Foreign Investment and National Security: Economic Considerations
Released: 2013-04-04T00:00:00

Overview

For more than half a century, the United States has led international efforts to reduce restrictions on foreign investment. In part, these efforts are related to a general commitment to open markets and to the free flow of international capital as an important component in economic development. At the same time, the United States is the largest foreign direct investor in the world and also the largest recipient of foreign direct investment. By year-end 2011, foreign direct investment in the United States had reached $2.6 trillion and U.S. direct investment abroad had reached $4.1 trillion, when direct investment is measured at historical cost. This dual role means that globalization, or the spread of economic activity by firms across national borders, has become a prominent feature of the U.S. economy and that through direct investment the U.S. economy has become highly enmeshed with the broader global economy.

The globalization of the economy also means that the United States has important economic, political, and social interests at stake in the development of international policies regarding direct investment. With some exceptions for national security, the United States has established domestic policies that treat foreign investors no less favorably than U.S. firms. In addition, the United States has led efforts over the past 50 years to negotiate internationally for reduced restrictions on foreign direct investment, for greater controls over incentives offered to foreign investors, and for equal treatment under law of foreign and domestic investors.

In light of the terrorist attacks on the United States on September 11, 2001, however, some Members of Congress have been reexamining some elements of this open-door policy and have argued for greater consideration of the long-term impact of foreign direct investment, especially where that investment takes the form of an acquisition, a merger, or a take-over of an existing U.S. company. In particular, these concerns have centered around the impact of such investments on the structure and the industrial capacity of the economy, and on the ability of the economy to meet the needs of U.S. defense and security interests, including a terrorist attack. As a result of these concerns, in 2007 Congress changed the way foreign direct investments are reviewed through P.L. 110-49 , the Foreign Investment and National Security Act of 2007. Through P.L. 110-49 , Congress strengthened its role in reviewing foreign investments by enhancing its oversight capabilities. There is no precise way, however, to estimate the exact dollar amount for the economic costs and benefits of national policies that attempt to direct or restrict foreign direct investment for national security concerns. Also, there is no way to determine if foreign investment policies are implemented to enhance national security or to engage in a form of economic protectionism. In some cases, other policy tools may well be preferred over intervening in the foreign investment process.

Foreign Direct Investment in the United States

Foreigners invested $234 billion in nominal terms in U.S. businesses and real estate in 2011, according to data published by the Department of Commerce. As Figure 1 shows, this represents a 14% increase over the $155 billion invested in 2010. Investments abroad by U.S. parent firms increased by 28% in 2011 to $419 billion, up from the $328 billion they invested abroad in 2010. The increase in foreign direct investment flows mirrors a rebound in global flows following the sharp drop in direct investment flows in 2009 and 2010. The cumulative amount, or stock, of foreign direct investment in the United States on a historical cost basis rose from $2.26 trillion in 2010 to about $2.55 trillion in 2011. This marked an increase of 12.5%. The Department of Commerce does not attempt to deflate the annual nominal amounts for direct investment with a specific price deflator. Instead, the department publishes alternative estimates based on current cost and market value to provide other measures of the value of direct investment.

Foreign direct investments in the U.S. manufacturing sector as a whole in 2011 were higher than in 2010 and accounted for nearly half of the overall increase in foreign direct investment in 2011. Foreign direct investment in the banking, finance, retail trade, and professional services all increased in 2011, compared with investments in 2010. In comparison, investments were down in the wholesale trade, real estate, and information sectors. Data for the first two quarters of 2012 indicate that foreign direct investment in the United States is down about 41% from the amount recorded in the comparable period in 2011. Such investments may well continue to lag behind similar investment in 2010 in the second half of the year if the rate of economic growth stalls.

New spending by U.S. firms on businesses and real estate abroad, or U.S. direct investment abroad, although substantial, fell sharply in 2009 compared to 2008. Net investments fell from $332 billion in 2008 to $221 billion in 2009, according to the Department of Commerce. As indicated in Figure 1 , a drop in U.S. direct investment abroad that occurred in 2005 reflects actions by U.S. parent firms to reduce the amount of reinvested earnings going to their foreign affiliates for distribution to the U.S. parent firms in order to take advantage of one-time tax provisions in the American Jobs Creation Act of 2004 ( P.L. 108-357 ).

According to the U.N. World Investment Report , global foreign investment flows reached $1.5 trillion in 2011, a 16% increase over the amount recorded in 2010 in 2011, as indicated in Table 1 . The growth in foreign investment flows reflects higher profits by multinational corporations and an increase in the rate of growth in developing countries. In 2009, global foreign investment flows dropped by 33% from that recorded in 2008, reflecting the financial crisis and drop in economic growth in most developed economies. The developed economies traditionally have absorbed about two-thirds of global direct investment flows, but this share dropped to half between 2009 and 2011, reflecting the differential impact of the financial crisis which affected the developed economies more than the developing economies. Africa continues to receive the smallest share, generally less than 5%, with Latin America receiving about 14% and Asia getting close to one-third during the 2009-2011 period. A study on investment trends by the Organization for Economic Cooperation and Development (OECD) reported that direct investment outflows reached a record $1.8 trillion in 2007, in part due the decline in the value of the dollar relative to the Euro, which results in an upward valuation in dollar terms in investments that originally had been priced in Euros.

