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McKinsey Executive Roundtable Series in International Economics: Inward Investment and U.S. National Security [Transcript; Federal News Service, Inc.]

Speakers: Kenneth G. Lieberthal, Arthur F. Thurnau Professor of Political Science, William Davidson Professor of Business Administration, University Of Michigan, Patrick A. Mulloy, Commissioner, U.S.-China Economic and Security Review Commission, and William A. Reinsch, President, National Foreign Trade Council; Former Undersecretary of Commerce for Export Administration, U.S. Department of Commerce
Presider: Jeffrey R. Shafer, Vice Chairman, Global Banking and Head of Economic and Political Strategies, Citicorp
June 13, 2006
Council on Foreign Relations New York, NY

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MR. JEFFREY SHAFER: I’m going to keep up the council’s reputation for running its meetings on time and start promptly this morning.

The meeting this morning is part of the McKinsey Executive Roundtable Series in International Economics. The series is sponsored by the Council’s Maurice R. Greenberg Center for Geoeconomic Studies and the Corporate Program.

I want to remind everyone to turn off their cell phones, their BlackBerrys and all other wireless communications. And I would like to warn people, unlike some Council meetings, this meeting today will be on the record.

The subject for this morning’s discussion is “Inward Investment and U.S. National Security.” The subject has received a lot of attention lately. Last year it was brought to the fore by a possible CNOOC, the Chinese oil company, bid for Unocal; and earlier this year the Dubai Ports World acquisition of management contracts for U.S. ports as a part of its acquisition of the British P&O created a firestorm of attention. Public concern has run very high, and Congress right now is considering legislation to modify the Exon-Florio amendment under which foreign acquisitions in the U.S. are reviewed to ensure they do not threaten national security.

These political concerns about foreign investment have been revived in other countries as well: France, Spain, Portugal, Italy and Russia have all made noises or taken measures to block foreign investments. And Russia is especially interesting, because it closes as much of its market to foreign investment, and is pressing fairly loudly for access to the energy markets in Western Europe and the United States.

I think we’ve got a great panel to discuss these issues this morning. You have the biographies of the panel members. Let me just introduce briefly: Ken Lieberthal, who is a professor of business administration at Michigan, and a former senior director for Asia on the National Security Council; we have Pat Mulloy, who is the U.S.- China economic and security review commissioner and a former assistant secretary of Commerce for market access and compliance—and also, where I met him first, the Senate Banking Committee staffer; and finally we have Bill Reinsch, president of the National Foreign Trade Council, also a U.S.-China economic and security review commissioner, and a former undersecretary of Commerce for export administration, and Senate staffer.

Now, the panel asked me if I would, before asking you to speak, set the scene very briefly as to what we’re going to talk about today. For 200 years the U.S. was open to foreign investment, and attracted strong investment flows from Europe in the 19th century. The only exceptions to complete openness were seizures of enemy property in time of war. This has not been the case with most other countries until relatively recently.

Now, in the United States concerns about inward investment from the Middle East with pockets full of petro dollars led to the establishment of the Committee on Foreign Investment in the United States by executive order in 1975, and CFIUS monitored investment that had no new powers to enforce anything at that point.

Japan’s emergence as a global superpower—global economic power in the 1980s and its flurry of acquisition of U.S. assets in the late ‘80s, including Rockefeller Center and Pebble Beach, raised American anxiety about whether the U.S. was threatened. This culminated in the passage of the Exon-Florio amendment in 1988, following an attempted Japanese purchase of French-owned Fairchild Semiconductor, which operated in the U.S.

The Exon-Florio amendment gave powers to CFIUS to block—to review and block foreign investments in the United States if they threaten national security. But it did not define national security, which is something I think we want to talk about this morning.

The Byrd Amendment, passed in 1992, requires a full review of the acquisition is by an entity controlled by a foreign government and could affect national security. The foreign control or ownership issue—is another I think important dimension of this—recurs.

The CFIUS process actively addressed in investment and resulted in controls being implemented in a number of acquisitions involving sensitive technology or contracts. But only one transaction was blocked; and, in the interest of full disclosure, I should say I chaired CFIUS at the sub-Cabinet level from 1993 to 1997 when this was going on, and it was pretty quiet in those days.

Over the past two years, the three concerns that I’ve mentioned that originally gave rise to the CFIUS process have come to the fore again. This time it’s the emergence of a new economic rival—not Japan; this time it’s China. The refilling of the petro dollar pockets and the appearance once again of Middle Eastern investors has also revived those sensitivities, especially against the background of 9/11. And, finally, the state-owned character of a number of the acquirers has become an issue.

We’re going to try to focus on the issues driving the debate today: What is national security, and how might foreign investment threaten it? Is state ownership or control a special problem? How does U.S. behavior in this area affect U.S. interests, for example the likelihood of retaliation against U.S. investors abroad?

Given the panelists’ interests, this is going to be a somewhat—but they to tell me not wholly—a China-centric discussion. I think this is not a problem, so long as we not fall into the mind-set that China is somehow unique. It does pose both security concerns and concerns about overreaction, however, that could arise with a number of countries, and is not a bad case study.

I’m going to start by asking each panelist to give us three or four minutes of perspective on the issues as they see them; and then

I’m going to probe a bit to make sure the main points are on table, and then turn to you for questions. So let me start now first with Pat.

