Investment Restrictions on China: The Decision that Wasn’t
Yesterday, the White House weighed-in on investment restrictions pertaining to China’s practices related to technology transfer, intellectual property (IP), and innovation. While most observers were expecting a new framework for restrictions on Chinese investment in the United States, what emerged was presidential endorsement for reforms to existing mechanisms for screening foreign investment and controlling the export of sensitive technologies. Yesterday’s announcement may represent a near-term de-escalation in “trade war” tensions between the United States and China; however, the effectiveness of the endorsed reforms can only be measured over the span of years. At a minimum, these reforms will likely make it more difficult for U.S. and Chinese companies to transact in one another’s high-tech sectors.
Q1: What’s in the White House statement?
A1: In March 2018, the U.S. trade representative (USTR) released findings of its Section 301 Investigation of China, prompting President Trump to direct the treasury secretary to “address concerns about investment in the United States directed or facilitated by China in industries or technologies deemed important to the United States.” An announcement from Treasury was expected late this week, with most observers anticipating a new framework that would limit or prevent Chinese investment in U.S. technology firms and block certain U.S. technology exports to Beijing.
Instead, the White House released a statement on Wednesday that gives presidential support for pending legislation to protect critical technologies from “harmful foreign acquisitions.” That legislation, the Foreign Investment Risk Review Modernization Act (FIRRMA), recently passed the Senate and the House, and is entering a reconciliation process before heading to the White House for the president’s signature.
Rather than call out China by name, the White House statement refers to “certain countries” that seek to obtain cutting-edge technologies and intellectual property in industries those countries deem important. It goes on to advise that Congress’s failure to pass a strong FIRRMA bill would result in the deployment of “new tools, developed under existing authorities,” likely a reference to the International Emergency Economic Powers Act (IEEPA), which gives the president broad authority in the case of an unusual and extraordinary threat.
Q2: What would FIRRMA do?
A2: Both the Senate and House versions of FIRRMA include major reforms to how the Committee on Foreign Investment in the United States (CFIUS) would screen foreign investment in the United States. For instance, FIRRMA would expand CFIUS coverage beyond mergers and acquisitions of existing U.S. assets to include select non-passive and greenfield investments as well as transactions involving real estate near to sensitive government installations. In another first, CFIUS filings would become mandatory for acquisitions involving the release of critical technologies to a foreign person or government.
But the most controversial issue in the CFIUS debate has been over outbound technology transfers, which often occur through joint ventures rather than direct investments. Here the administration has thrown its support behind the existing export licensing process to protect sensitive technologies. The existing export controls process already requires an export license for the transfer of controlled goods or technology, whether it is in the context of a joint venture or any other arrangement. Since that process already exists, and since it already controls critical technology exports, the obvious question is what will the administration be adding?
The answer appears to be an expansion of the list of controlled items either by simply interpreting the term “national security” more broadly than previous administrations or by creating a new basis for export controls focused on strengthening the U.S. industrial base or promoting economic competitiveness. Doing the latter would move the export control process into new territory, focused more on economic than security outcomes, and it could represent a major expansion of the list of controlled items.
Q3: Will FIRRMA fix the problem of sensitive technology transfer to China?
A3: The acquisition of Western technology by means licit or illicit has been a goal of Chinese policy since China’s economy opened to the West. The United States recognized this problem as early as the mid-1990s, when it unsuccessfully sought cooperation from its allies to block advanced technology transfers to China. U.S. allies argued that China was a market, not a military threat, and that technology transfers did not pose a national security risk. U.S. companies had similar views, believing that they could manage the risk of technology loss while reaping the benefits of market access. In the last few years, the views of allies and companies have changed and reflect greater concern about technology transfer to China. Export control processes designed for the Cold War will need to be updated for a new geopolitical environment.
The combination of expanded CFIUS coverage and new restrictions on the transfer of critical technology can be steps in the right direction, provided their application is focused on national security concerns. The heightened scrutiny of joint ventures, which China has used in some instances to coerce technology transfer, is long overdue. One lesson we have learned, however, is that when the United States erects new barriers, China looks to find ways around them, and this will likely involve espionage (including cyberespionage), using Chinese graduate students to gain technology, and recruiting American researchers to move to China.
In addition, enforcement will always be an issue, particularly in today’s world where technology is easily transferred digitally. Large companies know the rules and try to abide by them. The biggest risk is start-ups or small companies that may not even be aware of the restrictions and/or may not be interested in learning about them when the result might work against financial interests. In addition, if the system is expanded into economic controls as outlined above, that will be highly disruptive for companies who have long been doing business with China without licensing requirements. Getting them to understand and adhere to what will be new controls for them will be a major challenge for enforcement authorities at the Department of Commerce.
Q4: Is China breathing a sigh of relief?
A4: Yes, but Beijing knows this is no more than a momentary respite in a long-term challenge. The Chinese media characterized the step as a “softening” of U.S. policy but still expressed concerns about the overall tightening. Analysts estimate that specific executive action to restrict Chinese investment could have been as damaging to the commercial relationship as tariffs. It would have explicitly singled out China, and essentially banned new Chinese investment in most high-tech sectors and limited U.S. investment in China in these same industries. Beijing would have been forced to retaliate, most likely targeting U.S. companies on the ground with non-tariff actions, such as anti-monopoly investigations or other kinds of harassment. For the moment, this escalatory path can be avoided.
Nevertheless, there is no reason for China to celebrate. Although President Trump put aside the most confrontational approach, he accepted a new law that substantially expands the scope of investment reviews and will permanently make it more difficult for the United States and China to carry out investment deals in one another’s high-tech sectors. The House vote of 400-2 reflects a consensus across the U.S. political landscape, meaning that the outcome of the November midterms or next presidential election is unlikely to result in the United States being more receptive to Chinese investment. Moreover, this is exactly the opposite outcome China had hoped for in pursuing a bilateral investment treaty (BIT). That window of opportunity seems to have closed. Moreover, although other countries have not followed the Trump administration in threatening unilateral tariffs against China, several—the European Union, Japan, Australia, and Canada—are all moving in the direction of restricting Chinese investment in one way or another. This could have a genuinely detrimental effect not only on China’s efforts to acquire technology but on a more rational distribution of China’s financial assets.
Finally, while the United States has stepped back from the brink on investment, the smart money is still betting on the Trump administration going through with putting 25 percent tariffs on $34 billion in Chinese products starting on July 6th. China has promised to respond in kind, if not kindly, and the United States has likewise pledged that if China retaliates, it would then penalize an additional $200 billion in Chinese goods. The chances of escalation in the near-term via tariffs are still quite real. In sum, Beijing is less likely breathing a sigh of relief than taking in a big gulp of air to prepare for the forthcoming storm.