United States General Accounting Office

GAO Report to the Chairman, Committee on

National Security, House of

Representatives

April 1996 FOREIGN

INVESTMENT

Foreign Laws and

Policies Addressing

National Security

Concerns

G O A

years

1921 - 1996

GAO/NSIAD-96-61

GAO United States

General Accounting Office

Washington, D.C. 20548

National Security and

International Affairs Division

B-270033 

April 2, 1996

The Honorable Floyd Spence

Chairman, Committee on National Security

House of Representatives

Dear Mr. Chairman:

In a prior report to you,1

 we examined implementation of the Exon-Florio

legislation2

 and related amendments by the interagency group, the

Committee on Foreign Investment in the United States (CFIUS). This

legislation authorizes the President to suspend or prohibit foreign

acquisitions, mergers, or takeovers of U.S. companies when there is

credible evidence that a foreign controlling interest might threaten

national security and other legislation cannot provide adequate protection.

As agreed with your office, for comparative purposes, we undertook a

follow-on effort examining how other countries monitor foreign direct

investment in their national security-related industries.3

 We compared the

Exon-Florio legislation with the laws of four major investors in the United

States—Japan, France, Germany, and the United Kingdom. Specifically,

we focused on (1) the legal framework governing foreign direct

investments posing potential national security concerns, (2) the barriers

and incentives for U.S. companies to invest in these countries’ national

security-related industries, and (3) the U.S. companies’ business activities

in response to these barriers or incentives. In addressing the second and

third objectives, we focused on the defense industry because it has the

most direct link to a country’s national security. Details on our scope and

methodology are presented in appendix I.

Results in Brief Japan, France, Germany, and the United Kingdom each have the authority

to block investments for national security reasons, as does the United

States. However, all five countries have infrequently used this authority in

recent years. Some of these countries have established processes for

reviewing foreign investment for national security concerns. Japan and

1

Foreign Investment: Implementation of the Exon-Florio and Related Amendments (GAO/NSIAD-96-12,

Dec. 21, 1995).

2

The Exon-Florio legislation was a provision of the Omnibus Trade and Competitiveness Act of 1988

and is part of the Defense Production Act of 1950, 50 U.S.C. app. 2170.

3

For the purposes of this report, national security-related industries include—but are not limited

to—companies that have defense contracts or make defense sales.

Page 1 GAO/NSIAD-96-61 Foreign Investment
B-270033 

France review certain foreign direct investments for national security and

other concerns. Germany and the United Kingdom have no general

screening authority that explicitly considers national security issues

related to foreign investment, but the United Kingdom can consider harm

to public interest in its antitrust review process.

U.S. defense company officials we interviewed said they had not pursued

defense-related direct investment in Japan, France, Germany, or the

United Kingdom because of basic economic factors such as the size of the

defense markets in these countries, as well as informal barriers, such as

domestic company ownership structures. The officials said that such

factors could be more important considerations in some countries than

the legal framework. Most countries offer investment incentives, but U.S.

defense company officials did not cite these as a major reason for

investing.

U.S. defense company officials said they were pursuing access to overseas

defense markets through strategies other than foreign direct investment.

For example, U.S. defense companies either licensed technology to

Japanese companies or made direct sales to Japan. In the three European

countries, U.S. companies formed partnerships to compete for particular

projects.

Background International mergers and acquisitions have increased in recent years,

returning to the high levels of activity that characterized the late 1980s.

Cross-border mergers in Europe in 1994 were almost double the level of

1993 in value terms. U.S. firms were the most active buyers in Europe.

Similarly in the United States, foreign companies significantly increased

their investment activity. However, Japanese companies decreased their

overseas acquisitions in the first half of 1994.

According to the Organization for Economic Cooperation and

Development (OECD),4

 total foreign direct investment5 inflows and

outflows among member countries have increased in recent years. OECD

reported that inflows grew by almost 60 percent for selected countries

while outflows grew by 14 percent in the 1993-94 time period. The growth

4

OECD is a forum for monitoring economic trends and coordinating economic policy among its 

26 member countries, which include the economically developed free market democracies of North

America, Western Europe, and the Pacific.

5

The OECD definition of foreign direct investment is capital invested for the purpose of acquiring a

lasting interest in an enterprise and exerting a degree of influence on that enterprise’s operations.

Page 2 GAO/NSIAD-96-61 Foreign Investment
B-270033 

of inflows is largely attributable to massive inflows into the United States.

However, there is a significant variation in flows across individual

countries, as shown in figure l.

Figure 1: Foreign Direct Investment

Inflows and Outflows, 1994

United States

Japan

France

Germany

United Kingdom

0 10 20 30 40 50 60

U.S. dollars in billions

Outflows Inflows

Source: Recent Trends in Foreign Direct Investment, OECD, April 3, 1995. U.S. data from Survey

of Current Business, U.S. Department of Commerce, August 1995.

Defense Industry Activities In the defense industry, company business activities have been affected by

declining defense budgets. As shown in figure 2, France, Germany, the

United Kingdom, and the United States have decreased their defense

budgets in real terms over recent years. In contrast, Japan’s defense

budget has been increasing but at a decreasing rate, from a 3.8-percent

increase between 1990 and 1991 to a 0.9-percent increase between 1993

and 1994.

Page 3 GAO/NSIAD-96-61 Foreign Investment
B-270033 

Figure 2: Trends in Defense Budgets for Selected Countries, 1990-95a

1990 1991 1992 1993 1994 1995

60

70

80

90

100

110

120

60

70

80

90

100

110

120

Fiscal year

Percentage of 1990 budget

United States

Germany

France

United Kingdom

Japan

Source: GAO analysis based on The Military Balance, 1990-96, International Institute for Strategic

Studies.

aThe data are adjusted for inflation and indexed using 1990 as the base year.

Given declining defense budgets, most defense firms worldwide are

consolidating to improve competitiveness. U.S. defense firms have

pursued consolidation within the United States to downsize and reduce

overcapacity. To a certain extent, some of the European countries have

contracted and restructured their individual defense industries. Germany

and the United Kingdom, in particular, have encouraged numerous defense

manufacturers to consolidate into unified conglomerates or “national

champions.” In contrast, French defense companies have consolidated

more slowly. Mergers and acquisitions are uncommon in Japan’s defense

industry, which is restructuring by such means as shifting resources away

Page 4 GAO/NSIAD-96-61 Foreign Investment
B-270033 

from defense production into commercial sectors and reducing production

lines.

According to the Center for Strategic and Budgetary Assessments,6

cross-border defense mergers, acquisitions, and joint ventures have been

largely intra-European, as shown in figure 3. Transatlantic defense

investment activity has been characterized by European acquisitions of

U.S. companies rather than U.S. acquisitions of European companies. Few

U.S. companies are acquiring Japanese companies. The Center for

Strategic and Budgetary Assessments also reports that foreign acquisitions

occurring in Japan are between companies only marginally engaged in

defense work.

Figure 3: U.S.-European Cross-Border Defense Mergers, Acquisitions, and Joint Ventures

Joint Ventures

Intra-European

Transatlantic

Defense Mergers and Acquisitions

Intra-European

Europe-led 

U.S.-led

Source: Center for Strategic and Budgetary Assessments.

Note: Europe-led and U.S.-led refer to transatlantic mergers and acquisitions.

6

The Center for Strategic and Budgetary Assessments (formerly the Defense Budget Project) is an

independent research organization that analyzes national security policies and defense budgets.

Page 5 GAO/NSIAD-96-61 Foreign Investment
B-270033 

International Agreements

With Provisions Affecting

National Security

Agreements among countries have widely recognized the right of

sovereign nations to take measures protecting their essential national

security interests. For example, article 223 of the Treaty of Rome7

 states in

part that European member nations may take measures “necessary for the

protection of the essential interest of its security which are connected

with the production of or trade in arms, munitions and war material.” This

article essentially allows national governments to suspend European

Union free trade and competition rules on the grounds of national

security. Also, OECD’s main foreign direct investment instruments, the

National Treatment Instrument and Codes of Liberalization, recognize that

countries can take actions based on essential security or other interests.

In September 1995, OECD began negotiating a multilateral agreement on

investment. This agreement is intended to develop high standards for

liberalization of foreign direct investment regimes and investment

protection and to include effective dispute settlement. Exceptions to the

investment principles will be negotiated. According to some experts, one

exception will permit each member country to exempt certain industries

or sectors from the agreement commitments due to national security

concerns.

Broad Authority

Exists to Block

Investments for

National Security

Reasons

The Exon-Florio legislation grants the President of the United States the

authority to take appropriate action to suspend or prohibit foreign

acquisitions, mergers, or takeovers of U.S. businesses that threaten to

impair the national security. To exercise this authority, the President must

find that (1) credible evidence exists that the foreign interest exercising

control might take action that threatens to impair national security and

(2) provisions of law, other than the Exon-Florio legislation and the

International Emergency Economic Powers Act, do not provide adequate

authority to protect the national security. Since the enactment of the

legislation in 1988, the President has used this authority once when

ordering divestiture of a Chinese company’s acquisition of a U.S. aircraft

parts company.

