Outbound Investment Screening Would Be a Mistake

Congress is hammering out the final details of legislation to address growing concerns over economic competition with China. Grabbing the most attention has been the bill’s proposed $52 billion fund to support semiconductor manufacturing in the United States. But the House version includes a mechanism that would subject some foreign investments by U.S. companies to a review if those investments are made in certain countries. Potentially, investments could be blocked. The impetus behind this is to limit the transfer of technology to China through U.S. investments that could be used to bolster China’s military and civilian surveillance capabilities. While the United States has long screened inward foreign investments for national security reasons, an outbound screening mechanism would mark a major shift in foreign policy. In particular, it would expand the executive branch’s authority to regulate commerce with foreign nations, blur the line between economic welfare and national security, and generate new uncertainty for American investors already operating in a high-risk environment. Outbound investment screening would be a mistake, and any action—either by Congress or the president—warrants scrutiny.

The Casey-Cornyn Bill

Last year, Senators Bob Casey (D-PA) and John Cornyn (R-TX) introduced the National Critical Capabilities Defense Act of 2021 (NCCDA), which was included in the America COMPETES Act, which the House passed in February 2022. The legislation would establish an interagency Committee on National Critical Capabilities (CNCC), led by the United States Trade Representative (USTR). The CNCC would be responsible for screening outbound investments by U.S. companies that involve “national critical capabilities” in “countries of concern.” This committee would also conduct regular reviews to support recommendations for Congress on how to increase resiliency of these critical supply chains. If the CNCC finds that there is “unacceptable risk to one or more national critical capabilities,” transactions can be blocked or modified.

Unlike inward foreign investment screening, which is overseen by the Committee on Foreign Investment in the United States (CFIUS) and applies to all foreign investors, the proposed outbound mechanism is country-specific and limited to foreign adversaries and nonmarket economies. It is essentially targeted at U.S. investments in China and Russia, though there is room to broaden its application.

Lawmakers are trying to reconcile the House and Senate versions of the China competition bills into the Bipartisan Innovation Act, where the outbound investment screening mechanism is but one of several trade issues being considered. While there is bipartisan support for greater scrutiny of capital flows between the United States and China that could undermine U.S. national security interests, establishing an outbound screening mechanism faces significant obstacles and raises several questions about the appropriate scope of such a regime and its application.

The Red Flags

First, the scope of “national critical capabilities” is broad and includes medical supplies, components used for military or intelligence operations, and items essential for critical infrastructure, among others. The legislation also gives the CNCC the authority to identify “additional articles, supply chains, and services to recommend for inclusion in the definition of ‘national critical capabilities,’” leaving the possibility for continuous expansion of which items fall into that category. As the past few years of trade policy have shown us, when national security concerns are vaguely defined, anything can be considered a threat. This was plainly revealed in litigation over the expansion of Section 232 tariffs on steel and aluminium by the Trump administration, where government lawyers agreed that even imports of peanut butter could be construed as a threat to national security. Ambiguous language increases the possibility that such rules will be used for protectionist—rather than legitimate—national security reasons. What, precisely, constitutes national critical capabilities should be narrowly defined. Of course, Section 232 is unique in that a subsection links economic welfare with national security interests, providing the president with broad discretion in defining a threat. The language of the NCCDA also has the potential for broad interpretation, particularly if USTR heads the process—more on that below.

The bill also defines what constitutes a “covered transaction” in a way that leaves substantial uncertainty for American companies. A transaction is covered if it “could result in an unacceptable risk to a national critical capability.” But it’s unclear who will determine what qualifies as an “unacceptable risk” and when this decision would be made. It is possible that a party engaged in a transaction may not even be aware that it could result in an unacceptable risk. This could generate major uncertainty for investors.

Second, it is not clear why the United States Trade Representative should oversee this process when it has never been involved in investment screening, nor does it have the capability to collect and analyze data related to national critical capability supply chains. USTR has expertise in trade negotiations and litigation, and works, in part, to facilitate market access for U.S. companies abroad. This raises the possibility that this new authority could be used as leverage in ongoing negotiations or trade disputes.

A 2021 report by the U.S.-China Economic and Security Review Commission recommended that outbound investment screening should also involve the Secretaries of Defense and Commerce, due to both agencies having more experience than USTR on national security matters. The Department of Commerce already collects data on supply chains and duplicating its work at a much smaller agency would not make much sense. The Department of the Treasury is also a logical agency to involve in any outbound screening mechanism because of its experience with CFIUS reviews, where it must carefully consider whether an action supports U.S. national security interests.

Is Another National Security Tool Necessary?

It is not evident that a separate outbound investment screening mechanism of this scale is necessary. The big question for policymakers is whether current mechanisms can adequately address national security concerns, or whether they can be reformed to take these issues into account. The United States has a robust export control regime, and it is not clear that an outbound investment screening mechanism would capture any additional national security concerns that the export control regime cannot address. And if the current regime does not fill a particular gap, it would be worthwhile to first consider amendments to existing regimes than create an entirely new process.

