Foreign Investment and National Security:
Economic Considerations
James K. Jackson
Specialist in International Trade and Finance
March 10, 2011
Congressional Research Service
7-5700
www.crs.gov
RL34561
CRS Report for Congress
P
repared for Members and Committees of Congress
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.
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Foreign Investment and National Security: Economic Considerations
Contents
Overview .................................................................................................................................... 1
Foreign Direct Investment in the United States ............................................................................ 2
National Security ........................................................................................................................ 6
OECD Arrangements ............................................................................................................ 7
Critical Infrastructure.......................................................................................................... 10
Essential Security Exclusions .............................................................................................. 11
U.S. Foreign Investment Policy................................................................................................. 13
Exxon-Florio and CFIUS .................................................................................................... 13
Critical Infrastructure/Key Resources .................................................................................. 14
Foreign Investment and National Security Act of 2007 ........................................................ 16
Strategic Materials Protection Board ................................................................................... 17
Economic Considerations.......................................................................................................... 18
Conclusions .............................................................................................................................. 22
Figures
Figure 1. Foreign Direct Investment in the United States and U.S. Direct Investment
Abroad, Annual Flows, 1990-2009 ........................................................................................... 3
Figure 2. Inward and Outward Global Direct Investment Position, by Major Area, 2009.............. 5
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, 2008............................................................................................................. 6
Table 3. Examples of National Definitions of Critical Infrastructure .......................................... 11
Table 4. Industrial Sectors Included in National Critical Infrastructure Plans ............................. 12
Contacts
Author Contact Information ...................................................................................................... 24
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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 2009, foreign direct investment in the
United States had reached $2.3 trillion and U.S. direct investment abroad had reached $3.5
trillion, when direct investment is measured at historical cost. 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 have been reexamining some elements of this open-door policy and have
argued 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 an 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 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 over intervening
in the foreign investment process.
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, 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.
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Foreign Direct Investment in the United States
Foreigners invested $269 billion in U.S. businesses and real estate in 2009 and $325 billion in
2008, according to data published by the Department of Commerce,3 as Figure 1 shows. The
annual change in the value of foreign direct investment includes new investment and an upward
or downward valuation adjustment of existing investments. The decrease in foreign direct
investment flows in 2009 compared with 2008 mirrors a slowdown in global flows. According to
the United Nations’ World Investment Report, global foreign direct investment inflows decreased
by 16% in 2008 and 37% in 2009, reflecting the global economic recession and financial issues
related to the 2008-2009 financial crisis. Recent data indicate that global foreign direct
investment flows increased slightly in early 2010, marking the bottom of the global slump in
direct investment spending. According to the Department of Commerce, investment spending by
foreigners in 2009 compared with 2008 decreased as a result of a sharp drop in net equity capital,
associated with the drop in stock market values, a decrease in intercompany debt, but a rise in
reinvested earnings.4 The majority of investments were in the manufacturing sector; investments
also rose in the information sector and in the finance sector.
New spending by U.S. firms on businesses and real estate abroad, or U.S. direct investment
abroad,5 although substantial, fell sharply in 2009 compared to 2008. Net investments fell from
$332 billion in 2008 to $221 billion in 2009, according to the Department of Commerce.6 As
indicated in Figure 1, a drop in U.S. direct investment abroad that occurred 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).
3 Thomas, Sarah Scott, Erin M. Whitaker , U.S. International Transactions: Second Quarter of 2010. Survey of Current
Business, October 2010, p. 62. 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 Weinberg, Douglas B., Erin M. Whitaker, , U.S. International Transactions: Fourth Quarter and Year 2009, Survey of
Current Business, April 2010, p. 26-35.
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 Thomas, Sarah Scott, Erin M. Whitaker, , U.S. International Transactions: Second Quarter of 2010. Survey of Current
Business, October 2010, p. 62. 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.
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Figure 1. Foreign Direct Investment in the United States and U.S.
Direct Investment Abroad, Annual Flows, 1990-2009
Source: U.S. Department of Commerce.
