Order Code RL34561
Foreign Investment and National Security:
Economic Considerations
June 27, 2008
James K. Jackson
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division

---

Foreign Investment and National Security: Economic
Considerations
Summary
The United States is the largest foreign direct investor in the world and also the
largest recipient of foreign direct investment. This dual role means that
globalization, or the spread of economic activity by firms across national borders, has
become a prominent feature of the U.S. economy and that through direct investment
the U.S. economy has become highly enmeshed with the broader global economy.
This also means that the United States has important economic, political, and social
interests at stake in the development of international policies regarding direct
investment. With some exceptions for national security, the United States has
established domestic policies that treat foreign investors no less favorably than U.S.
firms.
The terrorist attacks on the United States on September 11, 2001, spurred some
Members of Congress and others to call for a reexamination of elements of the
traditionally open environment in the United States for foreign investment. In
particular, some Members argue that greater consideration must be given to the long-
term impact of foreign direct investment on the structure and the industrial capacity
of the economy and on the ability of the economy to meet the needs of U.S. defense
and security interests. In addition, policymakers from a broad group of nations are
evaluating their national policies concerning foreign investment within the context
of their national security concerns. As a result of these initiatives, Members of
Congress may be pressed to address U.S. policies that focus on the role of foreign
direct investment more extensively within a broader national security framework.
This report assesses recent international developments as the leaders from a
number of nations work to reach a consensus on an informal set of best practices
regarding national restrictions on foreign investment for national security purposes.
This report also provides one possible approach for assessing the costs and benefits
involved in using national policies to direct or to restrict foreign direct investment for
national security reasons. Within the United States, there is no consensus yet among
Members of Congress or between the Congress and the Administration over a
working set of parameters that establishes a functional definition of the national
economic security implications of foreign direct investment. In part, this issue
reflects differing assessments of the economic impact of foreign investment on the
U.S. economy and differing political and philosophical convictions among Members
and between the Congress and the Administration.
This report will be updated as events warrant.

---

Contents
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Foreign Direct Investment in the United States . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
National Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
OECD Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Critical Infrastructure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Essential Security Exclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
U.S. Foreign Investment Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Exon-Florio and CFIUS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Critical Infrastructure/Key Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Foreign Investment and National Security Act of 2007 . . . . . . . . . . . . . . . . 17
Strategic Materials Protection Board . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Economic Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
List of Figures
Figure 1. Foreign Direct Investment in the United States and U.S. Direct
Investment Abroad, Annual Flows, 1990-2007 . . . . . . . . . . . . . . . . . . . . . . . 3
Figure 2. Inward and Outward Global Direct Investment Position,
By Major Area, 2006 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
List of Tables
Table 1. Global Annual Inflows of Foreign Direct Investment, By Major Area . . 4
Table 2. Select Data on U.S. Multinational Companies and on Foreign
Firms Operating in the United States, 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Table 3. Examples of National Definitions of Critical Infrastructure . . . . . . . . . 11
Table 4. Industrial Sectors Included in National Critical Infrastructure Plans . . 13

---

Foreign Investment and National Security:
Economic Considerations
Overview
For more than half a century, the United States has led international efforts to
reduce restrictions on foreign investment. In part, these efforts are related to a
general commitment to open markets and to the free flow of international capital as
an important component in economic development. At the same time, the United
States is the largest foreign direct investor in the world and also the largest recipient
of foreign direct investment. By year-end 2006, foreign direct investment in the
United States had reached $1.8 trillion and U.S. direct investment abroad had reached
$2.4 trillion. This dual role means that globalization, or the spread of economic
activity by firms across national borders, has become a prominent feature of the U.S.
economy and that through direct investment the U.S. economy has become highly
enmeshed with the broader global economy.
The globalization of the economy also means that the United States has
important economic, political, and social interests at stake in the development of
international policies regarding direct investment. With some exceptions for national
security,1 the United States has established domestic policies that treat foreign
investors no less favorably than U.S. firms. In addition, the United States has led
efforts over the past 50 years to negotiate internationally for reduced restrictions on
foreign direct investment, for greater controls over incentives offered to foreign
investors, and for equal treatment under law of foreign and domestic investors.
In light of the terrorist attacks on the United States on September 11, 2001,
however, some Members of Congress are reexamining some elements of this open-
door policy and are arguing for greater consideration of the long-term impact of
foreign direct investment, especially where that investment takes the form of an
acquisition, a merger, or a take-over of existing U.S. company. In particular, these
concerns have centered around the impact of such investments on the structure and
the industrial capacity of the economy, and on the ability of the economy to meet the
needs of U.S. defense and security interests, including a terrorist attack. As a result
of these concerns, in 2007 Congress changed the way foreign direct investments are
reviewed through P.L. 110-49, the Foreign Investment and National Security Act of
2007.2 Through P.L. 110-49, Congress strengthened its role in reviewing foreign
1 CRS Report RL33103 Foreign Investment in the United States: Major Federal Statutory
Restrictions, by Michael V. Seitzinger.
2 P.L. 110-49 originated in the first session of the 110th Congress as S. 1610, the Foreign
Investment and National Security Act of 2007, introduced by Senator Dodd on June 13,
(continued...)

---

CRS-2
investments by enhancing its oversight capabilities. There is no precise way,
however, to estimate the exact dollar amount for the economic costs and benefits of
national policies that attempt to direct or restrict foreign direct investment for
national security concerns. Also, there is no way to determine if foreign investment
policies are implemented to enhance national security or to engage in a form of
economic protectionism. In some cases, other policy tools may well be preferred to
intervening in the foreign investment process.
Foreign Direct Investment in the United States
Foreigners invested $180 billion in U.S. businesses and real estate in 2006 and
invested $277 billion in 2007, according to data published by the Department of
Commerce,3 as Figure 1 shows. The rise in the value of foreign direct investment
includes an upward valuation adjustment of existing investments. According to the
Department of Commerce, investment spending through 2007 increased as a result
of the relatively stronger growth rate of the U.S. economy, the world-wide resurgence
in cross-border merger and acquisition activity, and investment in the U.S.
manufacturing, information and depository institutions as overseas banks and finance
and insurance companies sought access to the profitable U.S. financial market.4
New spending by U.S. firms on businesses and real estate abroad, or U.S. direct
investment abroad,5 rose sharply in 2006 to $235 billion up from the $8 billion net
in 2005. New investments in 2007 likely exceeded $330 billion, according to
balance of payments data published by the Department of Commerce.6 The drop in
U.S. direct investment abroad in 2005 reflects actions by U.S. parent firms to reduce
the amount of reinvested earnings going to their foreign affiliates for distribution to
the U.S. parent firms in order to take advantage of one-time tax provisions in the
American Jobs Creation Act of 2004 (P.L. 108-357).
2 (...continued)
2007. On June 29, 2007, the Senate adopted S. 1610 in lieu of a competing House version,
H.R. 556 by unanimous consent. On July 11, 2007, the House accepted the Senate’s version
of H.R. 556 by a vote of 370-45 and sent the measure to the President, who signed it on July
26, 2007. On January 23, 2008, President Bush issued Executive Order 13456 implementing
the law.
3 Bach, Christopher L., U.S. International Transactions in 2007. Survey of Current
Business, April 2008, p. 48. Direct investment data reported in the balance of payments
differ from capital flow data reported elsewhere, because the balance of payments data have
not been adjusted for current cost adjustments to earnings.
4 Ku-Graf, Louise, Foreign Direct Investment in the United States: New Investment in 2007,
Survey of Current Business, June 2008, p. 33-40.
5 The United States defines direct investment abroad as the ownership or control, directly
or indirectly, by one person (individual, branch, partnership, association, government, etc.)
of 10% or more of the voting securities of an incorporated business enterprise or an
equivalent interest in an unincorporated business enterprise. 15 CFR § 806.15 (a)(1).
6 Bach, Christopher L., U.S. International Transactions in 2007, p. 48.