Japan, France, Germany, and the United Kingdom do not have laws

directly analogous to the Exon-Florio legislation, but nevertheless have

broad legislative authority to block foreign investments for reasons of

national security or national interest. For example, the Japanese and

French laws provide the governments broad powers to block investments

that might imperil national security, public order, and public safety. The

7

The Treaty of Rome established the European Economic Community.

Page 6 GAO/NSIAD-96-61 Foreign Investment
B-270033 

Japanese government has not invoked this authority in recent years while

the French government has restricted nine investments in the past several

years.8

 Germany’s law also permits restriction of private investment flows

in either direction for balance of trade considerations and foreign policy,

public order, and national security reasons, but such restrictions have not

been used to date. The United Kingdom has never used its broad

discretionary power to block foreign investments for national interest. The

legal investment frameworks of Japan, France, Germany, and the United

Kingdom are discussed in appendixes II, III, IV, and V, respectively.

In the United States, the President designated CFIUS as responsible for

reviewing foreign investment transactions. Although notifications are

voluntary, CFIUS retains the right to review at any time any acquisition not

notified to the Committee. The Exon-Florio regulations also permit a CFIUS

member to submit a notice of a proposed or completed acquisition for a

national security review. A CFIUS determination that there are no national

security issues essentially eliminates the risk that the President will at a

later time block the transaction or order a divestiture.9

Each of the countries we examined has a reviewing mechanism that

differs in focus from CFIUS. Japan and France both have a formal process in

which foreign investments are reviewed for several reasons, including

public order, public safety, and national security. The United Kingdom and

Germany have no general screening authority that explicitly considers

national security issues related to foreign investment.10 However, as do

many other nations, the United Kingdom and Germany have antitrust

screening mechanisms. The United Kingdom, through its antitrust process,

may make determinations based on harm to public interest. Germany’s

antitrust review mechanism does not screen for adverse impact on

national security, but antitrust decisions against a merger may be

overturned if the merger is considered to be in the public interest.

As shown in table 1, similarities and differences exist among the CFIUS

process and selected reviewing mechanisms in Japan and France. For

example, CFIUS and the other countries’ reviewing entities are similar in

that they perform case-by-case evaluations. These reviews have resulted in

8

According to French government officials, none of the transactions were blocked for national security

reasons. The French government blocked the transactions for public order reasons.

9

The Exon-Florio regulations allow CFIUS to reopen its consideration of a transaction if parties fail to

provide material information or submit false or misleading information.

10In one case involving the foreign acquisition of a German defense company, the German federal

government established an ad hoc review committee to examine the terms of the transactions and

possible national security implications.

Page 7 GAO/NSIAD-96-61 Foreign Investment
B-270033 

few denied transactions based on national security concerns. However,

significant differences exist among the reviewing mechanisms. Japan and

France review foreign investments for national security and other reasons.

While transactions are voluntarily notified to CFIUS, the two countries’

reviewing mechanisms require mandatory notification for transactions

meeting certain criteria. Also, Japan and France have a judicial appeal

process, unlike the United States.

Table 1: Selected Countries’ Foreign Investment Reviewing Mechanismsa

Characteristics of

reviewing mechanisms United States Japan Franceb

Reason for reviewing National security. National security, public

order, public safety, and

economy.

Public order, health, or security; public functions;

research, production, or trade in arms, ammunition,

explosive powders and substances destined for

military use or wartime equipment.

Reviewing body CFIUS. Ministry of Finance and

Ministry in charge of

industry.

Ministry of Economics and Finance, consulting with

Ministries of Industry and Defense.

Notification Voluntary. Mandatory. Mandatory.

Review time Thirty-day review;

45-day investigation;

15-day presidential

review for cases

investigated.

Thirty days; can be

extended up to 5 months.

Up to 1 month, unless postponement rights are

exercised.

Judicial appeal No. Yes. Yes.

Case-by-case evaluation Yes. Yes. Yes.

Outcomes and time frame Fifteen cases

investigated since 1988;

President blocked 1 case.

None since 1992 law

revisions.

Eight rejected in 1992-93 and one in 1994 for public

order reasons.

aGermany and the United Kingdom are not included in the table because neither country has a

foreign investment specific review mechanism that can consider national security implications.

bThe French government changed its foreign investment law in February 1996 to abolish prior

authorization of non-European investments meeting certain French franc thresholds. However,

prior authorization is still required for all foreign investments in French entities carrying out public

functions or activities that may affect public health, order, or security, or for investments involving

research, production or trade in arms, ammunition, explosive powders and substances destined

for military use or wartime equipment.

Source: GAO analysis.

Limitations Reported to

OECD

All five countries impose some type of sectoral restrictions on foreign

direct investment that are notified to OECD. For example, the five countries

impose similar restrictions on maritime transport. OECD members also

Page 8 GAO/NSIAD-96-61 Foreign Investment
B-270033 

report measures based on public order and essential security interests that

are considered limitations to the National Treatment Instrument.11 Of the

five countries, only Germany reported no limitations for essential security

interests. Table 2 shows the national treatment limitations that affect

defense or national security-related areas in our selected countries.

Table 2: Selected Public Order and Essential Security-Related Measures Reported to OECD

Country

Foreign investment measures based on

essential security considerations

Government purchasing measures

based on essential security

considerations Other related measures

United States The Exon-Florio legislation provides the

President power to block foreign

acquisitions that threaten to impair national

security.

Foreign controlled enterprises may not be

granted a contract or subcontract involving

classified information, except under special

arrangements determined on a

case-by-case basis.

None.

Japan Specific investment plans of foreign

controlled enterprises could be altered or

suspended when national security, public

order, or public safety is deemed

threatened in such industrial sectors as

aircraft, arms, explosives, nuclear energy,

and space.

None. None.

France National treatment is not applicable to

enterprises whose activities are directly or

indirectly related to national defense and

armaments. The government reserves the

right to apply conditions on the creation,

extension, or conduct of business

enterprises under foreign control or to

obtain guarantees.

Preference is accorded to locally owned

firms in procurement for the armed forces

with regard to items for military purposes.

None.

Germany None. None. None.

United Kingdom British Aerospace PLC and Rolls Royce

PLC restrict the number of foreign-held

shares at any one time to 29.5 percent of

the ordinary voting equity. The articles of

association also provide citizenship

requirements for the directors.

In a limited number of cases,

foreign-controlled enterprises may not be

granted defense procurement contracts

where overriding security reasons apply.

Certain citizenship

requirements for

ex-Plessy companies

engaged in classified

work. VSEL Consortium

PLC has citizenship

requirements for certain

executives. There is also

a veto over disposal of

company assets.

Source: National Treatment for Foreign Controlled Enterprises, OECD, 1993.

11This instrument is a nonbinding agreement. It provides that OECD member countries will apply the

same laws, regulations, and administrative practices to foreign-owned companies as would apply to

domestic investors in like situations. Member countries must notify OECD of all measures constituting

exceptions to this principle.

Page 9 GAO/NSIAD-96-61 Foreign Investment
B-270033 

Economic Conditions

and Informal Barriers

Influence Investment

Decisions

Fundamental economic conditions and informal barriers to doing business

in the selected countries can be important determinants of whether U.S.

firms pursue foreign direct investment options. Officials at many of the

U.S. defense companies we interviewed were not planning to invest

abroad because of the relatively small size of the countries’ defense

markets. They frequently cited basic economic factors and informal

barriers, such as high land prices or domestic company ownership

structures, as more important to their evaluation of investment options

than the legal framework. Furthermore, the officials said that governments

offer some incentives to invest, such as tax breaks, but these are not a

significant factor in making investment decisions.

Some U.S. defense company officials we interviewed said the size of the

defense markets in the four countries often did not justify major equity

investments. For example, the German and British defense budgets are

declining, which can make it less attractive for U.S companies. Although

the Japanese government has one of the larger defense budgets, it has a

comparatively smaller equipment acquisition budget. As shown in figure 4,

the U.S. defense budget was larger than those of the other countries

reviewed.

Page 10 GAO/NSIAD-96-61 Foreign Investment
B-270033 

Figure 4: Defense Budgets for

Selected Countries, 1995a

United States

Japan

France

Germany

United Kingdom

0 50 100 150 200 250 300

U.S. dollars in billions

Source: The Military Balance, 1995-96, International Institute for Strategic Studies.

aThe data is not adjusted for inflation.

U.S. defense and commercial companies are affected by the business

environment overseas. In weighing decisions to invest abroad, U.S.

company officials we interviewed said certain economic or social

conditions can serve as disincentives. For example, companies established

in France and Germany face strict labor practices and cannot lay off

workers easily. In Japan, obstacles to doing business include labor costs,

the tax burden, and high rent and land costs. Such factors make

investment expensive and can affect the profit margins of established

companies in these countries.

U.S. defense company officials we interviewed indicated company

ownership structures can deter foreign direct investment. For example,

extensive cross-shareholdings between businesses and large institutions

exist in both Germany and Japan, which serve the long-term investment

needs of domestic companies and discourage foreign investors. In France,

the government has majority ownership of most of the major defense

Page 11 GAO/NSIAD-96-61 Foreign Investment
B-270033 

companies and significant influence over other private defense-related

companies. Unlike France, the United Kingdom has largely privatized most

companies since 1979. However, the British government retains “golden

shares,” or special consent rights, in certain privatized companies. This

may include placing limits on foreign ownership as with British Aerospace

PLC and Rolls Royce PLC.

