What Happens When Foreign Investment Becomes a Security Risk?

Introduction

The United States is both the world’s largest foreign direct investor and the largest beneficiary of foreign direct investment (FDI). But like every sovereign country, it has sought to temper its embrace of open markets with the protection of its national security interests. Achieving this balance, which has shifted over time, has meant placing certain limitations on overseas investment in strategically sensitive sectors of the U.S. economy.

Established in 1975, the Committee on Foreign Investment in the United States (CFIUS) is a powerful interagency panel that screens foreign transactions with U.S. firms for potential security risks. Lawmakers expanded the committee’s powers in 2018 amid a rising tide of Chinese investment, and in 2022, President Joe Biden issued the first set of specific criteria for the committee to identify national security threats. Meanwhile, other Western countries, from Australia to the United Kingdom, are tightening their own scrutiny of foreign investments.

How does the United States benefit from foreign investment?

Washington has traditionally led international efforts to bring down barriers to cross-border capital flows with the goals of expanding investment opportunities for U.S. multinational businesses and creating a more stable and efficient international system. The United States relies greatly on foreign inflows to compensate for a shortage of savings at home, and it routinely ranks among the most favorable destinations for foreign direct investors. Foreign direct investment—the ownership or control by a foreign entity of 10 percent or more of a domestic enterprise—plays a significant and growing role in the U.S. economy.

According to research by the Department of Commerce, foreign investment supported some sixteen million U.S. jobs [PDF] in 2019, or 10.1 percent of the total labor force. On average, foreign firms pay higher salaries than their domestic competitors; they are also disproportionately involved in manufacturing.

What are the concerns over foreign investment?

Concerns with foreign transactions are typically associated with mergers, acquisitions, and takeovers of domestic firms rather than new investments, known as greenfields. The U.S. government, much like its peers around the globe, has passed legislation that empowers federal agencies to review foreign deals that could cause significant outsourcing of jobs, a loss of control over agricultural supply chains, the sharing of sensitive technologies, or impairment of critical infrastructure.

But many economists warn that imposing burdensome restrictions on FDI inflows could inspire retaliatory policies by other nations. To avoid this, the thirty-eight members of the Organization for Economic Cooperation and Development (OECD), as well as twelve nonmember states, have signed a nonbinding commitment to treat foreign-controlled firms on their territories no less favorably than domestic enterprises. Governments under this agreement are, however, provided considerable latitude to exempt sectors of their economies deemed essential to national security. Countries define this “critical infrastructure” in various ways [PDF], but most definitions include services and assets that, if disrupted, would have a significant negative impact on a country’s economy or national security.

International investment experts Alan P. Larson and David M. Marchick, who coauthored a 2006 Council Special Report on the subject, say that state ownership of multinational firms is often benign. However, they note that concerns arise “when the foreign company’s decisions become an extension of the government’s policy decisions rather than the company’s commercial interests.” The authors cite as a cautionary example a move by Russian energy giant Gazprom in 2006 to cut gas supplies to Ukraine, which some Western observers considered a politically motivated decision.

More recently, leaders in Europe and the United States have raised concerns about investments by large Chinese firms whose operations are influenced by the governing Chinese Communist Party. U.S. policymakers have become sensitive to Chinese attempts to acquire critical technologies, or advanced technologies that the government deems significant to national security. Officials have accused Beijing of forced technology transfers, or requiring Western firms to share technology in order to do business with Chinese companies. Both President Donald Trump and President Biden took steps to restrict China’s acquisition of advanced U.S. technologies, citing their potential role in China’s military buildup and control over critical supply chains.

How has the review of foreign investment evolved?

Federal oversight of foreign investment has evolved over time, often in response to changing economic and security conditions. President Gerald Ford created CFIUS in 1975 amid growing investments by members of the Organization of the Petroleum Exporting Countries, or OPEC, in the United States, which many policymakers saw as potentially suspect.

