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Foreign Investment and U.S. National Security

Author: Jonathan Masters, Deputy Editor
September 27, 2013

Introduction

The United States is both the world's largest foreign direct investor and the largest beneficiary of foreign direct investment (FDI). But like every sovereign country, it has sought to temper its embrace of open markets with the protection of national security interests. Achieving this balance, which has shifted over time, has meant placing certain limitations on overseas investment in strategically sensitive sectors of the U.S. economy.

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The Committee on Foreign Investment in the United States was established in 1975 to review acquisitions of U.S. firms by foreign entities that could erode national security. Recent political opposition to some high-profile foreign investment activity, including the 2006 Dubai Ports World controversy, has fed a perception among some that the United States has stepped back from its open-door policies. The federal government, however, reviews only a small fraction of the hundreds of annual foreign acquisitions, and it blocks transactions in only the rarest of cases. In a record-setting deal, CFIUS approved the sale of Smithfield Foods to Shuanghui International Holdings Ltd. in September 2013, the largest Chinese purchase of a U.S. company in history.

HuaweiA cleaner wipes the glass door of a Huawei office in Wuhan, Hubei province (Courtesy Reuters).
How does the United States benefit from foreign investment?

Washington has traditionally led international efforts to bring down barriers to cross-border capital flows, with the goals of expanding investment opportunities for U.S. multinational businesses and creating a more stable, efficient international system. At the same time, the United States relies greatly on foreign inflows to compensate for a shortage of savings at home. The United States routinely ranks among the most favorable destinations for foreign direct investors. Foreign direct investment—the ownership or control by a foreign entity of 10 percent or more of a domestic enterprise—plays a modest but growing role in the U.S. economy.

Foreign Direct Investment Expressed in billions. Note: The drop in U.S. investment abroad in 2005 reflects actions by U.S. parent companies to take advantage of a one-time tax provsion. Source: Department of Commerce.

According to the Department of Commerce, foreign firms owned more than thirty thousand businesses in the United States in 2010, employed nearly six million people (roughly 4 percent of the civilian workforce), and paid higher average salaries than their domestic competitors. Moreover, foreign firms are disproportionately involved in manufacturing—more than twice the ratio of the total U.S. economy—and they often provide high-skill jobs and training that lift local economies. In 2010, China-owned Pacific Century Motors bought auto-parts maker Nexteer, saving thousands of jobs in Saginaw, Michigan. "This city went from being an exhibit of America's industrial decline to a case study in the impact of Chinese investment money on U.S. communities," said the Wall Street Journal. Indeed, many states and cities aggressively pursue foreign direct investment.

What are the concerns over foreign investment?

Concerns with foreign transactions are typically associated with mergers, acquisitions, and takeovers of established domestic firms rather than new, so-called greenfield investment. U.S. lawmakers, much like their peers around the globe, have passed legislation that restricts or reviews foreign deals that could cause a loss of sensitive technologies, a significant outsourcing of jobs, or impair various sectors of critical infrastructure. In recent years, many nations have reassessed their laws in light of fears associated with international terrorism and global investments by state-owned enterprises (foreign-government controlled) and sovereign wealth funds, many of which suffer from transparency and accountability issues.

But many economists warn policymakers that imposing burdensome restrictions on FDI inflows could trigger similarly restrictive policies by other nations. To avoid this, the thirty-four member countries of the Organization for Economic Cooperation and Development (OECD), as well as ten nonmember states, have signed a nonbinding commitment to treat foreign-controlled firms on their territory no less favorably than domestic enterprises. Governments under this agreement are, however, provided considerable latitude to exempt sectors of their economies deemed essential to national security. As shown in Table 1, countries define "critical infrastructure" in various ways.

Critical InfrastructureSource: OECD

Former director of the Congressional Budget Office Douglas Holtz-Eakin says there are legitimate security concerns, but says that foreign companies, state-owned or private, should be free to earn money from critical infrastructure provided they do not have direct operational control. "The issue is less about ownership and more about management," he says.

International investment experts Alan P. Larson and David M. Marchick, who coauthored a 2007 Council Special Report on the subject, agree that state ownership in multinational firms is very often benign. However, they note that concerns arise "when the foreign company's decisions become an extension of the government's policy decisions rather than the company's commercial interests." The authors cite the move by Russian energy giant Gazprom to cut gas supplies to Ukraine in 2006, which some Western observers considered a politically-motivated decision, as a cautionary example.

Has the review of foreign investment changed?

Federal oversight of foreign investment has evolved over time, often in response to changing economic and security conditions. The Gerald Ford administration created the Committee on Foreign Investment in the United States in 1975 amid congressional unease with growing OPEC-nation investment in the United States, which many policymakers saw as potentially suspect. The interagency CFIUS was charged with coordinating U.S. policy on foreign investment and reviewing transactions that could have significant consequences for U.S. interests.

However, in the ensuing years, many in Washington felt the oversight body was falling short of its obligations. In 1988, Congress strengthened the CFIUS review process by passing the Exon-Florio amendment to the Defense Production Act of 1950. Much as in the previous decade, the reforms stemmed from concern with growing foreign investment—this time Japanese—in sensitive U.S. industries, including a bid by computer giant Fujitsu to purchase U.S.-based computer chip maker Fairchild Semiconductor.

