Unraveling the 3 Major Points of Tension between the US and China

Sign up for CNN's Meanwhile in China newsletter to stay updated on the country's rise and its global impact. The leaders of the two biggest economies in the world are set to meet on Wednesday after a year-long gap, and they have a lot to discuss.

US President Joe Biden and Chinese leader Xi Jinping are set to meet in San Francisco during the Asia-Pacific Economic Cooperation (APEC) summit. The meeting is expected to address various challenging matters such as trade, technology, and investment. With both sides expressing willingness to enhance relations, there has been considerable diplomatic engagement throughout the summer.

While this has helped stabilize the overall relationship, experts tell CNN they arent expecting major breakthroughs this week from the high-stakes talks.

In southern Shandong Province, China, a functioning coal power plant can be observed on September 27, 2021. As the biggest source of carbon emissions, China aims to reach its emission peak by 2030 and achieve carbon neutrality by 2060. Nevertheless, recent electricity supply issues causing factory closures and power outages in homes have led the government to accentuate the significance of traditional energy supply. This development has raised concerns among environmentalists in anticipation of the upcoming United Nations Climate Change Conference (COP26) in Glasgow. (Photo credit: Andrea Verdelli/Getty Images)

US and China commit to scaling up renewable energy sources instead of fossil fuels in anticipation of the Biden-Xi summit. However, the criticality of restoring normalcy, as stated by Biden, holds immense significance for the world economy.

According to Scott Kennedy, trustee chair in Chinese business and economics at the Center for Strategic and International Studies, if there is a lack of cooperation, the global economy will disintegrate into multiple smaller entities, resulting in reduced growth and increased inequality. He further emphasizes that the risks associated with this situation are extremely significant, but the meeting provides a chance to make gradual improvements through the reestablishment of communication in the past year.

Here are the key economic issues between both countries, and whats at stake:

Declining trade flows

Amid worsening relations, US officials have highlighted the necessity to "de-risk" from China, aiming to diminish reliance on Chinese markets and suppliers while avoiding complete disengagement. The Biden administration frames this strategy as a means to effectively navigate heightened geopolitical uncertainty, without pursuing a complete separation of the world's leading economic powers.

According to Chenggang Xu, a senior research scholar at the Stanford Center on China's Economic and Institutions, recent trade data demonstrates a notable shift. He observed that China had been the United States' largest trading partner for a significant duration, but now it has dropped to the third position.

In the initial nine months of the current year, Mexico and Canada have surpassed the second largest economy in the world to become the leading trading partners for the United States. They collectively represent 15.7% and 15.3% of the total US trade, respectively, while China accounts for 11.1% based on the most recent data from the US government.

Shipping cranes standing over container ships at the Port of Oakland in California

Justin Sullivan/Getty Images

Still, the two largest economies in the world continue to have a significant level of mutual dependence. In 2022, the trade of goods between them reached an all-time high of almost $691 billion, with the United States remaining China's top trading partner, following the Association of Southeast Asian Nations and the European Union.

However, the current situation may be undergoing a shift. According to a survey conducted by the American Chamber of Commerce in Shanghai, in September, it was revealed that 40% of respondents were redirecting or considering diverting their investments that were initially intended for China.

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Gina Raimondo seeks improved relations with China amidst technology and Taiwan-related tensions. Xu stated that the trend of decoupling or de-risking is already apparent, citing examples like the departure of American companies like Vanguard, a prominent asset management firm, from China.

Chinese data also indicates that foreign companies are withdrawing their funds. In the third quarter, the measure of foreign direct investment into China experienced its first negative result in 25 years.

Geopolitical tensions, including Russia's invasion of Ukraine in 2022 which exposed Europe's reliance on Moscow for energy, as well as increasing risks in China such as potential raids on companies and detentions of executives, have unsettled companies. This year, there has been a crackdown on international consulting firms, further raising risks for businesses. US Commerce Secretary Gina Raimondo even stated that some now consider the country as "uninvestable."

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

China and the United States have been involved in an intensifying dispute regarding China's acquisition of cutting-edge semiconductors and the necessary materials and equipment for technological development. In a recent move, the US government limited the range of semiconductors that American companies can export to China, citing national security concerns. These export controls were initially implemented in October 2022 and have since been enhanced.

The Biden administration considers the recent measures necessary to hinder China's military progress by preventing the potential use of the hardware and addressing loopholes in current regulations. Beijing, in response, has accused Washington of turning trade and tech matters into weapons.

