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House Committee on Foreign Affairs: Examining the Flow of U.S. Money into China’s Military Might

House Committee on Foreign Affairs
Examining the Flow of U.S. Money into China’s Military Might
Wednesday, January 17, 2024

Topline

  • Members of both parties discussed the need for an outbound investment regime and urged the passage of legislation that takes a sector-based approach.
  • A few Republicans, including Reps. Hill, Barr, Huizenga, and Davidson argued for an entity-based approach involving sanctions.

Witnesses

  • The Honorable Matthew Pottinger, Chairman of FDD China Program, Foundation for Defense of Democracies
  • Jason Matheny, President and Chief Executive Officer, the RAND Corporation
  • Peter Harrell, Non-Resident Fellow, Carnegie Endowment for International Peace

Opening Statements

House Foreign Affairs Committee Chairman Michael McCaul (R-Texas)

In his opening statement, McCaul outlined how the CCP’s goals and actions constitute a clear and present danger to the security interests of the U.S. and its allies. He said that we are in a generational competition with an adversary set on upending the global balance of power and explained that whoever controls the best technology will prevail in the competition. McCaul said export controls can’t stop big investors from using their money and know-how to build highly advanced technology companies in China. He emphasized that U.S. money is fueling the CCP war machine and surveillance state and lamented that the U.S. has no effective tools to stop these key investments that are harming our national security.

McCaul explained that the Foreign Affairs Committee unanimously passed H.R. 6349, the Preventing Adversaries from Developing Critical Capabilities Act (PADCCA) in November. He noted the bill was supported by both the Trump and Biden Administrations, before discussing the Biden Administration’s targeted outbound investments Executive Order. McCaul emphasized the need to get PADCCA signed into law, as China’s surveillance state is exploiting loopholes in U.S. policy to access billions of dollars in US investment and expertise. He called for country-wide prohibitions for key technologies, instead of an entity-by-entity approach. McCaul noted that he and Ranking Member Meeks requested that Treasury decide whether to sanction a Chinese surveillance company that contributes to the Uyghur genocide, but that Treasury decided not to sanction the company. McCaul pointed out that this example highlights the weakness of the sanctions-based approach. McCaul said the witnesses would explain why an outbound, forward-looking, and sector-based regime is necessary. He concluded that while sanctions have an important role to play, they can’t be a substitute for an outbound regime that is authorized by Congress.

House Foreign Affairs Committee Ranking Member Gregory Meeks (D-N.Y.)

In his opening statement, Meeks lauded the bipartisan nature of the Committee’s work on H.R. 6349, the Preventing Adversaries from Developing Critical Capabilities Act. He warned that the CCP is developing technologies with dangerous implications for American security and is intent on exploiting and stealing the world’s critical technologies. Meeks noted that the Biden Administration issued a game changing Executive Order on outbound investment in August and is currently crafting regulations to implement the Executive Order. Meeks emphasized that the Executive Order does not mean Congress is off the hook and called on Congress to create a statutory framework for the EO and provide the Administration with the tools and resources to effectively implement an outbound screening program and provide certainty to the private sector. He concluded that H.R. 6349 is the most effective and robust legislative solution.

Testimony

The Honorable Matthew Pottinger, Chairman of FDD China Program, Foundation for Defense of Democracies 

In his testimony, Pottinger warned that the scales of global power are beginning to tip towards our adversaries, in part because of the leverage that we are providing them. He explained that American know-how and capital helped foster the growth of China’s military might, as U.S. companies and investment funds helped modernize China’s high-tech military surveillance apparatus. Pottinger emphasized that corporate independence in China is an illusion. He noted Congress has an opportunity to build on the steps taken by the Trump and Biden Administrations to prevent U.S. capital from fueling China’s military and intelligence capabilities.

Pottinger urged Congress to take a sectoral approach rather than an entity approach. He explained that the Treasury Department seems disinterested in limiting investment in Chinese military-linked companies and added that it would be better and simpler to apply new rules to entire sectors. Pottinger said these rules should cover all strategic and military technologies and noted that the Biden Administration’s draft rules are a good start, as is H.R. 6349. He suggested that Congress and the Administration consider adding biotech, directed energy, space tech, advanced manufacturing, autonomous systems, and green energy technologies. Pottinger said the rules should be applied to all investments, including in publicly listed companies, and include all transactions, not just future ones. He concluded that Congress should consider broadening transparency to full prohibitions on investments in targeted sectors.

Jason Matheny, President and Chief Executive Officer, the RAND Corporation

Matheny tested positive for COVID-19 and did not testify. His written testimony is available here.

