This piece originally appeared in The Future of Conservative Internationalism Volume III.
Economic statecraft refers to the combination of policies and instruments required to advance American prosperity and enhance and protect American security. Today, the two are increasingly intertwined since the technologies associated with economic growth cannot, fundamentally, be separated from national security, nor can they be separated from the character of political, economic, and military systems.
The term economic statecraft has witnessed a resurgence for two fundamental reasons. The first is China. The second is the growing recognition that trade policies and the interdependence of nations associated with these policies matter to domestic constituencies and to national security. As one expert put it, we are “overdue rethinking of the relationship between domestic and international economic policy.”1 David Feith’s paper explores how to craft a deliberate decoupling strategy as a key component of a broader economic statecraft strategy toward China. In the current period of competition between the United States and China (which Feith and others have dubbed the “New Cold War”) Feith offers a compelling argument for how the United States must improve its economic statecraft to address the “daunting challenge” posed by China. The purpose of this response is to examine whether or not selective decoupling is likely to achieve the worthy goals Feith outlines and to offer some additional comments on the concepts and its challenges.
A Step Back
During the Cold War between the United States and the Soviet Union, the requirements of economic statecraft were quite different than during the present period. US-Soviet economic interdependence was limited. Aside from espionage (which was a factor), there was little concern about how US capital and know-how were aiding the Soviet economy or helping to grow its key sectors. Overall, there was little opportunity for American investments into the Soviet economy because the Soviet Union heavily restricted inward foreign investments. Indeed, foreign investments were almost entirely forbidden. Foreign capital was considered inconsistent with the basic tenets of the socialist command economy—principles such as central planning and regulation, concentration of all productive assets in the state, and disapproval of foreign economic entanglement.2
Of course, there were some exceptions. Investments that were made tended to be “limited either to relatively simple purchase/sale transactions or the construction of turnkey plants with no equity retained by the Western party in the constructed enterprise.”3 From the 1970s-90s, the United States did provide billions of dollars in loans and credit guarantees to the Soviet Union for the purchase of American grain. At home, these types of exchanges as well as other types of aid were justified on the grounds of realpolitik: Gorbachev and Yeltsin claimed they needed economic assistance to bolster their political capital to make political and economic reforms.4
Later, the Reagan Administration lifted restrictions on the export of oil and gas drilling and pipe-laying equipment to the Soviet Union in order to improve US trade balances and industrial competitiveness.5 (The Soviet oil and gas industries were still riddled with inefficiencies—which in some cases even undermined the value of foreign equipment imports.)6
Fast Forward
The current situation is different and thus comparisons to the Cold War are limited. The United States and China are highly intertwined.
Apart from Hong Kong, the United States remains China’s most important financial counterpart and US markets continue to serve as key fundraisers for Chinese companies. Americans (and their pension funds) continue to reinvest in China. And despite the increased attention and concern, capital continues to flow there. While, as the Rhodium group points out, direct investment and venture capital flows between the United States and China have declined since 2016, “passive” investment in equity and debt has grown.7 Rhodium estimates that there was over $3 trillion in US-China two-way equity and bond holdings (including securities held in central banks’ reserves) at the end of 2020—nearly double the official figure of $1.8 trillion. US holdings of Chinese securities were about $1.2 trillion at the end of 2020.8
Moreover, even at the height of US concerns about key tech sectors as they relate to China, such as the semiconductor industry, investments into China have continued. Many experts have noted that the US share of global semiconductor manufacturing declined from 37 percent in 1990 to 12 percent in 2020 and that it is important to maintain our dominance in this domain—particularly in relation to the production of leading-edge chips. The Biden Administration’s early 2021 supply chain review focused on the importance of the microchip sector.9 Yet last year, the Wall Street Journal reported that from 2017 through 2020, 58 deals were made—more than double the number from the prior four years.10
Future Challenges
Despite the soundness of Feith’s recommendations and their contribution to US security interests, there are three challenges to implementing a regime of selective decoupling.
First, the difficulty of getting the US private sector to shift its approach toward China should not be underestimated. As Feith points out, most Chinese technology companies owe their existence to Silicon Valley venture capital firms. While some investments have declined and changed, many have not. As noted above, even as tensions with China have grown, US-China trade and investment ties remain highly intertwined. In 2020, China was America’s largest goods trading partner, third largest export market, and largest source of imports.10 Recent developments suggest a “softening” in bipartisan support for certain measures. For instance, one key sticking point in the enormous US-China Competition Act is centered on outward capital flows. There is growing opposition to an outbound investment review regime, with a chorus of lobbyists and law firms arguing that if there is such a regime, it should be narrow in scope. Opponents successfully removed outbound investment screening from the US Innovation and Competition Act (USICA), though it reemerged in the America Creating Opportunities to Meaningfully Promote Excellence in Technology, Education, and Science (COMPETES) Act.
In the past, even though the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) expanded the jurisdiction of the Committee on Foreign Investment in the United States (CIFIUS), ultimately the implementing regulations were scoped more narrowly than what the statute permitted.12 Although the Biden Administration continued the Trump Executive Order that banned American investment in firms with ties to China’s military, the implementation date has been pushed back. While it was due to go into effect in early June, one news report noted that just ahead of the deadline, “the Washington agency charged with enforcing the ban quietly notified investors that they would not be punished for holding onto such securities.”13
Related to the ambivalence of the US private sector is the role of other countries. One of the biggest problems with implementation of investment bans will be the role of other actors. The United States remains the largest recipient of foreign direct investment ($384 billion) but China is the second, with $334 billion.14 That means that billions of dollars will continue to flow into China even if US investments into China are reduced. Considering how to address this “displacement” factor will be a key issue for policy makers.
A second obstacle will be the problem of organizational structures that are capable of implementing policy shifts. As Feith explains, it has taken the Commerce Department four years to modernize export controls as required by the 2018 Export Control and Reform Act. Though that law required the Commerce Department to begin modernizing export controls by publishing new lists of foundational and emerging technologies, Commerce has still not published those lists. Moreover, as Feith also points out, under the Commerce Department’s “lax licensing regime,” only about 1 percent of China’s purchases from US exporters are actually denied—sanctioned Chinese firms can still buy components for manufacturing chips at 10 nanometers and above. It is hard to see how under a situation whereby existing procedures are not being effectively used, additional demands will be successfully implemented.
Third, while Feith is correct in arguing that we should work to deter China, “partly by convincing Xi that China’s economy would face catastrophic consequences if he moved on Taiwan,” there is a flip side to using decoupling as a deterrent. A long period of decoupling and the reduction of interdependence between our economies could actually mitigate the impact of sanctions on China. That is, the more decoupling drives China’s independence from the United States, the less value sanctions will have over time. It is questionable whether or not over the long term, Chinese vulnerability to sanctions will remain the same.
China has been working assiduously, for years, to reduce its vulnerabilities to the United States. Its “dual circulation” approach seeks to increase US dependence on China while reducing Beijing’s dependence on the United States. As China watches sanctions against Russia unfold, this determination is only likely to increase.
This piece originally appeared in The Future of Conservative Internationalism Volume III.