MR. PATRICK A. MULLOY: Thank you, Jeff. I want to thank the Council for inviting me to participate in today’s program, entitled “Inward Investment In U.S. National Security.” Now, my own perspectives are influenced by the fact that I was general counsel of the Senate Banking Committee in 1988 when the law was written, Exon-Florio provision, to give the president the authority to block a foreign acquisition of an American company if it was deemed to threaten the national security of the United States.

So my first perspective is to make clear that you understand Article I, Section 8 of the Constitution gives the Congress, not the president or the executive branch, the right to regulate foreign commerce. So this is constitutionally a power within the authority of the Congress. They delegated this authority to the president. The president in turn put it in the preexisting CFIUS, which was set up by executive order in 1975. The Treasury chairs the CFIUS. So my own view is that the way the present system has been administered makes it very difficult for Congress to do proper oversight of how its Congressional grant of authority is being carried out by the executive branch. And I’m happy to expand on that later.

My second point. The foreign acquisitions that we now see going on at an increasing rate is the flip side of your current account and trade deficit. When you are running huge, moving toward a trillion dollars a year current account, as Warren Buffett says, “We’re like the rich family selling off part of the estate to live a lifestyle we’re no longer earning.”

My third point is that if you’re going to say everything should be for sale, then you don’t have to worry about this. But if you say there are things in the United States that should not be for sale, then how do you make the judgment and how do you administer a system that can say certain things are not for sale?

Fourth, the present system that CFIUS carries out is looking at individual acquisitions, not individually, rather than looking at the cumulative for patterns of acquisitions. In 1992, when I was with the Senate Banking Committee staff and we did some oversight hearings on how Exon-Florio was being carried out, we noted that President Bush the First’s science adviser, Dr. Allan Bromley, said a nation’s technology base can be nibbled from beneath it through a coherent plan of purchasing entrepreneurial companies.

In a hearing that we did in the Senate Banking Committee in June of 1992, chaired by Senator Paul Sarbanes, Mr. Peter Mills, then the chief executive of SEMATECH—SEMATECH was a joint government- industry consortium to ensure that the United States kept the leadership in the semiconductor industry, because it was important to our national security—Peter Mills said, quote, “Foreign interests have targeted key U.S. technologies, and the present CFIUS law or its implementation is ineffective in preventing these transactions.”

At that same hearing, Laura Tyson, then a professor at Berkeley, came in and testified at that hearing, and she said you have to make a distinction between a foreign government-owned corporation and a private foreign corporation, because the foreign government-owned corporation doing the acquisition—that may not be a market transaction. And this is what she said, quote: “The interests of the American seller cannot be assumed to be synonymous with America’s national interests.” She said, “When the foreign government is on one side of the negotiating table, the U.S. government should be on the other side.”

In response to those points, in 1992, the Congress passed the Byrd-Sarbanes amendment to CFIUS. And it did two things. One, it said that you have to do some more detailed investigation, the 45-day investigation if it’s a foreign government-owned company. That’s where Treasury got caught in the latest Dubai—they did not do that, even though it was a foreign government-owned corporation. Two, the Congress passed a law saying we want the intelligence agencies to do a report after one year, and then every four years thereafter, about whether any has a coordinated strategy to buy up critical technologies in the United States. In the first and only report done, despite the statutory mandate, in 1994 the Treasury said that they did not find a coordinated strategy; but they did say this was not evidence that such a coordinated strategy did not exist; okay, and they did say that foreign governments give indirect assistance and guidance to domestic firms that are acquiring U.S. companies.

So the point I want to make is other countries do have national strategies on how to move themselves up the food chain technologically and want a globalized economy. I do not think our present system is being carried out the way the Congress wrote the law, and is not serving our national interests in reviewing foreign acquisitions of U.S. companies.

MR. SHAFER: Bill?

MR. WILLIAM A. REINSCH: I’m going to take a slightly different view. I think Pat’s created an elegant straw man. I don’t know anybody who believes that everything is for sale. I think most people believe that there ought to be some process by which we can make judgments about selling off pieces of the national patrimony.

The question is more properly, and he got to this at the end, whether we’re doing it right or whether we’re not doing it right. And I guess I’m inclined to take the view that, well, I think there’s no question but that CFIUS has made some political mistakes, the DP World case being a classic—and some public relations mistakes. It’s a lot harder to prove they made a security mistake, and that’s what the debate ought to be about.

Let me take one step back though, and at the same time make the point that this is not an insignificant issue. The decisions that are made are not without consequences. If we screw this up, there’s a whole lot of things that are going to happen that would be unpleasant for the general populace as well as for policymakers. Jeff did a superb job, I think, of laying out the context and giving you some of the history. We do go through waves of paranoia about investment in this country, often prompted by international crises of one sort of another, war, whatever; and they tend to dissipate sometimes because the war is over. In the ‘80s it dissipated because of the Japanese propensity to buy high and sell low which caused people to not be quite as concerned about acquisitions as they were before.

But, right now, making the right decision about what to do is a lot more important than it was in the previous cases because of the global economic interdependence that we all know about so well, and that both Jeff and Pat alluded to. We have an enormous, enormous current account deficit. We have an enormous budget deficit. The government has to borrow very large sums of money to sustain that, and it’s us consumers that are borrowing large sums of money to sustain their lifestyle, which is all not irrelevant. Those of you that are economists—and Jeff’s certainly a better one than I am—know the macroeconomic consequences of starting the wrong cycle here. If foreign investment for one reason or another is convinced to go somewhere else, what happens then? We have to sustain those deficits, at least in the short run somehow. The federal government is going to start—is going to want to borrow more; is going to have to find other sources of income in foreign dollars. The dollar—that means, among other things, the dollar starts to go down, interest rates start to go up. Those of you that have adjustable rate mortgages and large credit card debts are going to very unhappy three or four years from now, because of the consequences.