Globally, the total, or cumulative, amount of foreign direct investment surpassed $20 trillion in 2011 (the latest year for which detailed data are available), as indicated in Figure 2 . Nearly three-fourths of this amount is invested in the most economically-advanced developed economies. The developed economies as a group not only are the largest recipient of investment funds, but they are also the largest source of those funds. Similar to the United States, those countries that are the largest overseas investors also tend to be the most attractive destinations for foreign investments. The clear exception to this general observation is Japan, which had invested $962 billion abroad through 2011, but had received $226 billion in investment inflows. Among the developing economies, Asia, which includes China, had accumulated $4.0 trillion in direct investment, followed by Latin America (2.05 trillion) and Africa ($570 billion).

By the end of 2010, there were about 2,300 U.S. parent companies with nearly 27,000 affiliates operating abroad, as Table 2 indicates. In comparison, foreign firms had about 6,000 affiliates operating in the United States. U.S. parent companies employed nearly 23 million workers in the United States, compared with the 13.3 million workers employed abroad by U.S. firms and the 5.8 million persons employed in the United States by foreign firms. Although the U.S.-based affiliates of foreign firms employ less than half as many workers as the foreign affiliates of U.S. firms, they paid about 80% of the aggregate employee compensation in the United States as did the U.S. affiliates operating abroad. The affiliates of foreign firms operating in the United States had a higher value of gross product than did the foreign affiliates of U.S. parent companies. The foreign affiliates of U.S. firms, however, had total sales that were nearly twice as high as those of the U.S. affiliates of foreign firms. The foreign affiliates of U.S. firms, however, paid 10 times more in taxes to foreign governments than the affiliates of foreign firms operating in the United States paid in taxes to the U.S. government.

U.S. multinational companies also play an important role in the U.S. economy. According to the total output of U.S. parent companies, or gross product, they produced $2.9 trillion in goods and services in 2010, up 21% from the $2.4 trillion dollars they produced in 2009. This amount comprised about 21% of total U.S. private industry gross product, a share of total gross product of U.S. parent companies that has remained fairly consistent since the early 1990s despite significant changes in the U.S. economy as a whole. The data also demonstrate the impact the improvement in the U.S. economy after 2002 had on the operations of U.S. multinational companies.

National Security

Since the end of World War II, the United States has led efforts internationally to reduce official government restrictions on foreign investment. One prominent exclusion to these efforts and to commitments incorporated in international treaties is the right of nations to protect their own "essential security interests." The terrorist attacks of September 11, 2001, combined with the growing role of state-backed investors, or sovereign wealth funds (SWFs), has spurred a number of nations to reconsider their national security interests relative to inward investment and to consider placing additional restrictions on foreign investments in areas considered to be an essential security interest. For the most part, such restrictions apply to mergers, acquisitions, and takeovers of existing firms and not generally to new establishments. These actions, in turn, have raised concerns among the members of such organizations as the OECD, which promotes the concept of liberalized government restrictions on the free flow of international investment.

OECD Arrangements

With some exceptions for national security, the United States has long been considered one of the most receptive economies in the world to foreign direct investment. The United States has led efforts to negotiate internationally for reduced restrictions on foreign direct investment, for greater rules on incentives offered to foreign investors, and for equal treatment under law of foreign and domestic investors. In particular, the United States has supported efforts within the OECD to develop such legally nonbinding arrangements as the OECD Code of Liberalization of Capital Movements (covering both long- and short-term capital movements) and the Code of Liberalization of Current Invisible Operations (covering cross-border trade in services). In addition, the OECD has issued a basic statement on foreign investment, The Declaration on International Investment and Multinational Enterprises , which is a general statement of policy regarding the rights and responsibilities of foreign investors.

The United States and other signatories to the OECD arrangements recognize that one notable exception to the open investment policies provided for in the OECD instruments, as well as in customary international law, is that governments can take measures they "consider necessary to protect essential security interests" and to maintain "public order or the protection of public health, morals, and safety." Such an exception has been recognized in various international agreements, in countless bilateral investment treaties, and in investment chapters of free trade agreements. According to the OECD, "The right to protect essential security interests of the state, as an exception to treaty commitments, has been well established in treaty practice."

Another aspect of this policy is that each state is best situated to assess its own security interests and to decide whether essential security interests are at stake relative to certain types of investments. Under customary international law, the argument of necessity has been interpreted to mean an incident that poses a grave and imminent peril to a country, or a threat to such vital interests as, "political or economic survival, the continued functioning of its essential services, the maintenance of internal peace, the survival of a sector of its population, and the preservation of the environment of its territory." Various agreements, including multilateral agreements and OECD investment instruments, acknowledge that each nation has the exclusive role of determining for itself whether a restriction on foreign investment is necessary to protect its essential security interests.

As governments move to assess their national policies on foreign investments, they are faced with a trade-off between their desires to preserve and expand an open international investment environment with the national responsibility to safeguard essential security interests. This trade-off is complicated further by the nature of the threats that are associated with mergers, acquisitions, and takeovers of existing firms. Such investments generally are not viewed as posing an immediate threat to the stability or security of a nation. Some observers, however, view some of these investments as posing potential threats to the economy in the form of a loss of technology related to national security, a loss of jobs due to outsourcing, or a threat associated with state-backed investors who use their investments to advance political objectives. As a result, policies directed at reviewing foreign direct investments are best described as precautionary measures. In this report, the national security threats posed by mergers, acquisition, or takeovers do not include overt acts of transnational terrorism that are meant to dissuade foreign capital inflows. The OECD reports that a number of governments have started to review their policies on inward foreign investment in response to a "changing context for national security and the increasing prominence of new investors, including large investors controlled by foreign governments." From France and Germany, the United States and Canada, to various non-OECD countries, existing regulatory regimes have been used to deter certain investments in infrastructure for national security concerns or countries have tightened their regulations on security grounds.