---

CRS-3
Figure 1. Foreign Direct Investment in the United States and U.S.
Direct Investment Abroad, Annual Flows, 1990-2007
Billions of dollars
$350
Foreign Direct Investment in
$300
the United States
$250
$200
U.S. Direct Investment
$150
Abroad
$100
$50
$0
-$50
1990
1992
1994
1996
1998
2000
2002
2004
2006
Year
Source: CRS from U.S. Department of Commerce data
Note: the drop in U.S. direct investment abroad in 2005 reflects actions by U.S. parent
companies to take advantage of a one-time tax provision.
According to the U.N. World Investment Report,7 the largest 100 multinational
corporations in the world experienced a stagnation of their sales, employment, and
growth in assets from 2000 to 2003, but global foreign direct investment flows
picked up in the 2004-2007 period, as indicated in Table 1. In 2005, 2006, and 2007
global direct investment flows grew by 27%, 38%, and 18%, respectively, to reach
$1.5 trillion. The rise in global direct investment flows was driven by an increase in
corporate profits worldwide and resulting higher stock prices that raised the value of
cross-border mergers and acquisitions. The developed economies continue to absorb
about two-thirds of global direct investment flows, with the developing economies
sharing the rest. Africa continues to receive the smallest share, generally less than
3%, with Latin America receiving about 8% and Asia getting between 18% and 22%.
The United Nations estimates that foreign direct investment should remain strong
through 2009.8 A recent study on investment trends by the Organization for
Economic Cooperation and Development (OECD) reports that direct investment
outflows reached a record $1.8 trillion in 2007, in part due the decline in the value
of the dollar relative to the euro, which results in an upward valuation in dollar terms
in investments that originally had been priced in euros. The OECD projects that the
7 World Investment Report 2007, United Nations, July 2007, p. 5.
8 World Investment Prospects Survey: 2007-2009. United Nations Conference on Trade and
Development, 2007.

---

CRS-4
overall amount of direct investment flows in 2008 will decline as a result of lower
levels of foreign direct investment into and out of the United States.9
Table 1. Global Annual Inflows of Foreign Direct Investment, By
Major Area
(in billions of dollars and percent shares)
2005
2006
2007
2005
2006
2007
Inflows of foreign direct
Share of annual foreign
investment
direct investment inflows
(in billions of dollars)
(in percent)
World
$945.8 $1,305.9 $1,537.9
100.0%
100.0%
100.0%
Developed economies
590.3
857.5
1,001.9
62.4
65.7
65.1
Western Europe
495.0
566.4
651.0
52.3
43.4
42.3
European Union
486.4
531.0
610.0
51.4
40.7
39.7
Other Western Europe
8.6
35.4
38.0
0.9
2.7
2.5
North America
129.9
244.4
n.a.
13.7
18.7
n.a.
United States
101.0
175.4
192.9
10.7
13.4
12.5
Other developed econ.
-34.6
46.7
n.a.
-3.7
3.6
n.a.
Developing economies
314.3
379.1
438.4
33.2
29.0
28.5
Africa
29.6
35.5
35.6
3.1
2.7
2.3
Latin America
75.5
83.7
125.8
8.0
6.4
8.2
Asia
209.1
259.8
277.0
22.1
19.9
18.0
Other Europe
41.2
69.3
97.6
4.4
5.3
6.3
Source: World Investment Report, 2007, United Nations. Annex table B.1; Foreign Direct Investment
Reached New Record in 2007, UNCTAD press release, January 8, 2008.
Globally, the total, or cumulative, amount of foreign direct investment reached
$12 trillion in 2006 (the latest year for which detailed data are available), as indicated
in Figure 2. Nearly three-fourths of this amount is invested in the most
economically-advanced developed economies. The developed economies not only
are the greatest recipient of investment funds, but they are also the greatest source of
those funds. Similar to the United States, those countries that are the largest overseas
investors also tend to be the most attractive destinations for foreign investments. The
clear exception to this general observation is Japan, which had invested $450 billion
abroad through 2006, but had received $107 billion in investment inflows. Among
the developing economies, Asia, which includes China, has accumulated $1.9 trillion
in direct investment, followed by Latin America ($908 billion) and Africa ($315
billion).
9 OECD FDI Outflows and Inflows Reach Record Highs in 2007 But Look Set to Fall in
2008. OECD Investment News, June 2008, p. 1.

---

CRS-5
Figure 2. Inward and Outward Global Direct Investment Position, By
Major Area, 2006
Total = $12 Trillion
World $12.0
$12.5
Developed economies $8.5
$10.7
Western Europe $5.4
$6.4
France $0.8
$1.1
Germany $0.5
$1.0
Netherlands $0.5
$0.7
United Kingdom $1.1
$1.5
United States $1.8
$2.4
Australia $0.2
$0.2
Japan $0.1
$0.4
Developing economies $3.2
$1.6
Latin America $0.9
$0.4
Africa $0.3
$0.1
Asia $1.9
$1.2
16 14 12 10 8
6
4
2
0
2
4
6
8 10 12 14 16
Trillions of Dollars
Trillions of Dollars
Inward Stock
Outward Stock
Source: United Nations
By the end of 2005, there were more than 2,300 U.S. parent companies with
24,000 affiliates operating abroad, as Table 2 indicates. In comparison, foreign firms
had about 5,300 affiliates operating in the United States. U.S. parent companies
employed nearly 22 million workers in the United States, compared with the 10.3
million workers employed abroad by U.S. firms and the 5.5 million persons
employed in the United States by foreign firms. Although the U.S.-based affiliates
of foreign firms employ slightly more than half the number of workers as the foreign
affiliates of U.S. firms, they paid almost as much in aggregate employee
compensation in the United States as did the U.S. affiliates operating abroad. The
foreign affiliates of U.S. parent companies, however, had a third higher value of
gross product than did the affiliates of foreign firms operating in the United States.
In addition, the foreign affiliates of U.S. firms had total sales that were a third higher
than that of the U.S. affiliates of foreign firms. The foreign affiliates of U.S. firms,
however, paid three times more in taxes to foreign governments than did the affiliates
of foreign firms operating in the United States. The overseas affiliates of U.S. parent
companies also paid nearly twice as much in taxes relative to their sales as did U.S.
parent companies and as did foreign-owned affiliates operating in the United States.

---

CRS-6
Table 2. Select Data on U.S. Multinational Companies and on
Foreign Firms Operating in the United States, 2005
(in millions of dollars unless otherwise indicated)
U.S. Multinational Companies U.S. Affiliates
of Foreign
Parent
Affiliates
Firms
Companies
Number of firms
2,303
24,456
5,331
Employment (thousands)
21,768.5
10,333.3
5,530.1
Employee compensation
$1,288,871
$391,846
$363,340
Gross product
$2,303,060
$882,099
$539,869
Total assets
$16,767,078
$9,951,716
$6,848,777
Sales
$7,588,306
$4,224,685
$2,755,941
Taxes
$166,767
$168,811
$49,595
R&D Expenditures
$NA
$28,316
$34,637
Source: U.S. Direct Investment Abroad: Operations of U.S. Parent Companies and Their Foreign
Affiliates, Preliminary 2005 Estimates; and Foreign Direct Investment in the United States:
Operations of U.S. Affiliates of Foreign Companies, Preliminary 2005 Estimates.
U.S. multinational companies also play an important role in the U.S. economy.
According to the total output of U.S. parent companies, or gross product, they
produced $2.3 trillion in goods and services in 2005, up slightly from the $2.2 trillion
dollars they produced in 2004. This amount comprised about 21% of total U.S.
private industry gross product, a share of total gross product of U.S. parent
companies that has remained fairly consistent since the early 1990s despite
significant changes in the U.S. economy as a whole. The data also demonstrate the
impact the improvement in the U.S. economy after 2002 had on the operations of
U.S. multinational companies.
National Security
Since the end of World War II, the United States has led efforts internationally
to reduce official government restrictions on foreign investment. One prominent
exclusion to these efforts and to commitments incorporated in international treaties
is the right of nations to protect their own “essential security interests.” The terrorist
attacks of September 11, 2001, combined with the growing role of state-backed
investors, or sovereign wealth funds (SWFs),10 has spurred a number of nations to
reconsider their national security interests relative to inward investment and to
consider placing additional restrictions on foreign investments in areas considered
to be an essential security interest.11 For the most part, such restrictions apply to
mergers, acquisitions, and take-overs of existing firms and not generally to new
establishments. These actions, in turn, have raised concerns among the members of
10 For additional information, see CRS Report RL34336, Sovereign Wealth Funds:
Background and Policy Issues for Congress, by Martin A. Weiss.
11 World Investment Report, 2007, p. 14.