Exon-Florio granted the president far-reaching authority to block a foreign acquisition on "national security" grounds, broadly defined—an executive decision that does not require the legislature's approval and cannot be judicially reviewed. The Reagan administration, in turn, delegated the power to administer Exon-Florio to CFIUS.

"CFIUS was [thereby] transformed from a purely administrative body with limited authority to review and analyze data on foreign investment to one with a broad mandate and significant authority to advise the President on foreign investment transactions and to recommend that some transactions be blocked," explains the Congressional Research Service.

In February 1990, President George H.W. Bush used this enhanced authority to void the sale of Mamco Manufacturing, a Seattle-based aircraft parts maker, to a Chinese state-owned aviation company.

What changed after the Dubai Ports World scandal?

The CFIUS process was amended most recently by the Foreign Investment and National Security Act of 2007 (FINSA), which passed in the wake of the Dubai Ports World scandal (DPW). In March 2006, amid a flurry of U.S. political opposition, the Dubai-owned firm scuttled its bid to acquire control of major U.S. port operations. Many in Congress said that the controversial deal would increase the risk of a terrorist attack on the United States. On the other hand, the George W. Bush administration and CFIUS had previously approved the transaction.

FINSA provided Congress greater oversight of CFIUS and expanded the legal meaning of national security to include critical infrastructure (as outlined in the 2001 USA Patriot Act). The act requires CFIUS to investigate all foreign investment deals where the overseas entity is owned or controlled by a foreign power, irrespective of the nature of the enterprise. According to some experts, this shifted the burden of proof from CFIUS to foreign firms to show that they do not represent a security risk.

How does the CFIUS review process work?

CFIUS operates under the discretion of the president and is chaired by the secretary of the treasury. It includes the heads of the following departments: Justice, Homeland Security, Commerce, Defense, State, and Energy, as well as the U.S. trade representative and the director of the Office of Science and Technology Policy. Several other offices also contribute: the Office of Management and Budget, Council of Economic Advisers, National Security Council, National Economic Council, and Homeland Security Council. In addition, the director of national intelligence and the secretary of labor are nonvoting, ex officio CFIUS members.

Prior to a formal, voluntary filing with the committee, parties to a foreign deal that may have security implications are highly encouraged to consult with CFIUS staff confidentially to identify and address any potential concerns. Once a formal notification is submitted, CFIUS reviews the proposed deal for a period of up to thirty days, during which time it can request additional information and provide feedback to the parties. Most reviews conclude in the initial period; the few that raise concerns trigger a second, forty-five-day investigation. CFIUS and the transacting parties may negotiate a mitigation agreement to address any national security concerns. After the investigation period, the committee may make an adverse recommendation to the president, who then has fifteen days to make a decision.

Regulatory experts say the committee's work is "intellectually honest," and very meticulous. "It's like a full physical, performed by a battery of doctors that run every conceivable test," said David Fagan, law partner at Covington and Burling LLP, a Washington, DC-based firm with a robust CFIUS practice.

Only the president has the authority to block a transaction, but two conditions must be met beforehand: the president must have "credible evidence" that the deal will impair national security, and he/she must determine that other U.S. laws are insufficient to safeguard national security.

How often does CFIUS review foreign investments?

CFIUS only reviews "covered" transactions, which are any merger, acquisition, or takeover resulting in "foreign control of any person engaged in interstate commerce in the United States." Transactions not covered are those conducted "solely for the purpose of investment" or where the foreign investor "has no intention of determining or directing the basic business decisions of the issuer."

As shown in the chart below, CFIUS reviewed roughly 10 percent of all transactions involving foreign firms acquiring U.S. firms from 2008 to 2011. Of those, nearly 90 percent were completed, and none were blocked by the president. However, firms have preventively withdrawn notices rather than receive a negative CFIUS recommendation or a formal ban from the White House. In February 2011, China telecom giant Huawei voluntarily divested its assets in 3Leaf, a U.S. technology firm, before a likely prohibition order from President Obama. Other firms have made similar decisions in recent years.

President Obama, acting on CFIUS recommendations, ordered the Chinese-owned Ralls Corporation to divest its interest in Oregon wind farms in September 2012, citing national security concerns. Earlier in the year, Ralls had purchased the sites, one near restricted U.S. Navy airspace where drones are tested, without reporting the deal to CFIUS. It was the first time in more than two decades that the White House formally prohibited such a deal.

Many analysts say such setbacks can skew the debate, and they stress the need to promote the quiet Chinese successes in U.S. investing. "Most Chinese investments have not and should not raise real [security] concerns," writes Marchick. "Senior U.S. officials should highlight the many successful investments Chinese companies have made."

How do U.S. policies on foreign investment compare with the rest of the world?

The OECD ranked the United States' FDI regulatory regime as relatively closed, more restrictive than peer nations. The 2012 study took into account foreign equity limitations, screening mechanisms (e.g., CFIUS), restrictions on the foreign employment, and operational constraints.

FDI Regulatory RegimesSource: OECD

An updated General Accountability Office review of the foreign investment policies of ten nations (Canada, China, France, Germany, India, Japan, the Netherlands, Russia, the United Arab Emirates, and the UK) offers an instructive comparison. Authors note that in many ways the systems are similar to each other, where most have a formal review process with an established time frame to assess security concerns. However, most nations have a mandatory review process if a foreign investment hits a certain dollar amount, or if the buyer will gain a controlling or blocking stake. Also unlike the U.S. system, half of the nations studied allow decisions to be appealed in court or other means.

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