3 key sources of tension between the US and China

Hong Kong (CNN) — Leaders of the world’s top two economies will have plenty to discuss when they meet on Wednesday for the first time in a year.

US President Joe Biden and Chinese leader Xi Jinping are slated to get together in San Francisco on the sidelines of the Asia-Pacific Economic Cooperation (APEC) summit, where they’re likely to tackle a range of thorny issues from trade to tech to investment.

Both sides have signaled they’re ready to improve ties, following a flurry of diplomatic activity over the summer.

While this has helped stabilize the overall relationship, experts tell CNN they aren’t expecting major breakthroughs this week from the high-stakes talks.

Even so, finding ways to “get back on a normal course” — in the words of Biden — matters hugely to the global economy.

“If they don’t get along, the global economy will fragment into a bunch of smaller pieces that will lead to slower growth and greater inequality,” said Scott Kennedy, trustee chair in Chinese business and economics at the Center for Strategic and International Studies.

“The downside risks are amazingly high and this meeting offers the opportunity to make incremental progress based on the renewal of communication over the last year.”

Here are the key economic issues between both countries, and what’s at stake:

Declining trade flows

As relations have deteriorated in recent months, US officials have pointed to the need to “de-risk” from China, which refers to reducing exposure to Chinese markets and suppliers, without cutting ties entirely.

The Biden administration has framed the strategy as a way to manage America’s exposure to increased geopolitical uncertainty, while emphasizing that its goal is not an all-out decoupling of the world’s economic superpowers.

Recent trade data shows this shift, according to Chenggang Xu, a senior research scholar at the Stanford Center on China’s Economic and Institutions.

“For a quite long period of time, China had been the largest trading partner of the United States,” he noted. “Now, China is number three.”

In the first nine months of this year, Mexico and Canada eclipsed the world’s second largest economy as America’s top trading partners, accounting for 15.7% and 15.3% respectively of total US trade, compared to China’s 11.1%, according to the latest US government data.

Still, the world’s top two economies remain hugely interdependent. The goods trade hit a record high in 2022, reaching nearly $691 billion, and the United States is still China’s number one trading partner after the Association of Southeast Asian Nations and the European Union.

The reality on the ground, though, may be changing. In September, the American Chamber of Commerce in Shanghai said 40% of respondents to a survey were redirecting or planning to divert investment originally planned for China.

“Whether you call that decoupling or de-risking, this is already a trend,” said Xu. He also pointed to some American companies leaving China altogether, such as asset management giant Vanguard.

Chinese data also suggests foreign companies are moving their money out. In the third quarter, a measure of foreign direct investment into China turned negative for the first time in 25 years.

Companies have been spooked not just by geopolitical tensions, particularly Russia’s invasion of Ukraine in 2022 that highlighted Europe’s dependency on Moscow for energy, but growing risks in China, such as the possibility of raids on companies and detentions of executives. This year, a crackdown on international consulting firms has raised risks for businesses, prompting some to even view the country as “uninvestable,” according to US Commerce Secretary Gina Raimondo.

Despite that, the secretary has encouraged US firms to continue expanding in the country, underscoring the complexities at the heart of the relationship.

Escalating chip war

Over the past year, both sides have been progressively escalating a feud over China’s access to the most advanced semiconductors, as well as the materials and equipment needed to create the technology.

Last month, citing national security, Washington reduced the types of semiconductors that American companies could sell to China, further tightening a sweeping set of export controls first introduced in October 2022.

The Biden administration deems the latest measures necessary to prevent potential use of the hardware for China’s military advancement and to close loopholes in existing regulations. In response, Beijing has accused Washington of “weaponizing trade and tech issues.”

The restrictions impact companies such as Nvidia (NVDA), which has been forced to adjust its shipments of high-end chips to China and pointed to a potential “permanent loss of opportunities” in the long run.

China is by far the world’s largest market for semiconductors, accounting for 36% of sales for US companies, according to the Semiconductor Industry Association, which represents American chipmakers.

The group has previously called on both countries to dial down tensions through dialogue, saying that overly broad restrictions may “encourage overseas customers to look elsewhere.”

China has imposed its own curbs. in August, it limited exports of gallium and germanium, two elements essential to making semiconductors. The country is by far the world’s biggest gallium producer, and a leading global producer of germanium, according to the US Geological Survey.

Two months later, just days after the announcement of the latest US chip restrictions, Beijing also unveiled plans to curb exports of graphite, a mineral required to make batteries for electric vehicles. China cited national security grounds for both sets of measures.

The tussle has spilled over to other countries. In recent months, Japan and the Netherlands have joined the United States in tightening exports of advanced semiconductor manufacturing equipment, citing security reasons.

China has accused “certain countries” of “coercing” other nations into rolling out the curbs, without naming the United States specifically.

Businesses and governments around the world “don’t want to be forced to choose between either the US or China,” said Zongyuan Zoe Liu, a fellow for China studies at the Council on Foreign Relations (CFR) and author of the book “Sovereign Funds: How the Communist Party of China Finances its Global Ambitions.”

“So the fact that these two leaders are meeting, I think it is already a sign to say, ‘Well, we are trying.’”

Tighter investment curbs

In August, Washington announced it would limit US investments in advanced technology in China, including AI, quantum computing and semiconductors, to protect national security and to prevent American money from being potentially used to fund the military.

The executive order represents a break from previous US policy, even though Congress has worked on similar legislation and former US President Donald Trump had previously expressed support for more aggressive investment curbs during his term, according to experts.

The restrictions, which are being drafted and set to take effect next year, cover investments by US venture capital and private equity firms, as well as joint ventures.

Analysts and investors have told CNN that the constraints will exacerbate a slump in dealmaking between the two economies, which was already drying up.

In the third quarter, venture capital deals in China involving a US investor totaled about $300 million, compared with $2 billion the same period the previous year, according to PitchBook.

Some companies have made the drastic move of splitting up their US and China operations.

In June, top global venture capital firm Sequoia was the first to announce it would cordon off its operations into three entities covering different regions, followed by a similar announcement from fellow Silicon Valley firm GGV Capital in September.

Both cited the complexities of running a centralized global business. Both companies’ expansive investments in China had also drawn attention from US lawmakers amid growing rancor with Beijing.

Though Sequoia’s decision may not have been an “immediate response to US-China tensions, the added challenges that have arisen likely pushed this breakup sooner than planned,” PitchBook analysts said in a September report, pointing to the Biden administration’s new investment restrictions.

If US-China tensions continue to remain high, there could be more breakups to come, the analysts wrote.

Listed American companies with big business in China, such as Apple (AAPL) and Tesla (TSLA), may face higher scrutiny, too. On Tuesday, a US Congressional advisory body said lawmakers should consider legally mandating publicly traded companies to provide more detailed disclosures of their exposure to China.

That could include information about a firm’s total assets in the country or about “the influence of any company personnel associated with the Chinese Communist Party in corporate decision-making,” the US-China Economic and Security Review Commission wrote in a report.

For now, the wider US-China relationship continues to face so many challenges that “the bar is not really that high,” in terms of expectations for the Biden-Xi meeting, said Liu, the CFR fellow.

“As long as nobody walks out of the meeting … I think that’s a good sign.”

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