Along with additional tariffs on Chinese products, intensified efforts by the United States to restrict Chinese investors are weighing on cross-border investment.

Chinese foreign direct investment (FDI) in the United States dropped over 80 percent year on year to just $5 billion in 2018 from $29 billion in 2017 and $46 billion in 2016, according to a report recently released by the U.S.-China Investment Project, a research initiative led by the Rhodium Group and the National Committee on U.S.-China Relations. Though Chinese investment in the United States declined sharply in 2018, its investment in overseas markets grew 4.2 percent year on year to $130 billion, according to the Ministry of Commerce of China.

The report said that the decrease is not a mere correction following the previous boom, but a fall to the lowest levels since 2011.

The sharp decline is partly due to China's restriction on speculative outbound direct investments in real estate, hotels and sports clubs starting in late 2017. A more noticeable reason is that Chinese investors are encountering stepped-up investment screening by the United States amid tensions between the two largest economies.

"A more defensive U.S. posture and the uncertain outlook for bilateral relations clearly impacted U.S.-China investment flows in 2018, much more so than trade," said the report. "Our data show that while trade protection has been more bark than bite (U.S. imports from China have risen throughout the Donald Trump administration), the hawkish mood has deeply impacted U.S.-China investment dynamics."

"On the investment side, we've already had some disconnections," said Daniel Rosen, a founding partner of the Rhodium Group and one of the authors of the report, at its launch event in New York City on May 8.

The report was unveiled immediately after Trump's May 5 announcement of additional tariffs on Chinese products.

"If there is a truly 'toxic' environment between two nations, it doesn't really matter what the technical legal terms say is permissible and what's not. It's generally going to be fairly difficult to make investments," Rosen said.

From a classic international economic policy perspective, Rosen said, against the threat of higher tariffs, there is a new motivation to do direct investment on the other side of the tariff wall. "So the tariff war per se isn't the killer to the potential for a two-way investment flow. It's the 'toxicity' that's behind it," Rosen said.

The report said that irrespective of any trade deal, U.S. national security concerns and China-U.S. strategic mistrust are rooted in structural trends that will persist for a prolonged period of time.

The authors called on leaders to "manage this reality and find ways to address novel security concerns without too much protection, which would threaten long-term innovative capacity and prosperity."

A staff member works at the Emerging Technology Center of Chinese home appliances maker Midea in California, the U.S., on May 15, 2017(XINHUA)

Increased scrutiny

Last year, there was tougher enforcement by the Committee on Foreign Investment in the United States (CFIUS) and a lot more investment screening, including going back to already closed transactions and asking companies to divest again, said Thilo Hanemann, a partner at the Rhodium Group and another author of the report.

Chinese investors had to give up deals worth more than $2.5 billion in the United States in 2018 due to unresolved CFIUS concerns, according to the report.

In sectors such as information and communications technology (ICT) and infrastructure, Chinese investment suffered the most from intensified U.S. national security reviews last year.

Data from the report show that China's FDI in the U.S. ICT sector decreased from $2.7 billion in 2017 to $200 million in 2018. In the transportation, construction and infrastructure sectors, Chinese investment plunged from $10.4 billion in 2017 to $100 million in 2018.

Worse still, "the shift that we've seen so far doesn't even yet reflect the impact of these new regulations that were passed last year," Rosen said.

These refer to the Foreign Investment Risk Review Modernization Act (FIRRMA) and the Export Control Reform Act (ECRA), which were passed by U.S. lawmakers in August 2018.

According to the report, FIRRMA gave CFIUS jurisdiction to review non-controlling foreign interests in critical infrastructure and technologies, and sensitive personal data for the first time and ECRA could have far-reaching implications for research labs and other intellectual property-generating investments.

U.S. restrictive investment policies toward China have had a ripple effect on other economies as well.

"Aggressive U.S. unilateralism and defensive policies toward China are polarizing other members of the Organisation for Economic Co-operation and Development. Some are aligning with U.S. views on Chinese capital flows and general openness," said the report.

In March, the Council of the European Union (EU) approved a new framework for screening FDI in the EU. The new legislation, which went into effect in April, does not name China, but is widely believed to target Chinese investments in technology and infrastructure.

Nikkei Asia Review reported on May 9 that Japan is also set to restrict foreign investors from buying into its hi-tech manufacturers, "in a move that hews closely to the U.S. and its hardline policy on investments from China."

Japan will amend its Foreign Exchange and Foreign Trade Act, adding 20 more sectors that will restrict foreign investment, including integrated circuits and semiconductor memory devices, software developers and data processing services.

Uncertain future

The China-U.S. investment report said that Chinese firms' commercial appetites for investing abroad remain strong. Given that Chinese outbound investment stock is still low at just 15 percent of the GDP, there remains ample opportunity for growth in non-sensitive areas.

However, policy hurdles in both the United States and China remain significant headwinds to increasing Chinese investment in 2019 and beyond.

While Chinese investment in the United States witnessed sharp decline even before full implementation of the new FIRRMA and ECRA laws, forthcoming regulations "could yet create additional hurdles for Chinese investment in the United States," said the report.

It also found that Chinese venture capital in the United States had remained virtually untouched by investment screening until November 2018 when the FIRRMA pilot program started, but upcoming implementation rules may deal a heavy blow to Chinese venture capital and other minority investment.

Regardless of the ultimate outcome, it will take some time for Chinese firms to feel confident that they can continue to access the U.S. market without running afoul of these new regulations, said the report.

The uncertain outlook for Chinese investment is definitely not good news for the United States.

"Investment done right creates enormous benefits: It creates jobs in local communities, increases choice for consumers and creates productive business relationships that strengthen people-to-people connections," wrote Stephen Orlins, President of the National Committee on U.S.-China Relations in the report's foreword. "When our countries add regulations that unnecessarily impede investment, however, these positive forces are diminished significantly, even reversed."

Catherine Pan-Giordano, Partner and Corporate Group Head at Dorsey & Whitney's New York office, cited Chinese investment in the U.S. biotech sector as an example. She said that more than 50 percent of U.S. biotech funding comes from other countries and the vast majority comes from China, which is in fact the single largest investor in U.S. biotech programs, startups and institutions. "So we may not feel the impact today, but the industry is already feeling it," she said.

Although the U.S. health, pharmaceutical and biotech sectors attracted the most Chinese investment in 2018, the amount declined to $1.4 billion from $2.5 billion in 2017.

Adding that biotech programs include cancer and stem cell research, Pan-Giordano said, "By the time people feel the impact on their real lives, it may be a life and death situation. So it affects everybody."

"I think the private sector needs to lead the dialogue by talking about facts, talking about data," she said.

Constance Hunter, chief economist for KPMG LLP, said that the business roundtable seems to have had very little impact on the Trump administration and its handling of the situation. "We're in uncharted territory where it would seem there are a lot of interests aligned to having tensions de-escalated, but the political bodies are acting against those commercial interests."

Copyedited by Rebeca Toledo

Comments to yushujun@bjreview.com