---

CRS-7
such organizations as the OECD,12 which promotes the concept of liberalized
government restrictions on the free flow of international investment.
OECD Arrangements
With some exceptions for national security, the United States has long been
considered one of the most receptive economies in the world to foreign direct
investment. The United States has led efforts to negotiate internationally for reduced
restrictions on foreign direct investment, for greater rules on incentives offered to
foreign investors, and for equal treatment under law of foreign and domestic
investors. In particular, the United States has supported efforts within the OECD to
develop such legally non-binding arrangements as the OECD Code of Liberalization
of Capital Movements (covering both long-and short-term capital movements) and
the Code of Liberalization of Current Invisible Operations (covering cross-border
trade in services). In addition, the OECD has issued a basic statement on foreign
investment, The Declaration on International Investment and Multinational
Enterprises, which is a general statement of policy regarding the rights and
responsibilities of foreign investors.
The United States and other signatories to the OECD arrangements recognize
that one notable exception to the open investment policies provided for in the OECD
instruments, as well as in customary international law, is that governments can take
measures they “consider necessary to protect essential security interests” and to
maintain “public order or the protection of public health, morals, and safety.” Such
an exception has been recognized in various international agreements, in countless
bilateral investment treaties, and in investment chapters of free trade agreements.
According to the OECD, “The right to protect essential security interests of the state,
as an exception to treaty commitments, has been well established in treaty practice.”13
Another aspect of this policy is that each state is best situated to assess its own
security interests and to decide whether essential security interests are at stake
relative to certain types of investments. Under customary international law, the
argument of necessity has been interpreted to mean an incident that poses a grave and
imminent peril to a country, or a threat to such vital interests as, “political or
economic survival, the continued functioning of its essential services, the
maintenance of internal peace, the survival of a sector of its population, and the
preservation of the environment of its territory.”14 Various agreements, including
multilateral agreements and OECD investment instruments, acknowledge that each
nation has the exclusive role of determining for itself whether a restriction on foreign
investment is necessary to protect its essential security interests.
12 For additional information, see CRS Report RS21128, The Organization for Economic
Cooperation and Development, by James K. Jackson.
13 International Investment Perspectives: Freedom of Investment in a Changing World, 207
Edition, Organization for Economic Cooperation and Development, 2007, p. 105.
14 Ibid., p. 100.

---

CRS-8
As governments move to assess their national policies on foreign investments,
they are faced with a trade-off between their desires to preserve and expand an open
international investment environment with the national responsibility to safeguard
essential security interests. This trade-off is complicated further by the nature of the
threats that are associated with mergers, acquisitions, and take-overs of existing
firms. Such investments generally are not viewed as posing an immediate threat to
the stability or security of a nation. Some observers, however, view some of these
investments as posing potential threats to the economy in the form of a loss of
technology related to national security, a loss of jobs due to outsourcing, or a threat
associated with state-backed investors who use their investments to advance political
objectives. As a result, policies directed at reviewing foreign direct investments are
best described as precautionary measures.15 In this report, the national security
threats posed by mergers, acquisition, or take-overs do not include overt acts of
transnational terrorism that are meant to dissuade foreign capital inflows.16 The
OECD reports that a number of governments have started to review their policies on
inward foreign investment in response to a “changing context for national security
and the increasing prominence of new investors, including large investors controlled
by foreign governments.”17 From France and Germany, the United States and
Canada, to various non-OECD countries, existing regulatory regimes have been used
to deter certain investments in infrastructure for national security concerns or
countries have tightened their regulations on security grounds.18
Due to the increased attention focused on the national security aspects of inward
foreign investment, the OECD formed in June 2006 the “Freedom of Investment,
National Security and ‘Strategic Industries’” project. Through the seven rounds of
meetings, including the latest one held in March 2008, members19 of the investment
project have agreed to support three principles for national investment policy
measures that address essential security interests: 1) transparency and predictability;20
2) proportionality;21 and 3) accountability. Proportionality refers to the concept that
restrictions on foreign investment should be no greater than is needed to protect
15 Friedman, Benjamin H., The Terrible ‘Ifs’, Regulation, Winter 2007/2008, pp. 32-40.
16 Enders, Walter and Todd Sandler, Terrorism and Foreign Direct Investment in Spain and
Greece, in Sandler, Todd, and Keith Hartley, eds., The Economics of Conflict, Vol. II.
Cheltenham, UK; Northhamption, MA; Edward Elgar, 2003.
17 Freedom of Investment, National Security and “Strategic” Industries: Progress Report
by the OECD Investment Committee. Organization for Economic Cooperation and
Development, April 2008.
18 International Investment Perspectives, p. 55.
19 The members of the project include the 30 members of the OECD, the 10 non-member
adherents to the Declaration (Argentina, Brazil, Chile, Egypt, Estonia, Israel, Latvia,
Lithuania, Romania, and Slovenia), Russia, and other countries that attended at least one
session: China, India, Indonesia, and South Africa.
20 Transparency and Predictability for Investment Policies Addressing National Security
Concerns: A Survey of Practices. Organization for Economic Cooperation and
Development, May 2008.
21 Proportionality of Security-Related Investment Instruments: A Survey of Practices.
Organization for Economic Cooperation and Development, May 2008.

---

CRS-9
national security. In June 2007 at the annual summit of the Group of Eight22 (G8)
leading industrialized nations, the group issued a “Declaration on Freedom of
Investment, Environment and Social Responsibility.” The final summit statement
also emphasized the group’s continuing support for the OECD project on Freedom
of Investment, National Security and “Strategic Industries.” The G8 statement also
offered its support for a free flow of investment by indicating that:
We will work together to strengthen open and transparent investment regimes
and to fight against tendencies to restrict them. Erecting barriers and supporting
protectionism would result in a loss of prosperity. We therefore agree on the
central role of free and open markets to facilitate global capital movements. We
reaffirm that freedom of investment is a crucial pillar of economic growth,
prosperity and employment....Against this background we remain committed to
minimize any national restrictions on foreign investment. Such restrictions
should apply to very limited cases which primarily concern national security.
The general principles to be followed in such cases are non-discrimination,
transparency and predictability. In any case, restrictive measures should not
exceed the necessary scope, intensity and duration.23
The OECD project on investment is expected to issue its final report in mid-
2009, at which point the project is expected to issue policy guidance in the form of
a menu of best practices for the signatories to consider so that as they implement
investment policies they do so in a way that is consistent with the three principles.
While it is too early to tell, nations, including the United States, may choose to adjust
their national laws to have them conform to the recommendations of the OECD’s
final report. The OECD members also have agreed to adopt a set of 14 guidelines
that are meant to serve as the basis for establishing investment policy measures.
These guidelines are designed to assist nations in adopting investment measures that
safeguard national security and are consistent with the three principles of
transparency, proportionality, and accountability. These measures are:
! Non-discrimination: Governments should treat similarly situated
foreign and domestic investments in a similar fashion.
! Transparency/Predictability: Regulatory practices should be as
transparent as possible while also protecting the confidentiality of
sensitive information.
! Codification and publication: Laws, particularly evaluation criteria
used in reviews of investment transactions, should be codified and
made public.
! Prior notification: Governments should take steps to notify interested
parties about plans to change investment policies.
22 The Group of Eight nations includes Canada, France, Germany, Italy, Japan, Russia, the
United Kingdom, and the United States.
23 Growth and Responsibility in the World Economy, G8 Summit Declaration, June 7, 2007.
Paragraphs 10 and 11.