For example, in 2018 the Export Control Review Act (ECRA) established an interagency process to determine where additional export controls are needed in both emerging and foundational technologies. However, Commerce has been criticized for the speed with which it is developing the list of technologies that are of primary concern for exports to China. Though curtailing sensitive technology transfer is of pressing concern, Commerce should be given time to figure out how best to apply export controls in this space, especially given the rapidly changing nature of technology. Keeping the Commerce Control List up to date is critical to ensure Commerce can respond to national security threats, but it also has knock-on effects for the CFIUS process as well. Commerce may also need to think of how it could speed up the identification process with input from industry.

The web of rules to address these concerns does not end there. Pursuant to Executive Order 13873 in 2019, Commerce established a new process by which it could review transactions concerning information and communications technology and services (ICTS). The Congressional Research Service defines ICTS as covering a wide range of items such as “internet systems, wireless networks, cellular phones, computers, satellite systems, artificial intelligence, quantum computing, and cloud computing services.” There are similarities and overlaps to CFIUS review in this process. It is notable that Commerce was given broad authority to restrict ICTS transactions. This raises further questions about whether additional tools are needed to address these issues, or whether an outbound investment screening mechanism would simply pile on to an already diverse set of policy tools crafted to address national security concerns in international trade and investment.

The lack of consensus on an outbound screening mechanism is reflective of the fact that it is generally unclear if the benefits of such a mechanism will outweigh the costs. Since outbound screening appears to be focused solely on “countries of concern,” most U.S. investments would not be subject to the mechanism. In fact, 75 percent of the United States’ direct investment position overseas is in high-income developed countries. Creating a massive new bureaucratic process for a small portion of U.S. investments may not be the most efficient policy.

At the same time, the Rhodium Group estimates that the screening mechanism would cover roughly 43 percent of U.S. investments in China. This will significantly affect how investors weigh their business decisions, and increase the costs of doing business, not just through compliance with new regulations, but also by discouraging companies from investing in China at all. With business and consumers already struggling with inflation, and a weak economic outlook for the United States, now is not the time to make it more difficult for U.S. investors to seek economic opportunities, and give investors from other countries an advantage. Furthermore, foreign-owned subsidiaries in the United States would be subject to these new rules as well, and that could influence future decisions about whether to invest in the United States in certain sectors considered critical for national security. The U.S Chamber of Commerce has noted that some firms are concerned about what activities will be covered under the mechanism, and “question whether mundane international activities such as hiring salespeople in some foreign markets would trigger the tripwires in this unprecedented measure.” U.S. companies currently in China would be forced to give their investments a second look.

What’s Next?

As Congress meets to finalize the Bipartisan Innovation Act before the August recess, there appear to be efforts to scale back the Casey-Cornyn language. The first major revisions were proposed in mid-June, and were pitched as compromise language that would provide more clarity and close some loopholes. That draft language also left open who would head the CNCC, leaving that decision up to the president. However, opposition to the proposal has remained. Most recently, a pared-down version of the outbound investment screening mechanism was put forward that focuses on transparency requirements for companies that receive funding from the bill, but removes the authority to block or modify transactions in the review process. It is not clear if this will be modified further, or whether it will be scrapped entirely from the final bill.

In May, the Department of Treasury offered an alternative proposal, suggesting the creation of a pilot program on outbound investment screening to help identify the authorities and capacity that will be necessary to implement such a mechanism. The proposal from Treasury is different from the NCCDA in a few notable ways: the types of transactions subject to review are more narrowly defined; it creates a reporting requirement, but Congress would be responsible for acting on that information, not the executive branch; and it does not vest review authority with USTR. Lawmakers have not signaled interest in the Treasury proposal.

Meanwhile, the Joe Biden administration has not taken a position on the NCCDA, in part due to internal disagreements on the issue. However, the administration has indicated that it is considering executive action to address outbound investment concerns. But any action will likely come after the bill is settled and will depend on what parts, if any, of the outbound investment screening mechanism make it into the final legislation.  

Other countries are likely keeping a close watch on what the United States does here. If an outbound screening mechanism is adopted, other jurisdictions are likely to follow suit. The ripple effect of these actions would be global in scale and could make countries that adopt strict screening mechanisms less competitive sources of foreign investment in the future. In crafting a policy on outbound investment screening, policymakers should be mindful about how this may serve to restrict future capital flows and U.S. leadership in foreign investment—perhaps the United States’ most potent tool of international influence.

Congress should be clear-eyed in its scrutiny of any outbound investment screening proposals as it deliberates the final form of the Bipartisan Innovation Act, and exercise caution before it delegates additional authority to the executive branch in regulating commerce with foreign nations. If the outbound investment screening mechanism is not adopted as part of the bill, the Biden administration should avoid taking any executive action. The issue is a big one, and its far-reaching implications are worthy of an entirely separate and carefully reasoned debate.