Image Source: Reuters
The Biden administration claims the People’s Republic of China (PRC) is leveraging its technological capabilities to promote its authoritarian governance model, modernize its military, and privilege its interests and values in the international system. As part of its efforts to address this challenge, the administration has singled out certain technologies as having the potential to undermine the security of the United States and its allies, and thus necessary to restrict China from accessing them. The administration calls its economic restrictions against China a “small yard, high fence” approach. The idea is to place strict restrictions on a small number of technologies with significant military potential while maintaining normal economic exchange in other areas.
The Chinese government views U.S. economic restrictions as economic containment meant to contain China’s rise and protect U.S. hegemony. U.S. allies are also skeptical of U.S. economic restrictions on China, viewing the restrictions as serving protectionist goals, rather than simply protecting national security.
The Biden administration’s approach may end up being the right one. However, as the number of companies and sectors targeted increases, the United States risks further damaging its relations with China, losing allied support, and harming its own companies while failing to restrain China’s technological growth.
What Restrictions Has the Biden Administration Announced?
Export controls: In October 2022 and October 2023, the Bureau of Industry and Security (BIS) announced new export controls focused on restricting China’s “ability to obtain advanced computing chips, develop and maintain supercomputers, and manufacture advanced semiconductors.” In addition to these controls, BIS under the Biden administration has added over 200 Chinese companies to the Entity List, which bars designated entities from importing almost all U.S.-origin products without the exporter obtaining a license.
Financial sanctions: In June 2021, President Biden signed an executive order creating the Non-Specially Designated Nationals Chinese Military-Industrial Complex List (NS-CMIC List) sanctions program. The executive order prohibits U.S. persons from purchasing or selling the publicly traded securities of companies determined by the Secretary of Treasury to be involved in China’s defense and related material or surveillance technology sectors. The executive order listed 59 companies, and nine companies were added in December 2021.
Inbound investment screening: In September 2023, President Biden signed an executive order providing direction to the Committee on Foreign Investment in the United States (CFIUS) on the risks CFIUS should consider when reviewing covered transactions. The executive order includes the following sectors: semiconductor manufacturing and advanced packaging, microelectronics, artificial intelligence (AI), biotechnology and biomanufacturing, quantum computing, advanced clean energy, climate adaptation technologies, critical materials, elements of the agriculture industrial base that have implications for food security, pharmaceuticals, and active pharmaceutical ingredients, and information and communications technology, as well as the defense, public health and biological preparedness, energy sector, and transportation industrial bases.
Outbound investment screening: In August 2023, President Biden signed an executive order establishing an outbound investment screening mechanism. According to the advanced notice of proposed rulemaking, the Department of the Treasury is considering notification requirements and/or prohibitions on mergers and acquisitions, private equity investments, venture capital investments, greenfield investments, joint ventures, and certain debt financing transactions by U.S. persons related to semiconductors and microelectronics, quantum information technologies, and AI sectors that are critical for China’s military, intelligence, surveillance, or cyber-enabled capabilities.
How “Small” is the Yard?
Across the four categories of economic restrictions, the administration targets ten general technologies/products and five “industrial bases.” Even if one narrows the list to technologies targeted by two or more economic restrictions, that still leaves semiconductors and microelectronics, AI, quantum information technologies, defense, and surveillance technology.
The administration tries to narrow the scope of these restrictions. Semiconductor export controls are designed to cover certain advanced chips and the equipment and expertise needed to make them. Sanctions focus on Chinese companies involved in military, intelligence, and security research and development programs, weapons and related equipment production, and the use of surveillance technology to facilitate repression or human rights abuses. And inbound investment screening focuses on military, intelligence, surveillance, or cyber-enabled capabilities.
A challenge the administration faces is that, except for defense, all the technologies targeted by two or more restrictions are dual use. The semiconductors targeted by U.S. export controls are necessary for advanced AI models, cutting-edge weapons systems, and complex surveillance systems, but are also used in autonomous vehicles, 5G-connected phones, and AI with commercial applications. AI has the potential to improve facial recognition, information operations, and autonomous weapons, but will also speed up drug discovery, help with language translation, and optimize logistics. Quantum information technologies may allow militaries to operate in GPS-denied environments, improve submarine detection, and quickly break modern encryption, but may also speed up drug development, improve product design, and optimize supply chains. Lastly, surveillance technologies can help countries spy on their citizens, but can also help people protect their homes and businesses and help governments conduct legitimate police investigations.
Even Biden administration officials acknowledge the economic importance of these technologies. Secretary of Commerce Gina Raimondo noted that semiconductors “drive innovation in nearly every emerging technology” and National Security Advisor Jake Sullivan called microelectronics, quantum information systems, artificial intelligence, biotechnologies, biomanufacturing, and clean energy technologies “force multipliers.”
Although the yard could be bigger, given the range of technologies/products targeted by the Biden administration and their dual-use nature, current restrictions go beyond a “small yard.”
How “High” is the Fence?
The United States is using a wide range of authorities to restrict China’s access to certain technologies, often levying multiple types of restrictions on the same sets of technologies. However, it is not clear that this amounts to a “high fence.”
Regarding semiconductor export controls, the United States needed cooperation from Japan and the Netherlands for the controls to be fully effective. While Japan and the Netherlands joined the U.S. semiconductor export controls, the countries differ in the authorities they possess (e.g., Japan does not prohibit re-exports) and the types of semiconductor equipment covered. Additionally, the administration granted Samsung and SK Hynix an indefinite exemption from the export controls for their factories in China and is likely to do the same for TSMC.