Peter Harrell, Non-Resident Fellow, Carnegie Endowment for International Peace

In his testimony, Harrell lauded the Biden Administration for taking an important step with Executive Order 14105 (EO 14105), which was intended to begin addressing the risk of certain investments which could help China develop an edge in key technologies. He explained that unlike an outbound investment regime that focuses on sanctions on specific Chinese companies, a sectoral outbound investment regulation can limit risky investment in early-stage Chinese companies. Harrel noted that while EO 14105 is important, it’s still vital for Congress to act. He explained how legislation along the lines of H.R. 6349 would put U.S. investment restrictions on a permanent statutory foundation while strengthening and expanding on the Administration’s action.

Harrell said he understood the desire for a more expansive approach than H.R. 6349 but explained that regulating U.S. investment in specific Chinese sectors is a new endeavor and said it’s appropriate to focus today on the most important technology sectors. He noted broad legislation would risk undermining progress by creating confusion, and urged Congress to start with a tailored approach, focusing on sectors where we know there are problems. He concluded that the U.S. tried to use economic engagement with China to make China more like the U.S., a strategy that did not and will not work. 

Question & Answer

Sector-Based Approach to Outbound Investment

Chair McCaul noted the key technology sectors are semiconductors, AI, quantum, hyper sonics, and high-performance computing. He asked Pottinger if a prohibition based on the sector would be more effective than an entity-approach. Pottinger said a sector-based approach would be much simpler and less resource intensive. He added that it would prevent American firms and regulators from getting tangled in the web of Chinese shell companies.

Chair McCaul said using export control laws and a sector-based approach on capital flows going into China will be a powerful combination. 

Chair McCaul asked Harrell to elaborate on the business community’s ability to understand what Congress is talking about when they are talking about a sector. Harrell said the business community has experience with export controls and understands a sector-based regime. He said businesses will understand the outbound regime when it’s moved to a tailored complementary investment regime. 

Ranking Member Meeks asked Pottinger to identify some of the critical problems that an outbound regime should tackle which can’t be addressed through CFIUS sanctions or export controls. Pottinger said the money that is represented by big name private equity and venture capital firms in the U.S. represents more than just the dollar signs, it represents know-how, networks, and talent. He added that export controls are a lagging indicator because by the time those technologies mature, the cats already out of the bag. He noted the goal of an outbound investment regime would be to close that loophole and capture these technologies before the seeds are planted.

Ranking Member Meeks noted the Biden Administration’s Executive Order identified three sectors that could pose a national security threat to the U.S. – semiconductors, microelectronics, and quantum information. He asked Harrell about the benefits of utilizing a sector-based approach rather than a company-by-company approach to outbound investment. Harrell said China can set up front companies to evade company export controls, like they did with Huawei.

Rep. Brad Schneider (D-Ill.) asked if a sanctions approach led by the Treasury would catch a Chinese AI startup and prevent them from developing military technology. Pottinger said it would easily miss that. Schneider then asked if a sectoral approach would catch the same start up. Harrell said yes, adding that it would also require the investor to come in and tell the U.S. government about that start up.

Entity-Based Approach to Outbound Investment

Rep. Andy Barr (R-Ky.) emphasized that a sector-based approach and entity-based approach are not incompatible. He also disagreed with the assertion that a sector-based approach is stronger.

Barr asked a series of questions to demonstrate the limitations of a sector-based approach. He asked if a sector-based outbound investment restriction would block Beijing-directed subsidies at a state-owned enterprise. Pottinger said not necessarily. Barr also asked if a restriction on outbound investment would impede investment from non-U.S. investors. Pottinger said not unless the U.S. builds a coalition to support that goal. Barr then asked if the Biden EO impacts investors in other countries. Harrell said those investors can’t use a U.S. bank to facilitate that investment, which makes it a little harder for them.

Barr asked if full blocking SDN sanctions would have a multilateral, extraterritorial effect. Pottinger said yes. Barr replied that this is why we should not just dismiss the entity-based approach. He added that OFAC is particularly equipped to adjust sanctions. 

Rep. Young Kim (R-Calif.) asked if there is a way to reconcile the sector-based and entity-based approaches. Harrell noted that sanctions approach has value with respect to China. He added that the Biden Administration should be more aggressive using the existing EO signed by President Trump, which limits U.S. investment in publicly traded securities of big Chinese companies who are linked to the Chinese military. Harrell used an example explaining that if we sanctioned all of China’s mobile telecommunications providers, which are all on the DOD’s entity list, it would effectively prevent all American companies from doing business in China, because none of their employees in China could use the telephone. He concluded that there is a place for sanctions, but we need to be careful in our application. Pottinger said that SDN sanctions are a more powerful tool but can be overkill. He explained that the sector approach is simplistic and less resource intensive, which makes it easier for companies to understand. He concluded that he wouldn’t know how to meld the two approaches together.

Rep. Warren Davidson (R-Ohio) said sanctions work well and are the right way to solve the problem. Chair McCaul replied that an entity can be changed overnight in China, and explained a sector-based approach solves that problem. Davidson asked McCaul if OFAC and the current sanctions regime are not up to the task of preventing sanctions evasion. McCaul said the question is what’s most effective and reiterated that an entity-based approach can be manipulated by the CCP.

