A Somewhat Tightening Vise on US FDI in Chinese High-Tech: Death by 1000 Cuts… or So…

The United States (US) recently issued a “Final Rule” to implement President Joseph Biden’s August 2023 Executive Order titled “Addressing United States Investments in Certain National Security Technologies and Products in Countries of Concern.” They both target persons from the People’s Republic of China. US persons are forbidden from “certain transactions…involving a defined set of technologies and products” and required to give notice of “certain other transactions…involving a defined set of technologies and products.” The “defined set” involves artificial intelligence (AI), quantum information technologies, and semiconductors and microelectronics and subsets within these categories. These sectors are critical for cybersecurity, intelligence and surveillance, and weapons. The US seeks to deny or limit China’s access to related money, goods, and technology as well as engineering, scientific, and managerial talent.[1] This “Hot Topics, Cool Analysis” (HTCA) blog provides background, discusses the Final Rule’s implications, identifies future uncertainties, and offers some business recommendations.

US controls on China’s access to American technology have taken the form of export controls, more intense review of inward Chinese foreign direct investment (FDI), limits on American investment in the stock and bonds of Chinese companies tied to the Chinese military or human rights violations, and countering China’s the Digital Silk Road.[2] Over the past four years or so, talk about a reverse Committee on Foreign Investment in the United States (CFIUS) process, meaning a review process for outward FDI to China, became louder. Still, no meaningful restraints appeared due to the complexity of inter alia defining “investment,” identifying the sectors needing targeting, and specifying restriction and penalty forms. Industry lobbying further hindered action. Concerns that action might fuel further declines in bilateral relations and spark Chinese retaliation also seem relevant.[3] Ultimately, Washington embraced a “Small yard, high fence” strategy that minimizes bureaucracy, red tape, business burdens, and deal delays, curries favor with allies, and incentives investors to restrain themselves.[4]

There are doubts Final Rule restrictions will notably intensify pressure on China. After all, the US already restricts exports of semiconductor tools, design, and manufacturing equipment to China and bans the purchase of the securities of “bad” Chinese companies such as those noted above. Second, not many are investing in quantum in China. Third, US entities already have been moving to dramatically reduce their investments in China for economic and political reasons. Fourth, massive pools of domestic funds reportedly exist in China. Fifth, China already has been moving to indigenize and the key players in some sectors are not investible private companies.[5] Aside from this, the limits are limited, as discussed. For instance, restrictions do not prohibit all AI, but only AI involving a certain amount of computing power, and investment in publicly listed Chinese companies is not prohibited.[6]

As is, the Final Rule will weigh on American entities and those of US-allied countries. It indisputably will increase administrative, legal, risk management, public relations (“PR”), and planning burdens. Another reason is that American entities will lose investment opportunities and the associated product, talent, and knowledge. Yet another is that it likely will make them shy about being involved with China given the risk that they will be stigmatized. Beyond this, American investors may be shunned by the Chinese side or find their competitors gaining opportunities they would have had. Worse, Beijing may retaliate against American firms.[7] Signaling this risk, China responded to the Final Rule by calling on the US to “respect market economy principles” and “stop politicizing and weaponing economic issues” and by saying it “deplores and rejects the US’s Final Rule” and reserved the “right to take further actions.”[8]

It is uncertain if the Final Rule will survive, expand or constrict, or be implemented well. Survival is in doubt because past comments suggest newly elected President Donald Trump may scrap the regulations.[9] Expansion or constriction is unknown because the power balance among difference constituencies in the new Administration is unclear. On the one hand, businesspeople (at least very rich ones) have Trump’s ear. On the other hand, many of the President’s nominees for top national security and foreign policy posts are very strong anti-China hawks. On a related note, there are many in Congress such as Representative John Moolenaar, Chair of the US House Select Committee on the CCP, that want greater restrictions on more types of investment in a wider range of sectors.[10] Let’s not forget the President is an enigma—he is strongly critical of China, but also very transactional. Battles among government agencies further have the potential to affect rule expansion and constriction as well as implementation.[11] In concept, US allies have the potential to shape the Final Rule’s evolution and implementation, too.[12]

As mentioned in my HTCA blog from 18 months ago, businesses and individuals (quite obviously) need to keep on top of evolving developments.[13] That blog also implied they need to lobby—the fluid environment described in the paragraph above suggests, though, that new lobbying opportunities and channels exist. Beyond the above, US businesses and investing individuals need to devote sufficient time identifying the gains and risks associated with Final Rule covered sectors and related sectors, the viability and cost of options that allow them to obtain similar gains elsewhere, and the risks associating with diversification, downsizing, or decoupling if they cannot obtain their desired policies through lobbying and/or PR work. Lastly, they need to contemplate if they might face Chinese retaliation and, if so, how they will offset or eliminate the downsides.