---

CRS-10
! Consultation: Governments should seek the views of interested
parties when they are considering changing investment policies.
! Procedural fairness and predictability: Reviews should have time
limits; sensitive information should be protected.
! Disclosure of investment policy actions: Governments should
disclose investment policy actions as a measure of accountability.
! Regulatory proportionality: Restrictions should not be greater than
needed to protect national security.
! Essential security concerns are self-judging: Countries have the right
to determine what is necessary to protect their own national security.
! Narrow focus: Investment restrictions should be narrowly focused
on concerns related to national security.
! Appropriate expertise: Measures related to national security
concerns should be designed so that they can benefit from national
expertise on national security and that it is possible to weigh the
benefits of the investment policies against the impact of the
restrictions.
! Tailored responses: Investment measures should be tailored to the
specific risks posed by specific investment proposals.
! Last resort: Restrictive investment should be used as a last resort
when other policies cannot be used to eliminate security-related
concerns.
! Accountability: To ensure accountability by government agencies,
investment measures should be reviewed by government oversight,
judicial review, periodic regulatory impact assessments, and
requirements that decisions to block an investment should be taken
at high government levels.
Critical Infrastructure
As part of the general area of essential security concerns associated with foreign
investment, numerous nations have focused on the concept of critical infrastructure
as a separate area of concern within the rubric of essential security interests.24 As
Table 3 indicates, national definitions of critical infrastructure differ among
countries, although most of the countries surveyed by the OECD define critical
infrastructure as physical infrastructure that provides essential support for economic
24 Protection of “Critical Infrastructure” and the Role of Investment Policies Relating to
National Security, The Organization for Economic Cooperation and Development, May
2008, p. 2.

---

CRS-11
and social well-being, for public safety, and for the functioning of key government
responsibilities. In most cases, the national definitions of critical infrastructure are
broad statements that provide national governments with a wide latitude for deciding
which assets or sectors to designate as critical. Such definitions implicitly
acknowledge the importance that the broader economic and security context plays in
determining which sectors might be selected for designation as critical and that this
designation may change depending on the circumstances.
Table 3. Examples of National Definitions of Critical
Infrastructure
Australia
Those physical facilities, supply chains, information technologies and
communication networks which, if destroyed, degraded or rendered
unavailable for an extended period, would significantly impact on the
social or economic well-being of the nation, or affect Australia’s
ability to conduct national defense and ensure national security.
Canada
Those physical and information technology facilities, networks,
services and assets which, if disrupted or destroyed, would have a
serious impact on the health, safety, security or economic well-being
of Canadians or the effective functioning of governments in Canada.
Germany
Organizations and facilities of major importance to the community
whose failure or impairment would cause a sustained shortage of
supplies, significant disruptions to public order or other dramatic
consequences.
Netherlands
Products, services and the accompanying processes that, in the event
of disruption or failure could cause major social disturbance. This
could be in the form of tremendous casualties and severe economic
damage.
United
Those assets, services and systems that support the economic,
Kingdom
political and social life of the UK whose importance is such that loss
could: 1) cause large-scale loss of life; 2) have a serious impact on
the national security; 3) have other grave social consequences for the
community; or 4) be of immediate concern to the national
government.
United
In the overall U.S. critical infrastructure plan the definition includes
States
systems and assets, whether physical or virtual, so vital to the United
States that the incapacity or destruction of such systems and assets
would have a debilitating impact on security, national economic
security, national public health or safety, or any combination of those
matters. For investment policy it is defined as: those systems and
assets, whether physical or virtual, so vital to the United states that
the incapacity or destruction of such systems and assets would have
a debilitating impact on national security.
Source: Protection of Critical Infrastructure and the Role of Investment Policies Relating
to National Security, The Organization for Economic Cooperation and Development, May
2008.

---

CRS-12
Essential Security Exclusions
Members of the OECD and other countries that choose to adhere to the
voluntary OECD National Treatment Instrument retain the option to exclude sectors
of their economy on the grounds of essential security interests from the national
treatment standard. In such cases, nations are using discriminatory practices to
restrict foreigners from investing in sectors of their economies that are deemed to be
important to national security. In making such exceptions, nations that are parties to
the National Treatment Instrument provide a notification to the other members that
they are requesting an exemption from the protocol, thereby providing a method to
make the process transparent to all the signatories of the Instrument.
According to a recent OECD study, countries that are adhering to the OECD
National Treatment Instrument have exempted an extensive array of discriminatory
foreign investment policies from the Instrument in order to protect critical
infrastructure from foreign investment. For instance, all 39 nations that are a party
to the Instrument report that they discriminate against foreign investment in one or
more critical infrastructure sectors. Of these sectors, transport in the most targeted
sector, with all 39 countries reported having discriminatory measures.25 Such
restrictions generally fall within three categories: 1) blanket restrictions that cover a
specific activity; 2) sector-specific restrictions that affect investment in a specific
sector of the economy; and 3) measures that apply to a broad range of infrastructure
investments and approval procedures that could be used to block infrastructure
investments that are deemed to pose threats to essential security interests.
The OECD also concluded that the national restrictions were notably general in
their descriptions. In turn, the OECD concluded that the generality of the restrictions
is due to four issues: 1) the nature of the security threats may affect perceived threats
and vulnerabilities; 2) the assessment of the threats may be affected by the nationality
of the foreign investor; 3) some perceived threats may be resolved easily through
mitigation efforts, while others may not; and 4) not all countries have the capabilities
to conduct in-depth evaluations of potential national security threats. The OECD
also concluded that it is difficult to assess the value such restrictions have in
enhancing the essential national security of the members. In most cases, such
policies are measures of last resort when other national laws or measures are
determined to be insufficient, or they can provide a process that assists various
agencies within a national government with identifying and dealing with security
threats that might be posed by international investment.26
25 Protection of Critical Infrastructure and the Role of Investment Policies Relating to
National Security, p. 6.
26 Ibid., p. 8.

---

CRS-13
Table 4. Industrial Sectors Included in National Critical Infrastructure Plans
Sector
Australia
Canada
Netherlands
United
United
European
Kingdom
States
Union
Energy
X
X
X
X
X
X
(including
nuclear)
Communications
X
X
X
X
X
Finance
X
X
X
X
X
X
Health care
X
X
X
X
X
X
Food
X
X
X
X
X
X
Water
X
X
X
X
X
X
Transport
X
X
X
X
X
X
Safety
Emergency
X
X
Emergency
Emergency
X
services
services
services
Government
X
X
X
X
X
Chemicals
X
X
X
X
Defense
X
X
X
X
industrial base
Other sectors or
Public
Legal/
Dams,
Space and
activities
gatherings,
judicial
commercial
research
national
facilities,
facilities
icons
national
monuments
Source: Protection of Critical Infrastructure and the Role of Investment Policies Relating to National
Security, The Organization for Economic Cooperation and Development, May 2008.
U.S. Foreign Investment Policy
U.S. policy toward foreign direct investment is based primarily on the
conclusion that direct investment benefits both the home and the host country and
that the benefits of such investment outweigh the costs. Most economists argue that
free and unimpeded international flows of capital, such as direct investment,
positively affect both the domestic (home) and foreign (host) economies. The
essence of this argument is that for the home country, direct investment abroad
benefits individual firms, because firms that invest abroad are better able to exploit
their existing competitive advantages and are able to acquire additional skills and
advantages. This tends to further enhance the competitive position of these firms
both at home and abroad and shifts the composition and distribution of employment