However, in the ensuing years, many in Washington felt the oversight body was falling short of its obligations. In 1988, Congress strengthened the CFIUS review process by passing the Exon-Florio amendment to the Defense Production Act of 1950. Much as in the previous decade, the reform stemmed from concern with growing foreign investment—this time Japanese—in sensitive U.S. industries, including a bid by computer giant Fujitsu to purchase U.S.-based computer chipmaker Fairchild Semiconductor.

Exon-Florio transformed CFIUS into a powerful review body and granted the president far-reaching authority to block a foreign acquisition on “national security” grounds, broadly defined. Executive decisions do not require congressional approval and cannot be judicially reviewed.

The CFIUS process was amended again by the Foreign Investment and National Security Act of 2007 (FINSA), which passed in the wake of the Dubai Ports World scandal. In March 2006, amid a flurry of U.S. political opposition, the state-owned firm based in the United Arab Emirates’ capital of Dubai scuttled its bid to acquire control of major U.S. port operations. Many in Congress said that the controversial deal would increase the risk of a terrorist attack on the United States. President George W. Bush and CFIUS had previously approved the transaction. FINSA provided Congress greater oversight of CFIUS, expanded the legal meaning of “national security” to include critical infrastructure, and required CFIUS to investigate all foreign investment deals in which the overseas entity is owned or controlled by a foreign power.

In 2022, Biden signed an executive order introducing the first explicit articulation of specific risks that CFIUS must consider. The order established five criteria for reviewing a potential deal: effect on U.S. supply chains, including those unrelated to defense; effect on U.S. leadership in advanced technologies; how the transaction is situated within industry investment trends; cybersecurity risks that could emerge from the transaction; and risks to the private data of people in the United States.

What role has increasing Chinese investment played?

Lawmakers and security officials have become increasingly concerned about the growth of Chinese investments in U.S. companies, which have totaled more than $180 billion since 2005. Successive U.S. administrations have decried the Made in China 2025 industrial policy, through which Beijing leverages Chinese investment in foreign technology firms to quickly develop China’s own high-tech manufacturing sector. In 2022, Biden recognized that “some countries use foreign investment to obtain access to sensitive data and technologies for purposes that are detrimental to U.S. national security.” 

CFIUS has expanded its scrutiny in recent years, making more deals subject to its purview. In 2016, the agency broadened its review process to apply more oversight to so-called non-notified transactions—that is, deals that had not been registered with the agency.

In 2018, Congress passed—and Trump signed—the Foreign Investment Risk Review Modernization Act (FIRRMA), which many experts have called the most significant overhaul of the agency’s powers since 1988. FIRRMA allows CFIUS to review a wider range of transactions, including any “non-passive” investment in U.S. firms involved in critical technology or other sensitive sectors. It also lengthens the review period, gives CFIUS greater leeway to suspend transactions, increases funding and staffing for the agency, and mandates a separate process to review the export of sensitive U.S. technologies.   

While the legislation did not target Beijing by name, Chinese investment in the United States has decreased since it became law. According to CFIUS data, transaction registrations from Chinese investors fell by 43 percent [PDF] in the two-year period after the legislation was passed, down to an average of 32 percent per year.

Skeptics of the reforms, meanwhile, worry that they could overburden CFIUS, hamper the competitiveness of U.S. companies, and dampen the dynamism of the technology sector. Policies that restrict Chinese investment in the United States can be “costly, (harming U.S. industries and innovators), imprecise (chilling more activity than intended), and even futile (failing to remedy the relevant Chinese tech threats),” writes the Carnegie Endowment for International Peace’s Jon Bateman.

How does the CFIUS review process work?

CFIUS operates under the discretion of the president and is chaired by the secretary of the treasury. It includes the heads of the following departments: Commerce, Defense, Energy, Homeland Security, Justice, and State, as well as the U.S. trade representative and director of the Office of Science and Technology Policy. Several other offices also contribute: the Council of Economic Advisers, Homeland Security Council, National Economic Council, National Security Council, and Office of Management and Budget. In addition, the director of national intelligence and the secretary of labor are nonvoting, or ex officio, members.

Before FIRRMA, CFIUS reviewed every merger, acquisition, or takeover resulting in “foreign control of any person engaged in interstate commerce in the United States.” FIRRMA expanded this extent of review to include noncontrolling investments.

