Senator John Cornyn has led other members of the U.S. Senate in sponsoring the Foreign Investment Risk Review Modernization Act of 2017, which updates the procedures of the Committee on Foreign Investment in the United States (CFIUS). The bill orders CFIUS for the first time to investigate the potential dangers from proposed foreign acquisitions to U.S. technological and industrial leadership across entire industries, sectors, and areas in the U.S. economy. This would set the stage for rejecting any transaction that “is likely to reduce the technological and industrial advantage of the United States relative to any country of special concern.” It also orders CFIUS for the first time to investigate whether proposed foreign acquisitions emanate from a country that has “a demonstrated or declared strategic goal of acquiring a type of critical technology that a United States business that is a party to the transaction poses,” so as to possibly reject such acquisitions.
Theodore H. Moran
Nonresident senior fellow - Peterson Institute
These “reforms” of CFIUS constitute a fundamental departure from the committee’s traditional practice of narrowly identifying national security threats arising from foreign acquisitions, without excluding foreign acquisitions across entire industries, sectors, or areas of the U.S. domestic economy that might reduce the U.S. technological and industrial advantage vis-à-vis another country. This new broader approach would unavoidably put the U.S. government in the business of designing a national industrial policy by picking and choosing which areas to protect.
American governments of all political persuasions have long recognized that foreign investors make significant contributions to the U.S. domestic economy. Foreign multinational corporations that invest in the U.S. pay higher wages, offer greater benefits, exhibit higher productivity, provide more value-added to U.S. domestic inputs, import via superior access to external supply chains, export more goods and services, and engage in greater research and development than purely U.S. domestic firms. At the same time, foreign investors put competitive pressure on U.S. firms to upgrade their technologies, management practices, and quality-control procedures, and often offer channels of learning for imitation by U.S. firms. Indeed, the most recent data show that 12 percent of all productivity gains by firms in the U.S. economy over more than two decades can be traced to spillovers from foreign investors. Such spillovers originate from foreign investors from BRIC countries—such as China, Russia, and Brazil—as well as from foreign companies headquartered in OECD economies.
For this reason, American governments at the national level—as well as U.S. state and local governments—have been eager to welcome foreign investors into the domestic economy.
In the U.S., as in other developed country economies, approximately 80 percent of foreign investments take place via acquisition of a target firm in the target country, depending upon the industry. This leads to concern that under certain circumstances the foreign takeover of a U.S. firm might pose some kind of national security threat to the U.S.
Current CFIUS regulations have left the definition of threats to national security open ended, but an empirical examination of CFIUS cases shows that the committee’s threat assessments can be separated into three distinct types, and the conditions under which each threat becomes plausible can be distinguished from situations in which the harm envisioned is not credible.
The first threat derives from a possible leakage of sensitive technology to a foreign company or government that might deploy or sell such technology so as to be harmful to U.S. national interests. To assess the plausibility of this threat is a two-step process. Step one is to calculate the damage that could be done if the technology were deployed against U.S. interests. Step two is to calculate how readily available such technology is in international markets to see if it makes sense to refuse the transfer to foreign hands. If alternative sources of the technology held by the acquired firm are widespread, national security will not be served by blocking the transaction.
The second threat springs from the ability of the foreign acquisitor, acting independently or under instructions from the home government, to delay, deny, or place conditions upon provision of output from the newly acquired producer. To assess the plausibility of this threat also requires a two-step analytic process. The first step is to calculate how “crucial” or “critical” the process or product is—crucial or critical is defined as the cost of delay or doing without. The second step is to calculate how concentrated the international industry is, how abundant are near substitutes to the processes or products of the company that is being acquired, and how high are switching costs. If the goods and services of the company being acquired are widely available and switching costs are low, there is no plausible threat to U.S. national security.
The third threat derives from the potential that acquisition of a U.S. company might allow a foreign company or its government to penetrate the U.S. company’s systems so as to monitor, conduct surveillance, or place destructive malware within those systems. If alternative suppliers of the goods and services from the company to be acquired are readily available, any user who feared penetration could simply switch to another provider. This threat is particularly prominent in assessing foreign acquisitions involving critical infrastructure. A sub-version of this threat lies in surveillance via proximity to U.S. military bases or defense installations.
In each of these scenarios, CFIUS has hitherto interpreted its mandate too narrowly, with a specific focus on whether foreign acquisition of a U.S. firm might pose a credible national security threat to the U.S.—or not—on a case-by-case basis.
U.S. national interests would be best served by maintaining CFIUS’s narrow focus on specific threats that might arise from particular acquisitions within industries. Excluding entire industries, sectors, or areas of the U.S. economy from foreign acquisitions—with zero-sum attention to whether such acquisitions might erode U.S. technological or industrial advantage vis-à-vis the home country of the acquiring firm—could weaken U.S. competitiveness. But how should a country like the U.S. that favors an open, welcoming approach to trade and investment deal with acquisitions from a country that does not, like China?
The U.S., U.K., Europe, Japan, South Korea, and other developed economies have a strong interest in pushing China to respect its World Trade Organization obligations to keep markets open to trade and investment. This push should be combined with pressures on the Chinese government to make its state-owned enterprises operate more transparently and competitively, without support or protection on the part of the Chinese authorities. The U.S. and its economic allies should try to limit foreign multinational investors from being subjected to technology-sharing mandates and localization requirements in China.
If the U.S. wants to change Chinese investment behavior, the U.S. Trade Representative, the Department of Commerce, and the White House should jointly lead the effort. Using CFIUS on a case-by-case basis to try to change Chinese approaches to industrial policy would be neither efficient nor effective.