U.S.-China Economic and Security Review Commission Calls for Further Tightening Trade and Investment with China

On November 17, the U.S.-China Economic and Security Review Commission released its 2021 Annual Report to Congress. The report argues that “China's leadership resorted to a familiar playbook of government support for industry,” and in certain sectors it would challenge the U.S. dominant position in the market. It also warns that U.S.-China financial connectivity poses risks to U.S. national security. In response, it suggests that Congress take action to restrict, and to increase the transparency of, investment and trade activity with China.

The report noted at the outset that “[d]espite continued tense rhetoric between Washington and Beijing during 2021, bilateral trade is returning to pre-tariff levels and U.S. capital flows to China are on the rise.” In particular:

U.S.-China economic integration is strengthening in some areas but weakening in others. Bilateral trade flows and U.S. portfolio investment into China are increasing. Bilateral foreign direct investment flows are down, but there is an increase in venture capital, private equity, and other investments, and the types of acquisition targets are changing. Despite ongoing political frictions and concerns about discriminatory treatment, many U.S. companies remain committed to the Chinese market.

On the U.S. side, the report noted that:

The Biden Administration is building on the Trump Administration’s assertive approach to addressing China’s unfair economic practices, threats to U.S. national security, and denial of human rights by engaging U.S. allies and international institutions in confronting Beijing.

On the China side, the report stated that:

Despite tense rhetoric, China’s government seeks to prevent commercial tensions with the United States from escalating in order to maintain economic stability, even as both countries seek to strengthen supply chain security.

In 2021, China focused on using its economic heft for both economic gain and geopolitical leverage. The Chinese government significantly expanded its use of economic coercion to punish critics and compel behavior it desires from foreign countries and firms. In late 2020 and 2021, the Chinese government also moved quickly in developing a legal and regulatory framework to counter foreign restrictions on Chinese companies and individuals. A central objective in China’s expanding legal arsenal is to impose costs on foreign companies complying with U.S. laws that limit technology transfer to China.

The report pointed out that “Chinese policymakers have diminished the potential role of the market and have strengthened the hand of the state to direct innovation in emerging technologies” and warned that “[e]ven where China is not able to succeed in its ambitious goals, its implementation of a grand strategy can still have significant consequences for U.S. national security, competitiveness, and jobs.”

The report highlighted some specific sectors, including new energy vehicles, cloud computing, and synthetic biology as areas where China may challenge U.S. dominance.

The report also cautioned about China’s relations with Latin America and the Caribbean:

China’s economic importance and targeted political influence encourage Latin American and Caribbean governments to make domestic and foreign policy decisions that favor China while undermining democracies and free and open markets. China’s position as a top trading partner and bilateral lender for many countries gives it economic and political leverage. Substantial foreign direct investment from China is a tool of influence, as accumulation of assets affords Chinese companies the power to impact local and domestic prices in key sectors, such as minerals and energy.

Overall, the report made a number of recommendations related to trade and investment:

Congress should create a Technology Transfer Review Group within the Executive Office of the President to identify emerging and foundational technologies and ensure the implementation of related export controls, as well as oversee multilateral engagement related to export controls, foreign investment screening, and regulations on technology transfer.
Congress should consider legislation to create the authority to screen the offshoring of critical supply chains and production capabilities to China, so as to protect U.S. national and economic security interests and to define the scope of such supply chains and production capabilities. This would include screening of outbound U.S. investment.
Congress should enact legislation expanding the jurisdiction of existing U.S. investment restrictions targeting Chinese entities placed on the Non-Specially Designated Nationals (SDN) Chinese Military-Industrial Complex (NSCMIC) Companies List as well as the scope of targeted entities, including expanding the prohibitions under Executive Order 14032 to non-U.S. persons or non-U.S. markets.
Congress should consider comprehensive legislation to address risks from investments in Chinese equity, debt, and derivative instruments, including prohibiting investment in Variable Interest Entities linked to Chinese entities, and requiring reporting of publicly traded companies to the Securities and Exchange Commission (SEC) in relation to their sourcing, supply chains, and transactions with listed companies.
Congress should direct the SEC to require that publicly traded U.S. companies with facilities in China must report on an annual basis whether there is a CCP committee in their operations and summarize the actions and corporate decisions in which such committees may have participated.
Congress should consider strengthening U.S. competitiveness in building out Latin American and Caribbean infrastructure through the expansion of funding mechanisms, including low-interest loans from U.S. lending institutions to U.S. companies willing to invest in targeted critical infrastructure projects in high-priority Latin American and Caribbean countries.

During a public release event for the report, Vice Chairman Robin Cleveland noted that:

We see three trends that make clear the [Chinese Communist] party's not letting up on the top down throttle. First, over the past few years, 1,741 government guidance funds have been established. The rapid growth is troubling, especially as there's no real evidence of success. One example, they've invested $21 billion in funding to target China's domestic chipmaking capabilities, which has performed poorly, with a goal of generating 40% domestically sourced chips by 2020. Chinese companies have manufactured roughly 6% of the chips used in China. The second trend of concern is, since 2017, 73% of non-state firms have established party cells, interfering in personnel and management decisions. And finally, we see an increased effort of government entities to take ownership stakes in non-state companies, Didi and ByteDance come to mind in this area.

When asked a question about whether there are possibilities for the Biden administration to work on RCEP or CPTPP, the Commissioners seemed to support in general the idea of building a stronger economic relationship with the Indo-Pacific region, although maybe not through joining the RCEP or CPTPP. Commissioner Roy Kamphausen said that:

We ought to consider a range of options to deal with this challenge, or put differently, we should make use of all the tools in the toolkit to compete with China. And it's clear that China views multilateral trade agreements as an avenue or as a space in which to compete with the United States. I mean, we see the recent example which the PRC has applied to join CPTPP, as an example of an effort to be a part of and lead in the regional trade system in Asia. So we argued in our additional view, that this broad consideration of multilateral trade agreements needs to be part of the toolkit that we, the country, take up in our competition with China. And it's not an endorsement of a rejoining of CPTPP. It's rather a reflection that we are leaving some of the tools available to us unused.

Commissioner Michael Wessel stated that:

We are trading with many of these countries, economic engagement is the right thing to do. I think the concern which was reflected in the additional views is that the past model of trade agreements has been deficient. And that we need new approaches that, you know, update and reform our rules that don't look at trade specifically as a tool of foreign policy, but rather recognize their economic impact on the U.S. and focus more on that. And I think the additional views accurately reflect that. And it's something that I think on a going forward basis, we will all be able to work on. So I think there's less disagreement that you know, trade agreements, economic tools are in the tool chest, they've been inaccurately or inappropriately designed in the past. We need to update them. And then I think there's a basis for moving forward.

Commissioner Derek Scissors pointed out that:

The Biden administration, just this week, has started talking about a 2022 trade initiative in the Indo-Pacific, using language like 2022, Indo-Pacific trade framework, so very, very close to sort of regular language. And that may be a topic for us to take up next year. If, you know, trade policy starts in the administration. So if they follow through in that initiative, something we may talk about, we're going to have to face the fact that the U.S. is divided over trade. And if there's a meaningful trade initiative, it's going to have elements that everybody doesn't like. They like these five elements, they don't like these two. So hopefully the Biden administration will follow through, we will be able to address it, and you know, it's a bipartisan commission, if we can hack out some agreement on a trade approach, maybe that will take hold in Congress then.