Lawyer Up: U.S.-Chinese decoupling hits foreign direct investment

The relationship between the U.S. and China has been on a downward spiral of late. A nearly three-year COVID-19 pandemic has done little to reverse this course.

House Speaker Nancy Pelosi’s visit to Taiwan in August and China’s ensuing military exercises accelerated the spiral into a free fall. Washington and Beijing have not only openly exchanged verbal threats, but also taken concrete actions, to decouple from each other economically, politically, diplomatically and militarily, prompting some observers to call it a “new Cold War.”

Since 2017 the U.S. has implemented a multitude of aggressive measures in quick succession to accelerate the decoupling. On the economic front, this rapid decoupling has had profound impacts on nearly every aspect of the bilateral economic relationship between the two countries, ranging from foreign direct investment, technological competition, capital markets and supply chains to currency divergence. This article focuses on the impact of this decoupling on foreign direct investment, or FDI, both inbound investment from China and outbound investment to China.

According to the China Global Investment Tracker jointly maintained by American Enterprise Institute and Heritage Foundation, from 2005 through July, the U.S. has been the leading destination for large Chinese investments, taking in over $180 billion.

Chinese investments in the U.S. peaked in 2016, reaching a whopping $55.6 billion, counting only the 56 large deals. That number dropped to $23.48 billion in just a year and steadily declined for five years thereafter, finally hitting bottom in 2022 at a meager $0.48 billion.

Similarly, for Hawaii, based on data collected by Rhodium Group and the National Committee on U.S.-China Relations, over the past three decades, Chinese FDI in all industries totaled $1.02 billion, of which $933 million was absorbed by the real estate and hospitality sector.

Virtually all of the investment in this sector poured in over a short span of three years from 2014 to 2016, registering an annual capital inflow of $343 million, $197 million and $383 million, respectively. After dropping to $10 million in 2017, Chinese investment in Hawaii dried up.

Beijing’s tough capital control and sectorial restrictions on outbound investments, coupled with China’s COVID-19 lockdowns, have undoubtedly contributed to this rapid decline. However, heightened regulatory scrutiny and open hostility toward Chinese investments are largely responsible for their disappearance in the U.S.

The Foreign Investment Risk Review Modernization Act, enacted in 2018, and its implementing regulations, greatly expanded the jurisdiction of the Committee on Foreign Investment in the U.S. and its authority to review and take actions to address any national security concerns arising from certain transactions involving foreign persons.

In particular, greater scrutiny will be applied to certain equity investments in areas related to critical technologies, critical infrastructure, businesses with sensitive personal data, and certain types of real estate transactions. It is no secret that the intent of FIRRMA is to limit Chinese investment in the U.S.

Similarly, U.S. FDI in China has experienced a steady decline. According to Rhodium Group, U.S. FDI in China dropped to $8.7 billion in 2020, a 33% decline compared with 2019 and the lowest level since 2004. This took place in the same year that China attracted more investment from elsewhere and overtook the U.S. to become the world’s largest recipient of FDI.

The decline will be further accelerated if and when Congress enacts the proposed new legislation to create a mandatory outbound investment screening regime to review U.S. investments in the so-called “countries of concern” including China.

Despite these headwinds, capital continues to flow from China into the U.S., albeit more quietly now and in less sensitive areas such as the residential real estate market. According to the National Association of Realtors, Chinese buyers topped the list of foreign buyers in terms of dollar volume for eight consecutive years until 2021, when China slid to No. 3. In 2022, although China stayed in third place in deal volume, buyers from China paid the highest average purchase price at over $1 million for U.S. residential homes.

In terms of location, California has been the favorite for Chinese buyers for many years. Here in Hawaii, according to Title Guaranty, for three consecutive years from 2015 to 2017, China ranked No. 3 for dollar volume, after Japan and Canada. It dropped to No. 4 in 2018 and further declined to No. 6 in 2019, No. 7 in 2020 and No. 5 in 2021. The geopolitical risks and a myriad of other challenges notwithstanding, the U.S. remains an attractive destination for Chinese capital. Many expect to see a rebound once the travel restrictions are lifted.

Kai Wang is a partner at Carlsmith Ball LLP and chair of the firm’s Greater China Practice Group. She can be reached at kwang@carlsmith.com.