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For almost a decade, ITIF has advocated for CFIUS reform to better address serious issues with Chinese foreign direct investment (FDI), especially acquisitions, into the U.S. economy. In 2018, Congress passed the Foreign Investment Risk Review Modernization Act (FIRRMA) to reform the national security review process of foreign acquisitions of U.S. businesses by the Committee on Foreign Investment in the United States (CFIUS).
ITIF argued for CFIUS reform for one main reason: China. As we noted in testimony to the Senate Foreign Relations Committee:
Chinese efforts to intentionally target U.S. advanced-industry enterprises across a range of high-value-added sectors only continues to intensify, meaning that CFIUS procedures need to be strengthened to ensure that Chinese entities, particularly those guided or backed by Chinese-government influence or funding, are not able to acquire U.S. companies or technology that could damage America’s economic or national security.
In part because of pressure from the Treasury Department, the drafters of FIRRMA did not include a “blacklist” in the legislation that would have made it clear that investment by companies from China would be inherently suspect, while investment from allies would operate under the presumption of being allowed. However, the original Senate version of FIRRMA sought to create a sort of “triage” approach at CFIUS, where investors from white-listed countries would for the most part not need their transactions reviewed at all. That would have left CFIUS to focus on the true problematic transactions from nations such as China that employ blatantly state-led industrial and economic development practices. Moreover, the House bill that emerged from the Financial Services Committee actually took a “blacklist” approach. Despite the absence of this language in the final bill there was an understanding among most people involved in the drafting that the administration would implement the law in this way. Indeed, as the Congressional Research notes, “the legislation does allow CFIUS to discriminate among foreign investors by country of origin in reviewing investment transactions by labeling some countries as “a country of special concern”—a country that has a demonstrated or declared strategic goal of acquiring a type of critical technology or critical infrastructure that would affect United States leadership in areas related to national security.”
As the Trump administration implements FIRRMA, the most important thing it should consider is that CFIUS should treat Chinese acquisitions of U.S. companies fundamentally differently than acquisitions from our allies. As such, CFIUS should not evolve into a general investment screen to review or limit all foreign investment, for the principal reason that most foreign acquisitions or mergers from companies hailing from market-oriented, democratic nations allied with the United States help, not hurt, U.S. competitiveness and technological strength.
To be sure, there are at least four reasons to restrict Chinese investment. The first is reciprocity. In most industries in China, particularly advanced technology ones, American companies cannot own majority stakes in Chinese companies, much less buy them outright. In many cases, U.S. firms seeking market access in China, particularly ones with sophisticated technology, must engage in a joint venture with a Chinese firm. As one industry article advising U.S. companies wrote, “To participate in China’s industry ecosystem, it is essential to establish connections with the stakeholders in China, such as government, customers, suppliers, and even competitors, and to seek opportunities in cooperation and development through mutual understanding and engagement.” With regard to the life-sciences market in China, an industry analyst writes that, “To enter the Chinese market, you may come in by licensing an asset, which we have done, or you can create a joint venture, which we have also done. But you cannot go in by yourself.” And as the U.S. Congressional Research Service reports:
The OECD’s 2014 FDI Regulatory Restrictiveness Index, which measures statutory restrictions on foreign direct investment in 57 countries (including all OECD and G20 countries, and covering 22 sectors), ranked China’s FDI regime as the most restrictive, based on foreign equity limitations, screening or approval mechanisms, restrictions on the employment of foreigners as key personnel, and operational restrictions (such as restrictions on branching, capital repatriation, and land ownership).
Second, many attempted Chinese acquisitions of U.S. companies are not market-based. In many cases, the companies are subsidized by the Chinese government, enabling them to outbid other purchasers. A case in point was the acquisition of the U.S. printer company Lexmark. In 2016, the Chinese government’s National Integrated Circuit fund, a fund created by the Chinese government and largely funded by Chinese government agencies and state-owned enterprises (SOEs), backed a Chinese company to buy Lexmark. As one report noted, the IC fund “became the third largest investor in Apex Technology, a Chinese investment consortium. Shortly after, Apex acquired U.S. computer printer maker Lexmark International in an all-cash deal worth $3.6 billion, a 17% premium on Lexmark’s closing share price.”
Third, a significant share of Chinese acquisitions or attempted acquisitions are undertaken for the principal reason of acquiring American intellectual property (IP) and know-how and moving it to China. While Chinese firms rely on intellectual property theft and forced joint ventures and tech transfer for much of their foreign knowledge and tech acquisition, they also use FDI as a key tool. This is very different than the motivation for firms headquartered in Commonwealth nations, Europe, Japan, South Korea, and the United States, which usually acquire firms for reasons of synergy and scale economies, not stripping out valuable IP and moving it to the home country.
Fourth, as the Trump administration has rightly noted, China represents the rise of a new great power threat. As the 2018 National Defense Strategy states, “China is a strategic competitor using predatory economics to intimidate its neighbors while militarizing features in the South China Sea.” In this sense, allowing Chinese companies to buy American companies, even if they are not directly related to defense technologies, strengthens the Chinese economy and potentially its military.