Now, I don’t think—and I don’t know very many economists who think that we are—the decisions we make about what we’re talking about today are going to produce some enormous crisis, either with the dollar from spike of interest rates. It’s more like sand leaking out of the bag. As people with large numbers of dollars overseas decide that there’s other places where they can put them. The IMF warned less than a month ago that they have already seen some evidence of Arab investment declining in the United States and going into other countries instead. Now, that may or may not be something that we are concerned about. In the short run it may be a blip on the screen. You start to add all these things up, and the consequences that I described begin to take hold. So I think it’s important as we go through the legislative exercise to fashion a process that doesn’t tell everybody that America’s door is closed, and that focuses on national security as the really defining force as to whether or not an acquisition should be blocked or more likely should be changed—because there’s only been one that’s blocked, as Pat pointed out.

The other issue of course, from the standpoint of my memory, which tend to be large countries—companies—is what Jeff alluded to, which is retaliation. He described the Russian case. There’s an interesting circumstance with India going on right now, where an Indian company that had a problem with CFIUS here responded by going back to its government and urged them to put into place exactly the same kind of procedures that they just went through here as far as American investment in India is concerned.

Thirty years ago we used to fight with the Canadians about precisely this point. We used to go north to try to buy pieces of their oil industry, and the Trudeau government kept trying to stop that. And the debates became rather bitter until there wasn’t a Trudeau government anymore.

We can replay all that, and we can actually inspire all that in other countries if we don’t handle this properly as well. So I think it’s important to proceed carefully.

The thought I’d leave you with is the one I began with, which is it seems to me the question for the CFIUS process is: Do we have an appropriate definition of national security, and are we making decisions in the process that are consistent with that definition? I think it’s very hard to identify a case in some 1,600 filings that there have been since 1988, where CFIUS made a significant mistake. And maybe we can get back to that later.

MR. SHAFER: Ken?

MR. KENNETH G. LIEBERTHAL:Thank you. Really a pleasure to join this panel and conversation. I want to pick up where Bill Reinsch left off, which is: Are we defining national security correctly? And my basic observation here is that I think to some extent we’ve been having such a problem with the issue of what we should do about inward the foreign direct investment, because part of the reaction to that is security; but part of it is simply a reaction that reflects fears about globalization, hollowing out of our economy, loss of control of our own destiny.

Here I just want to note towhead statistics make very clear not only is the U.S. probably the world’s greatest winner from the process of globalization; but even if you look at the manufacturing sector of the U.S. economy, in 1994 the U.S. manufactured 22 percent of the world’s manufacturing output. Last year it was 24 percent of the world’s global manufacturing output. So we in fact are improving our position globally, and are not being hollowed out.

So, point number one, we have to take care to focus on security issues and not to use legislation or process to limit foreign direct investment as a way to protect ourselves from globalization. I think the globalization thing has to be clearly differentiated, and to my mind, dealt with in a much more positive fashion.

I have three points to make to bring this more around to the China-U.S. issue. First, there are largely parallel debates that are taking place in Beijing and Washington about the long-term future of the U.S.-China relationship. It’s really startling to talk with people on both sides and see how similar the issues at stake are. In both places fundamentally there are two big positions. One position says 15 years from now we are each other’s biggest problem, and so we had better take actions now to limit the size of the problem the other side can create for us 15 years from now. The other side of that debate says 15 years from now we may be each other’s biggest problem, but we may not be. It depends upon whether we can handle it skillfully enough to build a constructive relationship among big powers over the course of the future. With a little bit of luck and a lot of effort, we can get from here to there. The problem of course is that the people who are on the first side of that debate, why we’re called the pessimist side, advocate policies that are self-fulfilling prophecies. By trying to weaken the other side you signal to the other side that your long-term assumption is you’re going to be an antagonist and you provoke responsive policies that increase the chances of that outcome.

The—how does that fit in with this issue of foreign direct investment? When we go out of our way to either make or apply policies in a way that discriminates against Chinese companies’ capability to be—to acquire assets in the United States, that’s one of the signals to them that over the long run we are quite confident they are our enemy. And it is hard to think of a kind of day-to-day diplomacy that can offset the repercussions of that kind of fundamental signal. And they are looking for those signals, just as we look for them when we look at China.

The third point is that the issue of Chinese acquisitions in the United States is going to grow rapidly in scale and scope. So this is going to move more prominently onto our bilateral agenda in the coming years. That’s in part because Beijing is encouraging its own enterprises to do what they call go out, largely reflecting, frankly, the weakness of those enterprises domestically—not their great competitive strength. They want them to go out to learn how to be better enterprises, because it’s almost impossible to learn that within China.

We are also encouraging Chinese enterprises to come over and buy American. How are we doing that? First, we are pounding on the Chinese to strengthen the renminbi, which of course would make U.S. assets less expensive for them. And, secondly, U.S. private equity is now flooding into China. I think a lot of their opportunities are going to be to take Chinese firms back to the United States and emanate activity over here. So towhead’s providing both capital and critical know-how and capability to increase that process.