Each of the countries has incentives to offer foreign investors, but these

incentives played a limited role in influencing the investment decisions of

the U.S. defense company officials we interviewed. Most of the countries

offer some form of a tax incentive, low interest loan, or subsidy. Regional

incentives exist to attract foreign investors to certain geographic areas.

However, none of these investment incentives are defense specific.

Given the defense investment climate and economic conditions, many U.S.

defense company officials we interviewed did not view foreign direct

investment as an essential part of their strategy. However, some

investments have been made. For example, General Electric and the

French company, SNECMA, collaborated for over 20 years on the CFM-56

jet engine for commercial aircraft and established an equity joint venture

in 1974 to supply propulsion systems. In 1993, BDM International, Inc.,

invested in the German company, IABG, which conducts aerospace testing

and military and environmental studies.

Defense Companies

Pursue Other

Strategies to Gain

Market Access

To gain market access, U.S. defense companies are largely seeking

project-by-project business arrangements with European companies or

selling in niche markets. These arrangements can be less expensive for

U.S. companies to pursue compared to capital intensive equity

investments. Some U.S. company officials said that having relationships

with European partners is helpful because they offer knowledge of the

regulatory environment. Successful partnerships include McDonnell

Douglas and Westland Helicopters to produce Apache helicopters for the

British Ministry of Defense. E-Systems joined with three German

companies in developing the Senior Guardian recognizance program.

Motorola, through a French distributor, sells certain electronic products in

French niche markets, where the principal French defense electronics

manufacturer Thomson-CSF is not present.

In contrast with the European business arrangements, U.S. defense

companies export defense products and license technology from the

United States rather than make capital investments in Japan. This strategy

Page 12 GAO/NSIAD-96-61 Foreign Investment
B-270033 

is more advantageous to pursue because direct investment in Japan is

expensive. For example, Hughes Aircraft is licensing its radar technology

to a Japanese company for Japan’s F-15s. Also, Japan has obtained

technology and items from U.S. firms for the FS-X program.12 The U.S.

Department of State had approved over 500 FS-X munitions export

licenses by March 1994. Most of these licenses covered hardware for the

development and production of the prototype aircraft.

Agency Comments The Departments of the Treasury, Commerce, State, and Defense and the

Office of the United States Trade Representative generally agreed with our

draft report and provided minor technical comments. The Department of

Commerce, in official oral comments, said the draft report is an accurate

and balanced representation of the facts. The Office of the United States

Trade Representative, also in official oral comments, said that the report

will be useful for the ongoing multilateral agreement on investment

negotiations.

Officials from Japan, France, Germany, and the United Kingdom reviewed

the appendix corresponding to their country. Most of these officials

provided updated data or technical comments to the appendixes. We

incorporated their comments where appropriate.

We are sending copies of this report to interested congressional

committees and to the Secretaries of the Treasury, Commerce, State, and

Defense; the United States Trade Representative; and the Director, Office

of Management and Budget. We are also making copies available to other

interested parties upon request.

12For more information on the FS-X program, see our report entitled U.S.-Japan Cooperative

Development: Progress on the FS-X Program Enhances Japanese Aerospace Capabilities

(GAO/NSIAD-95-145, Aug. 11, 1995).

Page 13 GAO/NSIAD-96-61 Foreign Investment
B-270033 

Please contact me at (202) 512-4841 if you or your staff have any questions

concerning this report. Major contributors to this report are listed in

appendix VI.

Sincerely yours,

David E. Cooper

Associate Director,

Defense Acquisition Issues

Page 14 GAO/NSIAD-96-61 Foreign Investment
Page 15 GAO/NSIAD-96-61 Foreign Investment
Contents

Letter 1

Appendix I 

Scope and

Methodology

18

Appendix II 

Japan

20

Background 20

Legal Framework Exists for Reviewing and Blocking Foreign

Investments

21

Economic Factors and Indirect Barriers Inhibit Investment 23

Incentives Have Little Impact on Investment Decisions 25

U.S. Companies Obtain Access to Japan’s Defense Market

Through Approaches Other Than Direct Investment

26

Appendix III 

France

27

Background 27

Legal Framework Exists for Reviewing Foreign Direct

Investment

28

Indirect Barriers Hinder Foreign Direct Investment 30

Incentives Are Not Attractive to U.S. Defense Companies 32

Teaming Arrangements Are an Alternative to Foreign Direct

Investment

32

Appendix IV 

Germany

33

Background 33

Legal Authority, but No Framework Exists for Restricting

Foreign Direct Investment

33

Economic Factors and Government Requirements Impede

Investment in National Security-Related Industries

36

Incentives to Invest Are Too Limited to Attract U.S. Defense

Companies

37

U.S. Defense Companies Use Other Means to Obtain Market

Access in Germany

38

Appendix V 

United Kingdom

39

Background 39

Legal Framework Can Consider National Security Issues 40

Page 16 GAO/NSIAD-96-61 Foreign Investment
Contents

Government Involvement May Inhibit Foreign Direct Investment

in Some U.K. Companies

41

United Kingdom Offers Investment Incentives 42

U.S. Companies Use Approaches to Defense Procurement Other

Than Foreign Direct Investment

42

Appendix VI 

Major Contributors to

This Report

43

Tables Table 1: Selected Countries’ Foreign Investment Reviewing

Mechanisms

8

Table 2: Selected Public Order and Essential Security-Related

Measures Reported to OECD

9

Table III.1: French Defense Company Revenues and Ownership

as of 1993

31

Figures Figure 1: Foreign Direct Investment Inflows and Outflows, 1994 3

Figure 2: Trends in Defense Budgets for Selected Countries,

1990-95

4

Figure 3: U.S.-European Cross-Border Defense Mergers,

Acquisitions, and Joint Ventures

5

Figure 4: Defense Budgets for Selected Countries, 1995 11

Abbreviations

CFIUS Committee on Foreign Investment in the United States

FECL Foreign Exchange and Foreign Trade Control Law

MITI Ministry of International Trade and Industry

OECD Organization for Economic Cooperation and Development

Page 17 GAO/NSIAD-96-61 Foreign Investment
Appendix I 

Scope and Methodology

This report is a follow-on from our report that examined U.S. procedures

for reviewing foreign investment in U.S. national security-related

industries. We selected Japan, France, Germany, and the United Kingdom

to review because these four countries reported most frequently to the

Committee on Foreign Investment in the United States (CFIUS).

During our review, we interviewed many government officials. Within the

U.S. government, we interviewed officials from the Departments of the

Treasury, Commerce, State, and Defense; the Office of the U.S. Trade

Representative; and U.S. embassies in Japan, France, Germany, and the

United Kingdom. We also interviewed officials from the embassies of

France, Germany, and the United Kingdom in Washington, D.C.. We also

met with foreign government officials in the four countries, as follows:

• Japan

• Ministry of Finance,

• Ministry of International Trade and Industry, and

• Ministry of Posts and Telecommunications.

• France

• Ministry of Economics and Finance,

• Ministry of Industry, and

• Ministry of Defense.

• Germany

• Ministry of Finance,

• Ministry of Economics, and

• Ministry of Defense.

• United Kingdom

• Ministry of Trade and Industry,

• Ministry of Defense, and

• the Central Statistical Office.

While in France, we also interviewed officials from the Organization for

Economic Cooperation and Development (OECD) and the U.S. Mission to

OECD to discuss matters pertaining to various OECD instruments and the

ongoing negotiations on the Multilateral Agreement on Investment. In

addition, we interviewed officials at the European Commission and the

U.S. Mission to the European Union in Belgium to obtain their views on

European Union competencies in mergers and acquisitions and defense

issues.

To compare the legal frameworks of the four countries with the U.S.

Exon-Florio legislation, we reviewed (1) the laws in the original language,

Page 18 GAO/NSIAD-96-61 Foreign Investment
Appendix I 

Scope and Methodology

(2) translations of the laws and regulations, or (3) summaries of the laws

and regulations pertaining to foreign direct investment in each of the four

countries. In addition, we discussed our understanding of the laws with

the relevant government officials in each country. We also reviewed legal

journal articles that addressed the same issues.

To obtain information on the regulatory framework and the barriers and

incentives to investment and U.S. business activities in each country, we

interviewed representatives from industry associations, chambers of

commerce, research and educational institutions, and U.S. and foreign

embassies. We also interviewed officials from 20 U.S. companies that sell

defense-related products and officials from the North Atlantic Treaty

Organization and the Western European Union about opportunities for

U.S. defense companies to invest in Europe. We also conducted literature

searches for relevant information and reviewed documents from various

representatives and officials.

Our work was limited in two ways. First, we did not select a random

sample of companies; instead, we selected companies on the basis of the

type of business investment and the willingness of company officials to

speak with us. Therefore, we cannot make any statistically significant

conclusions based on our interviews. Second, we could not obtain data

concerning the number of U.S. direct investments in the defense industries

of these countries because U.S. government sources gather the data

according to industrial categories in which defense is subsumed. Instead,

we obtained defense investment data from the Center for Strategic and

Budgetary Assessments, which maintains a globalization database that

contains over 1,050 entries on international collaborative arms activities,

including defense mergers, acquisitions, and joint ventures. We did not

verify the information in the database.

