Economy, Talking Point

Decoupling: phase two

Washington pushes for new law to block US investment in China


Critical concern: US chipmakers may soon find it more difficult to do business in China

What’s the best way to stop China challenging for semiconductor supremacy?

Probably not by trying to suffocate its supply of key equipment and components, it seems, after reports this week that China’s chip sector has grown faster than anyone else’s over the last year.

Nineteen of the world’s 20 fastest-growing chip firms now hail from China, according to data compiled by Bloomberg, up from eight at the same time last year.

Much of that is a reaction to American efforts to choke off access to key parts and equipment for chipmaking, something that Chas Freeman – a long-time China expert (he translated for President Nixon in 1972) and a former US ambassador – talked about in a wide-ranging interview with WiC last week.

“One of the things I’ve learned over the years dealing with export controls in various contexts is that if a foreign entity knows that something can be done and vaguely how it can be done, cutting them off just stimulates them to do it themselves,” he explained. “I wish my own country, instead of trying to tear China down, was trying to build our own competitive capacity up. But we can’t seem to get our act together to pass the legislation and direct the funds and develop the institutions to do what the Chinese have been doing in terms of focusing investment on key sectors that do bear on the competitive capacity of our nation.”

In fact, the Biden administration is trying to move forward with both a ‘boost’ and a ‘contain’ strategy in a bid to maintain the American lead. It has been pushing for the Bipartisan Innovation Act, which would release billions of dollars of public investment into domestic research and technology. And on the other side of the coin it’s looking favourably on proposals to prevent American investment in areas that advantage its national rivals, including a new screening process that could block billions of dollars of investment going to China.

What’s behind the efforts to block American investment overseas?

The Wall Street Journal reported last week on the latest draft of the National Critical Capabilities Defense Act (NCCDA), which has cross-party backing in the Senate and the House of Representatives, to block outbound US investment viewed as counter to the national interest.

Russia, Iran, North Korea, Cuba and Venezuela all get mentions as countries of concern in the proposed legislation. But clearly the Chinese are the primary target for lawmakers anxious to protect the supply chain for critical goods and services, as well as prevent the leakage of key technologies from American firms to Chinese rivals.

As a quick summary, the Act would require US persons or companies to get clearance from a government committee for any activity that ‘develops, manufactures, services, manages, operates, utilises, sells or relocates a national critical capability to or in a country of concern’.

‘National critical capabilities’ are very broadly defined as supply chains, industries and technologies, including sectors such as semiconductor manufacturing, pharmaceuticals, large capacity batteries, artificial intelligence and quantum computing, as well as critical minerals and materials.

The ‘covered activity’ is also broadly laid out to include any form of investment or financing, as well as any transfer or contribution of intellectual property, technology or know-how.

Although the legislation doesn’t preclude capital inflows via the stock markets, it would scrutinise a much wider range of foreign direct investment (FDI) in which individuals or groups of investors set up entities or invest in new projects in China. That means it has the potential to block an array of investment by US firms from the building of new plants to the purchase of shareholdings in target companies. There could also be denials of capital contributions to joint ventures and the torpedoing of transactions that include the transfer of intellectual property or sharing of technologies.

How do the proposals compare to existing investment reviews in the US?

A review process like this would be the reverse of the activities of the Committee on Foreign Investment in the United States (CFIUS), a panel created in 1975 to screen foreign investment in assets in the US market. Four years ago CFIUS was also granted more oversight over transactions involving “critical technology” and “critical infrastructure” in rule changes that seemed intended to limit Chinese access to important  US-linked assets. Reviews have already prevented a range of takeovers by Chinese acquirers, including stopping Ant, the fintech arm of Alibaba, from buying MoneyGram in 2018, and forcing the Chinese buyout fund Wise Road Capital to drop its $1.4 billion bid for chipmaker Magnachip (South Korean, but US listed) last year.

Chinese investors have grown warier about doing deals that are likely to require CFIUS approvals and opponents of the NCCDA are claiming that it could have a similar impact on sentiment in damaging the commercial interests of American companies operating in China. “Despite the well-documented challenges of doing business in China, China is a critically important export and investment market for many US businesses,” the US-China Business Council, a lobby group, warned earlier this year, predicting that the new legislation would have a “chilling effect” on R&D and employment levels.

How much investment is likely to be affected?

With the full extent of the new law still to be finalised, it’s hard to reach a definitive conclusion on the levels of investment that could be subject to review. However, an assessment earlier this year of a previous draft of the legislation from the Rhodium Group, a research group, reckoned that as much as 43% – or at least $110 billion – of American FDI into China between 2000 and 2019 would have come in for scrutiny.

Rhodium pointed out that many of the sectors that have received the most American FDI in the recent past could fall within the definition of ‘critical’ capabilities that need to be protected, including automotive equipment and components, industrial machinery, and pharmaceuticals and biotech.

American companies already doing business in China may also have grounds for concern about getting approvals for investment to grow their existing operations. The legislation could also draw in firms from outside the United States, or at least their US-based subsidiaries, with mentions of how there needs to be scrutiny if a country or company of concern holds 5% of an entity’s shares, or simply if the entity, or subsidiary, is headquartered in a country of concern.

That could affect foreign firms that plan to invest in areas likely to fall within the remit of the new rules, like a South Korean semiconductor foundry or a European manufacturer of lithographic equipment.