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. In contrast, the decline in global foreign investment
spending in 2009 reflects the difficulties firms had raising funds for investment and the global
economic recession. The developed economies traditionally have absorbed about two-thirds of
global direct investment flows, but this share dropped to half in 2009, reflecting the differential
impact of the financial crisis which affected the developed economies more than the developing
economies. Africa continues to receive the smallest share, generally less than 5%, with Latin
America receiving about 10% and Asia getting about 27% in 2009 A recent study on investment
trends by the Organization for Economic Cooperation and Development (OECD) reported 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. Global foreign direct investment inflows
7 World Investment Report 2007, United Nations, July 2007, p. 5.
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decreased by 16% in 2008 and 37% in 2009. As a result, global foreign investment flows fell by
nearly half between 2007 when such investment recorded $2.1 trillion and 2009 when direct
investment was recorded at $1.1 trillion. The data indicate that global foreign direct investment
flows increased slightly in early 2010, marking the bottom of the global slump in direct
investment spending.
Table 1. Global Annual Inflows of Foreign Direct Investment, by Major Area
(in billions of dollars and percent shares)
2007
2008
2009
2007
2008
2009
Inflows of foreign direct investment
Share of annual foreign direct
investment inflows
(in billions of dollars)
(in percent)
World
$2,100.0 $1,770.9 $1,114.2
100.0% 100.0% 100.0%
Developed economies
1,444.1 1,018.3 565.9
68.8 57.5 50.8
Western
Europe
988.4 551.1 378.4 47.1 31.1 34.0
European Union
923.8
536.9
361.9
44.0
30.3
32.5
Other Western Europe
64.6
14.1
16.4
3.1
0.8
1.5
North America
374.4
379.8
148.5
17.8
21.4
13.3
United States
266.0
324.6
129.9
12.7
18.3
11.7
Other developed econ.
81.3
87.4
39.0
3.9
4.9
3.5
Developing economies
564.9 630.0 478.3 26.9 35.6 42.9
Africa
63.1 72.2 58.6 3.0 4.1 5.3
Latin America
163.6
183.2
116.6
7.8
10.3
10.5
Asia
338.2 374.6 303.2 16.1 21.2 27.2
Other Europe
91.0
122.6
69.9
4.3
6.9
6.3
Source: World Investment Report, 2010, United Nations. Annex table B.1, 2010.
Globally, the total, or cumulative, amount of foreign direct investment reached nearly $18 trillion
in 2009 (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 as a group not only are the largest recipient of investment funds, but
they are also the largest 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 $750
billion abroad through 2009, but had received $200 billion in investment inflows. Among the
developing economies, Asia, which includes China, had accumulated $3.0 trillion in direct
investment, followed by Latin America ($1.5 trillion) and Africa ($500 billion).
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Figure 2. Inward and Outward Global Direct Investment Position,
by Major Area, 2009
Source: United Nations.
By the end of 2008, there were about 2,200 U.S. parent companies with more than 26,000
affiliates operating abroad, as Table 2 indicates. In comparison, foreign firms had about 5,500
affiliates operating in the United States. U.S. parent companies employed over 21 million workers
in the United States, compared with the 11.9 million workers employed abroad by U.S. firms and
the 6 million persons employed in the United States by foreign firms. Although the U.S.-based
affiliates of foreign firms employ fewer workers than do 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 affiliates of foreign firms operating in the United States had a
higher value of gross product than did the foreign affiliates of U.S. parent companies. The foreign
affiliates of U.S. firms, however, 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 six times more in
taxes to foreign governments than did the affiliates of foreign firms operating in the United
States.