We conducted our review between March and December 1995 in

accordance with generally accepted government auditing standards.

Page 19 GAO/NSIAD-96-61 Foreign Investment
Appendix II 

Japan

Japan’s Foreign Exchange and Foreign Trade Control Law (FECL) is the

primary law pertaining to foreign direct investment and provides the

authority to block or restructure an investment. This law requires prior

notification of a proposed investment in certain industries so that the

Ministry of Finance and other ministries may review the proposed

investment to determine whether the investment might adversely affect

national security, public order, public safety, or the Japanese economy.

This authority, however, has not been used at least since 1992 because

(1) foreign investors informally consult with the ministries before formal

notification and (2) the ministries use administrative guidance1

 to affect

any potential investments. Indirect barriers and economic conditions, such

as the structure of Japan’s defense industry and the high cost of doing

business in Japan, discourage foreign investment in Japan, rather than

Japanese legal restrictions. Instead of foreign direct investment, U.S.

defense companies prefer to license technology to Japanese companies or

export directly to Japan.

Background Foreign direct investment in Japan is small compared to investment in the

other countries we reviewed. Japan received about 0.7 percent of all OECD

foreign direct investment inflows from 1971 to 1990, even though Japan’s

economy is the second largest in the world. Japan’s largest investor is the

United States, which accounted for 42 percent of all foreign direct

investment in Japan by the end of March 1992. However, the dollar value

of U.S. direct investment in Japan is small compared to Japanese direct

investment in the United States. As of 1994, U.S. direct investment in Japan

reached $37 billion, whereas Japanese direct investment in the United

States reached $103.1 billion, according to the U.S. Department of

Commerce.2

Japan’s overall defense budget is not declining, unlike most other major

economic powers. Japan’s defense budget has been growing for the past 

5 years, although at a steadily decreasing rate. The budget increased in real

terms 3.8 percent between 1990 and 1991, but by 1994, the budget

increased 0.9 percent from the 1993 level. However, Japan’s defense

acquisition budget has been declining for several years. From fiscal year

1

Administrative guidance refers to the suggestions or “unwritten orders” given by Japanese

government officials to firms to implement official policies. It is based on the broad discretionary

power of the bureaucracy rather than on specific laws.

2

Some experts argue that U.S. investments in Japan are undervalued. Nonetheless, they agree that U.S.

investments in Japan are much smaller than Japanese investments in the United States.

Page 20 GAO/NSIAD-96-61 Foreign Investment
Appendix II 

Japan

19913 until fiscal year 1994, Japan’s acquisition expenditures fell

17.9 percent. As Japan’s defense industry depends on sales to the Japan

Defense Agency, the industry is experiencing economic difficulty. The

Japan Defense Agency stated in a 1994 report that the defense industry is

in a harsh environment because of the declining acquisition expenditures

and economic depression.

Japan’s defense industry plays a small role in its economy, accounting for

about 0.6 percent of Japan’s total industrial production. Defense contracts

are heavily concentrated among a few companies. In fact, the top 

10 defense contractors account for about 60 percent of total expenditures.

However, even among the top defense contractors, defense-related sales

account for a small percentage of total sales compared to U.S. defense

companies.

Legal Framework

Exists for Reviewing

and Blocking Foreign

Investments

As Japan’s primary law concerning foreign direct investment, FECL

provides that the ministries may advise or order an investor to either

restructure or suspend a proposed investment if they determine that the

investment may harm national security, public order, public safety, or the

economy. However, the Japanese government has not used this authority

at least since FECL was amended in 1992, according to Japanese

government officials. Industry observers indicated that the ministries are

commonly consulted by companies or their legal representatives to obtain

informal approval prior to official notification. Ministry officials stressed

that this consultation is optional. Nonetheless, the ministries have the

opportunity to influence investment decisions prior to formal notification

through these consultations or by administrative guidance, according to

foreign company representatives and members of academia.

FECL provides a broad definition of foreign direct investment. FECL defines

foreign investment as (1) having at least 10 percent foreign ownership of

shares in a company listed on a Japanese stock exchange; (2) having

foreign ownership of any shares in an unlisted company; (3) establishing a

branch, factory, or other business office in Japan; (4) consenting to change

the corporate objectives of a domestic company with one-third or more

foreign ownership; or (5) lending certain types of money to domestic

companies.

3

Japan’s fiscal year begins on April 1 of that calendar year and ends on March 31 of the following

calendar year.

Page 21 GAO/NSIAD-96-61 Foreign Investment
Appendix II 

Japan

Notification Procedures FECL and its implementing documents require reporting or notification of

all foreign direct investment in Japan. The law provides for ex post facto,

or “after the fact,” reporting for investments in most industries, which are

identified in a public notice. A foreign investor must file a report with the

Ministry of Finance and the ministry with jurisdiction over the industry

through the Bank of Japan within 15 days after a transaction occurs.

Ministry of International Trade and Industry (MITI) officials stated that the

reason for ex post facto reporting was for statistical purposes and in case

of an emergency, such as a financial crisis or war.

The law requires prior notification for exceptional cases, in which foreign

direct domestic investment is proposed (1) by an investor from a country

not listed in the public notice and for which Japan has reciprocity

concerns and (2) in an industry not listed in the public notice. The public

notice excludes industries relating to national security, public order, or

public safety, as well as industries reserved by Japan under the OECD Code

of Liberalization of Capital Movements. Failure to notify the ministries can

result in jail time and/or a monetary fine.

FECL authorizes the Ministry of Finance and the ministries of jurisdiction to

review for national security and economic reasons any proposed

investments in industries requiring prior notification. The law provides

ministerial review to determine whether the proposed investments might

(1) imperil the national security or disturb the maintenance of public order

or public safety or (2) adversely and seriously affect the Japanese

economy. Sectors that require prior notification include aircraft and

aircraft parts, explosives and munitions, atomic power, space

development, and certain types of telecommunications.

Japan also requires prior notification of investments in sectors reserved

through the OECD Code of Liberalization of Capital Movements. Under the

OECD code, Japan reserves the following industries: agriculture, forestry

and fisheries; mining; oil; leather and leather products manufacturing; air

transport; and maritime transport. A Ministry of Finance official stated

that these industries are reviewed mainly for economic reasons, although

some are also reviewed for national security reasons.

The Review Process Ministerial reviews may extend from 30 days to 5 months. The ministries

have 30 days to review a proposed investment after a foreign company has

notified the ministries of its intent to invest. If the investor has not

received a response within that time, the transaction may be completed,

Page 22 GAO/NSIAD-96-61 Foreign Investment
Appendix II 

Japan

according to MITI officials. The ministries may extend the review period for

up to 4 months if they believe further inquiry is necessary. A Committee on

Foreign Exchange and Other Transactions also may extend the review

period an additional month.4

 However, a Finance Ministry official stated

that the review period usually is less than 30 days.

FECL and its related documents do not provide criteria to determine

whether a proposed investment will pose a national security or economic

threat. The ministries review investments on a case-by-case basis and

therefore apply no set standards, according to MITI officials. The

notification form requires information concerning the percentage of

shares to be acquired, the business plan of the investing company, and the

reason for the transaction. However, the ministries may consider

information related to foreign control, such as the number of foreign

board members and the foreign company’s reputation, according to

Japanese government officials.

Investors may appeal the decision of the ministries. FECL provides for a

public hearing if an investor wishes to contest the result of the ministerial

review. After the public hearing, an investor may appeal to the Japanese

courts to try to overturn a decision.

Economic Factors

and Indirect Barriers

Inhibit Investment

Economic factors and indirect barriers, rather than Japanese laws, appear

to be the primary determinants of foreign investment across sectors. The

U.S. company representatives that we interviewed stated that they have

encountered no legal barriers to foreign investment in Japan in recent

years. An American Chamber of Commerce in Japan report also indicates

that legal barriers to investment in Japan have been removed.

The nature of Japan’s defense industry acts as a deterrent to foreign

investment in that sector. Japan’s market for defense items is considered

by many observers to be too small to warrant the expense of establishing

facilities in Japan. Establishing manufacturing facilities in Japan would be

too costly and, according to one U.S. defense company official, would take

away from economies of scale achieved at U.S. production facilities.

Japan’s defense market has primarily one client, the Japan Defense

Agency, because the Japanese government basically prohibits exporting

defense items to third countries. While the Japan Defense Agency has one

of the larger defense budgets in the world, only 18.4 percent was devoted

4

The committee is appointed by the Minister of Finance to provide an opinion on direct investment and

other matters.

Page 23 GAO/NSIAD-96-61 Foreign Investment
Appendix II 

Japan

to equipment acquisition in fiscal year 1995. Furthermore, the Japan

Defense Agency’s preference for domestic procurement of defense items

and the prohibition on arms exports increases the acquisition costs

because of the high per unit cost of small production runs. As a result, the

acquisition budget buys fewer items.

The size and structure of Japanese companies that produce defense items

also discourage U.S. defense companies from attempting to purchase a

controlling share in these companies. Japan has few companies dedicated

solely to defense production. Most of the Japan Defense Agency’s defense

purchases are from huge Japanese conglomerates, such as Mitsubishi

Heavy Industries, Kawasaki Heavy Industries, and Fuji Heavy Industries.