Due to the increased attention focused on the national security aspects of inward foreign investment, the OECD formed in June 2006 the "Freedom of Investment, National Security and 'Strategic Industries'" project. Through the 13 rounds of meetings, including the latest one held in October 2010, members of the investment project have agreed to support three principles for national investment policy measures that address essential security interests: (1) transparency and predictability; (2) proportionality; and (3) accountability. Proportionality refers to the concept that restrictions on foreign investment should be no greater than is needed to protect national security. In June 2007 at the annual summit of the Group of Eight (G8) leading industrialized nations, the group issued a "Declaration on Freedom of Investment, Environment and Social Responsibility." The final summit statement also emphasized the group's continuing support for the OECD project on Freedom of Investment, National Security and "Strategic Industries." The G8 statement also offered its support for a free flow of investment by indicating that

We will work together to strengthen open and transparent investment regimes and to fight against tendencies to restrict them. Erecting barriers and supporting protectionism would result in a loss of prosperity. We therefore agree on the central role of free and open markets to facilitate global capital movements. We reaffirm that freedom of investment is a crucial pillar of economic growth, prosperity and employment.... Against this background we remain committed to minimize any national restrictions on foreign investment. Such restrictions should apply to very limited cases which primarily concern national security. The general principles to be followed in such cases are nondiscrimination, transparency and predictability. In any case, restrictive measures should not exceed the necessary scope, intensity and duration.

The OECD project on investment issued its final report in mid-2009 titled, "Building Trust and Confidence in International Investment," which included policy guidance in the form of a menu of best practices for the signatories to consider so that as they implement investment policies they do so in a way that is consistent with the three principles. So far, a number of OECD nations, including the United States, have adjusted their national laws to have them conform to the recommendations of the OECD's final report. At the Toronto Summit of the G-20 nations in June 2010, the members tasked the OECD with reporting on the trade and investment measures of the G-20 members. The recent OECD report indicated that G-20 members had resisted protectionist pressures and had taken measures aimed at facilitating and encouraging investment flows, but none of the OECD members had not adopted new restrictions on foreign investment related to national security. The OECD members have agreed to adopt a set of 14 guidelines that are meant to serve as the basis for establishing investment policy measures. These guidelines are designed to assist nations in adopting investment measures that safeguard national security and are consistent with the three principles of transparency, proportionality, and accountability. These measures are:

Nondiscrimination: Governments should treat similarly situated foreign and domestic investments in a similar fashion. Transparency/Predictability: Regulatory practices should be as transparent as possible while also protecting the confidentiality of sensitive information. Codification and publication: Laws, particularly evaluation criteria used in reviews of investment transactions, should be codified and made public. Prior notification: Governments should take steps to notify interested parties about plans to change investment policies. Consultation: Governments should seek the views of interested parties when they are considering changing investment policies. Procedural fairness and predictability: Reviews should have time limits; sensitive information should be protected. Disclosure of investment policy actions: Governments should disclose investment policy actions as a measure of accountability. Regulatory proportionality: Restrictions should not be greater than needed to protect national security. Essential security concerns are self-judging: Countries have the right to determine what is necessary to protect their own national security. Narrow focus: Investment restrictions should be narrowly focused on concerns related to national security. Appropriate expertise: Measures related to national security concerns should be designed so that they can benefit from national expertise on national security and that it is possible to weigh the benefits of the investment policies against the impact of the restrictions. Tailored responses: Investment measures should be tailored to the specific risks posed by specific investment proposals. Last resort: Restrictive investment should be used as a last resort when other policies cannot be used to eliminate security-related concerns. Accountability: To ensure accountability by government agencies, investment measures should be reviewed by government oversight, judicial review, periodic regulatory impact assessments, and requirements that decisions to block an investment should be taken at high government levels.

Critical Infrastructure

As part of the general area of essential security concerns associated with foreign investment, numerous nations have focused on the concept of critical infrastructure as a separate area of concern within the rubric of essential security interests. As Table 3 indicates, national definitions of critical infrastructure differ among countries, although most of the countries surveyed by the OECD define critical infrastructure as physical infrastructure that provides essential support for economic and social well-being, for public safety, and for the functioning of key government responsibilities. In most cases, the national definitions of critical infrastructure are broad statements that provide national governments with a wide latitude for deciding which assets or sectors to designate as critical. Such definitions implicitly acknowledge the importance that the broader economic and security context plays in determining which sectors might be selected for designation as critical and that this designation may change depending on the circumstances.

Essential Security Exclusions

Members of the OECD and other countries that choose to adhere to the voluntary OECD National Treatment Instrument retain the option to exclude sectors of their economy on the grounds of essential security interests from the national treatment standard. In such cases, nations are using discriminatory practices to restrict foreigners from investing in sectors of their economies that are deemed to be important to national security. In making such exceptions, nations that are parties to the National Treatment Instrument provide a notification to the other members that they are requesting an exemption from the protocol, thereby providing a method to make the process transparent to all the signatories of the Instrument.

According to a recent OECD study, countries that are adhering to the OECD National Treatment Instrument have exempted an extensive array of discriminatory foreign investment policies from the Instrument in order to protect critical infrastructure from foreign investment. For instance, all 39 nations that are a party to the Instrument report that they discriminate against foreign investment in one or more critical infrastructure sectors. Of these sectors, transport in the most targeted sector, with all 39 countries reported having discriminatory measures. Such restrictions generally fall within three categories: (1) blanket restrictions that cover a specific activity; (2) sector-specific restrictions that affect investment in a specific sector of the economy; and (3) measures that apply to a broad range of infrastructure investments and approval procedures that could be used to block infrastructure investments that are deemed to pose threats to essential security interests.