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Table 2. Select Data on U.S. Multinational Companies and on Foreign Firms
Operating in the United States, 2008
(in millions of dollars unless otherwise indicated)
U.S. Multinational Companies
Parent
U.S. Affiliates
Companies
Affiliates
of Foreign Firms
Number of firms
2,220
26,548
5,546
Employment (thousands)
21,003
11,879
6,279
Employee compensation
$1,373,115
$490,124
$451,984
Gross product
$2,396,288
$1,211,854
$1,726,681
Total assets
$16,841,239
$12,504,725
$12,666,896
Sales $8,727,800
$6,107,864
$3,819,986
Taxes $165,028
$195,100
$33,398
R&D Expenditures
NA
$36,991
$44,713
Source: U.S. Direct Investment Abroad: Operations of U.S. Parent Companies and Their Foreign Affiliates, Preliminary
2008 Estimates; and Foreign Direct Investment in the United States: Operations of U.S. Affiliates of Foreign Companies,
Preliminary 2008 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 $2.4 trillion in goods and
services in 2008, down slightly from the $2.6 trillion dollars they produced in 2007. 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),8 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.9 For the most part, such restrictions apply to mergers, acquisitions, and
takeovers of existing firms and not generally to new establishments. These actions, in turn, have
raised concerns among the members of such organizations as the OECD,10 which promotes the
concept of liberalized government restrictions on the free flow of international investment.
8 For additional information, see CRS Report RL34336, Sovereign Wealth Funds: Background and Policy Issues for
Congress, by Martin A. Weiss.
9 World Investment Report, 2007, p. 14.
10 For additional information, see CRS Report RS21128, The Organization for Economic Cooperation and
(continued...)
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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.”11
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.”12 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.
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 takeovers 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,
(...continued)
Development, by James K. Jackson.
11 International Investment Perspectives: Freedom of Investment in a Changing World, 207 Edition, Organization for
Economic Cooperation and Development, 2007, p. 105.
12 Ibid., p. 100.
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policies directed at reviewing foreign direct investments are best described as precautionary
measures.13 In this report, the national security threats posed by mergers, acquisition, or takeovers
do not include overt acts of transnational terrorism that are meant to dissuade foreign capital
inflows.14 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.”15 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.16
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 13 rounds of meetings, including the latest one held in
October 2010, members17 of the investment project have agreed to support three principles for
national investment policy measures that address essential security interests: (1) transparency and
predictability;18 (2) proportionality;19 and (3) accountability. Proportionality refers to the concept
that restrictions on foreign investment should be no greater than is needed to protect national
security. In June 2007 at the annual summit of the Group of Eight20 (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
13 Friedman, Benjamin H., The Terrible ‘Ifs’, Regulation, Winter 2007/2008, pp. 32-40.
14 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.
15 Freedom of Investment, National Security and “Strategic” Industries: Progress Report by the OECD Investment
Committee. Organization for Economic Cooperation and Development, April 2008; Eighth Roundtable on Freedom of
Investment, National Security and “Strategic” Industries, OECD, October 8, 2008.
16 International Investment Perspectives, p. 55.
17 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.
18 Transparency and Predictability for Investment Policies Addressing National Security Concerns: A Survey of
Practices. Organization for Economic Cooperation and Development, May 2008.
19 Proportionality of Security-Related Investment Instruments: A Survey of Practices. Organization for Economic
Cooperation and Development, May 2008.
20 The Group of Eight nations includes Canada, France, Germany, Italy, Japan, Russia, the United Kingdom, and the
United States.
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predictability. In any case, restrictive measures should not exceed the necessary scope,
intensity and duration.21
The OECD project on investment issued its final report in mid-2009 titled, “Building Trust and
Confidence in International Investment,” which included 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. So far, a number of OECD nations,
including the United States, have adjusted their national laws to have them conform to the
recommendations of the OECD’s final report. At the Toronto Summit of the G-20 nations in June
2010, the members tasked the OECD with reporting on the trade and investment measures of the
G-20 members. The recent OECD report indicated that G-20 members had resisted protectionist
pressures and had taken measures aimed at facilitating and encouraging investment flows, but
none of the OECD members had not adopted new restrictions on foreign investment related t
national security.22 The OECD members 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.
• 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.
21 Growth and Responsibility in the World Economy, G8 Summit Declaration, June 7, 2007. Paragraphs 10 and 11.
22 Fourth Report on G-20 Investment Measures, Organization for Economic Cooperation and Development, November
2010.
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• 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.23 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 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.
23 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.
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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, political and social life of the UK
Kingdom
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 systems and assets, whether
States
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.