However, defense sales provide a small percentage of sales for these

companies compared to U.S. defense companies. For example,

defense-related sales account for about 13 percent of Mitsubishi Heavy

Industries’ total sales, even though the company is the Japan Defense

Agency’s top defense contractor and is ranked as 1 of the top 20 defense

companies worldwide. Furthermore, U.S. company officials stated that the

size of a “heavy” makes it too expensive to try to buy a controlling portion

of one. Some U.S. company officials stated that, even if they wanted to

acquire a Japanese company that does defense work, the Japanese

government would discourage such action.

Across sectors, business practices, structural barriers, and economic

factors are frequently cited as major obstacles to investment. For example,

a study commissioned by the American Chamber of Commerce in Japan

and the Council of the European Business Community cited selective

enforcement of regulations as one of the main barriers to doing business

in Japan. Many of the representatives of U.S. defense companies we

interviewed, as well as numerous studies, stated that the high cost of doing

business in Japan, including labor costs, the tax burden, rent and land

costs, and regulatory issues, is a disincentive to investment. Foreign

acquisitions of Japanese companies face barriers caused by

cross-shareholding—the practice of companies holding shares of each

other’s stock—and keiretsu relationships—groups of affiliated companies

in related or unrelated fields that hold each other’s shares and may also

have financial (such as bank loans) or manufacturer-supplier ties or

distributor relationships. Cross-shareholding and keiretsu relationships

lessen the amount of shares available to buy on the stock market. In

addition, cross-shareholding may prevent a foreign company from taking

management control of a company, even if the foreign company is the

largest individual shareholder. The relationships among keiretsu members

Page 24 GAO/NSIAD-96-61 Foreign Investment
Appendix II 

Japan

make it difficult for foreign companies to buy into a member company and

also to sell products to members of the keiretsu.5

Recent bilateral discussions between the U.S. and Japanese governments

have addressed some of the barriers to U.S. investment in Japan. The

resulting agreement, which was signed in July 1995, detailed actions that

the Japanese government has recently taken and outlined criteria for

assessing the effectiveness of these actions. In addition, the Japanese

government has pledged to promote foreign investment into Japan.

Incentives Have Little

Impact on Investment

Decisions

The Japanese government offers a variety of incentives to encourage

foreign direct investment. The Law on Extraordinary Measures for the

Promotion of Imports and the Facilitation of Foreign Direct Investment in

Japan provides for tax incentives and loan guarantees for eligible foreign

companies.6

 For example, the law provides for (1) accelerated

depreciation of buildings, machinery, and equipment; (2) extension of the

carry-over period to 7 years for losses incurred during the first 3 years of

starting business in Japan;7

 and (3) exemption from special local

land-holding taxes if certain conditions are met. The law also provides for

loan guarantees for acquiring facilities and equipment. In addition to the

special measures provided by the law, both Japanese national and

prefectural governments offer incentives, such as tax incentives, subsidies,

low-interest loans, and loan guarantees.

Some U.S. companies have used these incentive programs. However, the

company and industry representatives that we interviewed were

unimpressed with the benefits provided by the incentives. Also, the 1995

survey by the American Chamber of Commerce in Japan and the European

Business Council indicated that survey respondents viewed these

incentives neither positively nor negatively. One company representative

stated that the incentives were of no real benefit because the paperwork

requirements for the incentive programs were onerous.

5

For further discussion of the Japanese business environment and some indirect barriers to

investment, see Competitiveness Issues: The Business Environment in the United States, Japan, and

Germany (GAO/GGD-93-124, Aug. 9, 1993).

6

This law has been extended until 2006.

7

Effective fiscal year 1996, companies may carry over losses incurred during the first 5 years, rather

than 3 years.

Page 25 GAO/NSIAD-96-61 Foreign Investment
Appendix II 

Japan

U.S. Companies

Obtain Access to

Japan’s Defense

Market Through

Approaches Other

Than Direct

Investment

Few, if any, U.S. companies have invested in Japan’s defense industry,

according to U.S. company, industry association, and Japanese

government officials we interviewed. U.S. defense company officials have

indicated that the decision not to invest in Japanese businesses is not

based on Japan’s regulatory environment, but on economic reasons.

Instead, U.S. companies have realized sales to Japan through exporting

from the United States and licensing technology, making the expense of

investing in Japan unnecessary. Many U.S. companies have established

branch or representative offices to facilitate these activities in Japan but

do not have manufacturing facilities. When U.S. firms that have defense

contracts in the United States have established either joint ventures or

100 percent-owned subsidiaries in Japan, these firms target the consumer

market, not defense.

Page 26 GAO/NSIAD-96-61 Foreign Investment
Appendix III 

France

The French foreign investment law requires prior approval of foreign

direct investment in sectors that affect public functions, public order,

health, security, or aspects of the defense industry but certain prior

authorization requirements were recently liberalized.1

 The French Ministry

of Economics and Finance has the authority to block foreign investments

made without proper authorization. The Ministry consults with the

Ministry of Defense in cases concerning investment in national

security-related industries. To date, Ministry officials are unaware of any

proposed investments by U.S. companies that were denied on national

security grounds in recent years. Nonetheless, few of the major French

defense companies are available for U.S. companies to acquire because

most are owned by the French government. U.S. companies prefer teaming

with French companies on a project-by-project basis to achieve defense

sales in France.

Background France is one of the main host countries for foreign direct investment

among OECD nations. France has received over $87 billion in foreign direct

investment, cumulatively from 1971 through 1992. About 30 percent of the

French economy is owned by foreign investors. U.S. foreign direct

investment in France reached almost $27.9 billion and French foreign

direct investment in the United States reached almost $33.5 billion in 1994,

according to the U.S. Department of Commerce. U.S. investments

represent about 36 percent of total sales by foreign-owned subsidiaries in

France. The French government characterizes much of the U.S. investment

in France as occurring in high growth, high technology areas.

The French defense budget has declined slightly in real terms during the

past 5 years. From 1990 to 1994, the French defense budget declined 

4 percent after adjusting for inflation. In addition, the French government

reduced its 1995 defense budget to $38.86 billion following a $1.7-billion

cut in procurement. The French government strongly supports its defense

industrial base and obtains nearly 90 percent of its defense equipment

from French companies. However, according to a French government

official, the Ministry of Defense plans to increase the percentage of the

budget devoted to cooperative efforts.

1

A new French law and decree on foreign investment was enacted in February 1996.

Page 27 GAO/NSIAD-96-61 Foreign Investment
Appendix III 

France

Legal Framework

Exists for Reviewing

Foreign Direct

Investment

French law requires prior authorization from the French Ministry of

Economics and Finance for foreign investments concerning (1) public

functions, (2) public order, health, or security, or (3) research, production

or trade in arms, ammunition, explosive powders and substances destined

for military use or wartime equipment.2

 The Ministry of Economics and

Finance has the authority to block foreign investment in these areas made

without proper authorization. Ministry of Economics and Finance officials

were unaware of any proposed U.S. investments being denied approval in

recent years. However, the French government blocked eight transactions

by non-U.S. companies in 1992 and 1993 and one in 1994 on public order

grounds.

French law defines foreign direct investment as (1) the purchase,

establishment, or expansion of a business or branch or (2) any other

transactions that enable nonresidents to acquire or increase control over a

company engaged in industry, commerce, agriculture, finance, or real

estate. It also generally defines foreign control as occurring when at least

20 percent of a company’s shares are owned by nonresidents or by

companies under the control of nonresidents. However, other factors may

be considered when determining foreign control, such as whether loans,

commercial ties, or licensing arrangements result in additional control by

a foreign entity. A company not listed on the stock exchange is considered

under foreign control when at least 33.33 percent of its voting rights are

owned by nonresidents.

Notification/Authorization

Procedures

Foreign investors must notify the French Ministry of Economics and

Finance of the intent to invest in sectors relating to government functions;

public health, safety, or order; or defense. The government has up to 

1 month in which to respond. If the government does not respond, the

investment is presumed to be approved, unless the Ministry of Economics

and Finance exercises its right of postponement. Any investor who has

failed to file the prior notification or to obtain the required prior

authorization is subject to a fine. The Minister of Economics and Finance

is able to annul an investment that would have been denied if the

procedures had been observed.

Until recently, French law made a distinction between European Union

and non-European Union investors in sectors not related to national

security, public health, safety, or order. Specifically, European Union

2

Certain foreign business transactions in these sectors will not be subject to the notification or

approval process. These include greenfield investments and increased foreign control in businesses

that are already at least 66.66 percent foreign controlled in terms of capital and voting rights.

Page 28 GAO/NSIAD-96-61 Foreign Investment
Appendix III 

France

investors were not required to obtain prior approval when acquiring a

controlling interest in a French company. However, such approval was

required for non-European Union investors acquiring a controlling interest

in any French company if the assets were worth at least 50 million French

francs or had annual sales of at least 500 million French francs. In

February 1996, the French government enacted legislation eliminating this

prior authorization requirement for non-European investors. Under the

new law, all investors are required to submit administrative notification to

the French government when the investment is made. This notification is

required for statistical purposes and to verify that the transaction has

taken place.