---

CRS-14
within the economy toward the most productive and efficient firms and away from
the less productive firms.
As a host country, the United States benefits from inward direct investment
because the investment adds permanently to the Nation’s capital stock and skill set.
Direct investment also brings technological advances, since firms that invest abroad
generally possess advanced technology, processes, and other economic advantages.
Such investment also boosts capital formation, contributes to a growth in a
competitive business environment and to productivity. In addition, direct investment
contributes to international trade and integration into the global trading community,
since most firms that invest abroad are established multinational firms.27
While U.S. policy toward inward and outward direct investment generally has
adhered to the overall objective of treating such investment impartially, there are a
number of notable exceptions. These exceptions can be classified as sectoral
restrictions that exclude foreign ownership from certain sectors of the economy and
approval procedures for mergers, acquisitions, and take-overs of existing U.S. firms
that could be used to block infrastructure investments that are deemed to pose threats
to essential national security. Foreign investors are constrained by U.S. laws that
bars foreign ownership in such industrial sectors as maritime, aircraft, mining,
energy, lands, communications, banking, and government contracting.28 Generally,
these sectors were closed to foreign investors to prevent public services and public
interest activities from falling under foreign control, primarily for national defense
purposes.
Exon-Florio and CFIUS
The second category of restrictions, characterized by such approval procedures
as the Exon-Florio provision, applies to foreign investment in existing U.S. firms
through mergers, acquisitions, or take-overs, but does not apply to foreign investors
who establish new businesses. In 1988, Congress approved the Exon-Florio
provision29 as part of the Omnibus Trade Act.30 The Exon-Florio provision grants the
President broad discretionary authority to take what action he considers to be
“appropriate” to suspend or prohibit proposed or pending foreign acquisitions,
mergers, or takeovers “of persons engaged in interstate commerce in the United
States” which “threaten to impair the national security.” The Exon-Florio provision
does not define national security, because Congress meant to have the term
interpreted broadly. Nevertheless, regulations developed by the Treasury Department
27 Such linkages appear to be important factors for both developed and developing host
countries, see Alfaro, Laura, Areendum Chanda, Sebnem Kalemli-Ozcam, and Selin Sayek,
How Does Foreign Direct Investment Promote Economic Growth? Exploring the Effects
of Financial Markets on Linkages. Working Paper 12522, September 2006, National
Bureau of Economic Research.
28 Seitzinger, Foreign Investment in the United States: Major Federal Restrictions.
29 For additional information, see CRS Report RL33312, The Exon-Florio National Security
Test for Foreign Investment, by James K. Jackson.
30 P.L. 100-418, title V, Subtitle A, Part II, or 50 U.S.C. app 2170.

---

CRS-15
to implement the law direct the members of the Committee on Foreign Investment
in the United States (CFIUS)31 to focus their reviews of foreign investments
exclusively on those transactions that involve “products or key technologies essential
to the U.S. defense industrial base,” and not to consider economic concerns more
broadly. CFIUS also indicated that in order to assure an unimpeded inflow of foreign
investment it would implement the statute “only insofar as necessary to protect the
national security,” and “in a manner fully consistent with the international obligations
of the United States.”32 The Committee is an interagency organization that serves the
President in overseeing the national security implications of foreign investment in the
economy.
The Exon-Florio process consists of three different steps for reviewing proposed
or pending foreign “mergers, acquisitions, or takeovers” of “persons engaged in
interstate commerce in the United States” to determine if the transaction “threatens
to impair the national security.” Such investments often imply a change in ownership
and not necessarily a change in the operations of the targeted U.S. company. CFIUS
has 30 days to conduct a review, 45 days to conduct an investigation, and then the
President has 15 days to make his determination. The President is the only officer
with the authority to suspend or prohibit mergers, acquisitions, and takeovers.
Neither Congress nor the Administration have attempted to define the term
national security as it appears in the Exon-Florio statute. Treasury Department
officials have indicated, however, that during a review or investigation each member
of CFIUS is expected to apply that definition of national security that is consistent
with the representative agency’s specific legislative mandate.33 For instance, over
time and through a series of Executive Orders, the Department of Defense has
developed the National Industrial Security Program (NISP) through which it has
adopted various provisions under the term, “Foreign Ownership, Control, or
Influence (FOCI).” These provisions attempt to prevent foreign firms from gaining
unauthorized access to “critical technology, classified information, and special
classes of classified information” through an acquisition of U.S. firms that it could
not gain access through an export control license. This type of review is run
independently of and parallel to a CFIUS review.
Critical Infrastructure/Key Resources
Arguably, the events of September 11, 2001, reshaped congressional attitudes
toward the Exon-Florio provision. This change in attitude became apparent in 2006
as a result of the public disclosure that Dubai Ports World34 was attempting to
31 For additional information, see CRS Report RL33388, The Committee on Foreign
Investment in the United States (CFIUS), by James K. Jackson.
32 Ibid.
33 Senate Armed Services Committee, Briefing on the Dubai Ports World Ports Deal,
February 23, 2006.
34 Dubai Ports World was created in November 2005 by integrating Dubai Ports Authority
and Dubai Ports International. It is one of the largest commercial port operators in the world
(continued...)

---

CRS-16
purchase the British-owned P&O Ports,35 with operations in various U.S. ports. After
the September 11th terrorist attacks Congress passed and President Bush signed the
USA PATRIOT Act of 2001 (Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism).36 In this act,
Congress provided for special support for “critical industries,” which it defined as:
systems and assets, whether physical or virtual, so vital to the United States that
the incapacity or destruction of such systems and assets would have a debilitating
impact on security, national economic security, national public health or safety,
or any combination of those matters.37
This broad definition is enhanced to some degree by other provisions of the act,
which specifically identify sectors of the economy that Congress considers to be
elements in the critical infrastructure of the nation. These sectors include
telecommunications, energy, financial services, water, transportation sectors,38 and
the “cyber and physical infrastructure services critical to maintaining the national
defense, continuity of government, economic prosperity, and quality of life in the
United States.”39 The following year, Congress transferred the responsibility for
identifying critical infrastructure to the Department of Homeland Security (DHS)
through the Homeland Security Act of 2002.40 In addition, the Homeland Security
Act added key resources to the list of critical infrastructure (CI/KR) and defined
those resources as: “publicly or privately controlled resources essential to the
minimal operations of the economy and government.”41 Through a series of
Directives, the Department of Homeland Security identified 17 sectors42 of the
economy as falling within the definition of critical infrastructure/key resources and
assigned primary responsibility for those sectors to various Federal departments and
34 (...continued)
with operations in the Middle East, India, Europe, Asia, Latin America, the Carribean, and
North America.
35 Peninsular and Oriental Steam Company is a leading ports operator and transport
company with operations in ports, ferries, and property development. It operates container
terminals and logistics operations in over 100 ports and has a presence in 18 countries.
36 P.L. 107-56, title X, Sec. 1014, October 26, 2001; 42 U.S.C. Sec. 5195c(e).
37 Ibid.
38 42 U.S.C. Sec. 5195c(b)(2).
39 42 U.S.C. Sec. 5195c(b)(3).
40 P.L. 107-296, Sec. 2, November 25, 2002; 6 U.S.C. Sec. 101.
41 6 U.S.C. Sec. 101(9).
42 The original sectors include 1) Agriculture and Food; 2) Defense Industrial Base; 3)
Energy; 4) Public Health and Healthcare; 5) National Monuments and Icons; 6) Banking and
Finance; 7) Drinking Water and Water Treatment Systems; 8) Chemical; 9) Commercial
Facilities; 10) Dams; 11) Emergency Services; 12) Commercial Nuclear Reactors, Materials,
and Waste; 13) Information Technology; 14) Telecommunications; 15) Postal and Shipping;
16) Transportation Systems; and 17) Government Facilities.