It seems to me that with these things going on we need to straighten out our priorities and principles so that we can provide a solid base for making the complex technical decisions that are involved in converting those principles into laws and regulations.

One final point to kind of frame the China side of this, which is we easily slip into a kind of discourse that assumes that when Chinese firms come over here, A, they’re acting on behalf of the state; and, B, they reflect the disciplined, integrated, well thought through set of moves that Beijing coordinates. Neither of the above is true. Beijing encourages their firms to go out; they try to provide some assistance. Anyone who thinks that this is carefully coordinated and disciplined has not looked in detail at anything in China recently, number one.

Number two, the distinction between public and private that Bill raised—I’m sorry, that Pat raised earlier—sounds very good, and in fact breaks down almost completely in China. Most of the Chinese public firms that come over are publicly listed firms with a great deal of private investment in them, including a great deal of international private investment in them. Almost every Chinese private firm that is strong enough to go abroad is strong enough to go abroad because of its close ties with the Chinese government and capital infusions from the Chinese government. This is a distinction with only a minor difference in China. And so trying to delineate what we should accept and what we shouldn’t on the basis of whether the Chinese government is involved is not a reasonable basis given the realities of China to make that kind of judgment. Thank you.

MR. SHAFER: Thank you, all.

Just to get the discussion started, I think I got the sense that one thing everyone would agree on is that Americans are concerned, and are rightly concerned, about national security, and that that is something that needs to be dealt with in some way. Is national security something that, to paraphrase Justice Potter Stewart, I know it when I see it? Or is it something that requires a more precise definition and sorting out of what we mean to manage the process. Ken?

MR. LIEBERTHAL: I’d make two comments just to get it going. One is our most fundamental national security requires that we remain competitive in—(inaudible)—If we lose that, the rest is gone.

So we cannot take measures that seriously reduce our capacity to be competitive over the long run, number one.

Number two, there are certain technologies that if they are transferred to those who wish us ill would be deeply harmful. There are relatively few of those. Technical people, way above my pay grade, as we all used to hear in the government, are the ones to make those decisions. We have a global technical regime, as Adam Segal has laid out so fully in his writing, that is now truly globalized. Microsoft’s largest R&D establishment is in Beijing. GE is building their worldwide largest R&D establishment in Shanghai. I mean, these are—the world is integrating. Within that broad sphere there are some technologies that can be identified where we literally can bottle them up and they’re crucial to key capabilities that we have. I think there are very few, and I think frankly they’re very hard to legislate.

MR. REINSCH: I think we are probably better off in a real sense with the Potter Stewart approach. As long as we have Potter Stewart or somebody like him initially making the judgments about what constitutes national security, I get really worried with the way some people want to expand the definition.

One of the big debates that’s going on right now with the pending legislation is essentially this: how to define the term. And I think most people have opted for a term that’s vague and sort of let CFIUS figure it out, but essentially using the kind of criteria that Ken has articulated. But that does lead to odd conclusions. You know, the Department of Homeland Security, for example, has defined food, agriculture, as an element of national security, which at one level you might think makes a lot of sense. Then you think, well, this means that the Ben and Jerry’s acquisition has national security implications and should be reviewed by CFIUS, because we’re selling the ice cream company to whoever it was—the British I guess. That goes a little bit beyond what I think Potter Stewart was talking about.

MR. MULLOY: Well, I think as, again, I said this was under the Constitution, Congress’s authority, and they delegate it. When they delegated this authority to the executive branch, they made quite clear how they wanted national security. They say the president, or his designee, should consider domestic production needed for projected national defense requirements—that’s right in the law—the capability and capacity of domestic industries to meet national defense requirements; three, “the control of domestic industries and commercial activity by foreign citizens as it affects the capability and capacity of the United States to meet the requirements of national security.” Finally, they put in the conference report: “The standard of review in the section is ‘national security.’ The conferees recognize that the term ‘national security’ is not a defined term in the Defense Production Act.” You see, they put this law in the Defense Production Act to indicate it meant larger industrial based views, not just narrow political-military national security looking at industrial and critical technologies.

So the term “national security”—this is the Congress—the term “national security” is intended to be interpreted broadly, without limitation to particular industries. Now, that’s the Congress. So it’s their authority and they’re telling the executive branch how they want it carried out. And I don’t think the executive branch is carrying it out in the way the Congress intended. And that’s why you have nobody in the Congress who trusts the present situation. You saw it in the CNOOC, when CNOOC was going to come over and purchase UNOCAL. You saw the big debate in the Congress, and that was because they didn’t trust the executive branch. They thought they’d just give everybody a green light to go ahead and purchase—till the Dubai Ports deal really caught the executive branch, because under the law when it was a foreign-owned corporation, government- owned corporation, they were supposed to do the initial 30-day review and then move into the 45-day really detailed review on the national security of this thing. And they did the 30 days and gave it a green light and went ahead. And they got caught. So that’s why Congress is upset with how this is being carried out by the executive branch.

MR. SHAFER: I think there is an almost universal view that there is a problem right now that there is a lack of confidence—not only in the Congress but the American people—about the way this issue has been managed. And there are I think two questions that follow from that. One is, Have there been real mistakes made that raise concerns about national security? And, two, Is it a process that is somehow flawed and needs to be fixed in order to maintain confidence? I’d like to get reactions or comments to the first of those first.

And Bill I think essentially said no.So maybe it’s more a question of the other two of you. Are there cases that you would identify where there was a bad outcome from a national security point of view? Either of you two?