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.24 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
24 Protection of Critical Infrastructure and the Role of Investment Policies Relating to National Security, p. 6.
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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.25
Table 4. Industrial Sectors Included in National Critical Infrastructure Plans
United
United
European
Sector Australia
Canada
Netherlands
Kingdom
States
Union
Energy (including
X X X X
X
X
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 industrial
X X X
X
base
Other sectors or
Public
Legal/
judicial Dams,
Space and
activities
gatherings,
commercial
research
national icons
facilities, national
facilities
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.
25 Ibid., p. 8.
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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 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.26
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 takeovers 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.27
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.
Exxon-Florio and CFIUS
The second category of restrictions, characterized by such approval procedures as the Exxon-
Florio provision, applies to foreign investment in existing U.S. firms through mergers,
acquisitions, or takeovers, but does not apply to foreign investors who establish new businesses.
In 1988, Congress approved the Exxon-Florio provision28 as part of the Omnibus Trade Act.29 The
Exxon-Florio provision grants the President broad discretionary authority to take what action he
26 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.
27 Seitzinger, Foreign Investment in the United States: Major Federal Restrictions.
28 For additional information, see CRS Report RL33312, The Exon-Florio National Security Test for Foreign
Investment, by James K. Jackson.
29 P.L. 100-418, title V, Subtitle A, Part II, or 50 U.S.C. app 2170.
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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 Exxon-Florio provision does not define national
security, because Congress meant to have the term interpreted broadly. Nevertheless, regulations
developed by the Treasury Department to implement the law direct the members of the
Committee on Foreign Investment in the United States (CFIUS)30 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.”31 The
Committee is an interagency organization that serves the President in overseeing the national
security implications of foreign investment in the economy.
The Exxon-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 Exxon-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.32
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 Exxon-
Florio provision. This change in attitude became apparent in 2006 as a result of the public
disclosure that Dubai Ports World33 was attempting to purchase the British-owned P&O Ports,34
30 For additional information, see CRS Report RL33388, The Committee on Foreign Investment in the United States
(CFIUS), by James K. Jackson.
31 Ibid.
32 Senate Armed Services Committee, Briefing on the Dubai Ports World Ports Deal, February 23, 2006.
33 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 with operations in the Middle East, India,
Europe, Asia, Latin America, the Caribbean, and North America.
34 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
(continued...)
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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).35 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.36
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,37 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.”38 The following year, Congress transferred the responsibility for
identifying critical infrastructure to the Department of Homeland Security (DHS) through the
Homeland Security Act of 2002.39 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.”40
Through a series of Directives, the Department of Homeland Security identified 17 sectors41 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 agencies, which are
designated as Sector-Specific Agencies (SSAs).42 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
(...continued)
presence in 18 countries.
35 P.L. 107-56, title X, Sec. 1014, October 26, 2001; 42 U.S.C. Sec. 5195c(e).
36 Ibid.
37 42 U.S.C. Sec. 5195c(b)(2).
38 42 U.S.C. Sec. 5195c(b)(3).
39 P.L. 107-296, Sec. 2, November 25, 2002; 6 U.S.C. Sec. 101.
40 6 U.S.C. Sec. 101(9).
41 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.
42 Sector-Specific Agencies include the Departments of: Agriculture, Defense, Energy, Health and Human Services,
Homeland Security, Interior, Treasury, and the Environmental Protection Agency.
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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 Exxon-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 2007.43 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 Exxon-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.
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.44 The statement offered strong support for the international flow of direct
investment. In part, the statement reads:
43 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.
44 President Bush’s statement is available at http://georgewbush-whitehouse.archives.gov/news/releases/2007/05/
(continued...)
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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 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.45 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
(...continued)
20070510-2.html.
45 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.
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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 specialty 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.
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, specialty 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
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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 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.46 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
46 International Investment Perspectives, p. 54-63.
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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.
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 misallocation 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
misallocation of resources. While mergers, acquisitions, or takeovers 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
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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 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
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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 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
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economic costs and benefits of national policies that attempt to direct or restrict foreign direct
investment for national security concerns. Also, it can be difficult 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.
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,
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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.
Author Contact Information
James K. Jackson
Specialist in International Trade and Finance
jjackson@crs.loc.gov, 7-7751
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