---

CRS-17
agencies, which are designated as Sector-Specific Agencies (SSAs).43 On March 3,
2008, Homeland Security Secretary Chertoff signed an internal DHS memo
designating Critical Manufacturing as the 18th sector on the CI/KR list.
By adopting the terms “critical infrastructure” and “homeland security,”
following the events of September 11, 2001, Congress demonstrated that the attacks
fundamentally altered the way many policymakers view the concept of national
security. As a result, many policymakers have concluded that economic activities are
a separately identifiable component of national security. In addition, many
policymakers apparently perceive greater risks to the economy arising from foreign
investments in which the foreign investor is owned or controlled by foreign
governments as a result of the terrorist attacks. The Dubai Ports World case, in
particular, demonstrated that there was a difference between the post-September 11
expectations held by many in Congress about the role of foreign investment in the
economy and of economic infrastructure issues as a component of national security
and the operations of CFIUS. For some Members of Congress, CFIUS seemed to be
out of touch with the post-September 11, 2001 view of national security, because it
remains founded in the late 1980s orientation of the Exon-Florio provision, which
views national security primarily in terms of national defense and downplays or even
excludes a broader notion of economic national security.
Foreign Investment and National Security Act of 2007
In 2007, Congress changed the way foreign direct investments are reviewed
through P.L. 110-49, the Foreign Investment and National Security Act of 2007.44
Through P.L. 110-49, Congress strengthened its role in two fundamental ways. First,
Congress enhanced its oversight capabilities by requiring greater reporting to
Congress by CFIUS on the Committee’s actions either during or after it completes
reviews and investigations and by increasing reporting requirements on CFIUS.
Second, Congress fundamentally altered the meaning of national security in the
Exon-Florio provision by including critical infrastructure and homeland security as
areas of concern comparable to national security. The law also requires the Director
of National Intelligence to conduct reviews of any investment that may pose a threat
to the national security. The law provides for additional factors the President and
CFIUS are required to use in assessing foreign investments, including the
implications for the nation’s critical infrastructure.
43 Sector-Specific Agencies include the Departments of: Agriculture, Defense, Energy,
Health and Human Services, Homeland Security, Interior, Treasury, and the Environmental
Protection Agency.
44 P.L. 110-49 originated in the first session of the 110th Congress as S. 1610, the Foreign
Investment and National Security Act of 2007, introduced by Senator Dodd on June 13,
2007. On June 29, 2007, the Senate adopted S. 1610 in lieu of a competing House version,
H.R. 556 by unanimous consent. On July 11, 2007, the House accepted the Senate’s version
of H.R. 556 by a vote of 370-45 and sent the measure to the President, who signed it on July
26, 2007. On January 23, 2008, President Bush issued Executive Order 13456 implementing
the law.

---

CRS-18
In another change, P.L. 110-49 requires CFIUS to investigate all foreign
investment transactions in which the foreign entity is owned or controlled by a
foreign government, regardless of the nature of the business. Some foreign investors
may well regard this approach as a change in policy by the United States toward
foreign investment. Prior to this change, foreign investment transactions were
reviewed in a way that presumed that the transactions contributed positively to the
economy. Consequently, the burden of proof was on the members of CFIUS to prove
during a review that a particular transaction threatened to impair national security.
P.L. 110-49, however, shifted the burden onto firms that are owned or controlled by
a foreign government to prove that they are not a threat to national security. In any
given year, the number of investment transactions in which the foreign investor is
associated with a foreign government likely is small compared with the total number
of foreign investment transactions. The number of such transactions, however, is
growing as some foreign governments experience a surge in their foreign exchange
reserves and they establish sovereign wealth funds in order to invest part of their
reserve funds abroad in an array of activities, including in U.S. businesses. Many
countries, such as China, also have state-owned enterprises that operate in the global
economy.
To clarify U.S. policy toward foreign investment after the Dubai Ports World
controversy and the impending passage of P.L. 110-49, President Bush released on
May 10, 2007, a policy statement on open economies.45 The statement offered strong
support for the international flow of direct investment. In part, the statement reads:
A free and open international investment regime is vital for a stable and growing
economy, both here at home and throughout the world. The threat of global
terrorism and other national security challenges have caused the United States
and other countries to focus more intently on the national security dimensions of
foreign investment. While my Administration will continue to take every
necessary step to protect national security, my Administration recognizes that our
prosperity and security are founded on our country's openness.
As both the world's largest investor and the world's largest recipient of
investment, the United States has a key stake in promoting an open investment
regime. The United States unequivocally supports international investment in this
country and is equally committed to securing fair, equitable, and
nondiscriminatory treatment for U.S. investors abroad. Both inbound and
outbound investment benefit our country by stimulating growth, creating jobs,
enhancing productivity, and fostering competitiveness that allows our companies
and their workers to prosper at home and in international markets. My
Administration is committed to ensuring that the United States continues to be
the most attractive place in the world to invest. I urge other nations to join us in
supporting an open investment policy and protecting international investments.
The CFIUS process is just one of three major provisions of law that authorize
the review of foreign direct investment transactions in the United States for their
impact on the economy. The National Industrial Security Program and the critical
industries provisions of various statutes also require that foreign direct investment
45 President Bush’s statement is available at
[http://www.whitehouse.gov/news/releases/2007/05/20070510-3.html]

---

CRS-19
transactions be reviewed. Generally, the reviews mandated by these three provisions
operate independently, although at times they have overlapped. The provisions
illustrate the complexities involved in defining most economic activities, which can
span a broad range of economic activities and fields. Most economic activities affect
various sectors and segments of the economy in ways that defy a narrow definition
and complicate efforts to distinguish those economic activities that are related to the
broad rubric of national security or to national economic security, which is even less
clearly defined.
Strategic Materials Protection Board
The Strategic Materials Protection Board, created in 2006, could restrict other
types of foreign investment transactions, although this likely will affect a small group
of such transactions. In retrospect, some observers hope this provision will prevent
future transactions similar to the 2005 merger between Magnequench International
and the Canadian-owned firm AMR Technologies, Inc., which shifted ownership of
the world’s largest producer of Neo powder (composed of neodymium, iron, and
boron) to produce Neo magnets.46 The Strategic Materials Protection Board was
mandated by Title VIII of the John Warner National Defense Authorization Act for
Fiscal Year 2007, signed October 17, 2006 and designated as P.L. 109-364. The act
established that the Strategic Materials Protection Board would be composed of
representatives from: the Secretary of Defense; the Under Secretary of Defense for
Acquisition, Technology, and Logistics; the Under Secretary of Defense for
Intelligence; the Secretary of the Army; the Secretary of the Navy; and the Secretary
of the Air Force. The Board is required to meet at least once every two years to make
recommendations regarding materials critical to national security and to report to
Congress on the results of meetings and on the recommendations of the Board. In
addition, the act prohibits the Department of Defense from buying “strategic
materials critical to national security” unless the metals are reprocessed, reused, or
produced in the United States, except under a number of conditions, including the
lack of availability of speciality metals.
The Board is directed in the statute to undertake four activities:
1) Determine the need to provide a long term domestic supply of materials
designated as critical to national security to ensure that national defense needs
are met.
2) Analyze the risk associated with each material designated as critical to
national security and the effect on national defense that the non-availability of
such material from a domestic source would have.
46 Neo magnets have a broad range of uses in products where strong magnetic properties are
required in conjunction with small size and weight, including hard disk drives, optical disk
drives, printers, faxes, scanners, camcorders, game consoles, pagers, PDA’s, mobile phones,
mp3 players, video recorders, transmission speed sensors in automobiles, airbag sensors,
instrument gauges, bearings, generators, cordless power tools, refrigerators, air conditioners,
and such military applications as magnets in the motors of the U.S. Joint Direct Attack
Munition, or smart bombs.

