has revealed semiconductor fab projects but is still unable to meet demand for advanced devices.

Way Forward

• Diversify Global Supply Chains: Use the "China Plus One" method to diversify risk and strengthen resilience to geopolitical or trade shocks. Strategic diversification enables continuous AI hardware flow. Example: Apple switches suppliers to Vietnam.
• Strengthen domestic manufacturing capabilities: Use programs like the Production Linked Incentive (PLI) to encourage local production in critical industries such as semiconductors and electronics. Reduces reliance on foreign resources. For example, consider Micron's PLI investment in its fab.
• Increase governmental and commercial R&D spending to promote innovation and reduce dependency on foreign technologies. Supports advanced AI solutions. Example: ₹1,000 Cr budget for PM-STIAC.
• Promote Workforce Skill Development: To satisfy AI demand, expand skilling initiatives associated with Industry 4.0 through programs such as PMKVY and Skill India. Talent is the backbone of artificial intelligence. Example: NASSCOM has established AI-ML courses.
• Modernize Digital and Physical Infrastructure: To meet AI's increasing energy and processing demands, invest in resilient digital infrastructure such as data centers, 5G, and power capacity. Consider Hiranandani Group's 250 MW data park.
• Encourage strategic international partnerships: Join bilateral and multinational tech alliances to promote knowledge exchange, co-development, and robust supply networks. Example: India-U.S. iCET technology partnership.
• Implement flexible, pro-innovation trade policies: Balance strategic protectionism with open-market policies that promote innovation, attract foreign direct investment, and lower obstacles. For example, tariff reductions on AI chip imports.
• Investigate Decentralized Infrastructure Technologies (DePIN): Use decentralized AI frameworks like DePIN to eliminate reliance on centralized data centers and enhance technology access in rural areas. As an example, consider the Helium Network for IoT connectivity.

Practice Question Q. The West is promoting India as a substitute for China's supply chain and a strategic ally to fight China's political and economic dominance.  Explain this statement using examples.