The OECD also concluded that the national restrictions were notably general in their descriptions. In turn, the OECD concluded that the generality of the restrictions is due to four issues: (1) the nature of the security threats may affect perceived threats and vulnerabilities; (2) the assessment of the threats may be affected by the nationality of the foreign investor; (3) some perceived threats may be resolved easily through mitigation efforts, while others may not; and (4) not all countries have the capabilities to conduct in-depth evaluations of potential national security threats. The OECD also concluded that it is difficult to assess the value such restrictions have in enhancing the essential national security of the members. In most cases, such policies are measures of last resort when other national laws or measures are determined to be insufficient, or they can provide a process that assists various agencies within a national government with identifying and dealing with security threats that might be posed by international investment.

U.S. Foreign Investment Policy

U.S. policy toward foreign direct investment is based primarily on the conclusion that direct investment benefits both the home and the host country and that the benefits of such investment outweigh the costs. Most economists argue that free and unimpeded international flows of capital, such as direct investment, positively affect both the domestic (home) and foreign (host) economies. The essence of this argument is that for the home country, direct investment abroad benefits individual firms, because firms that invest abroad are better able to exploit their existing competitive advantages and are able to acquire additional skills and advantages. This tends to further enhance the competitive position of these firms both at home and abroad and shifts the composition and distribution of employment within the economy toward the most productive and efficient firms and away from the less productive firms.

As a host country, the United States benefits from inward direct investment, because the investment adds permanently to the Nation's capital stock and skill set. Direct investment also brings technological advances, since firms that invest abroad generally possess advanced technology, processes, and other economic advantages. Such investment also boosts capital formation, contributes to a growth in a competitive business environment and to productivity. In addition, direct investment contributes to international trade and integration into the global trading community, since most firms that invest abroad are established multinational firms.

While U.S. policy toward inward and outward direct investment generally has adhered to the overall objective of treating such investment impartially, there are a number of notable exceptions. These exceptions can be classified as sectoral restrictions that exclude foreign ownership from certain sectors of the economy and approval procedures for mergers, acquisitions, and takeovers of existing U.S. firms that could be used to block infrastructure investments that are deemed to pose threats to essential national security. Foreign investors are constrained by U.S. laws that bars foreign ownership in such industrial sectors as maritime, aircraft, mining, energy, lands, communications, banking, and government contracting. Generally, these sectors were closed to foreign investors to prevent public services and public interest activities from falling under foreign control, primarily for national defense purposes.

Exxon-Florio and CFIUS

The second category of restrictions, characterized by such approval procedures as the Exxon-Florio provision, applies to foreign investment in existing U.S. firms through mergers, acquisitions, or takeovers, but does not apply to foreign investors who establish new businesses. In 1988, Congress approved the Exxon-Florio provision as part of the Omnibus Trade Act. The Exxon-Florio provision grants the President broad discretionary authority to take what action he considers to be "appropriate" to suspend or prohibit proposed or pending foreign acquisitions, mergers, or takeovers "of persons engaged in interstate commerce in the United States" which "threaten to impair the national security." The Exxon-Florio provision does not define national security, because Congress meant to have the term interpreted broadly. Nevertheless, regulations developed by the Treasury Department to implement the law direct the members of the Committee on Foreign Investment in the United States (CFIUS) to focus their reviews of foreign investments exclusively on those transactions that involve "products or key technologies essential to the U.S. defense industrial base," and not to consider economic concerns more broadly. CFIUS also indicated that in order to assure an unimpeded inflow of foreign investment it would implement the statute "only insofar as necessary to protect the national security," and "in a manner fully consistent with the international obligations of the United States." The Committee is an interagency organization that serves the President in overseeing the national security implications of foreign investment in the economy.

The Exxon-Florio process consists of three different steps for reviewing proposed or pending foreign "mergers, acquisitions, or takeovers" of "persons engaged in interstate commerce in the United States" to determine if the transaction "threatens to impair the national security." Such investments often imply a change in ownership and not necessarily a change in the operations of the targeted U.S. company. CFIUS has 30 days to conduct a review, 45 days to conduct an investigation, and then the President has 15 days to make his determination. The President is the only officer with the authority to suspend or prohibit mergers, acquisitions, and takeovers.

Neither Congress nor the Administration have attempted to define the term national security as it appears in the Exxon-Florio statute. Treasury Department officials have indicated, however, that during a review or investigation each member of CFIUS is expected to apply that definition of national security that is consistent with the representative agency's specific legislative mandate. For instance, over time and through a series of Executive Orders, the Department of Defense has developed the National Industrial Security Program (NISP) through which it has adopted various provisions under the term, "Foreign Ownership, Control, or Influence (FOCI)." These provisions attempt to prevent foreign firms from gaining unauthorized access to "critical technology, classified information, and special classes of classified information" through an acquisition of U.S. firms that it could not gain access through an export control license. This type of review is run independently of and parallel to a CFIUS review.

Critical Infrastructure/Key Resources

Arguably, the events of September 11, 2001, reshaped congressional attitudes toward the Exxon-Florio provision. This change in attitude became apparent in 2006 as a result of the public disclosure that Dubai Ports World was attempting to purchase the British-owned P&O Ports, with operations in various U.S. ports. After the September 11 th terrorist attacks Congress passed and President Bush signed the USA PATRIOT Act of 2001 (Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism). In this act, Congress provided for special support for "critical industries," which it defined as

systems and assets, whether physical or virtual, so vital to the United States that the incapacity or destruction of such systems and assets would have a debilitating impact on security, national economic security, national public health or safety, or any combination of those matters.

