Chinese Investment in the U.S. Tanks Amid Major Policy Crackdowns
With or without a trade war, Chinese foreign direct investment to the United States won’t stop tumbling anytime soon.
As Beijing and Washington exchange the first shots of the trade war, new U.S. tariffs dominate the headlines. But perhaps the biggest shift in U.S.-China economic relations is happening elsewhere: China’s foreign direct investment (FDI) dropped by 92 percent year-on-year in the first half of 2018 — and there’s little chance of the number picking up anytime soon, thanks to policy changes on both sides of the Pacific.
After Chinese FDI in the United States hit its peak of $46 billion in 2016, the number fell to $29 billion the following year. According to a Rhodium Group report published last month, Chinese acquisition and greenfield investment in the United States from January to May this year clocked in at only $1.8 billion, the lowest net value in seven years. In addition to investing far less, Chinese companies are also divesting at an unprecedented rate, putting their existing foreign assets, such as real estate holdings, up for sale.
The Chinese FDI decrease is triggered by crackdowns from both Chinese and U.S. lawmakers, which the report dubbed as a “double policy punch.” Michael Brown, a presidential innovation fellow working at the U.S. Defense Department’s Defense Innovation Unit Experimental (DIUx), maintains the FDI slump is likely a long-term trend.
Wary of significant capital outflow, the Chinese government put the brakes on what it called “irrational” foreign investments starting in late 2016. This policy shift was formalized in August 2017 when the State Council released its latest directive that divided outbound FDI into three categories: encouraged, restricted, and prohibited. Investments that align with the Belt and Road Initiative, which largely targets developing countries and is the signature project of Chinese President Xi Jinping, are given the green light, while those in real estate, entertainment, hospitality, and sports clubs, which had been the bulk of Chinese FDI in the United States, are restricted.
“China has clearly and publicly said, ‘We do not want to see so much capital leaving the country.’ The government is very savvy when it comes to wealthy Chinese trying to park assets overseas,” Brown said.
China’s outbound FDI was largely driven by huge real estate firms, once darlings of Beijing politics and now on the outs. The media and government portrayed FDI as a sign of China’s new power, giving Chinese companies easy access to low-interest loans from state-controlled banks as a result. Sprawling conglomerates such as Anbang Insurance Group, Dalian Wanda Group, HNA Group, and Fosun International — all of which, in practice, largely dealt in real estate — had been on spending sprees abroad, fueled by easy credit and the profits reaped from China’s own real estate boom. For instance, Anbang bought the Waldorf Astoria hotel in New York for $1.95 billion in 2014, the highest ever paid for a hotel. HNA, which started out as a regional airline before massively expanding into real estate, had a 9.9 percent stake in Deutsche Bank and 26 percent in Hilton Worldwide.
These generous acquisitions, often financed with low-interest loans from state-controlled banks, troubled government regulators, who prioritize financial stability above all else. The same month the State Council codified its new FDI rules, the Chinese Communist Party’s official news outlet, People’s Daily, published an article on “gray rhinos,” or highly foreseeable yet neglected threats. Without naming any companies, the article highlighted the party’s concern with a potential financial system meltdown. The sense of unease was not unfounded; the total credit extended to nonfinancial companies ballooned to 166 percent of China’s economic output in 2017.
The most high-profile government clampdown has been the arrest and indictment of Wu Xiaohui, the chairman of Anbang, who was once a high-flying businessman on par with the likes of Stephen Schwarzman. Wu, detained by the authorities in June 2017, is currently being prosecuted for fraud and embezzlement, though there is speculation that his risky financial dealings led to his downfall. FDI may have also acted as a vehicle for mega-rich Chinese, such as Wu, to get their own money out of the country at a time of sharply increased personal capital controls, providing them with a potential escape route abroad in the event of an investigation at home.
On the other side of the table, U.S. policymakers are growing increasingly suspicious of Chinese maneuvers to gain control of significant defense-applicable technologies developed in Silicon Valley, and they fear the safety and integrity of U.S. citizens’ personal data.
“We recognize that China has become a lot more powerful, and the role their investments play as a means for technology transfer has been reflected in the National Security Strategy and the National Defense Strategy,” said Brown, the DIUx expert who also served as the CEO of the cybersecurity firm Symantec from 2014 to 2016.
