On November 14, 2023, the U.S.-China Economic & Security Review Commission (the Commission) published its annual report to Congress. The report covers a wide range of topics, including a detailed assessment of the state of U.S. economic restrictions against China. The Commission analyzed and recommended improvements to U.S. export controls and investment restrictions that are aimed at preventing China’s military-civil fusion (MCF) program from leveraging U.S. technology.

To the extent the recommendations are accepted, industry could see even further restrictions on dealings with China. In particular, the proposals could result in more export controls enforcement and the granting of fewer licenses. Industry could also see additional scrutiny for Chinese investment into the United States.

A select summary of the report’s key findings and recommendations is below.

Export Controls. The Commission found that, even where coordinated with allies, current U.S. export controls are “insufficient” to stem the flow of knowhow and capital into China’s defense sector. The effectiveness of export controls is diluted by China’s MCF strategy, which combines the capabilities and innovation of civilian sectors “to drive military development through . . . policies and government-supported mechanisms.” This MCF strategy necessitates a “renewed focus on dual-use technologies, particularly in current multilateral regimes, which focus mainly on preventing the spread of military technologies that currently exist rather than preventing the development of new ones.”

The Commission recommended that Congress evaluate the possibility of establishing a single export licensing system. This system would integrate the Commerce Control List and the U.S. Munitions List, which refer to dual-use technology and armament licensing systems managed by the Commerce Department’s Bureau of Industry and Security (BIS) and the State Department’s Directorate of Defense Trade Controls, respectively. In evaluating the feasibility of a single export licensing system, the Commission advised that Congress evaluate, among other factors, (1) the commercial impact of combining the licensing systems, (2) which technologies to include in a combined system, and (3) which U.S. government agency should be in charge of the new system.

Additionally, the Commission recommended that Congress direct the General Accountability Office to evaluate the effectiveness of the recently imposed semiconductor export controls. These controls are designed to prevent China from acquiring or developing the capacity to manufacture certain advanced semiconductors. Last month BIS published interim final rules seeking to address certain gaps BIS found in its existing controls on advanced computing items, semiconductor manufacturing equipment, and items that support supercomputing applications and end-uses.

The Commission found that, following the implementation of BIS’s controls on the semiconductors that go into artificial intelligence (AI), MCF allowed China to expand its circumvention of U.S. restrictions by “scaling up thousands of intermediaries to [procure high]-end chips, including from U.S.-based NVIDIA.” This allowed the Chinese military to make rapid advances in AI for defense applications through its partnerships with civilian entities, and that “investment and procurement patterns suggest the [China] aims to use AI-enabled weapons systems to counter specific U.S. advantages and target U.S. vulnerabilities.”

Committee on Foreign Investment in the United States (CFIUS). The Commission recommended that CFIUS, an inter-agency committee that screens U.S.-bound investments, be granted the authority to “review investments in U.S. companies that could support foreign acquisition of capabilities to attain technological self-sufficiency or otherwise impair the economic competitiveness of the United States.” These “capabilities” would include investments in technology that are prioritized in the industrial policies of adversarial countries and investments in U.S. firms that have received funding from the U.S. government for projects critical to national security.

This recommendation from the Commission, if enacted, would complement an Executive Order issued by the Biden Administration last year directing CFIUS to consider additional national security risks in its evaluations of transactions. Importantly, the U.S. Treasury Department, which chairs CFIUS, is also in the process of drafting regulations to restrict U.S. outbound investment to countries that pose a risk to U.S. national security. CFIUS itself, as well as this forthcoming outbound investment screening mechanism, would have the effect of limiting China’s ability to procure technology that could go into the development of AI.

China’s Influence Over Foreign Militaries. China is keen to advance its technological prowess, partly through the acquisition of U.S. technologies. Because of this, there is a risk that U.S.-controlled technology could be supplied to the foreign militaries that China partners with. The Commission found that China seeks to deepen its influence over foreign militaries to undermine U.S. interests and “pursue relevant combat support capabilities in communications, logistics, survival skills, military medicine, and other basic military skills. Further, in addition to being a major exporter of small arms, “China has both improved the quality of its exports and expanded the range of equipment it provides, with the most notable advances in aircraft and ships.”

To that end, the Commission recommended that the U.S. Department of Defense (DOD) submit a report to Congress “detailing measures DOD is taking to mitigate the risk of the [Chinese military] gaining indirect knowledge of U.S. Armed Forces’ equipment and operational tactics, techniques, and procedures through interactions with the militaries of U.S. allies and partners.” The Commission also recommended that the report identify the steps necessary for end-use monitoring to ensure compliance.

In summary, U.S.-based firms should take the above issues raised by the Commission into account when considering sales to China or investments involving Chinese entities. Opportunities being pursued with China now may come under additional scrutiny or restrictions later as the Commission’s proposals are reviewed and potentially implemented.

Please contact our sanctions and export team if you need assistance navigating these developments in the course of certain sales to China.

Annual Report to Congress Proposes Counters to China’s Military-Civil Fusion Program