This broad definition is enhanced to some degree by other provisions of the act, which specifically identify sectors of the economy that Congress considers to be elements in the critical infrastructure of the nation. These sectors include telecommunications, energy, financial services, water, transportation sectors, and the "cyber and physical infrastructure services critical to maintaining the national defense, continuity of government, economic prosperity, and quality of life in the United States." The following year, Congress transferred the responsibility for identifying critical infrastructure to the Department of Homeland Security (DHS) through the Homeland Security Act of 2002. In addition, the Homeland Security Act added key resources to the list of critical infrastructure (CI/KR) and defined those resources as: "publicly or privately controlled resources essential to the minimal operations of the economy and government." Through a series of Directives, the Department of Homeland Security identified 17 sectors of the economy as falling within the definition of critical infrastructure/key resources and assigned primary responsibility for those sectors to various Federal departments and agencies, which are designated as Sector-Specific Agencies (SSAs). On March 3, 2008, Homeland Security Secretary Chertoff signed an internal DHS memo designating Critical Manufacturing as the 18 th sector on the CI/KR list.

By adopting the terms "critical infrastructure" and "homeland security," following the events of September 11, 2001, Congress demonstrated that the attacks fundamentally altered the way many policymakers view the concept of national security. As a result, many policymakers have concluded that economic activities are a separately identifiable component of national security. In addition, many policymakers apparently perceive greater risks to the economy arising from foreign investments in which the foreign investor is owned or controlled by foreign governments as a result of the terrorist attacks. The Dubai Ports World case, in particular, demonstrated that there was a difference between the post-September 11 expectations held by many in Congress about the role of foreign investment in the economy and of economic infrastructure issues as a component of national security and the operations of CFIUS. For some Members of Congress, CFIUS seemed to be out of touch with the post-September 11, 2001, view of national security, because it remains founded in the late 1980s orientation of the Exxon-Florio provision, which views national security primarily in terms of national defense and downplays or even excludes a broader notion of economic national security.

Foreign Investment and National Security Act of 2007

In 2007, Congress changed the way foreign direct investments are reviewed through P.L. 110-49 , the Foreign Investment and National Security Act of 2007. Through P.L. 110-49 , Congress strengthened its role in two fundamental ways. First, Congress enhanced its oversight capabilities by requiring greater reporting to Congress by CFIUS on the Committee's actions either during or after it completes reviews and investigations and by increasing reporting requirements on CFIUS. Second, Congress fundamentally altered the meaning of national security in the Exxon-Florio provision by including critical infrastructure and homeland security as areas of concern comparable to national security. The law also requires the Director of National Intelligence to conduct reviews of any investment that may pose a threat to the national security. The law provides for additional factors the President and CFIUS are required to use in assessing foreign investments, including the implications for the nation's critical infrastructure.

In another change, P.L. 110-49 requires CFIUS to investigate all foreign investment transactions in which the foreign entity is owned or controlled by a foreign government, regardless of the nature of the business. Some foreign investors may well regard this approach as a change in policy by the United States toward foreign investment. Prior to this change, foreign investment transactions were reviewed in a way that presumed that the transactions contributed positively to the economy. Consequently, the burden of proof was on the members of CFIUS to prove during a review that a particular transaction threatened to impair national security. P.L. 110-49 , however, shifted the burden onto firms that are owned or controlled by a foreign government to prove that they are not a threat to national security. In any given year, the number of investment transactions in which the foreign investor is associated with a foreign government likely is small compared with the total number of foreign investment transactions. The number of such transactions, however, is growing as some foreign governments experience a surge in their foreign exchange reserves and they establish sovereign wealth funds in order to invest part of their reserve funds abroad in an array of activities, including in U.S. businesses. Many countries, such as China, also have state-owned enterprises that operate in the global economy.

To clarify U.S. policy toward foreign investment after the Dubai Ports World controversy and the impending passage of P.L. 110-49 , President Bush released on May 10, 2007, a policy statement on open economies. The statement offered strong support for the international flow of direct investment. In part, the statement reads:

A free and open international investment regime is vital for a stable and growing economy, both here at home and throughout the world. The threat of global terrorism and other national security challenges have caused the United States and other countries to focus more intently on the national security dimensions of foreign investment. While my Administration will continue to take every necessary step to protect national security, my Administration recognizes that our prosperity and security are founded on our country's openness.

As both the world's largest investor and the world's largest recipient of investment, the United States has a key stake in promoting an open investment regime. The United States unequivocally supports international investment in this country and is equally committed to securing fair, equitable, and nondiscriminatory treatment for U.S. investors abroad. Both inbound and outbound investment benefit our country by stimulating growth, creating jobs, enhancing productivity, and fostering competitiveness that allows our companies and their workers to prosper at home and in international markets. My Administration is committed to ensuring that the United States continues to be the most attractive place in the world to invest. I urge other nations to join us in supporting an open investment policy and protecting international investments.

The CFIUS process is just one of three major provisions of law that authorize the review of foreign direct investment transactions in the United States for their impact on the economy. The National Industrial Security Program and the critical industries provisions of various statutes also require that foreign direct investment transactions be reviewed. Generally, the reviews mandated by these three provisions operate independently, although at times they have overlapped. The provisions illustrate the complexities involved in defining most economic activities, which can span a broad range of economic activities and fields. Most economic activities affect various sectors and segments of the economy in ways that defy a narrow definition and complicate efforts to distinguish those economic activities that are related to the broad rubric of national security or to national economic security, which is even less clearly defined.

