U.S.-China: If Not Economic Decoupling, Then What?

Stakes are rising as both Washington and Beijing role out sharper-edged trade policies under the banner of national or economic security. Political risks for U.S. businesses remain elevated, as both governments are expected to impose new export restrictions and increase monitoring of corporate activities. On July 26, U.S. Department of the Treasury Under Secretary for International Affairs Jay Shambaugh testified before the Senate Foreign Relations Committee on U.S. economic policy towards China. He outlined three U.S. objectives: protecting national security and human rights; pursuing healthy economic competition; and cooperating on areas of mutual concerns. He strongly denied that the U.S. is seeking to decouple the U.S. economy from China, arguing that the U.S. seeks a “fair and healthy” economic relationship that requires a “level playing field.” China has accused the U.S. of seeking decoupling, which was also denied by Secretary of the Treasury Janet Yellen during her visit to Beijing in early July. Nonetheless, geopolitical tensions and tit-for-tat economic restrictions are rising, and businesses must remain vigilant of elevated political risks in an increasingly charged strategic environment. 

U.S.: Selective Walling Off of Trade and Investment 

The Biden administration has taken several steps to cut China off from the U.S. economy, specifically in the tech space. Citing national security, the Biden administration last October unveiled a sweeping set of export controls that ban Chinese companies from buying advanced chips and chip-making equipment without a license. This is part of a larger policy to wall China off from the expertise and financial resources of the U.S. in the race to develop next-generation technology, seen as central to America’s long-term competitiveness. Currently, the Biden administration is focused on limiting Chinese access to technology used for digital surveillance, AI and quantum computing.

There are ongoing discussions about imposing new restrictions on exports of AI chips, as well as restrictions on investments in China in specific sensitive technologies with significant national security implications. Reportedly, President Biden is considering an executive order for a narrowly focused ban on new investments in cutting-edge technologies. The Senate just passed an amendment for the draft National Defense Authorization Act that would require U.S. companies to disclose to the Treasury Department when investing in advanced Chinese technology on national security concerns. Already, the Biden administration has added around 150 Chinese companies to the Commerce Department’s Bureau of Industry and Security Entity List, which severely restricts their access to commodities, software and technology for defense use. The House Select Committee on Strategic Competition Between the United States and the Chinese Communist Party sent letters to U.S. venture capital firms expressing “serious concern” with the firms’ investments in Chinese companies involved in sectors with potential national security applications, an indication that the committee is investigating U.S. companies.

The Biden administration is also taking action against Chinese imports. The U.S. has banned products made in China’s Xinjiang region because of Uyghur forced labor and Huawei equipment from critical telecommunications infrastructure for national security reasons. The effort to ban the popular social media app TikTok has faced steep domestic opposition, despite security concerns that the Chinese government can exploit the app to influence users and capture personal data.

These measures are in addition to the tariffs on Chinese goods imposed during the Trump administration, valued at $370 billion at the time, to punish Beijing for unfair trade practices, such as stealing intellectual property, coercing U.S. companies to transfer sensitive technology, and dumping of goods below the cost of production to increase market share. While the Biden administration has stated it is reviewing these tariffs, thus far they remain in place, partly for negotiating leverage. Additionally, there is strong support in Congress to keep tariffs in place to protect the resurgence in U.S. manufacturing and heavy industry. The “Buy American” requirements in the Bipartisan Infrastructure Law and Jobs Act and Inflation Reduction Act support the policy of sourcing from the U.S., not China, in the largest public investment in U.S. economic development in decades.  

China: Mounting Risks for Foreign Businesses

Chinese leaders vow sanctions will not halt their research and development of new technologies and they will respond in kind to new U.S. measures. Beijing has already responded with sharp measures targeting the U.S. and its allies, the latter in an effort to drive a wedge between Washington and European policymakers.

Effective August 1, China is restricting exports of some gallium and germanium products, metals used in semiconductors, aerospace and automobile industries. Beijing stated the restrictions were to protect national security; analysts assess it is in retaliation to Washington’s curb on technology exports and to give Beijing negotiating leverage. The announcement was made just prior to Yellen’s visit but has been in the works since Beijing passed a new law allowing the government to restrict a broad range of minerals and components. 

Beijing is not banning exports of gallium and germanium but requiring exporters to apply for a license and report the details of overseas buyers and their applications. While the government is not saying what types of applications will be rejected, defense-related end users may find their supply cut off. China controls the market for other rare earth metals, which if restricted would have far greater impact on the supply chain for EVs and military equipment.

Inside China, the regulatory environment for foreign businesses is challenging. Beijing has adopted intrusive anti-espionage and data protection laws, requiring foreign businesses to provide access to certain proprietary information. It has also limited access to government corporate registration databases and declared illegal the collection of information on Chinese companies that is a normal practice in conducting business due diligence. Beijing has also adopted an anti-sanctions law enabling retaliation against companies that adhere to sanctions against China. An “unreliable entities” list targets companies for punishment for undermining China’s interests. Companies on this list are blocked from making new investments in China and trade activity.

Like the U.S., China is protecting its domestic market in certain sectors, requiring Chinese companies to “Buy Chinese” even if the cost is higher. Beijing also banned Chinese operators of critical information infrastructure from buying products from Micron Technology, citing national security, but more likely as retaliation against the U.S. for export bans on semiconductors.

Economic Arms Race

In what some experts are calling an economic arms race between the U.S. and China, competition is expected to be fierce and rules of road written on the fly. While both countries have vested interests in keeping bilateral trade flowing, the hostile business environment is impacting business confidence and decision making. Companies are not only diversifying their supply chains to reduce dependence on China, but some are also shifting investments and Asian headquarters out of China to reduce risk, according to a new report by the European Union Chamber of Commerce in China. Companies are unlikely to be able to stay above the political fray, but rather risk becoming, or being seen as, instruments of state competition. In this charged context, U.S. businesses with exposure to Chinese-related risks will need to maintain situational awareness of regulatory trends and be sensitive to changes impacting operational environments. While the U.S. tends to telegraph policy changes by engaging business groups in policy discussions, Beijing operates more opaquely, with vaguely worded laws and policy statements and unexplained enforcement actions.   

A space to watch is whether U.S. congressional efforts to repeal China’s “Most Favored Nation” (MFN) trade status moves forward to become law. While U.S. experts disagree on whether reverting to “Normal Trade Relations” status would be a significant step towards economic decoupling, it would send a policy signal to the business community that sourcing from China is not favored. Repeal would result in tariffs on Chinese exports to the U.S. correlating with WTO tariff schedules, i.e., more than what the U.S. grants to favored economic partners such as the UK and EU for many products. The U.S. recently repealed MFN status for Russia, as part of a policy to punish the Kremlin for its war on Ukraine. Beijing is likely to see repeal as an aggressive trade act and a step towards decoupling.