How should we reform our FDI security reviews?

Investments in the U.S. by foreign nationals can raise important security issues.  The U.S. has a process to review the security implications of foreign investments.  This is centered in a committee or cabinet members called Committee on Foreign Investment in the U.S. (CFIUS).

The Institute of International Economics (IIE) has released its new book on this process: US National Security and Foreign Direct Investment (Edward M. Graham and David M. Marchick, May 2006).

This book is timely as Congress, in the light of this winter's Dubai Ports World controversy, is looking at changes to the U.S. process for security review of foreign investments. 

For a review of the Dubai Ports World debate, and a description of the current state of the process, see "Countdown to controversy: Dubai Ports World" (Ben Muse, March 6, 2006)

All the chapters are available at the book's web site - you can read, and download, but not annotate or print.  From the abstract:

Although a vital part of the US economy, foreign direct investment (FDI) in the United States periodically raises public and congressional alarms—as witnessed during Dubai Ports World's recent bid to acquire US port operations and Chinese firm CNOOC's attempt to buy US energy firm Unocal. Drawing fire from Congress are the Exon-Florio provisions of US law, which enable the president to block a foreign acquisition that threatens national security. This important new book finds that many proposed reforms risk harming the US economy without enhancing national security. The authors propose ways to strengthen the current interagency review of deals, including an improved process for reporting to Congress. 

Here's my summary of their policy recommendations, what we need to do and not to do.  What to do:

• Existing legislation provides a list of criteria to consider when evaluating an investment – for example, the impact of foreign investment on the ability of domestic industries to meet defense needs.  We should add “protection of critical infrastructure” to the list of issues CFIUS is expected to consider.  As a practical matter, critical infrastructure issues have been receiving increasing consideration since the Clinton administration.  The definition of critical infrastructure needs serious attention.
• Set security standards for foreigners in “sensitive positions”
• Create mechanisms for sharing information with Congress.  This does not mean radical transparency.  The process needs to be able to protect confidential private information and the security analysis, and to be able to publicity that might encourage politicization of the process.
• OECD, China, Russia, and India should work together to come up with general standards for national investment security procedures.
• Clarify and perhaps relax somewhat the standards CFIUS uses to identify foreign control.  Right now, as a practical matter, control is “presumed” when foreign ownership reaches 10% of a firm, although this is not laid out in regulations.  CFIUS needs a clearer set of guidelines for determining control.  Foreign investors need to be able to estimate the regulatory risk associated with an investment;  CFIUS has "no interest in reviewing complicated or contentious cases, in which an unclear control test potentially forces the agencies, or the President, to bar or condition an investment."

What not to do:

• No mandatory filing requirement.  Now security reviews are voluntary, done at the request of the companies involved.  However, a mandatory filing requirement is not necessary, because CFIUS can take a look at an acquisition retroactively, and require divestiture.  If CFIUS reviews an investment, and it is approved by the President, CFIUS can’t go back and second-guess itself.  This certainly gives firms with investments that may raise security issues an incentive to file voluntarily.  Requiring that all foreign acquisitions be filed with CFIUS "would be unwieldy, and could hamper CFIUS’s ability to protect national security.”  After all, very few foreign investments have security implications, and there are far more investments each year than CFIUS can look at.
• Don’t replace the Treasury Secretary as CFIUS chair.  The process is meant to identify and solve security issues without unduly burdening the flow of foreign investment into the United States.  The process currently provides an opportunity for careful vetting of the economic and security arguments by exploiting the “checks and balances” provided by input from a variety of security and economic agencies.  An economic agency is more likely to “try to move the process along, security agencies have been known to simply dig in and avoid engagement.”  A move of the chairmanship to a security agency head would upset the “checks and balances.”
• No “economic security” test.  This might create a general foreign investment review process that would inhibit foreign investments in the U.S.and provide other countries with an excuse to subject U.S.investments to similar review.  It would be hard to enforce because its extremely hard to define what “economic security” means.  This would provide endless opportunities for companies to engage protect themselves against competition by making spurious claims that a foreign investment in a competitor violates some "economic security" test.  It would encourage politicization of the review process.