US President Joe Biden has only a few months left in office before he hands over to his successor in January. While most of the United States and Europe are looking at the presidential race between Kamala Harris and Donald Trump, the US Treasury is busy working on finalizing a screening mechanism on US investments in China before the end of the year.
Although it might seem that it only concerns American companies and investors, it will create more than a headache for the EU. It is another piece of a package that Washington is implementing to limit China’s technological advances in emerging technologies. The European Union and Germany will not have much time until they feel the pressure to follow suit—much like on export controls.
This time, however, uncharted territory is entered, and Germany lacks an adequate picture of the economic transactions and operations its companies are conducting in China in emerging technologies to guide policymaking. The EU has tasked member states to review their outbound transactions. However, the process is prone to yielding mediocre results and pushing a necessary policy discussion further down the aisle.
The idea of “outbound investment screening” has been floated in the US since at least 2018. Its main aim is to restrict equity investments and their accompanying intangible outflow of expertise, networks, and management skills into Chinese high-tech companies over national security concerns. Several initiatives on introducing outbound investment screening legislation in Congress have failed in recent years however over political feuds between Democrats and Republicans.
President Biden reintroduced the matter with an executive order in the summer of 2023, and the administrative process is currently in the phase of a Notice of Proposed Rule Making, in which a draft rule is published by the US Treasury with a period for public consultation. This process will not involve direct law-making by the US Congress, but it does provide for congressional and presidential review in certain cases. Congress could also introduce separate legislation. Still, there is bipartisan support for restricting US financing of Chinese entities that develop advanced technology, which may also be used in "next generation military, surveillance, or cyber-enabled capabilities" and it is still possible that regulation will come this winter.
The European Union has included outbound investment screening as a possible measure in its Economic Security Strategy from June 2023 and the proposed EU commissioner for economic security is tasked to continue ongoing discussions with member states. Germany acknowledged in its China Strategy from last year the possibility that risks stemming from outbound investments might have to be addressed. So far, however, EU member states have shown little appetite for taking concrete steps and are demanding further analysis of the underlying issues. The European Commission has set a timeline to assess the need of a policy response until the end of next year. In Germany, less than a year ahead of national elections, any policy advances would need careful explanation during a time of economic woes.
Europe’s Lack of Data
The US approach is focused on investments by US persons and their controlled foreign entities in four technologies of concern: AI systems, semiconductors, microelectronics, and quantum information technologies. European investments in China, it might seem, are not particularly focused on technologies of concern that later find their way into military and security applications This certainly oversimplifies the case, but one major obstacle to having an informed debate amongst Europeans and with the US is the lack of adequate European data.
The European Commission tried to understand the ways in which European companies invest abroad and conducted a first assessment for the years 2013-2022. It found that 50 percent of outbound investments by European companies went to the US and the United Kingdom, adding up to 70 percent of total capital. However, it had to admit that data was limited and not granular enough. Another study suggests that in the 20-year period from 2003 until 2023, European companies made a total of 149 transactions into China involving the four technologies of concern, while the US accounted for 1,602 such transactions. This data is not complete, as the author admits, as much of the information on investment flows is not publicly available and it does not cover greenfield investments. It does suggest, however, three points that should be considered.
First, the number of transactions (and probably their amount) might be several times higher for the US than for the EU. Even one single investment could carry a risk, one could argue. When it comes to deciding on binding regulation, however, a qualifiable risk should be determined. Second, the biggest investments which, in future, would require screening have been made by German chemical and automotive companies as well as a French private equity and venture capital firm—two very different exposures, and across Europe there will be even greater variations. Therefore, taking EU level action would have to account for these differences. And third, in Germany, companies have invested considerably in the Chinese automotive sector’s AI companies involved in autonomous driving. This is a crucial technology for both civilian and military purposes. It shows how difficult it will be to draw a line between the two in practice.
