Protectionist Drift in Global FDI Policy Poses Threat to World Economy, Warns Council Special Report

After two decades of liberalization, many countries around the world are adopting new restrictions on foreign direct investment (FDI) that could retard continued progress, says a new Council Special Report, Global FDI Policy: Correcting a Protectionist Drift. It argues that these developments constitute a “protectionist drift” in FDI policy that could have damaging consequences for investment liberalization, which, even more than trade, has been the engine of global economic development in recent years. “Looking ahead, an even stronger protectionist drift…could exacerbate the ongoing turmoil in global capital markets, with widespread consequences for the real economy in many countries.”

The authors of the report, David Marchick, of the Carlyle Group, and Council Senior Fellow Matthew J. Slaughter, summarize new policy developments in five significant FDI-recipient countries (the United States, Russia, Canada, China, and Germany) and provide brief examples from a number of other countries as evidence of this trend. In the past two years, at least eleven major countries, which together receive more than 40 percent of the world’s FDI, have approved or are seriously considering new laws that would restrict or significantly increase government regulatory scrutiny of new foreign investment.

The report concludes that this new protectionism is largely the result of tighter scrutiny of foreign investments on national security grounds by countries around the world, following the congressional backlash in 2006 against the proposed acquisition of some U.S. ports by Dubai Ports World. Increasingly, those reviews have extended beyond traditional defense sectors to such new sectors as energy, ports, telecommunications, encryption technologies, and even gambling. Concern over investments from developing countries, especially China and oil-rich Middle East nations, is identified as one of the major causes of the shift in policy. In these countries, many of the biggest investors are government-owned enterprises, such as sovereign wealth funds (SWFs), which have raised concerns in the United States and Europe, despite the fact that SWFs have existed for more than 50 years and have been responsible investors.

According to the report, the spread of restrictions on FDI flows would result in considerable costs to the global economic system, reducing benefits to host and source countries alike. “The United States offers some of the clearest evidence on the host-country benefits of FDI inflows….Beyond employing millions of Americans, the U.S. operations of foreign companies make American workers and the overall economy more productive through investment in physical capital, investment in R&D, and trade.”  The authors explain that FDI outflows benefit source countries as well because “these outflows enhance the competitiveness of their multinational parent companies by allowing them to better serve foreign markets.”

In an effort to stem the protectionist drift, the report urges governments in countries that are recipients of FDI to embrace a “code of conduct” for reviewing foreign investments. This would allow countries to “better regulate FDI yet still reap its economic benefits.” This code should be based on the following principles:

• The investment-review law should be narrowly tailored and focused on national security alone and not on broader economic factors, which should be left to the market.
  
• The review process should be timely and predictable so as not to disrupt potential investments.
  
• The confidentiality of business transactions should be carefully safeguarded.
  
• Countries should avoid reviewing all FDI transactions in specific sectors such as telecommunications or energy, but if they choose to use such “sector lists,” those lists should be as narrow as possible.

The authors also recommend that finance ministers from key countries involved in international investment meet annually to discuss and refine these four principles, and that the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF) play a more active role in identifying and encouraging countries to adopt best practices for the review of FDI.

Marchick and Slaughter conclude that protectionist policies have already had some effect in discouraging FDI flows. “New policies that mean longer, more complex, and more regulated transactions can mean that the deals that result are less beneficial economically than they would have been without such restrictions,” providing a compelling argument for correcting this protectionist drift.

Full text of the report, including recommendations, is available on the Council’s website at www.cfr.org/global_fdi_policy/

David M. Marchick serves as managing director and global head of regulatory affairs for the Carlyle Group, a global public equity firm. In this position, Marchick provides government affairs, regulatory, and strategic advice and support to Carlyle’s fund managers and portfolio companies on a global basis. Prior to joining Carlyle, Marchick was a partner and vice chair of the international practice group at the law firm Covington & Burling LLP. He is an expert on foreign investment issues and has advised on a number of significant recent foreign acquisitions of U.S. companies. Marchick is the coauthor of the book U.S. National Security and Foreign Direct Investment (Institute for International Economics), has authored numerous articles in major business and trade publications such as the Financial Times, Wall Street Journal, and Far Eastern Economic Review, and frequently testifies before Congress. He earned his BA from the University of California, San Diego, his MA from the University of Texas, and his JD from the George Washington University Law School.

Matthew J. Slaughter is associate dean of the MBA program and professor of international economics at the Tuck School of Business at Dartmouth. He is also currently a research associate at the National Bureau of Economic Research; an adjunct senior fellow at the Council on Foreign Relations; an academic adviser to the McKinsey Global Institute; and a member of the advisory boards of the International Tax Policy Forum and the Tuck Center for Private Equity and Entrepreneurship. From 2005 to 2007, Slaughter served as a member of the Council of Economic Advisers in the Executive Office of the President. In recent years he has also been affiliated with the Federal Reserve Board, the International Monetary Fund, the World Bank, the National Academy of Sciences, the Institute for International Economics, and the Department of Labor. Professor Slaughter joined the Tuck faculty in 2002. He received his BA summa cum laude and Phi Beta Kappa from the University of Notre Dame in 1990, and his PhD from the Massachusetts Institute of Technology in 1994.

Council Special Reports (CSRs) are concise policy briefs that provide timely responses to developing crises or contribute to debates on current policy dilemmas. CSRs are written by individual authors in consultation with an advisory committee. The content of the reports is the sole responsibility of the authors.

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