Open Markets Start at Home

Douglas Holtz-Eakin
Special to's Think Tank Town
Thursday, August 17, 2006 12:00 AM

On August 1, Treasury Secretary Henry Paulson used his debut speech to make a strong case for open global trade and investment: "Nations that reform their economies, and open themselves to trade and competition, benefit their own citizens greatly. They see more jobs and higher living standards. And those nations that don't take these steps are left behind." At the same time, he raised the alarm against growing protectionism: "But in many countries -- even those that have seen the greatest gains from open markets -- there is a disturbing wave of protectionism. A number of countries are increasingly viewing market access as something that should apply to someone else's home market and not their own."

Paulson can do more than sound the alarm. Along with President Bush he can take a strong stand against investment protectionism in the United States. How? By thinking clearly and acting strongly on national security and inbound investment.

Earlier this year, international investors looked askance when an acquisition -- the purchase by Dubai Ports World (DPW) of Peninsular and Oriental Steam Navigation Company (P&O) -- dissolved into political controversy over putative security exposures from operations at a number of U.S. ports. This impasse came on the heels of heavy-handed Congressional interference in Chinese National Offshore Oil Corporation's (CNOOC) proposed purchase of American oil company Unocal.

One could hope that these episodes would be seen as a brief departure from the U.S. tradition of open international investment, a tradition that is one underpinning of the strong U.S. economy. Among developed economies the U.S. has experienced uniquely strong productivity growth in the past decade. A critical ingredient for this success has been openness to global trade in goods, services, and capital. Currently, U.S. subsidiaries of international companies have over 5 million employees and pay compensation of over $300 billion each year, or about $60,000 per employee. The tempest over DPW and CNOOC would suggest large inflows from unstable governments. In fact, the vast bulk (over 90 percent) of these investments has come from countries belonging to the Organisation for Economic Co-operation and Development (OECD) and a small minority is undertaken by firms with government control.

In general, openness to global markets, strong economic growth, and national security go hand in hand. For example, the Congressional Budget Office projects that over the next decade and one-half, defense plans will require spending an average of $500 billion (adjusted for inflation), a peak increase of roughly 20 percent over current levels and above the peak of the Cold War. Clearly, an important aspect of national security is an economy that grows strongly enough to generate resources for the private sector, social objectives, and our military and other national security needs.

Nevertheless, transactions do arise (and have arisen) in which national security considerations overwhelm their narrow economic desirability. Such transactions fall into the bailiwick of the Committee on Foreign Investment in the United States (CFIUS), which Congress created two decades ago to either ameliorate security exposures or veto undesirable acquisitions. To date, the CFIUS process has worked well to support well-functioning, open capital markets with specific carve-outs for transactions that pose a national-security threat. CFIUS has done its security job, but failed miserably in other respects. Communication with Congress has been poor and transparency has left much to be desired. In the aftermath of CNOOC (which never got to CFIUS) and DPW (which was approved), a Congress suspicious of security gaps and frustrated by its inability to exercise appropriate oversight seized the opportunity to revisit the entire issue. Reform of the CFIUS review process was the subject of a recent Council on Foreign Relations Special Report, Foreign Investment and National Security: Getting the Balance Right.

The legislative route is not the best way to go. While the House has passed sensible fine-tuning legislation, the Senate has raised the specter of wholesale politicization of investment approvals -- requiring, for example, notices to governors and congressional delegations of proposed purchases in their states; adding bureaucratic delays for investments that don't raise security concerns; and drawing Congress into the middle of the review process. The potential for damage to the U.S. investment climate is quite real.

A better approach would be to drop the legislative approach entirely. The president can take advantage of Hank Paulson's 30 years of experience in cross-border mergers and acquisitions and issue an improved executive order revising the marching orders for CFIUS to include greater transparency, improved cooperation with Congress, and improved monitoring of compliance. If this proves unsuccessful, Secretary Paulson can devote his energies to Congressional outreach in pursuit of legislation stripped of the potential for political interference.

Any lingering threat of politically-driven reviews will boomerang and directly hurt U.S. global investments. The greatest danger lies in other countries using recent U.S. missteps as a pretext for protectionist rules draped in the guise of national security. Press reports indicate that China will tighten screening of deals, and impose new curbs on foreign acquisitions. The Financial Times quotes a European banker as saying: "We should not be too critical of Beijing. After CNOOC was blocked by Washington from buying Unocal last year, no American should dare lecture Beijing about free markets." Similar episodes have transpired in France and India. A broader trend toward restricted capital markets would greatly damage the global economy, especially at a time when multilateral trade liberalization is losing steam. It would also directly hurt U.S. interests.

Douglas Holtz-Eakin is the Paul A. Volcker chair in International Economics and director of the Maurice R. Greenberg Center for Geoeconomic Studies at the Council on Foreign Relations. He most recently served as director of the Congressional Budget Office and chief economist of the White House Council of Economic Advisers.

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