As a result, companies like Nvidia (NVDA) are directly affected by these restrictions. They are now compelled to modify their shipments of high-end chips to China and have expressed concerns about facing long-term opportunities being permanently lost.

China holds the title of being the largest semiconductor market globally, encompassing a staggering 36% of sales for American companies, as revealed by the Semiconductor Industry Association, which acts as the representative body for chipmakers in the United States.

A semiconductor manufacturing facility in New York. US chipmaking companies are dependent on China for a large chunk of their sales.

Adam Glanzman/Bloomberg/Getty Images

The group has urged both countries to reduce tensions by engaging in dialogue, as excessive restrictions may incentivize international customers to seek alternatives.

In August, China implemented its own limitations by restricting the export of gallium and germanium, which are crucial elements in semiconductor production. According to the US Geological Survey, China is the largest global producer of gallium and a prominent producer of germanium.

Two months later, in close proximity to the recent disclosure of the most recent limitations imposed on US chips, Beijing additionally introduced proposals to limit the export of graphite, a mineral essential for the production of batteries for electric vehicles. China justified both sets of measures on the basis of national security.

A Nvidia HGX H100 server is set up at Nvidia Corp.'s headquarters in Santa Clara, California, USA on Monday, June 5, 2023. With its dominant position in the technology industry, Nvidia controls 80% of the market share for data-center accelerators, a specific type of chip. The current waiting period to obtain one of its AI processors is eight months. The photograph is credited to Marlena Sloss from Bloomberg via Getty Images.

The tech battle between the US and China is intensifying as China experiences a disruption in its access to AI chips. This conflict has also affected other nations, including Japan and the Netherlands, who have started restricting the export of advanced semiconductor manufacturing equipment for reasons related to security.

China has accused unnamed countries of pressuring other nations to implement restrictions, without explicitly mentioning the United States. Zongyuan Zoe Liu, a fellow for China studies at the Council on Foreign Relations (CFR) and author of "Sovereign Funds: How the Communist Party of China Finances its Global Ambitions," stated that businesses and governments worldwide prefer not to be compelled into choosing between the US and China.

Tighter investment curbs

Washington's announcement in August outlined measures to restrict US investments in advanced technologies such as AI, quantum computing, and semiconductors in China. The primary objectives behind these limitations are to safeguard national security and prevent American funds from potentially financing the military. Experts note that this executive order signifies a departure from past US policies, despite parallel efforts by Congress and previous support expressed by former President Donald Trump for more assertive investment controls during his tenure.

The upcoming restrictions, scheduled to be implemented in the following year, pertain to investments made by American venture capital and private equity firms, along with joint ventures. According to experts and investors interviewed by CNN, these limitations are expected to worsen the already declining transaction activities between the two nations.

In the third quarter, investments from a US investor in China's venture capital deals amounted to approximately $300 million, which is significantly lower compared to the $2 billion recorded during the same period in the previous year, as reported by PitchBook.

U.S. and Chinese national flags fly outside a company building in Shanghai, China, on Tuesday, October 22, 2013.

Tomohiro Ohsumi/Bloomberg/Getty Images/File

US investment curbs deal major blow to Chinese startups

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

Sequoia, a leading global venture capital firm, made headlines in June when it announced its decision to divide its operations into three separate entities, each focused on a specific region. The firm's move was soon followed by GGV Capital, another prominent Silicon Valley firm, which made a similar announcement in September. Both firms highlighted the challenges of managing a centralized global business and revealed concerns from American policymakers regarding their significant investments in China, further exacerbating tensions between the US and Beijing.

Sequoia's decision may not have been a direct response to the US-China tensions, but the additional challenges that have emerged may have accelerated the breakup earlier than anticipated, according to PitchBook analysts. They highlighted the new investment restrictions imposed by the Biden administration in a September report. The analysts also noted that if tensions between the US and China persist, further breakups may occur in the future.

American companies that have significant operations in China, such as Apple (AAPL) and Tesla (TSLA), may also come under increased scrutiny. A US Congressional advisory body suggested that lawmakers should contemplate enforcing legal requirements for publicly traded companies to offer more comprehensive disclosures regarding their involvement in China. These disclosures could encompass details about a company's total assets in the country or the impact of Chinese Communist Party-affiliated personnel on corporate decision-making, according to a report by the US-China Economic and Security Review Commission.

Liu, the CFR fellow, expressed that given the numerous challenges in the wider US-China relationship, the expectations for the Biden-Xi meeting are not set particularly high. According to Liu, a positive outcome would simply be if both parties manage to hold the meeting without anyone abruptly leaving.