MR. LIEBERTHAL: The only—I would agree with Bill’s broad point. I think the places where we’ve had bad outcomes have been in things kind of outside of the scope now of what we’re talking about. For example, we sell used equipment abroad, often on a bulk basis, and that at times, we found out afterwards, has included computers that still have the hard drives with secret data on it—you know, that kind of thing. That is not foreign acquisitions in the U.S.; it’s just kind of sloppiness around the margins. I’m not aware of any major case where we’ve allowed a foreign acquisition of something that’s come back to bite us.

MR. MULLOY: Well, let me just say I went to the oversight hearing that the Senate Banking conducted on this matter in March, and it turned out that under the Clinton administration there were 45 government-owned companies that purchased U.S. companies that they did not do the 45-day additional review. And under the Bush administration there were 45 or 46 companies, owned by foreign governments or controlled, that did purchases in this country without any thorough review. So we just know there were 90 cases in which they weren’t following the law.

So let me just give you one other. Bill pointed out there had been about 1,600 filings that went into the CFIUS process. What you have to know is that the Treasury Department, when it developed the regulation to carry out the CFIUS, provided that the whole system is voluntary. So if you’re going to do a foreign acquisition in this country, there’s nobody requiring you to give the government any notice. You will only get the notice if you want a safe harbor. But if you go through the CFIUS process, then you have a safe harbor that nobody will come and make you unwind it. There are about 1,600 of those. I think there’s more like 1,800. But there are about 4,200 other transactions in which nobody has seen anything. So we don’t know. We’re flying blind. That’s why we in ‘92 insisted that these intelligence studies be done. And they were done once, and then never done again by the executive branch. Does that sound like a group that’s serious about looking after the national security? I don’t think so. And that’s what has the Congress so upset about how this system is working.

MR. REINSCH(?): I think you moved onto—and it really—I think it is a matter of the process not inspiring public confidence. But just for precision, the Byrd Amendment says it requires a full review if the acquisition is by an entity controlled by a foreign government. And one thing we may want to get into is a distinction between ownership and control. I can think of foreign-owned enterprises that aren’t really government controlled; and I can think of enterprises that might be privately owned and are government controlled. And also the second condition is: and could affect the national security. I say this, because the one case I wrestled with a lot and decided not to go to the full—it was owned by the city of Dresden, and it had nothing to do with national security. We did think about that a lot.

MR. SHAFER: But to go on I think the real heart of the matter is—and I think you’ve identified one view as kind of a broader review process that is lacking here, and a follow-up processing. I’m wondering, maybe starting with the others, to identify what do you think needs to be done so that the American people feel that this issue is being monitored and dealt with in a way that they’re comfortable with?

MR. REINSCH: Well, that’s—the way I would approach that is to make it a far more complex question than the way you asked it, because I don’t think the solutions to the American people’s problems lie in a better CFIUS process, frankly. I mean, the American people have been told for the last four years that they should be scared, and that they should be scared of terrorists and that they should be scared of the Chinese. And our government has done a good job of making them scared. And now we’re facing the consequences of that fear: people are paranoid. We go through this periodically. I’m not sure that you can create a legislative process and an executive process that is going to make people not scared anymore. It’s a matter of leadership in the government and the conveyance of a different message. Maybe the times don’t call for a different message, but you have to do that.

As far as the process is concerned, I mean, I’m not going to defend the DP World process. It was not well handled certainly by the Treasury Department. The people who were supposed to be politically attuned really were asleep. And there are a lot of things they should have done to produce not so much a different—well, a different public outcome. At the same time, though, I would say the decision they made in the first instance was the correct one. I think it’s very hard to identify the national security consequences the Dubai Ports World owning terminals at six different U.S. ports. There’s a lot of port security issues that are legitimate. There’s a lot of serious threats to national security that are associated with ports, and none of them have anything to do with who owns the terminals. They have to do with a lot of other things that are not being addressed, by the way, although they started to be addressed in the wake of this case.

So I’m not sure that the answer to the question lies in a better process. I mean, if you want to add perhaps bells and whistles, the only thing—fine—the only thing I’d say is that you don’t want to add so many bells and whistles that foreign investors decide it’s too much trouble, you know, and I’m going to put my—I’m going to go to London or I’m going to put my money in the U.K., or I’m going to invest anywhere but here—Australia, New Zealand, whatever. If you start sending that signal, then all the consequences I talked about earlier start to unfold.

MR. SHAFER: Anyone want to add?

MR. LIEBERTHAL: Well, first of all, I want to applaud what Bill just said. Secondly, I think it’s worth keeping in mind that this is not strictly—the way this actually works in the U.S. is not strictly a matter of an objective analysis of national security and careful review and all that. That’s part of it. The other part of it is politics, and politics do play in many of the most public cases that come up about this kind of thing. And so does lobbying. If you look at the CNOOC-Unocal case last year, for example, right?—portrayed universally on the Hill, in no small part because Unocal has very good lobbyists, as the Zhongnanhai, the leadership compound in Beijing, making a concerted effort through CNOOC, its national oil company, to seize American oil assets and take this oil off the market. Well, the technical side notwithstanding, the Zhongnanhai in Beijing opposed CNOOC making that bid, did not support it. The one pro forma letter, period, quietly told them they were nuts, but could not convince a single member of Congress—(laughter)—right?—that that was the case. Politics has a lot to do with this. And so when you say what process could kind of change the outcome, frankly, I think that process gets overwhelmed by politics. So I think there should be a good process to protect our national security, but I think when it comes to selling it to the American people what you have to ask is that politicians don’t be politicians, and that’s a very tough sell.