Rep. French Hill (R-Ark.) also asked a series of questions about the efficacy of a sector-based approach. Hill asked whether the strongest possible option would be to put something on the OFAC list which offers some G7 clout on enforcing a sanctions regime. Harrell agreed with the importance of a multilateral approach. Hill noted the difficulties of a sector-based approach, adding that he couldn’t think of anything broader than AI, and asked if that would require an army of lawyers. Pottinger agreed that AI is tricky and urged Congress to look at reasonable use cases and the power of the actual model. He noted that AI is already being weaponized against us, including by ByteDance – which Americans invested in.

Hill responded that his mention of ByteDance is an example of where identifying a company is better than saying we want to cut off investment to AI. 

Rep. Bill Huizenga (R-Mich.) argued that Treasury is still where the most effective sanctions can be. He added that if we are not willing to enforce the laws that are already on the books, adding a new system is not necessarily the solution.

Rep. Mike Lawler (R-N.Y.) asked if it’s possible to utilize or expand existing export controls to restrict U.S. capital investment into China. Harrell said that even with the important reforms to export controls, they remain technology focused and not well-suited to go after dollars without a technology flow. Lawler asked if we need to develop a different vehicle or regime. Harrell said a different but complementary regime. 

H.R. 6349, the Preventing Adversaries from Developing Critical Capabilities Act

Rep. Madeleine Dean (D-Pa.) asked Harrell how H.R. 6349 goes further than the Executive Order issued by the President. Harrell emphasized that it’s very important for Congress to act, because having a permanent feature in American law sends a strong signal. He added that the bill expands the covered technology sectors and adds a permanent statutory footing.

Barr expressed his concerns over a provision in the bill, which discusses exceptions and says covered activity does not include an investment in a publicly traded security, index fund, mutual fund, or venture capital fund. Barr explained that the bill might restrict funding, but Americans would still be able to trade in those securities. Barr added that if the U.S. enacted full blocking sanctions, there would be no trading of these securities at all. Pottinger agreed that sanctions, when applied, come at a company from more angles than an export control or investment restriction with the challenge being how to incentivize Treasury to apply sanctions. 

Rep. Chris Smith (R-N.J.) said H.R. 6349 is an excellent bill and that he hopes it becomes law soon.

Criticism of U.S. Investment in China

Rep. Brad Sherman (D-Calif.) said if Americans have it in their interest to transfer technology to China, it will be transferred. He explained that Congress needs to outlaw the kind of investment where one has a controlling interest. Sherman added that every American company should disclose its China risk and what it is doing to safeguard shareholders from that risk. He noted that he is working on legislation to require these disclosures. 

Sherman said Congress should prevent index funds from investing in China and must prevent a capital gains allowance from investing in Chinese companies. Rep. Joe Wilson (R-S.C.) said he agreed with everything Sherman said.

Rep. Brian Mast (R-Fla.) asked how U.S. investment in China makes the U.S. subservient to China’s Belt & Road Initiative and advance China’s preparation for war. Pottinger said the Belt & Road Initiative is a vehicle for corruption, which hurts our interest because corruption becomes the mode for advancing power in the world.

Rep. Cory Mills (R-Fla.) said outbound investment provides our adversaries with invaluable information, skills, and innovation that pose harm to our national security interests. 

Rep. Mike Lawler (R-N.Y.) said it’s time to establish outbound investment restrictions for China.

Harm Caused by Outbound Investment

Rep. Greg Stanton (D-Ariz.) asked about the ramifications of not using an outbound investment regime to address concerns about the PRC’s critical technology sector. Pottinger explained that China is using cutting edge technologies specifically for the purpose of monitoring the thoughts, actions, and communications of people, and building systems to identify people based on their racial or ethnic background from a distance, so they can be put on surveillance or segregated. He cited DJI, a Chinese drone manufacturer, which has 70% of the consumer drone market as an example. Pottinger said DJI is supplying drones that are being used for military use on both sides of the Russia-Ukraine war. He concluded that DJI got its early investments from Americans.

Huizenga asked Pottinger if he was aware of any U.S. companies that invested in Chinese companies that have gone into partnership with the PLA. Pottinger discussed For Paradigm, an AI firm in China that has sold software to China’s military for battalion command decision making and human machine learning. He said For Paradigm was seeded by Goldman Sachs and Sequoia Capital. 

Rep. Rich McCormick (R-Ga.) asked if it would have made a difference in the advancement of AI and other technologies if the U.S. had banned outbound investment to China 15 years ago. Harrell noted that there are many cases over the last 15 years where a U.S. investor came into a Chinese high-tech company and the early U.S. investment was essential to the company’s ability to thrive and grow.

For more information on this meeting, please click here. 

For an archive of past SIFMA hearing coverage, please click here.