---

CRS-20
3) Recommend a strategy to the President to ensure the domestic availability of
materials designated as critical to national security.
4) Recommend such other strategies to the President as the board considers
appropriate to strengthen the industrial base with respect to materials critical to
national security.
The Strategic Materials Protection Board met on July 17, 2007, and published
a report in September 2007 of that meeting. At that meeting, the Board determined
that the term “materials critical to national security” would mean “strategic materials
critical to national security” as specified in the statute and would include those metals
listed in Section 842 of P.L. 109-364 (10 U.S.C. 2533b). In this section, speciality
metals are defined as:
1) Steel
A) with a maximum alloy content exceeding one of more of the following
limits: manganese, 1.65 percent; silicon, 0.60; or copper, 0.60 percent; or
B) containing more than 0.25 percent of any of the following elements;
aluminum, chromium, cobalt, columbium, molybdenum, nickel, titanium,
tungsten, or vanadium.
2) Metal alloys consisting of nickel, iron-nickel, and cobalt base alloys
containing a total of other alloying metals (except iron) in excess of 10 percent.
3) Titanium and titanium alloys.
4) Zirconium and zirconium base alloys.
Economic Considerations
The growing prominence of national security issues in the development of national
foreign investment policies is raising questions about how policymakers can evaluate the
economic costs and benefits of such measures when the measures are designed to restrict
mergers, acquisitions, and take-overs of domestic firms by foreign investors for national
security reasons. Indeed, such measures can sometimes focus more on achieving non-
economic objectives than on achieving economic efficiency or on supporting a market-based
allocation of resources. In addition, such policies often expose differing political and
philosophical differences between policymakers within countries and among countries.
Within the United States, for instance, such differences exist among Members of Congress
and between Congress and the Administration over the role foreign investment should play
in the economy. This analysis becomes especially complicated, because each nation has the
authority to define its essential security concerns on its own terms and to adjust its foreign
investment policy to meet that definition. As a result, such policies defy a straightforward
cost-benefit analysis and can mask economic protectionism. This section discusses one
possible framework for assessing the economic impact of more restrictive investment
policies.
Part of the difficulty involved in assessing the economic impact is that at present there
is no working set of parameters that establishes a functional definition of the national
security implications of such economic activities as mergers, acquisitions, or take-overs of
existing U.S. firms by foreign investors. This process of evaluation is even more difficult
in peace time when there is no immediate national security threat posed by foreign

---

CRS-21
investment that dictates the course of national security policies. In most cases, government
actions to stop or curtail foreign direct investment in the form of a merger, an acquisition,
or a take-over of an existing U.S., firm are mainly precautionary measures aimed at
addressing potential future actions that a foreign investor may take.47 This process of
identification is also complicated on a multi-lateral basis, because each nation has its own
definition of national security and its own approach to formulating policies regarding the
role of economic activity within the national security rubric.
Whether intended or not, intervention in the economy on national security grounds
creates a mix of industrial activities that most likely would not be achieved through
traditional economic market forces. Such intervention often is associated with three types
of economic activity. First, the intervention may involve efforts to prevent foreign firms
from acquiring certain U.S. firms as a result of the type of economic activity that
characterizes the U.S. firm or is related to the nature of the output produced by the U.S.
firm. Second, opposition on national security grounds may arise as a result of concerns over
the country of origin of the foreign acquirer. This type of concern has grown over the recent
past because of the growing role of sovereign wealth funds controlled by foreign
governments.
Third, national policies may provide special consideration for certain economic
activities in the form of economic incentives for U.S. firms or barriers against foreign
acquisition due to a belief that the targeted economic activities are important to national
security. In some cases, intervention in the foreign investment process may be justified on
a combination of economic and non-economic arguments. In these cases, the economic
costs and benefits that accrue to the economy as a result of the policy actions may be tied
directly to an assessment of the particular set of circumstances within which the cost-benefit
analysis is conducted.
In the standard textbook presentation, economic production arises from a combination
of the four main types of resources, or factors of production, namely: land, labor, capital,
and entrepreneurial ability. Of these four factors, labor and capital are generally singled out
due to their overwhelming importance in the production process. Growth within an
economy, then, is generally believed to arise from growth in the two main factors of
production, capital and labor, which are considered to be fixed at any particular point in
time. Over time, however, the rate of growth in the labor force combined with the rate of
growth in capital accumulation, or in the way in which capital is used, generally referred to
as the rate of growth in productivity, set limits on the rate at which the economy can grow.
In a dynamic economy such as that of the United States, some sectors are expanding,
or growing, at a rate that is faster than the economy as a whole, while other sectors are either
declining, or are growing at a rate that is slower than the economy as a whole. Since the
growth rate in the economy is governed by the rate of growth in the labor force and in
productivity, any sector of the economy that grows faster than the average rate for the
economy as a whole, can only do so by absorbing capital and labor from other sectors of the
economy that, then, must be declining or growing at a rate that is less than the average for
the economy as a whole, assuming that the economy is growing at close to full employment.
Over time, the growing sectors of the economy necessarily take away capital and labor from
the declining sectors of the economy. In the short-run, this transformative process may be
uneven and may well lead to a mismatch in skills between sectors, which likely would result
in some unused or underutilized resources.
47 International Investment Perspectives, p. 54-63.

---

CRS-22
Within the economy, economic theory maintains that demand and supply forces
determine the market prices for labor and for capital as the various sectors compete for these
scarce resources. These market prices, then, work to allocate resources within the economy
among the vast array of economic activities into those activities that use the resources in the
most efficient manner. Interference in this process, regardless of the reason, can cause a
mis-allocation of resources in the economy and a loss of efficiency, which imposes a cost
on the economy as a whole. In the case of government incentives, or subsidies, for a favored
industry, the cost to the economy arises from two sources. The first is the direct cost
involved in shifting resources into the protected sectors of the economy that are at variance
with the way in which market forces would allocate those resources.
The second cost is the indirect cost that arises from the benefits that are lost to the
economy from preventing resources, particularly foreign capital, from shifting into those
sectors that would be gaining resources through market forces, or the opportunity cost to the
economy that arises from a mis-allocation of resources. While mergers, acquisitions, or
take-overs of existing U.S. firms by foreign investors imply at least a change in ownership,
foreign investors may well possess additional technology, or other advantages that have
made them successful international competitors that would be lost if such an investment
were prevented for national security reasons. Economists argue that both direct and indirect
costs arise when national policies are used to intervene in the foreign investment process,
because such intervention generally is contrary to market forces which act to maximize
production efficiencies.
Government policies that attempt to enhance national security by restricting
acquisitions, mergers, and take-over of existing U.S. firms by foreign investors may also
alter the allocation of capital within the economy and, thereby, incur short-term and long-
term costs to the economy. For purposes of analysis, economists often divide production
and other economic activities into two time periods: the short run and the long run. The
distinction between the short run and the long run is not absolute, but is based on the ability
of the economy to shift resources among sectors based on market forces. Generally, labor
is thought to be the most mobile factor of production that can be shifted relatively quickly
among sectors within the economy and at a lower short-run cost than capital. On the other
hand, capital is generally thought of as comparatively more difficult to shift among
economic sectors over the short-run. For instance, workers can shift into and out of jobs in
response to market demand while it is difficult to shift production facilities or buildings
from one locale to another. As a result, in the short run, labor is thought of as the variable
factor of production, while capital is thought of as a fixed factor of production. In the long-
run, however, all factors are viewed as variable since all of the factors can be reallocated to
other sectors of the economy in response to shifts in long-term market forces. This division
between the short run and the long run simply means that under normal market conditions,
the costs of reallocating resources within the economy through public policy measures, or
preventing the allocation of capital into certain sectors through foreign investment, that are
not in tandem with market forces would accrue high short-run economic costs that would
need an equally high combination of short-run and long-run benefits in order to justify the
costs to the economy.
The distinction between the short-run and the long-run can change, depending on
conditions within the economy that may require a shift in capital and labor among sectors
of the economy. For instance, after the United States entered World War II, the U.S.
economy shifted from a peace-time consumer-oriented economy to a war-time arms-
producing economy within a relatively short period of time, because the external threats to
the country were so great that a dramatic shift in the industrial mix of the economy was
considered to be a necessary short-run cost that justified overriding market forces in order
to produce quickly the material necessary to defend the nation. In this case, the benefits to
the economy in terms of added security, principally the ability to defend the country from

