Biden Takes Measured Approach on China Investment Controls

At the same time, even moderate restrictions on China’s technology sector will increase the temperature in the U.S.-China tech war. Biden’s executive order aligns with the administration’s broader strategy to slow the growth of China’s tech sector by blacklisting hundreds of companies, blocking exports of critical technologies, and reducing China’s dominance in supply chains. Investment restrictions will likely expand, just as other U.S. sanctions programs have undergone mission creep.

Biden tasked the Treasury Department with implementing his executive order, leading it to issue an advance notice of proposed rulemaking that requests comments on how the government should limit U.S. companies’ investment in chips, quantum, and AI in China and establish notification requirements for related investments. Though headlines portrayed the executive order as enacting broad bans on investment in key technologies, Treasury’s advance notice is actually relatively narrow in scope.

An employee works on the production line at a semiconductor factory in Suqian in China’s Jiangsu province on Feb. 28. VCG/VCG via Getty Images

Treasury’s proposed limitations on investment are more circumscribed when it comes to quantum information technologies and AI systems in China—two areas where the Biden administration has yet to enact sweeping export controls. The broadest of these restrictions is a potential ban on investment in the production of quantum computers and their components. Other investment prohibitions related to quantum would apply only to certain end uses: investment in Chinese quantum sensing platforms would be prohibited if they are designed for use in military, intelligence, or surveillance applications, while investment in Chinese quantum communications systems would be prohibited if they are “designed to be exclusively used for secure communications.”

Similarly, investment in the development of Chinese software that incorporates AI systems would be prohibited only if such systems are designed to be used for “military, government intelligence, or mass-surveillance end uses.” These end-use controls are important because they limit the scope of the restrictions and would not block U.S. investment in beneficial civilian technologies in China such as using machine learning to better diagnose diseases or predict the impact of the climate crisis.

In addition to these limited prohibitions on investment, Treasury has proposed notification requirements for some types of investment in chips and AI in China. This notification regime has led observers to refer to such rules as “outbound CFIUS” because they create an external complement to the Committee on Foreign Investment in the United States, which screens inbound investments. Treasury is considering requiring firms to notify the government within 30 days of making investments in the design, fabrication, and packaging of legacy chips in China, as well as for investments in AI systems that are primarily designed for cybersecurity, facial recognition, robotics, and intelligence gathering.

On the whole, Treasury’s advance notice contains a number of measures that moderate the impact of outbound investment controls. The controls would not target intracompany transfers from U.S. parent companies to existing Chinese subsidiaries, exchange-traded fund investments, or passive limited partner investments below an as-yet-undetermined threshold. Investment in non-Chinese entities would be restricted only if at least half of their business is composed of Chinese subsidiaries engaged in prohibited activities. And unlike CFIUS, the advance notice indicates that Treasury will not review transactions on a case-by-case basis, reducing the potential for every investment notification to become a veto point.

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Part of the reason that Biden’s proposed outbound investment controls are limited in scope is that they have been subject to intense private-sector lobbying. Companies have opposed far-reaching restrictions as they could impose substantial legal costs and limit expansion of existing business lines in China. Lobbyists will have a field day with Treasury’s advance notice, submitting hundreds of comments by the late September deadline.

Although previous drafts of the executive order reportedly included restrictions on investment in Chinese biotechnology and green tech, Treasury’s advance notice targets only chips, quantum, and AI. On the other hand, the advance notice includes requests for comment on additional technologies where investment should be restricted as well as an annual review to determine if outbound investment controls should be tweaked or expanded. While there are still plenty of details for Treasury to fill in, Biden’s executive order represents a potential model for future restrictions: go slowly, take factors other than national security into consideration, and do not get too far ahead of allies.

This measured approach is a welcome departure from the type of process by which the Commerce Department enacted its October 2022 semiconductor export controls on China. Unlike those restrictions, the executive order was telegraphed ahead of time, the proposed rules stemming from it will be subject to the typical public notice and comment period before taking effect, and they focus on specific end uses of emerging technologies in China.

Members of the Biden administration have argued that the element of surprise was necessary to properly execute last year’s semiconductor export controls, but the ultimate effect was to unnecessarily alienate U.S. allies and partners. As Singapore’s foreign minister said at the time, the export controls were “all but a declaration of a technology war.”