The French government’s investment approval process is headed by the

Ministry of Economics and Finance. However, the Ministry of Economics

and Finance consults with the Ministry of Industry on all transactions and

with the Ministry of Defense if there is a national security concern. The

Ministry of Defense is responsible for monitoring industry structures to

ensure that strategic defense-related supplies are not excessively

concentrated in foreign-controlled sources, when these sources are less

reliable. Typically, sectors relating to national security could include

dual-use sectors such as chemicals and electronics, as well as production

of weapons. Ministry of Economics and Finance officials were not aware

of any recent cases in which the Ministry of Defense advised against

approving an acquisition by a foreign investor.

French law does not provide criteria for evaluating a proposed acquisition.

Furthermore, if the French government were not in favor of a proposed

acquisition, it could negotiate with investors informally. Foreign investors

have the right to appeal French government decisions in court, but in

practice that right is not exercised. U.S. embassy officials stated that U.S.

companies may be reluctant to appeal decisions to avoid the risk of

impairing future business ventures in France.

Other Limitations on

Foreign Investment

France maintains restrictions on foreign investment activity in certain

sectors of the economy. Under the OECD Code of Liberalization of Capital

Movements, France reserves the right to restrict foreign investment in air

transport, maritime transport, and insurance. In addition, France takes

exceptions to the OECD National Treatment Instrument in the following

areas: agriculture, air transport, broadcasting, insurance, maritime

transport, publishing, road transport, telecommunications, and tourism. In

the national security-related sectors, the French government reserves the

Page 29 GAO/NSIAD-96-61 Foreign Investment
Appendix III 

France

right to restrict the creation, expansion, or operation of foreign-controlled

aerospace companies. Furthermore, foreign-controlled defense companies

are not entitled to national treatment in defense procurement by the

French government.

Indirect Barriers

Hinder Foreign Direct

Investment

In general, the approval process for foreign investment is not considered a

significant barrier to foreign investment. Officials from the U.S. Embassy

in Paris stated that they have not received complaints from U.S.

companies since 1990 and that there have been no major investment

disputes since 1984. Indirect barriers to investment appear to inhibit

foreign investment.

French government ownership of a company can inhibit foreign

investment. The French government has majority ownership of most of

France’s major defense companies, as noted in table III.1. As a result,

controlling shares are not available for foreign companies to purchase.

French defense companies were included in the 1993 privatization law, but

these companies have yet to be privatized. In the event of privatization,

French law prohibits the French government from selling more than

20 percent equity to non-European Union investors during the first share

offering to the public.3

 Subsequently, private investors may resell their

shares to non-European Union investors. After privatization, the French

government can control a strategically important company through a

“golden share.”4

 Application of this measure has remained limited, since

few of the major French defense companies are privatized.

3

In this case, the law becomes a formal barrier to foreign direct investment. However, French

government officials said that this restriction on non-European investors may be repealed.

4

This share accords the French government special rights of control in a privatized company.

Page 30 GAO/NSIAD-96-61 Foreign Investment
Appendix III 

France

Table III.1: French Defense Company

Revenues and Ownership as of 1993

(dollars in billions)

Company name 1993 revenue Ownership

Thomson-CSFa

$4

State controlled: 60% Thomson SA, which is

state-owned

DCN 3 State controlled: 100% Ministry of Defense

Dassaultb

2

State controlled: 46% French government; 50%

Dassault family

Aerospatialeb

2

State controlled: 80% French government; 20%

Credit Lyonnaisc

CEA 2 State controlled: 100% French government

GIAT 1 State controlled: 100% French government

Eurocopter

1

State controlled: 70% Aerospatiale; 30%

Daimler-Benz

Matra 1 Privately owned (State controlled 1981-87)

SNECMA 0.8 State controlled: 97% French government

Sextant

0.7

State controlled: 66% Thomson-CSF; 33%

Aerospatiale

aThe French government announced that it would privatize Thomson-CSF by the end of 1996.

bAccording to French government officials, Dassault Aviation is expected to merge with

Aerospatiale within 2 years.

cThe French government has majority ownership of Credit Lyonnais.

Overcapacity and restrictive labor practices serve as disincentives to

foreign investment in French defense companies. Reducing current

overcapacity in French defense companies would require massive layoffs.

French law provides workers with extensive compensation packages in

the event of layoffs. As a result, several U.S. company officials stated that

they did not see the possibility of sufficient returns through investing in

French defense companies.

Across sectors, cross-shareholding among French corporations and close

relationships among French company and government officials can make

it difficult for foreign investors to acquire French companies. Often two or

more French companies will hold shares of each other’s stock, thus

providing a pool of stable shareholders. According to a U.S. embassy

report,5

 the practice of cross-shareholding arose from the French

government owning most large banks and insurance companies in the

past. The French government used the banks and insurance companies to

invest in other companies as a way of controlling other firms. In addition

to cross-shareholding, many French company officials have close personal

5

Investment Climate in France, FY95, U.S. Embassy Paris.

Page 31 GAO/NSIAD-96-61 Foreign Investment
Appendix III 

France

relationships with government officials. Most top French company and

government officials are alumni of the same universities. In addition, many

top French company executives sit on each others’ board of directors.

Incentives Are Not

Attractive to U.S.

Defense Companies

The French government offers investment incentives that are based on the

proposed investment’s contribution to regional development, particularly

in terms of job creation and development of the technology base.

Accordingly, the French government created the Delegation for Land Use

and Regional Incentives, which provides financial investment incentives,

such as grants, loans, tax credits, and support for research and

development. French national and local governments particularly provide

incentives to encourage start-up businesses that will create new jobs.

However, French ministerial officials acknowledge that these incentives

alone may not be large enough to attract U.S. defense companies.

Teaming

Arrangements Are an

Alternative to Foreign

Direct Investment

U.S. defense companies generally are not interested in investing in France

to achieve defense sales. General Electric and SNECMA have collaborated

for over 20 years on the CFM-56 jet engine for commercial aircraft, and

they formed a joint venture company in 1974 to supply propulsion

systems. U.S. firms typically either sell in niche markets in which French

firms do not compete or team with French firms on a project-by-project

basis to sell to the Ministry of Defense.

U.S. companies benefit from teaming with French defense companies

because the chances of selling to the French Ministry of Defense are

greater. Since the French government is subsidizing overcapacity in its

defense industry, it is unlikely to award prime contracts for major

equipment procurement to a foreign contractor. Furthermore, French

companies maintain close contacts with Ministry of Defense officials and

understand the French defense procurement process.

Page 32 GAO/NSIAD-96-61 Foreign Investment
Appendix IV 

Germany

The Federal Republic of Germany has the legal authority to restrict foreign

direct investment in its national security-related industries, but it has no

administrative controls, bodies, or practices that overtly monitor, screen,

track, or otherwise restrict such investments. Restrictions on foreign

ownership are limited to a few nondefense-related sectors and public

monopolies. While U.S. defense company officials identified disincentives

to investment in the defense sector, they indicated that they pursue market

access to Germany through project-by-project teaming arrangements

rather than through mergers or acquisitions.

Background Germany is one of the largest U.S. trading partners in Europe. The United

States is the largest single investor in Germany, accounting for over 

27 percent of its foreign direct investment by the end of 1992. The United

States invested about $1.6 billion in Germany in 1992, and Germany

invested almost $1.4 billion in the United States in 1992, according to OECD.

By the end of 1994, total U.S. direct investment in Germany was about

$39.9 billion, and total German investment in the United States equalled

about $39.6 billion, according to the U.S. Department of Commerce. While

Germany exported about $6.2 billion worth of arms between 1987 and

1991, its defense industry is of relatively minor importance for the

economy as a whole. German arms exports and imports accounted for no

more than 0.8 percent and 0.3 percent of total exports and imports,

respectively, in the 1980s.

Germany historically has depended upon the United States and other

countries for many of its security needs through cooperation with the

North Atlantic Treaty Organization. Furthermore, the United States

remains the largest seller of defense items to Germany; almost 74 percent

of Germany’s defense imports worth $2.6 billion came from the United

States between 1985 and 1989. However, German military procurement

has declined about 48 percent from 1990 to 1995.

Legal Authority, but

No Framework Exists

for Restricting

Foreign Direct

Investment

Germany retains the authority to regulate and/or restrict foreign

investment on the basis of national security, but it has never used that

authority. The German Foreign Trade Law gives the government the power

to restrict foreign direct investment for reasons of national security, public

order, foreign policy, and balance of trade considerations. However, to

date, the government has never imposed restrictions on foreign direct

investment for reasons of national security. The 1956 Treaty of Friendship,

Commerce and Navigation between the United States and Germany

Page 33 GAO/NSIAD-96-61 Foreign Investment
Appendix IV 

Germany

recognized the German government’s authority to take such actions

necessary to protect its national security interest. This authority would

allow the German government to prohibit foreign direct investment by

U.S. firms for national security reasons, but that authority has never been

invoked.

Germany has no other administrative controls, bodies, or practices that

restrict foreign investment in its national security-related industries.

German officials stated that their government neither screens nor tracks

foreign direct investment in German national security-related industries.

U.S. government analyses concur with this assessment.

