Who, Not What, Matters for Investment Barriers

Op-ed in Welt am Sonntag

November 4, 2007

Germans are right to be afraid of Russian government entities using their newfound wealth to buy significant stakes in some companies. The issue, however, is not which companies are at risk of takeover, whether European Aeronautic Defense and Space Company (EADS) or something with far less overt national security ties. The issue is the nature of such potential investor entities as Gazprom that have nonmarket motivations and operate under another government's control. In short, Germany and the European Union should respond by focusing more on who is looking to do the investment than what sector they are looking to invest in.

Minister-President Roland Koch of Hesse has usefully sparked the discussion of how to respond to investment in Germany by sovereign wealth funds and similar foreign public entities. Chancellor Angela Merkel has advanced this on both the European and domestic agendas, and given economic integration within Europe it would make more sense to have a common policy for the single European market. Less beneficially, though, the German policy proposals have largely consisted of setting up an entity comparable to the Committee on Foreign Investment in the United States (CFIUS) which would review proposed acquisitions. The American experience is not a model to be emulated.

CFIUS suffers from three problems that should not be replicated in Germany or Europe. First, it is an interagency process, meaning that it involves several different government agencies to make the decision, each of which has its own political motivations to come up with a reason for preventing an investment-but none has an interest in pushing strongly against the other agencies' opposition to an investment, so the framework is biased towards closing things off. Second, it is a very discretionary and thus opaque process, instead of a rules-based process. This allows for too much political interference and creates too much uncertainty for investors at large, rather than just the ones whose motives are suspect.

Third, and most damagingly, the CFIUS process relies on defining which investments would threaten to impair US national security. This is a fruitless pursuit. On the one hand, by the time the Defense Department and various lobbies get involved, it is almost impossible to rule out any sector, be it food distribution, steel production, electrical utilities, or financial services, from claims of national security importance. This leads to the open-ended protectionist possibilities that many have warmed about regarding the current German proposals.

On the other hand, it fails to distinguish between investors who are only looking to make a profit and those who might be motivated to invest in order to gain strategic leverage over (or even do damage to) key Western capabilities. Just because someone wants to get a stake in aircraft production does not make them a threat, but an investor that wants to do harm can do so from almost any industrial sector as a starting point. Making the sector of the investment the primary criterion for decisions on allowing foreign investment thus raises the probability of blocking legitimate investment while allowing potentially dangerous investors in.

A better alternative would be to set up national security barriers to investment on the basis of who is doing the investing. Consider a system whereby the criteria considered are whether the investor comes from an allied democratic country, whether the investor is held to market performance standards, and whether the investor's decisions are subject to government control. All of these criteria can be objectively verified by officials without political interference and are at no risk of being used as an excuse for protectionism, which removes the first two problems with the American CFIUS process. All of these criteria also can easily exclude investors who would have "strategic" or destructive intent, which the CFIUS process sometimes fails to do.

Such an investor-based, rather than investment target-based, regime would have the additional advantage of reinforcing the value of being together in the Western alliance. Governments that clearly placed themselves outside of the alliance's common values and legitimate boundaries would face some economic sanction for being untrustworthy. Meanwhile, Western governments would stop the farce of scrutinizing investments for "national security threats" from countries we are committed by treaty to common defense with. This kind of regime would naturally lead to better coordination and tighter definitions of national security restrictions on trade more broadly, rather than the recurring frictions over sensitive exports that the United States and European Union have with each other.

Some may be fearful of so clearly drawing a line between those entities whose money is welcome in Germany and other European democracies and those whose money is not. Yet, calls for "reciprocity" are even more intrusive and confrontational with the countries in question such as Russia or China and reduce the discussion to much too narrow and simply misguided criteria-do we really believe Gazprom buying a significant share of E.On would be safe for Germany just because RWE could buy into Rosneft? For that matter, would we believe that RWE's investment would be any safer than that of Shell into Sakhalin Island, even if supposedly on similar terms? Asking these questions just emphasizes that we know it is who does the investing, not what the investment would be in, which is what raises legitimate concerns.

Germany has a real opportunity for leadership on this issue of how to deal with foreign investors. Clearly, Merkel and Koch have put this towards the top of the EU agenda without invoking Sarkozy-style nationalism. After the recent overturning of the VW takeover barrier, there is all the more reason for Germany to show that it only wants to opt out of cross-border investment with good reason. Meanwhile, because the US Congress just revisited and reaffirmed its flawed CFIUS legislation, the initiative will not come from there. Time to take the national security aspect of investment seriously and make the approval process match the threat, instead of diverting attention and useful investment.