MR. SHAFER: Let’s go now to the audience. And please raise your hand when you’re recognized and stand. Somebody will bring you a microphone. Give your name and ask a concise question. Why don’t we start down in the front here.

QUESTION: Good morning. My name is John O’Connor, J.H. Whitney Company. I wanted to follow up your question about where are the damages. Where have things actually been hurt? And I’ll refer back to a meeting we had here about a month ago where we were pleased to have the four service chiefs here. And in their senior military guarded language each begrudgingly acknowledged that there were clear but tactical and strategic negative impacts to rejection of the Dubai Ports deal, that it did, and in subsequent conversations they have been much more forceful in the fact that that was a very important part of an overall engagement process for them, as well as having tactical support implications. There’s no—

MR. SHAFER: Are you going to ask a question or—

QUESTION: My question is: What possible process could prevent someone like Senator Schumer weighing in on an uninformed basis without any apparent effort to get informed, what can you possibly do to prevent that?

MR. MULLOY: Well, I would like to speak to that. What you have to understand—I never took a position on whether the Dubai Ports deal should go forward or not. My position was they failed to carry out the law as written. This was—it went through the 30-day review. Now, under the law it should have been done under the 45-day review. Now, the beauty of going through the 45-day review, then it puts it in the hands of the president, and then he has to report to Congress what he decided and the rationale. So Congress then, whose authority this is, has some way of judging whether this thing was done rightly or wrongly. Instead they did the 30 days, approved it, Congress knew nothing about, and then it blows up on them. See, that was the—that’s the problem: when you don’t follow the law, and you get outside the framework, you get into a real problem.

Let me give you one more example of what goes on here. So that the executive branch, so towhead they don’t have to do the reporting to the Congress, disposes almost all of these transactions during the initial 30 days. Now, if they’re coming to the end of the 30 days, which could drive them into doing a 45-day review, they ask a person to withdraw the transaction or to stop the clock. And then they do side deals on, Okay, we’ll approve it, if you do this, that or the other thing. And then it gets approved, Congress knows nothing about it, what the criteria were or anything else. Yet this is Congress’s authority. So they really jiggered this thing so that there’s no accountability and no judgment by the Congress of what is going on here. And that’s what makes the Congress uneasy with this whole process.

MR. SHAFER: There was somebody in the second table here who had their hand up before.

QUESTION: Steve Mukamal. You speak about globalization, and you speak about economies just like the economies of the world have become like a big bowl of soup that all gets mixed up. And sooner or later what runs—what’s the engine that runs the world? Is it domestic governments or the economy that becomes far more forceful than the governments that are trying to stop this thing from happening?

(Cross talk.)

MR. LIEBERTHAL: Thanks very much, I appreciate that. We’ve got until 10:30, right? (Laughter.) Actually you raise a terrific question. It’s a very fundamental question. I’ll give you a very succinct answer. The globalization is driven by underlying technological revolutions, revolutions in communications and data handling and transportation. These are not under the control of governments. The objective reality therefore is globalization can be distorted this way and that way but fundamentally can’t be stopped. Okay?

A second reality is that globalization is both good for maximizing the efficiency of use of resources, and terrible for maintaining community sensibilities and stability. It’s an enormously tension-inducing process as it takes control out of the hands of people—the communities with which people identify. And that’s where, third, governments come into play—governments and lots of other organizations, but among other things governments who have to try to grapple with maintaining not only quality of life but sense of control and sense of community and identity without which people don’t do well, as in the face of an objective diminution of controls of what crosses their borders, both ideas and information and goods and services, right? So it makes a lot of the objective problems in the world not conform to national boundaries. It makes it a very, very difficult thing for governments to deal with. But the reality is that’s life and that’s the role of governments, to try to cope with the consequences and maintain viable communities in a world that is being reshaped by technology and its imperatives.

MR. REINSCH: I’d put it in a slightly different way. It seems to me that the process Ken was talking about, in order words it accelerates change, and it accelerates change beyond the capacity of our institutions always to manage it, the government’s role is to address those consequences. A lot of the fights that go on in Washington are over whether you should try to slow that down or whether you should try to address the needs of the victims of the change. If you try to slow it down I think what you’ll run into exactly what Ken said; that there’s a bunch of sort of inexorable technological developments here that make it very difficult. If you try to meet the needs of the victims, for lack of a better term; and, more importantly, from an economic and national security perspective, if the government tries to make sure that it is running faster, if our country is running faster, that we are maintaining that competitiveness by moving up the value-added chain faster than the others, then the government has done its job.

MR. MULLOY: Well, let me thank you for that question. I don’t think it’s all just technology driving this. Public policy helps the process. For example, if China was not in the WTO, which we brought in—we made that possible—China would face about an average 42 percent tariff on its goods coming into the United States. When China got into the WTO, it meant that we were going to give it MFN permanently. So then it had a 2.5 percent average tariff on its goods coming into the United States. As a consequence, China got vast increases of investment from companies that want to invest in China and sell to the United States. And you see the trade figure just blowing out of the water. Sixty percent of China’s exports are from foreign invested companies. So it’s not just technology. There are public policies that make possible the globalization process. And I think it’s worthwhile to talk about the public policies that underlie the process, if the process is kind of going off the tracks. And everybody thinks it is, because the current global imbalances everybody says are not sustainable. Then how do we restructure the system so that we get something that is sustainable and that works? We’re going to have a current account deficit of almost $1 trillion by the end of this year.