U.S. Rep. Mike Gallagher, chair of the House Select Committee on Strategic Competition Between the United States and the Chinese Communist Party, attends a hearing on the Biden administration’s China strategy in Washington on July 20. Graeme Sloan/Sipa USA

Though Treasury’s advance notice proposes somewhat stronger restrictions than those contained in a measure that passed the Senate, which does not contain outright prohibitions on investment, there are indeed many loopholes in the proposal. It does not address U.S. investment in a wide number of technologies in China, nor does it require notification before an investment has been made or apply retroactively to investments made before it takes effect in the coming months.

But closing every loophole in U.S. curbs on China’s tech sector is a less urgent priority than many lawmakers believe. The U.S. already has extensive restrictions on various companies in China through blacklists such as the Entity List, the Unverified List, and the Non-Specially Designated Nationals Chinese Military-Industrial Complex Companies List, as well as export controls on thousands of technologies with military applications. Framing every gap in this sprawling array of constraints as a gaping loophole is misleading and counterproductive.

National security risks should not be the sole consideration when formulating U.S. international technology policy—policymakers must also weigh the economic, diplomatic, and technological fallout from restrictions on China’s tech sector. A myopic focus on ensuring than not a single U.S. dollar or chip flows to the People’s Liberation Army may be outweighed by the negative consequences of slowing global economic growth, antagonizing other countries, and increasing the risk of conflict with China.

In formulating additional outbound investment controls, the U.S. should carefully assess such costs, which may be serious. Casting a wide net could affect a large range of technology companies in allied countries, making U.S. allies less likely to adopt their own outbound investment controls. Preventing U.S. investors from acquiring equity in Chinese technology companies—which allows investors to learn about Chinese business practices—could slow U.S. technological development in areas where China is ahead of the U.S., such as batteries and telecommunications. At the extreme end, the International Monetary Fund projected this year that severe decoupling in foreign direct investment resulting in two blocs centered on the U.S. and China would reduce long-term global economic output by 2 percent, or $2 trillion annually using 2022 as a baseline.

A superconducting quantum computer is in operation at QuantumCTek in Hefei, Anhui province, China, on Feb. 7. Costfoto/NurPhoto via Getty Images

Outbound investment controls on quantum are also less significant because there are relatively few applications of this early-stage technology. Despite years of effort, there are no practical applications of quantum computers. Biden’s executive order states that quantum information technologies could aid in the “breaking of cryptographic codes,” but there is scant evidence that this is imminent. The National Security Agency has said that it “does not know when or even if a quantum computer of sufficient size and power to exploit public key cryptography … will exist,” and the National Academy of Sciences estimates this will not occur before 2030. Moreover, though the Pentagon is keenly interested in the potential for quantum sensors to identify stealth aircraft, even the Office of the Undersecretary of Defense for Research and Engineering has admitted that “quantum radar” is impractical.

The primary impact of restrictions on U.S. investment in Chinese quantum information technologies may be that they foreshadow complementary quantum export controls on China. While one could argue that the U.S. is being prudent in restricting investment that would advance Chinese quantum capabilities with military applications, another interpretation is that such controls are premature given the lack of U.S. investment in Chinese companies developing these nascent technologies.

Baidu chief technology officer Wang Haifeng speaks at the unveiling of the Baidu AI chatbot Ernie Bot at an event in Beijing on March 16. MICHAEL ZHANG/AFP via Getty Images

As in the U.S., AI hype has intensified in China in recent months as Chinese companies are developing dozens of large language models. A handful of Chinese large language models perform moderately well on some industry benchmarks, but there are substantial barriers preventing China from catching up to the U.S. in the near term. Major hurdles include China having fewer top-tier engineers of large AI models and associated compute clusters, more heavy-handed regulation, slower rollouts of user-facing large language models, and having to contend with U.S. export controls on advanced graphics processing units and semiconductor manufacturing equipment.

Efforts to block investment in the development of large AI models in China—or, for that matter, the export of related technologies and services to China—are fraught. Large AI models are a general-purpose technology that have the potential to significantly alter economies by, for instance, automating a large number of basic job-related tasks. Stalling China’s ability to develop such models could seriously impact its economy and should be approached with caution.

The scope of U.S. investment in Chinese AI companies is not completely clear. According to the Center for Security and Emerging Technology, U.S. investors participated in one-third of investment deals involving Chinese AI companies from 2015 to 2021, though the percentage of those investments that came from U.S. investors is unknown.

The Biden administration’s restrictions on investment in AI systems in China are significant not because they will starve Chinese AI startups of U.S. funding, but because they set the stage for U.S. export controls on AI. As both Commerce Secretary Gina Raimondo and Under Secretary of Commerce for Industry and Security Alan Estevez have stated, the U.S. intends to enact AI export controls on China; the comments that Treasury receives on its advance notice will help the Commerce Department determine the scope of those controls.

