Executive Summary
Washington ponders new mechanism with unknown effects
The US is weighing the benefits of outbound investment screening (OIS) to counter China. Introducing de facto capital controls requires Europe’s support, putting the transatlantic relations to a test.
The goal of OIS is “soft decoupling” to prevent the offshoring of increasingly discrete supply chains in aerospace, semiconductors, AI, IT, robotics, and other critical tech sectors to non-allied third countries.
Introducing OIS carries risks of protectionism and capital relocation, curbing freedom of investment and the (partial) restructuring of businesses in emerging tech
State of Play A new tool of economic statecraft in Washington
The idea of introducing a – US-only if needed, but preferably transatlantic – outbound investment screening (OIS) is gathering steam. This mechanism aims to screen and, eventually, ban certain US and European investments into critical tech sectors in non-allied third countries. The implicit goal is to prevent China from acquiring critical technologies through political pressure and, effectively, capital controls. Yet, capital controls increase economic costs and risks for American and European companies – from compliance burdens and higher risk premiums to a loss in strategic competitiveness. Washington’s actions are guided by geopolitical, not commercial, reasoning. The Biden administration is likely going to make it a central request to Europeans in confronting China. Many European countries are skeptical, but prioritize a strong transatlantic partnership. Furthermore, EU governments see increasing risks in being tied to Beijing-controlled tech supply chains.
Key Issues The idea behind Outbound Investment Screening –
and how it could work
OIS is part of the Biden administration's emerging technologies strategy. Its formulated objective is to shield America’s – and by extension the transatlantic – ‘technological ecosystem’, avoiding ‘disadvantageous’ supply chain relationships. The administration and Congress seem to have a three-fold rationale for promoting this mechanism: (1) efforts in other areas including the US-EU Trade and Technology Council (TTC) do not sufficiently cover critical technology offshoring, and (2) existing export controls and inbound FDI screening can be circumvented by investments into entities abroad. Furthermore, (3) OIS would be a suitable political lever to increase pressure on the systemic rival given China’s strong interest in critical tech investments.
In practice, OIS rather entails reporting requirements for specific tech sectors (e.g. semiconductors, AI, and robotics) along the lines of inbound FDI screening. Based on certain screening thresholds, the administration would thus acquire a means to prohibit certain investments abroad. However, Washington needs Europe on board, especially high-tech countries like Germany, the Netherlands, Sweden and France. The mechanism obviously cannot succeed if European investors were to simply substitute US investment banned by a unilateral screening.The US and Europe will therefore have to identify in which specific technologies and how far down the supply chains they would like to control access via OIS. In fact, the EU-US agreement on Airbus-Boeing of June 2021 could be a starting point for transatlantic OIS, beginning with aerospace and expanding into other sectors.
Challenges for European businesses and governments
OIS comes with a range of economic challenges, technical difficulties, and risks for businesses. First, it enhances decoupling and promotes protectionism. Affected tech sectors could disintegrate, and companies might have to undergo serious restructuring. Screening decisions could be driven by politics, not least because criteria are vague. European firms would lose out if the US protects its companies differently than the EU, given that capital controls are prohibited by EU law and WTO rules. Second, OIS will likely increase the compliance burden and restrict investors and businesses. Third, investors could possibly move to other locations from where they can invest more freely, i.e. with no OIS restrictions. This is why forming a broader coalition beyond the US and Europe is important, albeit probably difficult to achieve. Fourth, it is unclear how OIS will work technically, as capital can move within (micro-)seconds, whereas regulators would have to intervene retroactively. This would cause disruptions to operations for which businesses could not expect damage compensation. Furthermore, alternative payment methods such as crypto currencies can complicate an effective implementation.
So far, politicians and businesses in Europe are skeptical of OIS. However, because such a mechanism looks like the next “big thing” in Washington in the Sino-American rivalry, it may become a litmus test for transatlantic relations. Plus, Europeans have an interest in demonstrating that Biden’s cooperative approach yields more results than his predecessor’s unilateralism. There are also real long-term risks for Europe in not addressing Beijing’s dual-circulation strategy of strengthening its domestic market. China pursues its geopolitical goals of tying Europe into its supply chains and replacing European companies or making them more Chinese. The 2021 critical information infrastructure regulation, for instance, rendered European telecom equipment and service providers subject to national security reviews. This led to European firms localizing their production and research. Companies should better prepare for a mechanism to redirect investments in critical sectors.