The German government’s Federal Cartel Office has the authority to

review mergers and acquisitions, including foreign direct investment, for

violations of German antitrust laws. However, the Cartel Office, an

independent government agency that administers German antitrust laws,

does not screen for adverse impact to national security. If the Cartel Office

prohibited a proposed merger on the grounds it would have a detrimental

impact on competition, the Minister of Economics could override the

Cartel Office’s decision if it deemed the merger to be in the public interest.

Public interest can include job preservation or military necessity.

Germany imposes no limitations on national treatment for foreign

investors in the national security-related sectors or other sectors. Germany

extends national treatment to any foreign firm that establishes itself in

Germany, whether or not it is in the national security-related sector. Under

German law, any foreign firm registered as a limited liability company

(GmbH) or a joint stock company (AG) is regarded as a domestic

company. It also imposes no currency or administrative controls on

foreign direct investment.

Germany generally allows 100 percent foreign ownership of any company

within the country, except for a few sectors. Germany reserves the right to

restrict investment in air transport, maritime transport, and broadcasting

under the OECD Code of Liberalization of Capital Movements. Germany

also takes exceptions to the OECD National Treatment Instrument for

foreign investment in air and maritime transport. OECD reported that

Germany has no other informal measures that may impede foreign

investment.

Page 34 GAO/NSIAD-96-61 Foreign Investment
Appendix IV 

Germany

Germany Lacks a

Self-Sufficient Defense

Industry to Protect From

Foreign Investors

German and U.S. officials stated that historical and economic factors

account for Germany’s lack of restrictions on foreign investment in its

defense industrial sector. Germany has accepted its dependence on the

United States and the other North Atlantic Treaty Organization nations for

its national security. Moreover, Germany has always been economically

more dependent on outside sources for its supply of strategic minerals and

fuels than the United States, according to one Ministry of Finance official.

The post-war German defense industry has also been open to foreign

collaboration and investment because it has never been self-sufficient.

Germany, unlike the United States or France, does not have a great power

status to preserve through protecting a self-sufficient defense industrial

base, according to a U.S. government official. A Ministry of Defense

official concurred, estimating that about 70 percent of Germany’s military

weapon systems are made in cooperation with other countries.

Furthermore, Germany does not limit foreign direct investment through

any defense industrial base policies or economic security policies.

Security and Industrial

Base Concerns Raised in

Foreign Acquisition

German and U.S. officials know of only one case where national

security-related concerns were raised in an unsuccessful attempt to block

the acquisition of a German firm by a U.S. defense company. The German

government organized a review team headed by the Ministry of Finance to

examine the proposed sale’s terms and the U.S. company’s ties to the U.S.

government. Both German and U.S. officials stressed that this was an

ad-hoc procedure, on a one-time basis. The Ministry of Defense was one of

the first agencies to approve the sale. The Ministry of Defense had been

subsidizing the German company at a loss and wanted to privatize it,

according to a U.S. defense company official.

The German federal government approved of the sale, but others tried to

block it. Members of the Bundestag (Federal Parliament) and German

defense companies that were organizing a consortium to buy the company

objected on the grounds that the United States would obtain German

defense secrets. The French government also objected to a U.S. company

testing sensitive technology that the German company and French

companies shared through cooperative projects. Furthermore, the state

government objected to the potential loss of high-technology jobs within

the German state and pressured the federal government to reverse its

decision.

Page 35 GAO/NSIAD-96-61 Foreign Investment
Appendix IV 

Germany

In response to these objections, the U.S. company modified its acquisition

offer and attained a significant minority share in the German firm. It also

worked out arrangements with the federal government to safeguard both

sensitive defense data and German jobs. For example, the federal

government agreed to establish a Defense Oversight Board consisting of

personnel from the Ministry of Defense and the German company to

review security procedures and determine whether there are problems

with foreign influence and control to be resolved.

Economic Factors

and Government

Requirements Impede

Investment in

National

Security-Related

Industries

U.S. government and company officials we interviewed cited both

economic factors and German government requirements as disincentives

to invest in Germany’s national security-related industries. Germany’s high

labor costs and tax rates can limit foreign direct investment. Moreover,

Germany’s strict business regulations give the government authority over

both foreign and domestic companies. Companies established in Germany

face rigid labor practices; they cannot lay off workers easily and cannot

move or alter facilities without government permission. This tight control

of the business environment constitutes more of an investment

disincentive than any government body or screening practice, according to

one U.S. official.

German business relationships and corporate structure also inhibit foreign

direct investment. The close and long-term business relationships German

firms maintain with their suppliers are difficult for foreign firms to

penetrate. In addition, German corporations have interlocking

relationships with banks that make it difficult for outsiders to invest. In

1988, banks and insurance companies owned more than 20 percent of

Germany’s publicly traded companies.1

U.S. government and defense company officials cite the unfavorable

investment climate in Germany as reasons not to invest. The declining

German defense budget and the relatively low rates of return on

investment in the shrinking European defense sector are among the most

important factors influencing investment decisions.

German export controls, procurement regulations, and classified

information security procedures can also pose barriers to investment in

the defense sector, according to U.S. defense company officials. German

conventional weapon export controls have become particularly strict

1

For further information on the German business environment, see Competitiveness Issues: The

Business Environment in the United States, Japan, and Germany (GAO/GGD-93-124, Aug. 9, 1993).

Page 36 GAO/NSIAD-96-61 Foreign Investment
Appendix IV 

Germany

recently. German procurement regulations are complicated and difficult to

understand, according to some U.S. company officials. One German

industry representative pointed out, however, that every country has such

regulations that give an advantage to the domestic firms most familiar with

them.

Germany’s classified information security procedures were mentioned as a

possible barrier to investment, but these procedures were also

characterized as less rigorous in comparison to those of other countries.

According to a German official, the Ministry of Economics is not

concerned about foreign ownership of German defense companies. The

government maintains control of classified materials and information

through an “access check” of prospective buyers performed by the

Ministry of Economics. In this official’s view, these checks present no

problems to firms from the North Atlantic Treaty Organization countries.

Incentives to Invest

Are Too Limited to

Attract U.S. Defense

Companies

Germany encourages foreign direct investment in all economic sectors,

including its defense industry, and grants national treatment to all foreign

companies. Germany places no restrictions on foreign companies seeking

access to state-funded research and development funds and other

incentive programs. A U.S. embassy document states that U.S. companies

legally established in Germany are eligible for research and development

technology funds from the German federal government. Moreover,

German ministries pursue the involvement of foreign-based companies to

facilitate international cooperation. However, U.S. government and

defense company officials and German industry representatives indicated

that the research and development subsidies are generally too limited to

attract U.S. defense firms.

The German government allotted $12 billion for civilian research and

development in 1993, according to U.S. embassy figures. The incentives

are concentrated in basic and applied sciences, aerospace technology,

energy research and development, and information technology.

U.S.-affiliated firms are also eligible to participate in the Ministry of

Research and Technology’s priority “Technologies of the 21st Century”

programs, such as artificial intelligence and sensor technology. While no

formal barriers exist to U.S. affiliates’ participation in these programs, few

make use of these programs either in the national security-related sector

or in other sectors. A State Department document reported that U.S.

companies participate in only 8 of approximately 6,000 federally funded

projects. Moreover, a Department of Commerce report estimates that

Page 37 GAO/NSIAD-96-61 Foreign Investment
Appendix IV 

Germany

Germany awards approximately 85 percent of total military spending

(including research and development, procurement, and maintenance

spending) to domestic firms.

U.S. Defense

Companies Use Other

Means to Obtain

Market Access in

Germany

U.S. defense company representatives and embassy officials in Germany

stated that U.S. defense firms seek market access through cooperative

ventures with German firms on a project-by-project basis rather than

pursue longer term direct investment in Germany. Most of the U.S. defense

companies we contacted use this approach, including one company that

has acquired a small German defense-related firm.

Some company representatives stated that their U.S.-produced goods

remain sufficiently competitive to generate sales in niche markets (i.e.,

fulfill a German demand for subsystems they lack the capability to

produce themselves). They stated that to successfully compete, U.S. firms

enter partnerships with German firms to allow German participation, gain

influence with the German government, and acquire knowledge of the

procurement process through their German partners.

Page 38 GAO/NSIAD-96-61 Foreign Investment
Appendix V 

United Kingdom

British law provides no legal framework specifically designed to monitor

foreign direct investment for national security reasons. However, the U.K.

government has the authority to block or restructure takeovers of U.K.

companies by foreign or domestic companies for national or public

interest reasons. The United Kingdom restricts foreign direct investment in

certain sectors of the economy, which are registered under the OECD Code

of Liberalization of Capital Movements. Also, the government retains a

special share in key privatized companies, which in some cases limits

foreign ownership and also accords certain veto powers to the

government. U.S. company officials in the United Kingdom believe that the

legal and regulatory climate presents no obstacle to investments and that

U.S. defense firms are more likely to enter into teaming relationships with

U.K. companies rather than engage in mergers or acquisitions.