MR. SHAFER: Ken, do you want an additional—

MR. LIEBERTHAL: Yeah, just two points. One is China was not going to face a 40-some-odd percent tariff coming in, because we give them most-favored-nation status or normal trade relation status every year. We just do it year by year instead of permanently with a fight in the process.

Secondly, as you look at that huge surge in Chinese exports to the United States—you’re right, it’s from foreign-investor firms—those firms are Japanese, Taiwanese, Hong Kong, Singaporean—so that our trade deficit, global trade deficit—our trade deficit with all of those as a percentage of our global trade deficit has gone down over the last 20 years, not up. Within that, the China portion has gone up. Why? Because all of Asia’s advanced countries are now funneling their exports to the U.S. through China instead of doing it directly from their own bases. That is as a consequence of changes in underlying technology and the ability to save money by doing final assembly and export from China. I don’t think that’s changed the U.S. global trade position one iota. It’s just changed a little bit where things leap off to get into the U.S. from. So I would cast it somewhat differently from the way you just set it up, Pat.

MR. SHAFER: Let me, before asking the next question, there are invisible lines within the Council on Foreign Relations sometimes hard to keep track of. And I was—it was pointed out that the meeting that was referred to earlier with the service chiefs was an off-the- record, not for attribution, meeting. And this is an on-the-record meeting. So that reference in this meeting is now off the record. (Laughter.)

Next question. Over here. Please identify yourself and ask a brief question.

QUESTION: Jose Alvarez, Columbia Law School. One thing that I think I want to put on the table is that when Exon-Florio was passed it was of great worry to a lot of folks, especially in the State Department, that it doesn’t cross the line into investment screening, because we have over 40 treaties out there that say that we do not engage in investment screening, and neither to other countries. For this reason, Exon-Florio’s original language was changed to focus on national security and not essential commerce. So that’s one thing that I think I’d like to hear a little bit about.

But the other thing is that when it was passed—and I think I heard some of it here—the focus was on high technology. Post 9/11 at least some of the threats we face is from the low end of the scale; that is, nonstate actors, not government actors, who know for example the structural imperfections of a building, the blueprints to a blueprints to a building. And I’m curious whether CFIUS has changed its definition of national security to look at that end of the scale. Who has the blueprints to the new Freedom Tower if it’s built by a foreign-owned company, or not? And I think the American public would be more concerned about that post 9/11 than some of the high-tech items for instance.

MR. REINSCH: Glad you brought that up.

MR. LIEBERTHAL: Yeah.

MR. REINSCH: There’s been an evolution—and not above the table in the sense of the way people define the thing statutorily. There’s been an evolution in the way CFIUS actually approaches these cases. For a long time, I would guess the first 10 or so years, the cases were mostly done pursuant to I think a fairly—and Jeff will correct me if I’m wrong—but the key actor was largely the Defense Department, and the issue was, Is there an acquisition here that’s going to complicate the Defense Department’s ability to get what it needs, or to prevent the enemy from getting what he needs? And the Defense Department’s analysis was, you know, Do they make something that we care about? And, if they don’t, who cares? And if they do, can we still buy it, or can we buy it from somebody else? And if you—you know, as a practical matter, if the Pentagon said, We have no problem, nobody else stood up and said they had a problem, because nobody else was really willing to trump the Defense Department when it came to national security.

That began to evolve in the late ‘90s when we had a series of telecommunications acquisitions. And when we started having telecommunications acquisitions, you had new actors in the interagency process, largely the Justice Department as a proxy for the FBI, and the intelligence agencies coming in concerned about their ability to do certain activities that they like to do using the telecommunications backbone. And they were concerned about access. And that sort of created an evolution in thinking about national security, because you had new people saying, Wait a minute, we have national security equities that are different from the Defense Department.

In the last three or four years you had the Department of Homeland Security really become the biggest actor in this process. And their focus is much more on critical infrastructure, and their focus is a lot closer to what you recently described, because that’s where their equities lie. And they have really, I would argue, called the shots on the last handful of investigations that have occurred based on that set of criteria. I think in a way that validates the way the system was created—it’s actually operated pretty well—and the way the Treasury has run it really has been to allow the agency with the equities to take the lead and work with the acquiring party until its concerns have been addressed—or not, as the case may be, in which case they would recommend denial.

And as the public’s concept and the government’s concept of what’s important to national security has evolved, the process has kept step with that.

MR. SHAFER: I think we have time for one more question, and then that should save about one minute for the speakers each to give us their last thought. So who wants to have the last question? Or we can simply go now to our last thoughts.

QUESTION: Ken, on the bilateral investment treaties, the BITs, is this what you were referring to?

MR. LIEBERTHAL: Yeah, you have to understand that Congress of course, when it passes a law, the last in time law is that if the law overrides previous treaty commitments the law is the effective instrument, not the previous treaty. So if Congress wants to do that, they can. It doesn’t mean that you don’t have these obligations still on the treaties that you have to work out with the other guys. The Congress has the authority under the Constitution to do it, so that they might have paid attention to that, but it didn’t bind them.

MR. SHAFER: But it does have costs, right—

MR. LIEBERTHAL: It does have costs, yes. I just wanted to make that absolutely clearly understood.