Economic Competitiveness or Economic Security
There are also questions about the aim of investment restrictions for Germany in comparison to the United States. With the US rule is focused squarely on private equity and venture capital, with some debt financing and limited partnerships covered, German companies are mostly directly investing in operations in China. There are several challenges as a result.
One is the macroeconomic challenges for sectors that have maintained the same recipe for too long. Germany’s export economy is facing a structural crisis as some of its most profitable sectors, such as automotive and machinery, are dealing with ever stronger Chinese competition at home and abroad, while at the same time are still trying to grow in the Chinese market. Then there is a microeconomic challenge: some of Germany’s leading high-tech companies that are producing components for critical dual-use technologies are also relying on the Chinese export market or are building production sites there. Export controls should block any sensitive technology from getting into wrong hands in these cases. Here the question is whether there are cases in which these controls are not working, or where they are not enough. Lastly, some companies are pursuing a “China plus one” strategy, looking to expand in neighboring countries to hedge their operations against a worsening business environment in China. This opens the question whether investments in other countries than China could pose a possible concern.
The US approach might also put German and European companies at risk of over-compliance on the part of their US counterparts. Three parameters define what is controlled: the list of activities involving national security-relevant technologies, the covered transactions, and the covered (foreign) persons. It runs the risk of expanding the parameters over time and incentivizing US investors to be more cautious from the outset, making US capital more difficult to attract. For example, a German start-up building autonomous flying taxis with Chinese nationals among its investors could be off-limits. The proposed rule also aims to push allied countries further into a package deal, making adequate export controls and outbound investment rules a prerequisite for exceptions that the US Treasury would define.
More Data, Please!
Germany’s first response to all this should be to focus on developing a better understanding of investment flows. How to deal with the localization of production of certain sectors in foreign markets is a broader issue, which a single screening instrument cannot fully address. It is also politically sensitive, as politicians would have to walk a tight rope between keeping jobs at home and restricting investments into China—effectively a form of capital controls. Then again, understanding investment flows is an increasingly important capability amid rising geopolitical tensions.
China is uniquely able to harness the data of its globally interconnected economy. The US for its part is trying to understand the critical dependencies and bottlenecks of its economy better. The now proposed rule provides the US Treasury with the possibility to use information gathered for security relevant exceptions.
The EU has started to try and catch up. Member states are supposed to monitor outbound investments for one year to get a better picture. The European Commission has already acknowledged that the data it gathered previously lacks clarity on the technologies and sufficiently granular detail on the transactions. Whether member states can do better remains to be seen, but they will probably draw on questionnaires or direct enquiries with companies themselves. This is capacity intensive, subject to businesses’ willingness to share data, and potentially raises security concerns over sensitive data sharing.
At the same time, good policymaking requires reliable and up-to-date data. The current pace at which policy discussions on outbound investment screening in Germany are happening is too slow. US pressure is likely to increase further and German businesses are left in the air over their operations in China and other markets, since the potential risks emanating thereof are yet to be defined politically. All this makes half-baked policy solutions more likely.
Germany should, therefore, start a parallel endeavor to build a secure and efficient system of gathering firm-level data on (critical) transactions. Instead of capacity intensive monitoring, it could be more effective to draw on the financial sector’s compliance experience and the Bundesbank’s monitoring capacities. Germany’s central bank already gathers outbound investment data, however, with a different objective. It could be the right intermediary between the federal government and the financial sector to store this sensitive non-public data, given its mandate of independence. Such an approach would have to be based on a legally binding and thoroughly agreed typology for parameters that compliance structures would have to focus on and ensure that information is encrypted in a way that no party can see the full data, except for in cases of concern. The underlying digital infrastructure must meet maximum security standards of international banking practice.
Establishing a system for better economic data will not solve the pressing political questions, but it would at least enable policymakers to make better-informed decisions in the future—be it a decision for a mechanism that restricts certain outbound investments or against it.
Filip Medunić is a Research Fellow for Geoeconomics at the German Council on Foreign Relations (DGAP) in Berlin.