The United States is responding to China’s efforts to achieve the goals set out in its ambitious Made in China 2025 plan, which strives to make the country a global leader in technology, including semiconductors and robotics. A key component of this strategy, much to the Pentagon’s chagrin, is the requirement that every commercial technology in China be available to the People’s Liberation Army, a policy the Chinese government refers to as “civil-military fusion.”
As a result, the Committee on Foreign Investment in the United States (CFIUS) — the main U.S. government entity that can block foreign acquisitions of domestic businesses and safeguard technology — is now beginning to put a check on Chinese investments in the technology sector.
For the past two years, CFIUS in its current form has been criticized by national security experts for being overly lenient when reviewing Chinese deals. Noting its severe shortcomings, U.S. Defense Secretary James Mattis urged senators last year to update CFIUS “to deal with today’s situation.” CFIUS has a restricted mandate because it can review only specific deals involving a controlling interest by foreign investors, such as mergers and acquisitions. Sneakier maneuvers, such as smaller investments without a majority share, often easily fly under CFIUS’s radar.
A report published in January 2017 by the President’s Council of Advisors on Science and Technology (PCAST), commissioned under the Obama administration, called for the strengthening of “national-security controls in response to Chinese industrial policy aimed at undermining U.S. security.” The following month, DIUx released a separate report warning the U.S. government that it needed to exercise stronger oversight over Chinese investments and technological transfers.
“The PCAST report on semiconductors and the DIUx report were really the turning points, as many leaders across the government recognized the need to strengthen CFIUS,” Brown, the co-author of the DIUx report, said. “The government began to wake up to China’s focus on technology and sent the signal that the U.S. will be more consistent in turning down requests to buy assets in the context of tech transfer.”
As CFIUS begins to flex its muscles, U.S. lawmakers are taking notice. The committee successfully convinced President Barack Obama in December 2016 to block a Chinese investment fund from acquiring the U.S. subsidiary of Aixtron, a German semiconductor manufacturer. In September 2017, President Donald Trump nixed a deal involving a Chinese-backed investor seeking to acquire the U.S.-based semiconductor manufacturer Lattice. Both Obama and Trump cited national security concerns.
Additionally, CFIUS refused to approve the Chinese company Ant Financial’s $1.2 billion move to acquire the Dallas-based money transfer service MoneyGram this year due to concerns over the safety of U.S. citizens’ data, causing the two companies to call off the merger.
A report co-written by the National Committee on U.S.-China Relations and the Rhodium Group estimates that deals worth more than $8 billion were abandoned in 2017 due to “unresolvable CFIUS concerns.”
That number is set to surge in the coming years. Congress, under pressure from defense officials, is taking major bipartisan steps to further strengthen CFIUS and constrain Chinese investments on national security grounds.
The Foreign Investment Risk Review Modernization Act (FIRRMA) would expand the array of transactions under CFIUS’s purview, giving it the opportunity to investigate deals beyond outright mergers and acquisitions. Most consequentially, the legislation would reduce the acquisition threshold for CFIUS review from a 51 percent stake in the company — majority ownership — to simply any stake constituting a “substantial interest,” which would cover a far wider breadth of Chinese investments. Additionally, FIRRMA would strengthen the existing export control process in order to give the Commerce Department more leeway in regulating technology transfers.
Both the Senate and House versions of FIRRMA easily passed with overwhelming majorities last month. Trump said he will sign the bill if it comes to his desk, adding that he would direct his administration to deploy new tools to protect the “crown jewels” of U.S. technology in the event that Congress fails to “pass strong FIRRMA legislation.”
“Given that FIRRMA passed with an overwhelming 400-2 margin in the House, there are very good odds that action will be taken [by the United States],” Brown said.
Under pressure both at home and in the United States, Chinese firms have turned their backs on a country that was once a tempting target for investments. Now, that FDI may flow into developing countries through Belt and Road instead — although actual investments have been increasing only at the same steady rate as always, despite big promises from Beijing. But amid political fears and regulatory worries, the credit that once fueled spending sprees may also simply be gone.
Correction, July 9, 2018: Recent iterations of the proposed CFIUS legislation in the U.S. Congress changed the 25 percent acquisition threshold to cover any stake constituting a “substantial interest.” An earlier of this article mistakenly said that CFIUS would include the 25 percent threshold.
Humza Jilani is an editorial intern at Foreign Policy. @humza_jilani