Looming US investment restrictions on China threaten diplomatic engagement

Efforts to ease tensions between the US and China could be undermined by a series of diplomatic visits to Beijing as the White House presses ahead with plans to impose new restrictions on US investments in Chinese companies involved in quantum computing, artificial intelligence and semiconductors.

The looming restrictions were a major topic of discussion between Treasury Secretary Janet L. Yellen and senior Chinese officials during her four-day trip to China, which concluded Sunday.

The Treasury Department sought to narrow the restrictions, targeting private equity and venture capital investments in a few limited — but highly strategic — sectors. The ministry has also tried to ease concerns within China that the measures amount to a technology ban intended to harm the Chinese economy.

However, such measures are expected to anger China and will be the first test of the new communication channels that the world’s two largest economies are trying to restore.

“They will have concerns about our investment policies toward China,” said Mark Sobel, a former longtime Treasury official who is now the US president of the Official Monetary and Financial Institutions Forum. “The Chinese have their problems with us, and both sides have a clear understanding that there is tension.”

Recently, US-China relations have been pushed to their weakest point in years. Tensions have flared over the flight of a Chinese surveillance balloon over the United States, tighter controls on technology from Washington, Beijing’s partnership with Moscow during the war in Ukraine, and China’s continued threat to Taiwan.

In recent months, the Biden administration has worked to stem a further deterioration in the relationship, which it views as a potential threat to global peace and stability. In addition to Ms. Yellen, Secretary of State Anthony J. Blinkin Beijing last month and John Kerry, President Biden’s special envoy for climate change, heads there on Sunday.

But new investment restrictions from the United States could escalate the retaliatory measures used by the two countries as they try to build a “floor” in their relationship.

The new measures seem to have been pretty much settled for several months now. But the Biden administration appears to have delayed announcing them, given the troubled relationship with China. US government agencies are still discussing some of the details. Once restrictions are proposed, the private sector will have time to comment on the limits, which can shape how they are set.

Even if the Biden administration decides to delay issuing the measures, it will face mounting pressure from lawmakers, who are considering broader restrictions on investments in China.

Lawmakers and other supporters of the measures have complained that the current system allows US capital to flow into China and fund technologies that may ultimately pose a threat to US national security. The United States already prohibits American companies from directly selling some advanced technologies to China, and monitors investments in America by Chinese companies for potential security risks. But the US government has little insight and no control over the money that travels from the US to China.

Roger W. Robinson Jr., former chairman of the US-China Congressional Economic and Security Review Committee, testified last May: “China has harnessed, channeled, and exploited Western greed to advance its strategic goals to an unprecedented and perilous degree.” Hearing at home.

Members of the Biden administration have spent much of the past year assessing how broadly the investment restrictions would be applied, as officials reached out to business executives to get their opinions on the impact such a move might have. Industry groups and venture capitalists have lobbied aggressively against a broad ban on investment in China, saying it would disrupt important trading relationships and ultimately hurt the US economy.

The administration appears to have come up with a carefully designed measure, which would require companies to report more information to the government about their planned investments in China, while banning investments in a few sensitive areas with military or surveillance applications.

At a May hearing before the Senate Banking Committee, Paul Rosen, the Treasury’s assistant secretary for investment security, said the administration is “working to craft a narrow, focused program” to restrict investment in certain sensitive technologies that have national security implications.

Both proponents and critics acknowledge that the greater significance of this measure is what it could mean for regulation in the future. They say the new rules themselves are unlikely to do much in the short term to affect technology development in China, since the country is not short of investment funding.

The United States was the source of less than 5 percent of inward Chinese direct investment in both 2021 and 2022, said Nicholas R. Lardy, a non-resident senior fellow at the Peterson Institute for International Economics. In the first quarter of this year, investment in China was by venture capital firms and US private equity firms collapsed to nearly $400 million, down from a peak of about $35 billion in 2021.

But he said total domestic investment in China in the quarter was $1.5 trillion, adding that US venture capital and private equity inflows are “not even a rough miss.”

However, the new rules could prove important by setting a precedent for restricting private sector investment in China. It could be a tool that US officials turn to in times of tension with China, and a policy approach that may trickle down through advanced democracies in the coming years.

At G7 meetings in May, US officials discussed the possibility of aligning such policies with close allies. A report published this year by the Center for Strategic and International Studies noted that both South Korea and Taiwan have their own set of investment restrictions. The Taiwan rules place specific regulations on outward investment in China based on the type of technology and include prohibitions for high-tech sectors.

China introduced its own restrictions on overseas investment in 2016. Beijing has led the country’s businesses and households away from speculating on US real estate and even soccer clubs and instead buying offshore firms in aircraft production, heavy manufacturing, artificial intelligence, cybersecurity and other strategic sectors.

The Treasury Department will likely be the government agency responsible for implementing the new restrictions. Ms. Yellen was careful that if designed poorly, it could undermine the traditionally open investment climate in the United States.

Ms. Yellen said on “Face the Nation” on Sunday. She added that the controls “should not have a significant impact on the investment climate between our two countries”.

A senior Treasury official said Chinese officials had heard the justification given by the United States for the potential restrictions, but it was not clear whether they agreed with the rationale.

Chinese officials are also watching warily as the Biden administration issues a variety of export restrictions on the type of advanced chips that can be sent to China. The administration is considering new measures that could further limit Chinese companies’ ability to access the latest AI capabilities. via cloud services. Restrictions passed last October prevented Chinese companies from buying these products directly.

Despite these broad areas of disagreement, Mr. Sobel, the former Treasury official, noted that the United States and China still have few options but to continue talking to each other.

“We’re in the boat together,” he said, “and that means they just have to talk and get along — whether they’re happy with each other or not.”

Keith Bradshare Contribute to the preparation of reports.