On sanctions, the NS-CMIC List only prohibits investment in designated companies’ publicly traded securities. This approach ignores other types of investment, such as private debt, private equity, and joint ventures, giving U.S. individuals and companies multiple avenues to continue investing in sanctioned companies. Additionally, because the NS-CMIC List only applies to U.S. persons, individuals and companies from other nations can replace U.S. investors.
Lastly, inbound and outbound investment screening also face the problem of investment replacement. Annual Foreign Direct Investment (FDI) from China to Europe has exceeded FDI from China to the United States since 2019 and, in 2021, FDI from Europe to China, Japan to China, and South Korea to China exceeded FDI from the United States to China. Currently, 21 of the 27 European Union (EU) members have inbound investment screening mechanisms, however, the countries differ in the types of investments they can review and their inbound investment screening’s restrictiveness. Meanwhile, the EU does not have outbound investment screening regulations, although it is considering them.
Medium Yard, Medium Fence: What it Means
The Biden administration’s current approach to economic restrictions is closer to a “medium yard, medium fence” than a “small yard, high fence” approach. By going beyond a “small yard,” the administration plays into China’s perception that the United States is trying to contain its rise, jeopardizes allied cooperation, and increasingly harms U.S. companies. Meanwhile, by failing to construct a “high fence,” the administration risks failing to achieve its objectives.
The Chinese government is retaliating for U.S. economic restrictions. The PRC banned Chinese companies dealing with critical information from purchasing chips from Micron Technology (United States) and blocked a merger between Intel (United States) and Tower Semiconductor (Israel). The Chinese government also responded by restricting exports of gallium, germanium, and graphite, three materials used for semiconductor production.
Additionally, the United States needs allied cooperation on export controls, sanctions, and inbound and outbound investment screening for these restrictions to be most effective. However, U.S. allies are hesitant to join U.S. restrictions. U.S. allies do not all have the same threat perception as the United States regarding China and benefit from their economic relations with China. As the United States adds more and more restrictions, it may get harder and harder to gain allied cooperation.
There are also concerns about the domestic economic impact of U.S. restrictions. For example, Nvidia, Intel, and Qualcomm combined get more than $50 billion in annual revenue from China.
Furthermore, with the gaps between Japanese, Dutch, and U.S. export controls, Samsung and SK Hynix’s export control waivers, and the differences between U.S. and EU investment screening regulations, the United States could end up hurting U.S. companies and investors more than European, South Korean, and Japanese companies and investors. The more restrictions the United States adds, the more economic damage U.S. companies will face.
At the same time, China continues to grow its capabilities despite U.S. restrictions. China’s SMIC reportedly produced a 7nm chip and YMTC reportedly produced the most advanced 3D NAND memory chip for consumer devices. While China may be unable to produce the 7nm chips at a volume high enough to meet domestic demand and in a cost-effective manner, the achievements are significant given that U.S. export controls were created to prevent such technological leaps. Furthermore, the Chinese government is replacing U.S. investment with its own. For example, China launched a state-backed investment fund to raise $40 billion for its semiconductor industry.
Addressing the Shortcomings of the Current Approach
The Biden administration has made it clear it believes economic restrictions are an essential part of U.S. strategy and is willing to prioritize national security goals over economic considerations. If the administration remains committed to this approach, it should adopt a true “small yard, high fence” policy. The administration should narrow the technologies targeted by more than two types of restrictions to defense, AI, and semiconductors and microelectronics. The administration should focus on these sectors given their applications for advances in military, intelligence, cyber, and surveillance uses. These technologies also reinforce one another. Advanced AI applications use cutting-edge semiconductors and advanced AI will offer new military, intelligence, cyber, and surveillance capabilities. Meanwhile, the administration should deprioritize quantum information technologies and surveillance technologies. Most quantum technologies remain a long way from offering military applications. Meanwhile, China already has robust surveillance capabilities.
On the “high fence” side, the administration should close the gaps in the NS-CMIC List by prohibiting new equity investments in, debt financing for, and the formation of joint ventures or other corporate entities with companies on the list and by convincing allies to introduce similar sanctions. The administration should also tighten export controls by eliminating or shortening the indefinite waivers granted to Samsung and SK Hynix. Lastly, the administration should pressure the EU to adopt an outbound investment screening regime.
These actions require allied cooperation, and the administration should provide positive incentives for allies to join U.S. restrictions. One incentive could be signing a free trade agreement (FTA). The United States does not have FTAs with allies such as the United Kingdom, EU, and Japan. Another incentive could be loosening the Inflation Reduction Act’s American content requirements for clean energy technologies, which has frustrated the EU, South Korea, and Japan. A third incentive could be offering closer coordination with allies on extraterritorial sanctions, such as giving allies a comment period to provide their input before the United States imposes such sanctions.
In the end, going all in on a true “small yard, high fence” policy may not be the right approach. A “small yard” may be insufficient to constrain China’s military, intelligence, and surveillance capabilities, and a “high fence” may pose unacceptably high costs to U.S. businesses and technological innovation. The Biden administration’s current approach, however, is a middle-ground that will likely be ineffective and counterproductive. If the administration remains committed to a “small yard, high fence” approach, it should go all in on executing it.