QUESTION: I have a follow-up to Mr. O’Connor’s question. He asked a substantive question—Roger—(inaudible)—he asked a substantive question; he got a procedural answer. The procedural answer was interesting, but a different answer to a different question. There’s no known instance of a foreign direct investment that jeopardized or could have jeopardized national security. And of the 45 or 90 or 180 or 1,800 transactions that weren’t reviewed, presumably somebody looked at that data, and most of it was soap manufacturers buying other soap manufacturers and other nonsecurity related issues. Is there really a national security issue here at all?

MR. MULLOY: I think you’re making a presumption. You’re assuming—

QUESTION: Re-asking his question, what’s the substantive answer as to where the national security—

MR. MULLOY: See, my view is there have been 1,800 reviewed; there are 4,200 we don’t know anything about, because there’s no reporting—

QUESTION: No reporting, as they say. Aren’t these, most of them, not at all national—

MR. REINSCH(?): These things aren’t secrets. I mean, when you acquire a company people know about it.

MR. : Big deal.

MR. MULLOY: No, no. If there are 4,200 others out there being purchased, and nobody in the government with expertise on national security issues is looking at them, how can you then make the presumption that everything—you’re trying to prove a negative. I don’t think you can do that if you haven’t looked—

QUESTION: But I’m asking the question. It would be pretty easy for somebody to look at those, and we do have intelligence agencies and others which are paid to do stuff like that—

MR. MULLOY: Well, that’s exactly—

QUESTION: Where’s the issue?

MR. MULLOY: Well, that’s exactly what the Congress wanted done when they put that intelligence study in the ‘94 act, and it was done once and never done again. So nobody has been doing this kind of review that you’re talking about.

QUESTION: (Off mike.)

MR. SHAFER: This is an obviously stimulating important point. In my view I think it goes to the problems of the administration in satisfying both the public and Congress that they are in fact looking at things that are easy to look at, and it’s something that I would worry about if I were still at the Treasury.

But let me ask each of the panelists for a last word, and we’ll start with Bill.

MR. REINSCH: Well, I was happy to the last question, because I think that gets to the core of the issue. A lot of what’s gone on in the last eight months has been political, and I’d have to say, sadly, that it’s my own party that is doing a lot of it. But, you know, that’s all right; these things happen, and it will dissipate after November. (Laughter.) But I hope—at least for six months until the next cycle starts up. But I hope that in the process we won’t make any mistakes that we’re going to have to live with for the long term. It’s very hard to demonstrate that the process that we put in place in 1988 has not worked. And I hope that we don’t get so wrapped up in the public relations of this and the politics of this that we lose sight of that reality. I mean, going back to the question you asked—the off-the-record question that you asked, the question that is now off the record that you asked, What could have been done?—I was going to say—if the question is what could have been to stop Senator Schumer from saying something, the answer is nothing. I mean, we know that. But—(laughter)—if the question is what could have been done to defuse this, one answer would be if the—you know, people that I can’t name anymore had spoken out more loudly earlier it might have made a difference.

You know, people need to stand up and say, look, there are adverse consequences to going down the road you’re describing. And it’s time to come in after the facts and say, oops, it would have been helpful if people had said up front, Wait a minute, you need to think about this. Some people did, and they kind of got swept aside, which means they should have been noisier.

MR. SHAFER: Ken?

MR. LIEBERTHAL: I guess my view is influenced by the fact I’ve never worked on the Hill. I have worked in the executive branch. And I focus on foreign policy, international relations and security issues, not on law and some of the technical issues. And I’m therefore frankly worried that when these issues get into the public domain, especially up on the Hill, you tend to get both rhetoric and occasionally actions that really do come back to harm our national security—not purposely, obviously, but unintended consequence is that threat perceptions of the U.S. change, and don’t change in ways that are to our advantage. And I would have to take the word of others as to whether any serious mistakes have been made in the technical decisions reached by the executive branch, both in how many—you know, which transactions should be reviewed and how thorough those reviews were.

As I indicated earlier, I’m unaware of any instance where we have really seriously compromised our national security through those decisions. Having worked in the executive branch, I am convinced that the people there take national security extremely seriously under every administration. And generally these things go to, as Bill said, the interested agencies to take the lead. I think that is, on the whole, with some overview, but on the whole a better process than increasing the public debate in the highly politicized atmosphere of Capitol Hill of a larger component of how we reach our decisions here.

MR. SHAFER: Pat, very brief last word.

MR. MULLOY: The China Commission, of which I’m a part, in our 2004 report unanimously recommended that the Treasury not chair the CFIUS; that it be moved to another agency in the executive branch.

Two, I want to make the point about the CNOOC that Ken talked about. CNOOC is 70 percent owned by the Chinese government. CNOOC,

Limited, is the one that’s out and held by shareholders. But the Chinese government owns 70 percent of it. The largest American shareholder in CNOOC, Limited, at the time it was going to make that purchase sold its stock and said CNOOC is no longer behaving as a commercial company. So that was the point. Somebody needs to look at these transactions—and you can’t just let it up to a group that has some kind of monetary or other interest in it. You have to have some people in the United States government the people of the Congress trust and can delegate this authority to. And that’s the problem, that the system has been structured in a way that Congress gets no feedback and understanding of what are the criteria that are being used by the executive branch to carry out this grant of authority given them by the Congress.

MR. SHAFER: Okay. Well, thank you all. And join me in thanking the panel.

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Inward Investment and U.S. National Security

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