Strategic Materials Protection Board

The Strategic Materials Protection Board, created in 2006, could restrict other types of foreign investment transactions, although this likely will affect a small group of such transactions. In retrospect, some observers hope this provision will prevent future transactions similar to the 2005 merger between Magnequench International and the Canadian-owned firm AMR Technologies, Inc., which shifted ownership of the world's largest producer of Neo powder (composed of neodymium, iron, and boron) to produce Neo magnets. The Strategic Materials Protection Board was mandated by Title VIII of the John Warner National Defense Authorization Act for Fiscal Year 2007, signed October 17, 2006, and designated as P.L. 109-364 . The act established that the Strategic Materials Protection Board would be composed of representatives from: the Secretary of Defense; the Under Secretary of Defense for Acquisition, Technology, and Logistics; the Under Secretary of Defense for Intelligence; the Secretary of the Army; the Secretary of the Navy; and the Secretary of the Air Force. The Board is required to meet at least once every two years to make recommendations regarding materials critical to national security and to report to Congress on the results of meetings and on the recommendations of the Board. In addition, the act prohibits the Department of Defense from buying "strategic materials critical to national security" unless the metals are reprocessed, reused, or produced in the United States, except under a number of conditions, including the lack of availability of specialty metals.

The Board is directed in the statute to undertake four activities:

1. Determine the need to provide a long term domestic supply of materials designated as critical to national security to ensure that national defense needs are met. 2. Analyze the risk associated with each material designated as critical to national security and the effect on national defense that the nonavailability of such material from a domestic source would have. 3. Recommend a strategy to the President to ensure the domestic availability of materials designated as critical to national security. 4. Recommend such other strategies to the President as the board considers appropriate to strengthen the industrial base with respect to materials critical to national security.

The Strategic Materials Protection Board met on July 17, 2007, and published a report in September 2007 of that meeting. At that meeting, the Board determined that the term "materials critical to national security" would mean "strategic materials critical to national security" as specified in the statute and would include those metals listed in Section 842 of P.L. 109-364 (10 U.S.C. 2533b). In this section, specialty metals are defined as:

1. Steel A) with a maximum alloy content exceeding one of more of the following limits" manganese, 1.65 percent, silicon, 0.60; or copper, 0.60 percent, or B) containing more than 0.25 percent of any of the following elements; aluminum, chromium, cobalt, columbium, molybdenum, nickel, titanium, tungsten, or vanadium. 2. Metal alloys consisting of nickel, iron-nickel, and cobalt base alloys containing a total of other alloying metals (except iron) in excess of 10 percent. 3. Titanium and titanium alloys. 4. Zirconium and zirconium base alloys.

Economic Considerations

The growing prominence of national security issues in the development of national foreign investment policies is raising questions about how policymakers can evaluate the economic costs and benefits of such measures when the measures are designed to restrict mergers, acquisitions, and take-overs of domestic firms by foreign investors for national security reasons. Indeed, such measures can sometimes focus more on achieving noneconomic objectives than on achieving economic efficiency or on supporting a market-based allocation of resources. In addition, such policies often expose differing political and philosophical differences between policymakers within countries and among countries. Within the United States, for instance, such differences exist among Members of Congress and between Congress and the Administration over the role foreign investment should play in the economy. This analysis becomes especially complicated, because each nation has the authority to define its essential security concerns on its own terms and to adjust its foreign investment policy to meet that definition. As a result, such policies defy a straightforward cost-benefit analysis and can mask economic protectionism. This section discusses one possible framework for assessing the economic impact of more restrictive investment policies.

Part of the difficulty involved in assessing the economic impact is that at present there is no working set of parameters that establishes a functional definition of the national security implications of such economic activities as mergers, acquisitions, or take-overs of existing U.S. firms by foreign investors. This process of evaluation is even more difficult in peace time when there is no immediate national security threat posed by foreign investment that dictates the course of national security policies. In most cases, government actions to stop or curtail foreign direct investment in the form of a merger, an acquisition, or a take-over of an existing U.S., firm are mainly precautionary measures aimed at addressing potential future actions that a foreign investor may take. This process of identification is also complicated on a multi-lateral basis, because each nation has its own definition of national security and its own approach to formulating policies regarding the role of economic activity within the national security rubric.

Whether intended or not, intervention in the economy on national security grounds creates a mix of industrial activities that most likely would not be achieved through traditional economic market forces. Such intervention often is associated with three types of economic activity. First, the intervention may involve efforts to prevent foreign firms from acquiring certain U.S. firms as a result of the type of economic activity that characterizes the U.S. firm or is related to the nature of the output produced by the U.S. firm. Second, opposition on national security grounds may arise as a result of concerns over the country of origin of the foreign acquirer. This type of concern has grown over the recent past because of the growing role of sovereign wealth funds controlled by foreign governments.

Third, national policies may provide special consideration for certain economic activities in the form of economic incentives for U.S. firms or barriers against foreign acquisition due to a belief that the targeted economic activities are important to national security. In some cases, intervention in the foreign investment process may be justified on a combination of economic and noneconomic arguments. In these cases, the economic costs and benefits that accrue to the economy as a result of the policy actions may be tied directly to an assessment of the particular set of circumstances within which the cost-benefit analysis is conducted.

In the standard textbook presentation, economic production arises from a combination of the four main types of resources, or factors of production, namely: land, labor, capital, and entrepreneurial ability. Of these four factors, labor and capital are generally singled out due to their overwhelming importance in the production process. Growth within an economy, then, is generally believed to arise from growth in the two main factors of production, capital and labor, which are considered to be fixed at any particular point in time. Over time, however, the rate of growth in the labor force combined with the rate of growth in capital accumulation, or in the way in which capital is used, generally referred to as the rate of growth in productivity, set limits on the rate at which the economy can grow.