Background Overall foreign direct investment in the United Kingdom has increased

significantly over a 15-year period. Foreign direct investment in the United

Kingdom has risen from $28 billion in 1978 to over $195 billion by the end

of 1993. The United States is the largest foreign investor in the United

Kingdom. U.S. foreign direct investment in the United Kingdom reached

about $102.2 billion in 1994, according to U.S. Department of Commerce

figures. U.S. firms have established some 4,200 branches, subsidiaries, and

affiliates in the United Kingdom, while German and Japanese firms each

have established over 1,000 entities. U.S. investments in the United

Kingdom represented 43 percent of all its investments in the European

community by year end 1993. The United Kingdom had the largest share of

foreign direct investment in the United States in 1992, accounting for 

37 percent of its total foreign direct investment abroad. By comparison,

the other European Union countries combined account for 26 percent of

all foreign direct investment in the United States. U.K. foreign direct

investment in the United States reached about $113.5 billion by 1994.

The U.K. defense budget has declined some 25 percent in real terms over

the past 10 years, prompting significant consolidation of the defense

industry. Defense spending in the United Kingdom is expected to decline

by around 14.5 percent between 1992-93 and 1997-98, but the U.K.’s

defense expenditures remain above those of other European North

Atlantic Treaty Organization countries.

Page 39 GAO/NSIAD-96-61 Foreign Investment
Appendix V 

United Kingdom

Legal Framework Can

Consider National

Security Issues

The United Kingdom has no general notification requirements that

specifically govern all forms of foreign investment. The Industry Act of

1975 provides the U.K. government with the authority to intervene when

the takeover of important manufacturing concerns by nonresidents is

against the national interest. The law does not define the term “important.”

However, manufacturing industries are defined under the Standard

Industrial Classification Orders and include defense-related sectors such

as ordnance and aerospace equipment manufacturing. The U.K.

government has never used the authority provided under this act.

The Fair Trading Act of 1973 provides an anticompetitive review of both

foreign and domestic mergers and acquisitions. The act includes

provisions permitting review of transactions that meet a certain threshold1

for adverse effect on competition and the public interest. The Director

General of Fair Trading initially performs the review and advises the

Secretary of State for Trade and Industry whether the merger or

acquisition should be investigated further by the Monopolies and Mergers

Commission, an independent body. Under the law, the Secretary of State

for Trade and Industry has the authority to block or force divestiture of

mergers and acquisitions that the Monopolies and Mergers Commission

investigated and found to be against the public interest. A Department of

Trade and Industry official said that acquisitions can be blocked for

national interest reasons. The Secretary has 6 months after a merger to

request that the Monopolies and Mergers Commission investigate the

merger. The commission has up to 6 months to investigate the merger, but

the Secretary may authorize an additional 3 months. Companies can

appeal the Secretary’s decision to the judicial system.

The Fair Trading Act broadly defines the term “against the public interest.”

The law requires that the commission consider such factors as (1) effect

on competition in the United Kingdom, (2) consumer interests,

(3) development of new products, (4) cost reduction, (5) balancing the

distribution of industry and employment, and (6) promotion of

competitive activities of U.K. companies abroad. However, the

commission is not limited to consideration of these factors.

The Ministry of Defense provides input to the commission when mergers

of defense companies are under investigation, regardless of whether the

companies are national or foreign-owned, according to a Defense Ministry

1

This act sets a threshold for acquisitions of both publicly held and privately owned companies as

follows: (1) the gross value of the U.K. company being acquired exceeds 30 million pounds or (2) the

transaction would result in 25 percent or more of goods and services of the same description being

supplied by one enterprise.

Page 40 GAO/NSIAD-96-61 Foreign Investment
Appendix V 

United Kingdom

procurement policy official. The Ministry of Defense’s objective is to

ensure that the investigation’s results do not adversely affect its ability to

obtain value for money on procurement or inhibit competition for defense

procurement.

Other Limitations on

Foreign Investment

The United Kingdom maintains restrictions on foreign investment activity

in certain sectors of the economy. Under the OECD Code of Liberalization

of Capital Movements, the United Kingdom reserves the right to restrict

foreign investment in air transport, broadcasting, and maritime transport.

In addition, the United Kingdom reports limitations to the OECD National

Treatment Instrument based on public order and essential security

considerations in the following areas: investment in aerospace and

maritime transport and obtaining government defense procurement

contracts. The National Treatment Instrument also lists further measures

taken by the United Kingdom affecting corporate structure in certain

defense firms.

Government

Involvement May

Inhibit Foreign Direct

Investment in Some

U.K. Companies

Company officials we interviewed stated that the legal and regulatory

framework in the United Kingdom is not a barrier or disincentive to

foreign investment. However, one U.S. company official stated that the

involvement of the U.K. government in some U.K. defense companies

could inhibit foreign investment. After it privatized three major defense

companies, the U.K. government maintained limits on foreign ownership

for public order and essential security reasons. This government control

and authority is not rooted specifically in law. Instead, this involvement

arises from government ownership of a “golden share” established in the

articles of incorporation of these companies. This share does not give the

U.K. government control over the companies’ routine business activities,

investment decisions, or appointments. In each case, the articles provide

British citizenship requirements for the companies’ board of directors.

Other limitations are the following:

• The articles of incorporation for British Aerospace PLC limits foreign

ownership of voting stocks to 29.5 percent.

• The articles of incorporation of Rolls Royce PLC also limits foreign

ownership of voting stocks to 29.5 percent. Furthermore, the U.K.

government has the power to veto major disposal of assets.

• The articles of incorporation of VSEL restrict the size of any shareholding

interest (domestic or foreign) but also provide the government a veto on

major asset disposal decisions. The recent acquisition of VSEL by GEC

Page 41 GAO/NSIAD-96-61 Foreign Investment
Appendix V 

United Kingdom

was accompanied by an amendment to the articles of incorporation of

VSEL to allow GEC alone to exceed the 15-percent limitation on individual

shareholdings. The U.K. government does not hold a golden share in GEC,

but it will continue to hold the VSEL golden share.

United Kingdom

Offers Investment

Incentives

The national and local governments offer incentives to both foreign and

domestic companies to invest in designated areas in the United Kingdom

to promote economic development. For example, incentives to invest in

Northern Ireland include grants of up to 50 percent of project cost and

corporate tax relief. In one nationwide program, companies making

investments related to technology innovation or introduction into the

United Kingdom are eligible for government grants. General economic

factors also serve as incentives and include labor costs and corporate tax

rates that are lower than in many other European countries and no

restrictions on sending capital and profits abroad.

U.S. Companies Use

Approaches to

Defense Procurement

Other Than Foreign

Direct Investment

U.S. defense company officials generally did not see direct investment as

an essential part of their strategy to gain access to the U.K. defense

market. Rather, companies pursue access through the common practice of

forming project-by-project teaming arrangements with U.K. companies to

gain access to defense procurement contracts. For example, McDonnell

Douglas teamed with Westland to win a recent competition to supply the

British army with attack helicopters. In another case, Lockheed was

awarded a contract to deliver 25 C-130J transport planes to the Royal Air

Force. In this instance, Lockheed was the prime contractor and was part

of a consortium of 36 U.K. companies that was formed to successfully

compete for this procurement.

One U.S. defense company, however, became a U.K. company by

incorporating in the United Kingdom. Company representatives indicated

that, for business reasons, it was important to adopt a British identity.

However, the U.S. company is not investing in a manufacturing facility in

the United Kingdom. Furthermore, the U.S. company teams with other

U.K. firms to compete for contracts. For example, in one case the U.S.

company acted as prime contractor, but in another case, a U.K. company

acted as prime contractor.

Page 42 GAO/NSIAD-96-61 Foreign Investment
Appendix VI 

Major Contributors to This Report

National Security and

International Affairs

Division, Washington,

D.C.

Davi M. D’Agostino

Maria Cristina Gobin

Paula J. Haurilesko

Anne-Marie Lasowski

Karen S. Zuckerstein

Office of General

Counsel

Raymond J. Wyrsch

European Office B. Patrick Hickey

Mary R. Offerdahl

(705101) Page 43 GAO/NSIAD-96-61 Foreign Investment
Ordering Information

The first copy of each GAO report and testimony is free.

Additional copies are $2 each. Orders should be sent to the

following address, accompanied by a check or money order

made out to the Superintendent of Documents, when

necessary. VISA and MasterCard credit cards are accepted, also.

Orders for 100 or more copies to be mailed to a single address

are discounted 25 percent.

Orders by mail:

U.S. General Accounting Office

P.O. Box 6015

Gaithersburg, MD 20884-6015

or visit:

Room 1100

700 4th St. NW (corner of 4th and G Sts. NW)

U.S. General Accounting Office

Washington, DC

Orders may also be placed by calling (202) 512-6000 

or by using fax number (301) 258-4066, or TDD (301) 413-0006.

Each day, GAO issues a list of newly available reports and

testimony. To receive facsimile copies of the daily list or any

list from the past 30 days, please call (202) 512-6000 using a

touchtone phone. A recorded menu will provide information on

how to obtain these lists.

For information on how to access GAO reports on the INTERNET,

send an e-mail message with "info" in the body to:

info@www.gao.gov

PRINTED ON RECYCLED PAPER
United States

General Accounting Office

Washington, D.C. 20548-0001

Official Business

Penalty for Private Use $300

Address Correction Requested

Bulk Rate

Postage & Fees Paid

GAO

Permit No. G100