China/US: Tit For Tat Part 1

Washington’s latest move to hobble China’s economy through technology-related sanctions is undoubtedly an escalation. But it is unlikely to have more than marginal practical impact and will certainly not be as damaging as Beijing’s own steps aimed at scientific self-sufficiency.

The executive order signed by US President Joe Biden on 9 August banning new American investment in key technologies in China (i.e. artificial intelligence (AI), advanced silicon chips and quantum computing) should have come as no surprise to anyone even though it has been treated by the media as a watershed moment in China/US relations. To consider it as such is, in my view, misleading.

First, as Radio Free Mobile’s Richard Windsor and I were reflecting even three years ago in our Clash of the Titans series, there has been a de facto ‘second front’ to the technology war in the form of a swelling ‘finance war’ for some time now. To be fair to the media, the most obvious manifestation of this has been Beijing’s efforts to persuade Chinese tech firms to launch IPOs in markets other than New York (and preferably at home) rather than any moves by Washington. I include in this the new rules on overseas listings which were announced by the Chinese Security Regulatory Commission in February and which were supposedly an easing of hurdles imposed since 2021 but which, in fact, give regulators even more leeway in deciding which companies can access foreign markets and under what conditions. As for US actions, the long-running battle over auditing of Chinese firms listed in New York should be seen in this context even though it has been taking place within an established — and not purely China-focused — regulatory regime.

Second, US venture capital investment in China has, in any case, plummeted from a high of USD43.8bn in 2021Q4 to USD10.5bn in the second quarter of this year according to Pitchbook. Ironically, as Dr Windsor regularly reflects in his notes to clients:

“This is because the policies of the Chinese government in combination with its crackdown on the technology sector have already had the effect of scaring almost all foreign capital away from China”.

Thus, the executive order is effectively just another step in an established process.

As things stand, there remains a great deal of detail to be worked out before the order comes into force some time next year and it is already clear that regulators will be subjected to a good deal of corporate lobbying to water down its potential scope. However, in a rare policy area where there is broad bipartisan agreement and where Congress has been working on legislation with similar aims, this is unlikely to make much impact. It therefore seems very likely that the order will complement in many respects the ban on semiconductor exports announced on 7 October 2022. It follows that Washington’s claim to the effect that the executive order is purely about national security in a narrow sense is utterly disingenuous. As Dr Windsor wrote at the top of his note circulated immediately after the order was announced:

“The USA will place limits on US investment in 3 Chinese technology sectors in a move that is not really targeted at the Chinese military but further acts to limit China’s rise as a technology power that could lead to it challenging the USA in the geopolitical arena…. The official reason for these additional measures is to limit access to US capital and technology by China’s military but this looks to me like a fairly weak excuse for a much wider attack on China’s emergence as a world power.”

Pulling all this together, it would be fair to conclude that the executive order per se will have very little impact either on cash flow or on the sort of transfer of expertise which tends to go hand-in-hand with venture capital/private equity investment and which is the order’s principal target. However, as Dr Windsor contends, this is still “a further sign that more restrictions are coming”, and that “more technology sectors [will] come under export regulations over time”. Furthermore, it is very likely that, as is already the case with export bans, Washington will have some success in persuading close allies to go at least some of the way to matching its investment embargoes. Indeed, US officials claim that the European Commission, Germany and the United Kingdom have already expressed interest; and we can reasonably assume that both Japan and South Korea will follow suit, especially in the wake of last week’s trilateral security summit.

For its part, China clearly sees further escalation as a high probability. Richard Windsor again:

“…further actions are likely that target AI and quantum computing as outlined in this order as well as the Metaverse, 6G, and autonomous driving to name a few. This explains the rush by Chinese internet companies such as Alibaba, ByteDance, Tencent and Baidu to procure as many silicon chips from Nvidia as they can before the restrictions are tightened further. These are for the A800 chip that Nvidia released specifically for China [and] that complies with the internal speed limit that was defined in the orders that were released by the [US] Commerce Department on 7 October 2022. There is a strong possibility that this regulation will be tightened at any moment meaning that the A800 will no longer be available for sale in the Chinese market.”

Nevertheless, Dr Windsor concludes that, the efficacy of previous US measures notwithstanding, a ban on the export of A800 chips is also likely to have very little negative practical impact even if it does stand to be a further blow to Washington’s efforts to stabilise bilateral relations.

One way or the other, it remains the case that technology-related curbs imposed by the US should be seen alongside policy steps taken by Beijing itself which continue to hobble the private sector. I have written for Heteronomics at some length in recent months on China’s domestically imposed sanctions. To these assessments, I would now add some thoughts from Chatham House’s Yu Jie published in the Financial Times on 18 August. She rightly references President Xi Jinping’s 2018 call for a “whole nation approach” to scientific innovation in a quest for self-reliance as early anticipation of what we are seeing from Washington today. This included doubling down on domestic financial resources and “strengthening domestic talent-grooming and ‘reshoring’ of expertise to spearhead innovation”. Although she makes no specific mention of the executive order, there is clearly common ground here, making the following very pertinent to Washington’s latest move to stymie the flow of VC/PE-related technological expertise to China:

“Although China is keen to find a path to scientific self-reliance, in reality the country’s successes in science and technology are — as for its peers and competitors — a direct result of frequent exchanges and connectivity with the scientific community globally. The challenge for Beijing now is to determine how far the drive for ‘indigenous innovation’ can go in delivering China’s desired technological breakthrough without tapping into existing scientific powerhouses in the west…. What is lacking now is the political will to nurture creative endeavour and to allow a younger generation of researchers to question conventional wisdom.”

Thus, whatever emerges from the ongoing consultations in the US over the implementation of the executive order, in practice it remains the case that Beijing is doing much of Washington’s work for it on this count. As Yu Jie concludes:

“Ultimately, innovation takes time to bear fruit. It is a risky business that will require the party leadership to loosen some control. This is a conundrum that Xi and the party must now work to resolve.”

Easily and rightly said. However, as long as Xi Jinping remains at the helm this is unlikely to happen.

Part II is here.

This first appeared on https://www.heteronomics.com and was reposted with permission.

Photo by Johannes Plenio