Reviews may even be required in cases in which an entity risks being influenced by a national of a country of concern, which might give pause for thought for firms with board members of Chinese nationality.

Alongside transactions like the funding of new factories or joint ventures that include technological transfers, the legislation would also take aim at capital investments in Chinese start-ups and technology firms, which could target the foreign portfolio companies of US private equity sponsors.

“That potentially expands the jurisdiction of the original bill, which did not explicitly focus on capital flows into Chinese firms, though its language was broad enough to potentially include them if the White House saw fit,” reports Politico, a news website headquartered in the US.

Venture capital firms will be alarmed at the risk to future investments or to new rounds of financing for existing ones. Consider the position of VC firms like Sequoia Capital, for instance, which has made at least 40 investments in companies in the Chinese semiconductor sector since 2020, the Wall Street Journal reported last week.

How have critics of the bill responded?

Business groups are speaking out against giving the government new powers, arguing that the increased oversight could hamper their competitiveness. Interestingly the US Treasury is said to have shared some of the concerns about the broad scope of the new law and lobbied for a softening of the provisions in their earlier form.

The latest draft makes references to exemptions for “ordinary business transactions” that don’t involve transfers of advanced technology or intellectual property. But opponents have kept up their complaints that the Act is too broadly defined and that too many government agencies will be involved in enforcing it, increasing the chances of politicisation in the review body’s decisions.

“People are going to have the same complaints about this as they did the other one,” Clete Willems, who served on the National Security Council and National Economic Council during the Trump administration, told Politico last week. “It doesn’t resolve many of the concerns about the original bill, including that it’s overly broad, or that it will put US companies at a competitive disadvantage when they’re trying to sell into China.”

“I have yet to be convinced that existing export control laws are falling short,” added Pat Toomey, a Republican senator and a longstanding opponent of the new legislation. “Moreover, I’m concerned this proposal grants the federal bureaucracy sweeping new authorities to dramatically disrupt and halt the free flow of trade and investment, risking slower economic growth and higher prices for consumers.”

What about the current blocks on doing business with Chinese firms?

One of the options in Washington’s arsenal is to expand the current restrictions on investment overseen by the US Treasury, which prevent American nationals from trading in the securities of companies said to be connected to the Chinese military. Joe Biden broadened these restrictions last summer to block investment in publicly traded companies operating in surveillance technology and the grouping now comprises 68 Chinese firms, including Huawei, Hikvision, SenseTime, DJI, Megvii, SMIC, China Telecom, China Unicom and China Mobile.

Opponents of the NCCDA say that it would be a better idea to remodel this investment blacklist and they also argue that policymakers could be doing more to implement the Export Control Reform Act, passed in 2018 to control access to “emerging and foundational technologies”.

As part of this process the Department of Commerce administers an Entity List that targets foreign companies involved in “activities contrary to the national security or foreign policy interests of the United States”. Designated entities can be barred from importing almost any US-origin product without first obtaining a licence, which may be refused.

The number of China-based companies on this list increased from 130 to 532 between 2018 and the middle of this year, making up more than a quarter of the restricted companies in the group, notes Jon Bateman in a report on tech decoupling published by the Carnegie Endowment for International Peace in April.

Firms getting focus include leaders in sectors such as telecommunications (Huawei), AI (SenseTime and Megvii), semiconductors (SMIC and HiSilicon) and supercomputers (China’s National Supercomputing Centres).

However, supporters of the more aggressive approach in the NCCDA say that the Treasury’s investment blacklist of Chinese firms is too narrow in scope. They also complain that sales of American technologies haven’t been curtailed in the way first envisaged by the export control rules. Part of the complaint is that the Entity List has been used too selectively, with companies like Huawei and SMIC continuing to get approvals for shipments of billions of dollars of US tech components. It also takes too long to add new products and technology to the group of embargoed goods.

What’s happened is that the programme has been constrained by commercial pressures, its critics add. American businesses have lobbied against efforts to curtail their sales, leading to a situation in which export restrictions have been reduced to narrower areas such as high-end semiconductor manufacturing.

What happens next?

Concerns like these get more coverage because of the souring relationship between the two superpowers, which has spilled over into tensions in trade and investment.

Previous investment by American firms in China has generally been seen as a positive in generating corporate profits and bringing down prices for US consumers. But a more confrontational mood has taken hold, bringing something closer to a winner-takes-all mentality.

“We’re in an economic war, whether we want to use that language [or not]. I think it requires that we examine some issues that maybe 10 or 15 years ago we didn’t have to worry about,” Bob Casey, a Democrat senator and the co-author of earlier iterations of the NCCDA legislation, insisted this year.

In this kind of context, the blocking of outbound US investment would also align with the Bipartisan Innovation Act (BIA), through which the Biden administration plans to reboot American tech leadership with billions of dollars of funding for semiconductor manufacturing, as well as for groundbreaking research in areas like artificial intelligence, robotics and biotechnology.

Think of it as a two-pronged push from the US government: bolstering its technological base on home soil; whilst cutting off access to American capital and know-how for Chinese rivals.

Tellingly, the broader legislation has bipartisan support and House leaders have said they want to move quickly to a vote on the investment package before the recess later this summer. “Pass the damn bill and send it to me,” Biden urged Congress of the BIA in May. “If we do, it’s going to help bring down prices, bring home jobs and power America’s manufacturing comeback.”

“It’s no wonder the Chinese Communist Party is literally lobbying — paying lobbyists — against this bill passing,” Biden added.

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