Some AI researchers have argued that the U.S. could reasonably use export controls and other tools to block Chinese companies’ ability to release AI models above a certain capability threshold, thereby reducing the severity of such measures. For instance, the amount of compute used to train an AI model, unlike the size of a model or its anticipated capabilities, is a sufficiently good predictor of a model’s performance that the U.S. could adopt restrictions on this basis. Beyond efforts to slow China’s development of home grown large language models, Washington could attempt to prevent Chinese cloud providers from deploying compute-intensive AI models built in the U.S., as Alibaba and Baidu have done with Meta’s LLaMa 2, an open-source model.

The fundamental issue with this proposal is that large language models are civilian technologies that have yet to be applied in military settings. It is likely that these models will eventually be used for weapons design and strategic decision-making, but such applications are still in the R&D phase, and there is currently no candidate for a “killer app” for military uses. In any case, the export of large language models for many military applications, such as the production of defense articles or biological weapons, is already prohibited under the Commerce Department’s existing export controls and the State Department’s International Traffic in Arms Regulations.

Restrictions on China’s development of large AI models would also be thorny to implement. They would likely require a licensing regime for such models, which would necessitate mass surveillance to enforce and would reduce competition in the AI industry by raising barriers to entry. A poorly crafted threshold would either be unsuccessful in preventing China from developing powerful AI models—especially given the prevalence of open-source models—or be overbroad and slow China’s development of less capable AI systems. Though expansive restrictions on China’s technology development may be appealing at first glance, they are likely to provoke substantial blowback from China.

U.S. Secretary of State Antony Blinken (right) shakes hands with Wang Yi, director of the Office of the Central Foreign Affairs Commission of the Chinese Communist Party’s Central Committee, during their bilateral meeting in Jakarta, Indonesia, on July 13. DITA ALANGKARA/POOL/AFP via Getty Images

Additional AI or quantum export controls reminiscent of semiconductor restrictions enacted by the U.S. in October 2022 are likely to incite a strong response from Beijing. Perhaps the most likely form of retaliation by China would be an enlargement of existing countermeasures, such as export controls on additional inputs for semiconductor manufacturing.

These tit-for-tat measures make it more difficult to diffuse tensions and decrease the likelihood of conflict between the U.S. and China. Wang Yi, China’s top diplomat, told U.S. Secretary of State Antony Blinken during his recent visit to Beijing that U.S. restrictions on China’s tech sector are a serious impediment to improving U.S.-China relations. Wang demanded that the U.S. “lift illegal unilateral sanctions against China, stop suppressing China’s scientific and technological advances, and not wantonly interfere in China’s internal affairs.” While the Biden administration has crafted a measured approach to outbound investment controls, it remains unclear if it will be able to avoid a dangerous escalatory spiral in the tech war.

A man reads a Global Times newspaper article (center) that reads “U.S. has resisted strong skepticism about restricting investment in China,” posted on a public newspaper bulletin board in Beijing on Aug. 10. Andy Wong/Associated Press

The EU is on track to follow Washington’s lead and propose restrictions on outbound investment later this year, though the breadth of such measures remains unclear. The European Commission’s Economic Security Strategy states that Europe should adopt outbound investment controls because it has “a common interest in preventing the narrow set of technological advances that are assessed to be core to enhancing military and intelligence capabilities of actors who may use them to undermine international peace and security from being fuelled by our companies’ capital, expertise and knowledge.”

Germany, which accounts for roughly half of EU foreign direct investment in China, voiced support for such restrictions in its new China strategy, and the United Kingdom is also considering outbound investment controls. But business interests will likely prevent most U.S. allies from restricting outbound investment, as multinationals in allied countries are eager to profit from investments in China. In May, the U.S. was able to persuade the G-7 to a make only a mild statement recognizing the potential importance of future outbound investment controls. It is possible, however, that other countries will enact similar restrictions in response to U.S. arm-twisting. Many analysts anticipated that the U.S. would struggle to multilateralize semiconductor exports controls, but the Biden administration succeeded through high-level talks and substantial economic pressure.

New restrictions on capital flows into China are the last thing Beijing needs as it strains to boost consumer and investor confidence while its post-COVID recovery sputters. By one metric, foreign direct investment into China has fallen to its lowest level in 25 years, meaning that even a slight decline in investment due to new restrictions could have a disproportionate impact.

The Biden administration has done well to craft a measured approach to outbound investment controls on China. Yet even modest restrictions risk escalating the tech war and stymying diplomacy between Washington and Beijing. This delicate balance is unlikely to hold for long.