By Claude Barfield

In a recent piece, William Rau and I pointed out the fraught dilemmas American entertainment and financial firms face with their substantial investments in China. In both Washington and Beijing, however, broader and greater pressures are rising — particularly regarding investment in high-tech sectors.

Last month, as has been widely publicized, the US-China Economic and Security Commission recommended the creation of a US outward investment review process, aimed directly at American private investment in mainland China. The commission argued, “As China increasingly turns to capital markets to realize its technology development and military modernization ambitions, there is more acute risk that U.S. investment in China directly or indirectly benefits problematic companies.”

Specifically, the commission recommended the creation of a foreign investment review process that would prevent the “offshoring” of critical supply chains and foundational technological capabilities. On Capitol Hill, meanwhile, Sens. Bob Casey (D-PA) and John Cornyn (R-TX) have introduced legislation to carry out the commission’s proposal.

Furthermore, in negotiations over the massive CHIPS for America Act, which would spur research and
development and manufacturing in the US semiconductor industry, key
congressional leaders are proposing “guardrails” to prevent companies from
“double-dipping” (both requesting CHIPS Act funding and investing in the
Chinese semiconductor industry).

Reps. Ro Khanna (D-CA) and Mike Gallagher (R-WI) expressed
confidence that anti-double-dipping guardrails would be included in the final
funding proposals. Khanna stated, “I support strong guardrails. I don’t think U.S.
taxpayer investment should be going to something that is going to help China’s
competitiveness.” Gallagher added, “There can be no double dipping — you can’t ask for
CHIPS funding one day and announce plans to go build new fabs in China the
next.” Citing a Wall Street Journal report that chronicled dozens of semiconductor-related
deals by US companies over the past three years, Gallagher also expressed support for the above-cited outward investment
restrictions on US companies.

Should the so-called double-dipping ban become law, it would
have huge implications for the CHIPS Act and US plans to relocate semiconductor
manufacturing onshore. All three major semiconductor manufacturers — Intel,
Samsung, and Taiwan Semiconductor Manufacturing Corporation — have investments
and plants (or “fabs”) in China. There will be much more to analyze as events
move forward, but at a minimum, this unfolding situation illustrates the
inescapable dilemmas posed by Sino-US technological decoupling.

Finally, it should be noted that on the Chinese side, potential contradictions are also unfolding. Beijing has benefitted enormously from tapping capital markets in the US and elsewhere. However, under Chinese law, foreigners cannot own shares in most domestic sectors, so a quasi-legal mechanism known as a variable interest entity (VIE) was created to allow foreign investment in Chinese companies via offshore entities. According to one estimate, almost 80 percent of foreign investment in Chinese companies occurs through VIEs, located largely in offshore holding companies in the Cayman Islands. Over the past several decades, VIEs have been used by major Chinese tech companies including Alibaba, Tencent, and TikTok. As startups, these tech behemoths gobbled up hundreds of millions of dollars in foreign investment from sovereign wealth funds and investment firms such as Blackrock, Sequoia Capital, and Softbank — and many others.

It now appears that Chinese leaders plan to dramatically restrict the VIE route in order to
rein in foreign influence on future technologies. Namely, China’s regulators
will publish a blacklist of sectors in which VIEs will be forbidden, to ensure
China’s future “national champions” — particularly in telecoms and data-related
sectors — are not subject to foreign influence.

Within the limited space of this piece, here are
two questions — one for each side. On one hand, how far will the US go in
pressing — or even demanding — US allies follow American investment decoupling
restrictions on China? On the other hand, how far can Chinese president Xi
Jinping, who faces increasingly dangerous economic currents at home (as
underscored by an AEI panel this week), afford policies that progressively cut
off China from world capital markets without jeopardizing Beijing’s place in
global competition? At the moment, in both the US and China, national security
priorities seemingly outweigh economic considerations.

The post Investment deglobalization: How far will it go? appeared first on American Enterprise Institute – AEI.