Contrast that with investments from companies headquartered in allied nations, such as Canada, Germany, Japan, and South Korea; investments which are different in at least three key regards. First, for the most part, American companies can buy foreign companies in allied nations subject only to the same kind of anti-trust review the U.S. federal government uses to review mergers and acquisitions.
Second, acquisitions from these nations are market-based and not backed by the deep pockets of a mercantilist government. When a company from Germany or Japan, for example, seeks to buy an American company, it is the company and its shareholders who are paying for it and taking the risk. This significantly increases the likelihood that the deal is pro-growth for both nations.
Third, when a U.S. firms buys a foreign one, or when a foreign firm in an allied nation buys an American firm, the goal in both cases is to expand value, not strip it out. As discussed below, sometimes this is to achieve synergies in economies of scope (the combined company can now provide a broader array of product offerings, allowing it to be more competitive), or economies of scale (the combined company can combine resources, such as R&D and production facilities, so that it is more innovative or productive) and other synergies (such as ability to broaden channel and sales breadth globally). In both cases, the acquired firm is usually stronger than the two separate firms, able to take advantage of benefits that would be limited absent the acquisition/merger. And in most cases, this strengthens production in the United States. Indeed, studies show that market-based foreign direct investment increases economic productivity, and that foreign acquisitions, especially in R&D-intensive industries, boost the productivity of the domestic acquired firm. Moreover, in most cases the foreign acquiring firm already has significant existing facilities and investment in the United States. As the Commerce Department’s Select USA notes, foreign firms conduct over $62 billion in R&D annually in the United States and employ 7.4 million Americans. Finally, when firms from allied nations acquire U.S. firms the threat to overall economic and national security is limited or non-existent, especially when the acquisitions do not involve narrow, defense specific technologies.
Beyond these factors there are a number of reasons for a permissive and indeed welcoming approach to acquisitions and mergers from companies in allied, partner nations, particularly in advanced, technology-based industries such as semiconductors, machinery and equipment, vehicles, and pharmaceuticals. The core reason is that in most R&D and capital-intensive based industries scale economies are becoming an even more important factor in success. In these industries, firms need large amounts of capital not only to fund expensive R&D but also to build the latest production facilities. As the U.S. International Trade Commission notes, “the costs associated with developing semiconductor manufacturing equipment, which can reach $120 million per piece, have led to ongoing industry consolidation.” Costs of building a semiconductor fab have increased significantly and are now in the range of multiple billions of dollars. In fact, Taiwan’s TSMC is constructing a fab costing $17 billion. This is one reason why there have been 31 wafer fab closures in the United States from 2009-2018. Enabling U.S. firms, especially mid-sized ones, to merge or be acquired by foreign or domestic firms can be critical to enabling a strong advanced industry firms in the United States.
This is particularly true given that a core component of China’s industrial strategy is to build up very large firms, backed by massive amounts of cash and other subsidies, enabling them to “go out” and take market share around the world. We see that in many industries. In the biopharmaceuticals industry the Chinese government has put in place a strategy to weed out hundreds of small and mid-sized generic drug makers in order to establish a small number of large, robust national champions to sell drugs around the world. In high-speed rail, China’s government required the merger of China’s top two high-speed rail firms into the Chinese Railway Construction Corporation (CRCC). By 2016, CRCC had over two-thirds of global deliveries, taking significant market share away from the two other, now smaller leading firms, Alstom and Siemens.
There are only four ways to compete with these and other Chinese juggernauts. The first is to close markets in the rest of the world to them. While the Trump administration’s tariffs have limited some Chinese exports, it is not likely that U.S. tariffs will expand, nor is it likely that our allies will go down that path. And, indeed, resorting to having to apply such tariffs represents a non-optimal path for the U.S., and global, economy.
The second is for governments in advanced economies to create their own national champions. But this is difficult, if not impossible. Western governments rightly do not have the legal authority to force firms to merge. They could provide subsidies to enable firms to get much bigger, but few Western governments have either the inclination nor the budgets to do this at the requisite scale. And in the United States, not only budget limits but also an aversion to such activist industrial policy, makes this possibility nil.
This leaves only two possible approaches. The first is for U.S. firms lacking the scale needed to compete globally to go out of business. That might be okay if one believes in the “potato chips, computers chips; what’s the difference” theory of economic policy—in other words, that it makes no difference if the U.S. economy is home to advanced technology production or not. But thankfully across the political spectrum the view that America can give up on its advanced technology industries without paying a steep price is a shrinking minority.
So, the only real option is to let firms combine to get needed scale (while continuing to advocate for a global economic system predicated on private enterprise-led, market-based, rules-governed trade.) As my colleague Mike Lind and I point out in our book Big Is Beautiful: Debunking the Myth of Small Business, large firms are on average more productive, more innovative, pay higher wages, and export more. And sometimes the best, and often only, potential acquirer is a foreign firm from an allied nation. As such, as the Trump administration administers the newly reformed CFIUS it will be important that it clearly treats investments from adversaries, especially China, differently from investments from allies. We must recognize that, in China, America faces a geostrategic competitor that uses a mercantilist, state-led economic development strategy as a key means of statecraft and for the purpose of accumulating both economic and national security advantage. The countries in the latter case fundamentally do not operate their economies in this way, and so the presumption should be in favor of the investment/acquisition in the U.S. economy.