Prior to a formal filing, which is mandatory for some transactions involving critical technologies, the committee encourages parties to any foreign deal that could have security implications to consult with CFIUS staff confidentially to identify and address potential concerns. Once a formal notification is submitted, CFIUS reviews the proposed deal for up to forty-five days, during which time it can request additional information and provide feedback to the parties. Most reviews conclude in the initial period; the few that raise concerns trigger a second, forty-five-day investigation. CFIUS and the transacting parties sometimes need to negotiate a mitigation agreement to address any national security concerns. After the investigation period, the committee can make an adverse recommendation to the president, who then has fifteen days to make a decision. 

Only the president has the authority to block a transaction, but two conditions must be met beforehand: the president must have “credible evidence” that the deal will impair national security and must determine that existing U.S. laws are insufficient to safeguard national security.

How often does CFIUS review foreign investments?

In the decade plus since the 2008 global financial crisis, the number of companies filing transactions with CFIUS has steadily risen, from 65 in 2009 to 272 in 2021. The proportion of filings leading to an investigation has also risen, from about 40 percent before FIRRMA was enacted to nearly 50 percent in 2021.

Since the creation of CFIUS, presidents have only blocked deals on five occasions, though companies have withdrawn from deals they viewed as unlikely to win CFIUS approval. In 1990, President George H.W. Bush was the first to do so, voiding the sale of Mamco Manufacturing, a Seattle-based aircraft parts maker, to a Chinese state-owned aviation company. President Barack Obama blocked two: in 2012, he ordered the Chinese-owned Ralls Corporation to divest its interest in Oregon wind farms, citing national security concerns, and, in 2016, he blocked the takeover of the German semiconductor company Aixtron by a Chinese company with government ties.

Trump accelerated the pace, stopping two potential transactions during his term in office. In September 2017, he blocked the sale of the chipmaker Lattice Semiconductor in a deal partially financed by Chinese state-owned capital. And in March 2018, Trump acted quickly on CFIUS warnings that the proposed takeover of U.S. telecom leader Qualcomm by a Singapore-based company would reduce U.S. technological competitiveness and impair national security. The $142 billion deal was by far the largest to be blocked by presidential order, but it could soon be eclipsed if CFIUS bans TikTok, a popular video-sharing app that has been valued at over $300 billion. The CFIUS review of TikTok began during the Trump administration and is ongoing.

How do U.S. policies on foreign investment compare with the rest of the world?

In recent years, countries around the world have been reevaluating, and often tightening, their oversight regimes. Most have broadened the scope of what is considered “national security sensitive” to include energy, telecommunications, infrastructure, and health care.

Like the United States, other governments have increased screening of foreign investment as they become more concerned about record levels of Chinese acquisition activity, which primarily targets the industrial and technology sectors. In Europe, France began requiring state approval for most foreign bids in 2014, and Germany, China’s top investment destination in Europe, followed soon after. The United Kingdom passed the National Security and Investment Act in 2021, giving government officials the ability to review transactions in certain sectors. In addition, members of the European Union (EU) have prevented Chinese firms from buying several companies, including electricity transmission businesses and advanced chip manufacturers, despite a 2020 investment agreement that sought to increase commercial ties between the EU and China. Once heralded by the EU as “the most ambitious agreement China has ever concluded with a third country,” the deal has not been ratified, and member states continue to increase their scrutiny of Chinese investment. Chinese mergers and acquisitions targeting Europe have dropped, falling by 74 percent year over year in the first quarter of 2022, measured by deal value.   

Recent Chinese acquisition attempts have proven particularly controversial in Australia, where China has invested more than $110 billion since 2007, over 70 percent of which has been in the mining sector. Canberra has stepped up its scrutiny of foreign deals and mandated that all acquisitions of public infrastructure be reviewed. In 2016, Australia rejected a Chinese bid to buy its largest agribusiness, and in 2021, it canceled a deal that would have seen Victoria, the country’s wealthiest state, sign on to Beijing’s Belt and Road Initiative.