In a dynamic economy such as that of the United States, some sectors are expanding, or growing, at a rate that is faster than the economy as a whole, while other sectors are either declining, or are growing at a rate that is slower than the economy as a whole. Since the growth rate in the economy is governed by the rate of growth in the labor force and in productivity, any sector of the economy that grows faster than the average rate for the economy as a whole, can only do so by absorbing capital and labor from other sectors of the economy that, then, must be declining or growing at a rate that is less than the average for the economy as a whole, assuming that the economy is growing at close to full employment. Over time, the growing sectors of the economy necessarily take away capital and labor from the declining sectors of the economy. In the short-run, this transformative process may be uneven and may well lead to a mismatch in skills between sectors, which likely would result in some unused or underutilized resources.

Within the economy, economic theory maintains that demand and supply forces determine the market prices for labor and for capital as the various sectors compete for these scarce resources. These market prices, then, work to allocate resources within the economy among the vast array of economic activities into those activities that use the resources in the most efficient manner. Interference in this process, regardless of the reason, can cause a misallocation of resources in the economy and a loss of efficiency, which imposes a cost on the economy as a whole. In the case of government incentives, or subsidies, for a favored industry, the cost to the economy arises from two sources. The first is the direct cost involved in shifting resources into the protected sectors of the economy that are at variance with the way in which market forces would allocate those resources.

The second cost is the indirect cost that arises from the benefits that are lost to the economy from preventing resources, particularly foreign capital, from shifting into those sectors that would be gaining resources through market forces, or the opportunity cost to the economy that arises from a misallocation of resources. While mergers, acquisitions, or takeovers of existing U.S. firms by foreign investors imply at least a change in ownership, foreign investors may well possess additional technology, or other advantages that have made them successful international competitors that would be lost if such an investment were prevented for national security reasons. Economists argue that both direct and indirect costs arise when national policies are used to intervene in the foreign investment process, because such intervention generally is contrary to market forces which act to maximize production efficiencies.

Government policies that attempt to enhance national security by restricting acquisitions, mergers, and take-over of existing U.S. firms by foreign investors may also alter the allocation of capital within the economy and, thereby, incur short-term and long-term costs to the economy. For purposes of analysis, economists often divide production and other economic activities into two time periods: the short run and the long run. The distinction between the short run and the long run is not absolute, but is based on the ability of the economy to shift resources among sectors based on market forces. Generally, labor is thought to be the most mobile factor of production that can be shifted relatively quickly among sectors within the economy and at a lower short-run cost than capital. On the other hand, capital is generally thought of as comparatively more difficult to shift among economic sectors over the short-run. For instance, workers can shift into and out of jobs in response to market demand while it is difficult to shift production facilities or buildings from one locale to another. As a result, in the short run, labor is thought of as the variable factor of production, while capital is thought of as a fixed factor of production. In the long-run, however, all factors are viewed as variable since all of the factors can be reallocated to other sectors of the economy in response to shifts in long-term market forces. This division between the short run and the long run simply means that under normal market conditions, the costs of reallocating resources within the economy through public policy measures, or preventing the allocation of capital into certain sectors through foreign investment, that are not in tandem with market forces would accrue high short-run economic costs that would need an equally high combination of short-run and long-run benefits in order to justify the costs to the economy.

The distinction between the short-run and the long-run can change, depending on conditions within the economy that may require a shift in capital and labor among sectors of the economy. For instance, after the United States entered World War II, the U.S. economy shifted from a peace-time consumer-oriented economy to a war-time arms-producing economy within a relatively short period of time, because the external threats to the country were so great that a dramatic shift in the industrial mix of the economy was considered to be a necessary short-run cost that justified overriding market forces in order to produce quickly the material necessary to defend the nation. In this case, the benefits to the economy in terms of added security, principally the ability to defend the country from invasion or destruction, outweighed the short-run and long-run costs to the economy in terms of shifting resources into sectors of the economy that would not have been given priority under peace-time conditions.

In peace-time, without an imminent external threat, it is difficult to determine the economic parameters that define the terms "critical infrastructure," "homeland security," and "key resources." In addition, it is difficult to define clearly what role foreign investment should play as a separately definable component of national security. This is particularly true in the case of an individual economic transaction such as the acquisition of U.S. firm by a foreign firm. In these cases, the threats to the country often are not well defined or understood and it often is not an easy proposition to evaluate the costs and benefits to the economy as a whole of protecting or promoting certain economic activities. Similarly, it is often difficult to determine the national security elements of allowing or barring investors who are of certain foreign nationalities from acquiring U.S. firms. This problem is compounded under the current "War on Terrorism" in which potential threats to the United States may be decentralized and originate in sub-national organizations.

When policymakers decide to promote certain types of economic activities or to protect U.S. firms or economic activities from foreign investment on the grounds of national security, those officials are in effect weighing the costs and benefits to the nation, or more specifically the marginal costs and marginal benefits, of intervening to alter the mix of industrial activity in the economy. The costs in this case would include the direct short-run and long-run marginal costs associated with blocking foreign capital from being invested in certain favored sectors of the economy in contravention of market forces and, in the case of incentives for favored industries, the indirect costs involved in reducing the available capital and labor that could be used in the economy for more productive activities, or the opportunity cost of the labor and capital.