---

CRS-23
invasion or destruction, outweighed the short-run and long-run costs to the economy in
terms of shifting resources into sectors of the economy that would not have been given
priority under peace-time conditions.
In peace-time, without an imminent external threat, it is difficult to determine the
economic parameters that define the terms “critical infrastructure,” “homeland security,”
and “key resources.” In addition, it is difficult to define clearly what role foreign investment
should play as a separately definable component of national security. This is particularly
true in the case of an individual economic transaction such as the acquisition of U.S. firm
by a foreign firm. In these cases, the threats to the country often are not well defined or
understood and it often is not an easy proposition to evaluate the costs and benefits to the
economy as a whole of protecting or promoting certain economic activities. Similarly, it is
often difficult to determine the national security elements of allowing or barring investors
who are of certain foreign nationalities from acquiring U.S. firms. This problem is
compounded under the current “War on Terrorism” in which potential threats to the United
States may be decentralized and originate in sub-national organizations.
When policymakers decide to promote certain types of economic activities or to
protect U.S. firms or economic activities from foreign investment on the grounds of national
security, those officials are in effect weighing the costs and benefits to the nation, or more
specifically the marginal costs and marginal benefits, of intervening to alter the mix of
industrial activity in the economy. The costs in this case would include the direct short-run
and long- run marginal costs associated with blocking foreign capital from being invested
in certain favored sectors of the economy in contravention of market forces and, in the case
of incentives for favored industries, the indirect costs involved in reducing the available
capital and labor that could be used in the economy for more productive activities, or the
opportunity cost of the labor and capital.
The marginal benefits that accrue to the nation from such policy activities arise from
a combination of a number of factors. The nation may well benefit from the perceived gain
in national security and the economy may gain through the capital inflow that is represented
by the foreign investment in the form of a merger, acquisition, or take-over of an existing
U.S. firm. Foreign investors may also benefit the economy by bringing technological or
other production advantages to the United States. Foreign investment may also benefit the
economy by sustaining jobs and by producing actual goods and services. These benefits
may also include what may be termed the “national security” component of production, or
that part of production that satisfies national security concerns. Presumably, the economic
benefits would need to be at least as great as the non-economic benefits in order for national
policymakers to justify the economic costs. If non-economic benefits comprise the largest
share of the expected benefits that arise from the policy action, such a policy course might
be economic protectionism in the guise of national security and policymakers may realize
greater benefits for the nation by pursuing a different policy course that accrues fewer
economic costs.
In addition, the economic and non-economic benefits that are associated with a
particular policy may accrue to a large contingent within the economy, as would be the case
in a national emergency, or they may accrue to a few as is often the case with economic
protectionism. While this distinction between the dispersion of beneficiaries and the
allocation of the benefits within the economy is not an absolute way of evaluating national
investment policies, it does provide one measure for assessing the distinction between
measures that accrue high economic costs relative to few economic benefits within the
economy as a whole and may argue in favor of pursuing a different policy course. In some
cases the citizens of a nation may be willing to absorb high short-run and long-run costs in
order to achieve some non-economic national security goal that benefits a small contingent
within the economy. In such a case, however, it may be possible to achieve such a national

---

CRS-24
security goal through means other than through foreign investment policies that entail lower
costs for the economy.
The national security component of production may also be equated with a non-
economic good that satisfies a national or social objective related to some public assessment
of national security. The basis for such non-economic national security benefits can be
thought of as a spectrum of benefits that are associated with a similar spectrum of national
security threats. These threats can then be thought of as running from threats of imminent
destruction that would affect the economy as a whole to concerns about potential activities
that are at best tangentially associated with national security and that affect a narrow set of
workers and a limited amount of capital. As a result of this spectrum of potential versus real
threats and the dangers the threats pose to the economy, the benefits associated with policies
that are advanced on the grounds of national security will be stronger or weaker depending
on the context within which the argument is made.
Regardless of the nature of the national security threat, the direct and indirect costs to
the economy that arise from intervention in the investment process may be the same and
pose costs to the economy. Since the costs to the economy that arise from intervention
likely are the same, the key to public policy choices is the perceived benefits that are
associated with satisfying or addressing such national security concerns. In this way, the
marginal costs associated with intervention are equivalent to the marginal benefits that are
derived from the policy actions and may be thought of as the cost of satisfying such national
security concerns. In the time of full-scale war, the costs to the country of intervening in the
economy to redirect resources to produce defense and war material are justified on the basis
of the obvious benefits that arise from national survival. In less dire circumstances,
however, such cost-benefit comparisons are a great deal more difficult to make.
Conclusions
Following the terrorist attacks of September 11, 2001, policymakers in the United
States and abroad have increased their scrutiny of foreign investment in their economies as
a component of national security. There is no precise way, however, to estimate the exact
dollar amount for the economic costs and benefits of national policies that attempt to direct
or restrict foreign direct investment for national security concerns. Also, it can be dificult
to determine if foreign investment policies ultimately result in enhanced national security
or are a form of economic protectionism. In concept, the economic costs and benefits
associated with restrictive foreign investment policies can be evaluated to determine the
overall impact of such policies on the long-run economic performance of country.
Evaluating and assessing the national security importance of such policies is complicated,
however, because any such assessment naturally occurs within the context with which the
assessment takes place. A nation facing an imminent threat of destruction or annihilation
is willing to accept extraordinarily high economic costs in order to address such a danger
Within the United States, the proposed acquisition of P&O Ports by Dubai Ports
World in 2006 and the growing presence of investors that are owned or controlled by foreign
governments has sparked a debate between Members of Congress and the Administration
over the role of foreign investment in the economy. Part of this debate is focused on
determining a working set of parameters that establish a functional definition of the national
security implications of foreign direct investment. In part, this issue reflects differing
assessments of the economic impact of foreign investment on the economy and differing
political and philosophical views among Members of Congress and between the Congress
and the Administration.

---

CRS-25
Since 2006, the United States has participated in discussions spearheaded by the
OECD to develop a set of best practices to serve as guidelines for national policies that
restrict foreign investment for national security objectives. Presently, the participants have
agreed that each nation is its own best judge of its national security interests. At the same
time, they have agreed that national policies that restrict foreign investment for national
security reasons should be transparent, predictable, and non-discriminatory. The final
OECD report is scheduled for release in May 2009 and likely will contain a set of best
practices that Members of Congress may opt to review as a guide concerning U.S. laws and
regulations that govern the U.S. treatment of foreign investment relative to U.S. national
security objectives.
There are a number of factors that complicate efforts to assess the impact of policies
that restrict foreign investment for national security concerns. Some of those factors include
the difficulties that are involved in attaching a precise dollar amount to the economic costs
and benefits that are associated with such foreign investment policies. One possible
framework for assessing such policies is based on the concept of marginal costs and benefits
to the nation that accrue from policies that restrict foreign investment. In this case the
benefits are some combination of the economic and non-economic benefits that might be
expected to arise from the restrictions, while the costs include a set of real costs that the
economy would be expected to incur as a result of the policies. Measures that restrict
foreign direct investment that are based on expectations of achieving large non-economic
benefits relative to economic benefits and to large economic costs may not be an effective
tool. Instead, there may be other policy tools that could utilized to achieve the same goal,
but with lower costs to the economy.
While not determinative, another way of assessing such restrictions is by examining
the dispersion of the benefits throughout the economy. At times a nation may well be
willing to absorb the high costs that could be involved in protecting some economic
activities by restricting or controlling foreign investment. Generally, though it seems
reasonable to assume that a policy that is implemented in order to restrict foreign investment
that offers benefits to a small group of individuals within the economy and that entails high
economic costs relative to benefits, especially where non-economic benefits are a large share
of the expected benefits, could be replaced by other measures that accrue lower costs to the
economy.

---