US President Joe Biden has signed a momentous executive order that aims to limit American venture capital and private equity investments in Chinese firms in critical sectors like semiconductors, microelectronics, quantum information technologies, and certain artificial intelligence (AI) systems. The move has been characterized as a “national emergency” and represents a significant escalation in the economic rivalry between the two nations.
China’s Reaction and Concerns
China’s Ministry of Commerce has expressed strong concerns over these restrictions, describing them as attempts to “decouple and sever supply chains under the cover of eradicating national risks.” The ministry further accused the US of undermining the principles of fair competition, endangering international trade orders, and disrupting the safety of global supply chains. China also explicitly reserved the right to take measures in response.
Impact on Venture Capital and Foreign Direct Investment
Analysts believe the investment restrictions, referred to as the “small yard, high fence” policy, will significantly curtail venture capital and foreign direct investment (FDI) inflows into China’s economy. The restrictions are expected to hinder China’s technological advancement as well.
According to the Rhodium Group, the value of US FDI in China was $8 billion last year, the lowest since 2005, and the value of US venture capital investments in China was $1 billion last year, down from $19 billion in 2018.
Effects on the Technology Industry
He Jun, a senior researcher at Beijing-based Anbound Consulting, has expressed concerns that the restrictions will hit China’s hi-tech industry hard, as they seem to be directly targeting Chinese companies. With foreign investment already dwindling, China’s venture capital market is shrinking, with state-backed funding becoming the main source, leading to a more closed-loop market.
These developments have been met with skepticism by some in the Chinese private equity sector, who are wary of the constraints this might put on the growth and success of Chinese hi-tech firms.
New Investment Screening Mechanism
A new investment screening mechanism will require the US Department of the Treasury to be notified about any outbound capital flows in selected areas. This represents a first-of-its-kind move to curb US financial investment in China’s hi-tech industries.
Wider Geopolitical Context
The restrictions are part of the ongoing tech rivalry between the US and China. Washington has already blocked China’s access to vital US-controlled technologies, including semiconductors, and halted grants from US hi-tech firms producing “advanced chips” in China.
These latest moves could add uncertainty to ongoing talks over a potential visit to China by US Secretary of Commerce Gina Raimondo, who has expressed interest in visiting in “late summer.”
Concerns Over Future Development
Some analysts, such as Alfredo Montufar-Helu of The Conference Board’s China Centre for Economics and Business, have noted that the emphasis seems to be on setting high bars against China’s access to sensitive technology instead of a full decoupling. However, questions remain about how high the metaphorical fence will be and whether the restrictions might spill over into theoretically non-sensitive areas like autonomous driving, synthetic biology, and climate science.
Investment Decline
China has already experienced a significant reduction in US private equity and venture capital investments in 2022 due to coronavirus lockdowns and broader geopolitical tensions. They dropped by around 76% to $7.02 billion in 2022 from $28.92 billion a year earlier, according to S&P Global Market Intelligence.
Former head of a think tank under China’s Ministry of Commerce, Huo Jianguo, believes that if US investors pull back further, investments from other countries may hardly fill the gap. China’s direct investment liabilities plunged by 87% to a historical low of $4.9 billion in Q2 of this year.
Views from Various Experts
Stephen Olson, a senior fellow at Hinrich Foundation, argues that these measures will not improve China’s attractiveness to foreign direct investment providers. Reva Goujon, senior manager at Rhodium Group, sees the executive order as an initial step and highlights the importance of watching how it will define AI with potential military end-use applications.
Additional Context and Future Considerations
The latest executive order comes after the Biden administration implemented the Chips and Science Act in August last year, which aims to provide around $52 billion in incentives to reduce reliance on China for key components, including semiconductors.
Despite the current restrictions, some believe that companies will likely find workarounds to continue serving the Chinese market without breaching US rules. Others have pointed out that any restriction regime will inevitably experience leakage and circumvention over time.
In the face of these restrictions, some analysts argue that while Beijing can continue to pump funding into strategic industries, if that capital isn’t utilized effectively, it may only compound China’s already massive debt problems.
In terms of merger and acquisition activities, the outlook appears dim for the rest of the year, but there will be close scrutiny of transactions moving forward for signs of defensive investments in China.
Conclusion
The US’s latest investment restrictions on China mark a significant development in the complex economic relationship between the two superpowers. By targeting critical areas like semiconductors and AI, the executive order demonstrates a strategic attempt to curb China’s technological advancement. While Beijing has expressed grave concerns and reserved the right to respond, the impact on China’s economy, tech industry, and foreign investments will likely be profound. The situation also raises important questions about how international companies will navigate the evolving regulatory landscape. Whether this move represents a step towards full decoupling or a more nuanced approach to competition remains to be seen.
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