The marginal benefits that accrue to the nation from such policy activities arise from a combination of a number of factors. The nation may well benefit from the perceived gain in national security and the economy may gain through the capital inflow that is represented by the foreign investment in the form of a merger, acquisition, or take-over of an existing U.S. firm. Foreign investors may also benefit the economy by bringing technological or other production advantages to the United States. Foreign investment may also benefit the economy by sustaining jobs and by producing actual goods and services. These benefits may also include what may be termed the "national security" component of production, or that part of production that satisfies national security concerns. Presumably, the economic benefits would need to be at least as great as the noneconomic benefits in order for national policymakers to justify the economic costs. If noneconomic benefits comprise the largest share of the expected benefits that arise from the policy action, such a policy course might be economic protectionism in the guise of national security and policymakers may realize greater benefits for the nation by pursuing a different policy course that accrues fewer economic costs.

In addition, the economic and noneconomic benefits that are associated with a particular policy may accrue to a large contingent within the economy, as would be the case in a national emergency, or they may accrue to a few as is often the case with economic protectionism. While this distinction between the dispersion of beneficiaries and the allocation of the benefits within the economy is not an absolute way of evaluating national investment policies, it does provide one measure for assessing the distinction between measures that accrue high economic costs relative to few economic benefits within the economy as a whole and may argue in favor of pursuing a different policy course. In some cases the citizens of a nation may be willing to absorb high short-run and long-run costs in order to achieve some noneconomic national security goal that benefits a small contingent within the economy. In such a case, however, it may be possible to achieve such a national security goal through means other than through foreign investment policies that entail lower costs for the economy.

The national security component of production may also be equated with a noneconomic good that satisfies a national or social objective related to some public assessment of national security. The basis for such noneconomic national security benefits can be thought of as a spectrum of benefits that are associated with a similar spectrum of national security threats. These threats can then be thought of as running from threats of imminent destruction that would affect the economy as a whole to concerns about potential activities that are at best tangentially associated with national security and that affect a narrow set of workers and a limited amount of capital. As a result of this spectrum of potential versus real threats and the dangers the threats pose to the economy, the benefits associated with policies that are advanced on the grounds of national security will be stronger or weaker depending on the context within which the argument is made.

Regardless of the nature of the national security threat, the direct and indirect costs to the economy that arise from intervention in the investment process may be the same and pose costs to the economy. Since the costs to the economy that arise from intervention likely are the same, the key to public policy choices is the perceived benefits that are associated with satisfying or addressing such national security concerns. In this way, the marginal costs associated with intervention are equivalent to the marginal benefits that are derived from the policy actions and may be thought of as the cost of satisfying such national security concerns. In the time of full-scale war, the costs to the country of intervening in the economy to redirect resources to produce defense and war material are justified on the basis of the obvious benefits that arise from national survival. In less dire circumstances, however, such cost-benefit comparisons are a great deal more difficult to make.

Conclusions

Following the terrorist attacks of September 11, 2001, policymakers in the United States and abroad have increased their scrutiny of foreign investment in their economies as a component of national security. There is no precise way, however, to estimate the exact dollar amount for the economic costs and benefits of national policies that attempt to direct or restrict foreign direct investment for national security concerns. Also, it can be difficult to determine if foreign investment policies ultimately result in enhanced national security or are a form of economic protectionism. In concept, the economic costs and benefits associated with restrictive foreign investment policies can be evaluated to determine the overall impact of such policies on the long-run economic performance of country. Evaluating and assessing the national security importance of such policies is complicated, however, because any such assessment naturally occurs within the context with which the assessment takes place. A nation facing an imminent threat of destruction or annihilation is willing to accept extraordinarily high economic costs in order to address such a danger

Within the United States, the proposed acquisition of P&O Ports by Dubai Ports World in 2006 and the growing presence of investors that are owned or controlled by foreign governments has sparked a debate between Members of Congress and the Administration over the role of foreign investment in the economy. Part of this debate is focused on determining a working set of parameters that establish a functional definition of the national security implications of foreign direct investment. In part, this issue reflects differing assessments of the economic impact of foreign investment on the economy and differing political and philosophical views among Members of Congress and between the Congress and the Administration.

Since 2006, the United States has participated in discussions spearheaded by the OECD to develop a set of best practices to serve as guidelines for national policies that restrict foreign investment for national security objectives. Presently, the participants have agreed that each nation is its own best judge of its national security interests. At the same time, they have agreed that national policies that restrict foreign investment for national security reasons should be transparent, predictable, and nondiscriminatory. The final OECD report is scheduled for release in May 2009 and likely will contain a set of best practices that Members of Congress may opt to review as a guide concerning U.S. laws and regulations that govern the U.S. treatment of foreign investment relative to U.S. national security objectives.

There are a number of factors that complicate efforts to assess the impact of policies that restrict foreign investment for national security concerns. Some of those factors include the difficulties that are involved in attaching a precise dollar amount to the economic costs and benefits that are associated with such foreign investment policies. One possible framework for assessing such policies is based on the concept of marginal costs and benefits to the nation that accrue from policies that restrict foreign investment. In this case the benefits are some combination of the economic and noneconomic benefits that might be expected to arise from the restrictions, while the costs include a set of real costs that the economy would be expected to incur as a result of the policies. Measures that restrict foreign direct investment that are based on expectations of achieving large noneconomic benefits relative to economic benefits and to large economic costs may not be an effective tool. Instead, there may be other policy tools that could utilized to achieve the same goal, but with lower costs to the economy.

While not determinative, another way of assessing such restrictions is by examining the dispersion of the benefits throughout the economy. At times a nation may well be willing to absorb the high costs that could be involved in protecting some economic activities by restricting or controlling foreign investment. Generally, though it seems reasonable to assume that a policy that is implemented in order to restrict foreign investment that offers benefits to a small group of individuals within the economy and that entails high economic costs relative to benefits, especially where noneconomic benefits are a large share of the expected benefits, could be replaced by other measures that accrue lower costs to the economy.