Terra Firma

How debates over foreign investment, trade, and immigration are creating new barriers to entry

In the United States, heightened anxiety over national security, job losses in the manufacturing sector, and the polarization of domestic politics have intensified debates over policy on foreign investment in US assets, trade, and illegal immigration. The risk is growing that lawmakers will agree legislative changes on these issues which weigh on economic growth and damage relations with other states. President George W. Bush has opposed moves by both Democrats and fellow Republicans to tighten existing restrictions on all three fronts. But his diminished domestic political capital undermines his ability to shape the legislative agenda.

As the 2008 presidential and congressional elections draw closer, the protectionist trend is likely to accelerate. Leading members of both parties will work to deflect charges that they have left the country vulnerable to threats to national security and American jobs. If the US economy slows over the next 12 to 18 months, protectionist pressures will intensify further.

Approval Process threatens to discourage Foreign Investment

The controversies that erupted in Washington following the failed bids by a state-owned Chinese firm to acquire California-based Unocal in 2005 and a state-owned Arab company’s efforts to secure rights to operate several US ports in 2006 have generated public demand for changes to the process by which proposed foreign investments in US assets are reviewed and approved. The effect has been substantial. In 2005, the Committee on Foreign Investment in the United States (CFIUS) screened 65 such investment proposals. In 2006, that number jumped to over 100; with the number of follow-on investigations also rising significantly. Once a little-known arm of the executive branch, CFIUS itself now faces unprecedented scrutiny.

Fears that CFIUS reform will discourage foreign investment are not limited to worries over actual legislative changes; the threat alone can darken the investment climate. Reforms that increase public scrutiny of investment proposals, reveal information about a would-be investor’s competitive advantage, or generate significant project delays reduce the attractiveness of a growing number of opportunities.

Even some of the deals that CFIUS has approved have spooked potential investors. In November 2006, the committee signed off on a bid by the French firm Alcatel to acquire US-based Lucent Technologies. But the approval stipulated that the deal could be revisited (essentially forcing divestiture) if it was later determined that the deal raised national security concerns. Both the US business community and potential foreign investors fear that this highly unusual stipulation could become a new norm – and a convenient way for CFIUS to manage political pressure.

In mid-2006, the committee opened a retroactive investigation of Curaçao-based Smartmatic International’s 2005 acquisition of US-based Sequoia Voting Systems, largely over Smartmatic’s links to the Venezuelan government. CFIUS did not review the acquisition in 2005 because it did not then meet the committee’s broad definition of national security. In 2006, under intensifying congressional pressure, it did, forcing Smartmatic to divest its acquisition. All these changes risk a chill in much-needed direct investment flows into the US and could provoke retaliation against US firms overseas.

The Democratic takeover of Congress has reenergised the debate. On 18 January, 37 House members reintroduced legislation which calls for, among other things, a mandatory (rather than the currently discretionary) 45-day investigation of all acquisitions involving national governments, congressional notification at the conclusion of each investigation, and the full involvement of the intelligence community.

Among the more onerous provisions considered in the House and Senate versions of CFIUS reform in the last (Republican-led) Congress were the creation of a ranking system of countries based on compliance with non-proliferation agreements, consideration of a deal’s possible impact on control of US “critical infrastructure” (so broadly defined that it could include almost anything), and the extent of state-ownership of the would-be foreign investor.

In this environment of heightened scrutiny, CFIUS and US lawmakers are also likely to take an interest in the increasingly prominent role that “collective investment funds” (private equity and hedge funds), especially those with ties to their host governments, now play in global FDI. According to a recent UN report, private equity accounted for $135 billion in cross-border mergers and acquisitions in 2005. The report notes that while US and UK firms currently dominate private-equity FDI, a number of private-equity arms of governments in the Gulf flush with capital from oil revenues are also becoming active. The report notes that private equity firms involved in FDI are attracting “hostility” from politicians, unions, and others around the world, risking a spillover effect on foreign investment broadly.

Protectionist sentiment is impacting trade agreement negotiations

In addition, the Bush administration’s trade agenda faces an uncertain future. Fuelled by public anxiety over job losses, protectionist sentiment proved a potent component of both the 2004 and 2006 elections. The 2006 mid-terms replaced some two dozen free-trade Republicans with trade-skeptical Democrats. But rank-and-file members in both parties have recently defied their respective leaderships on trade votes. In fact, 94 Democrats and 66 Republicans (twice the number expected) voted against granting Permanent Normal Trade Relations status to Vietnam in the initial vote on the measure.

The breakdown of the Doha trade round last July has shifted US focus from multilateral to bilateral trade agreements. In part, that’s because “trade promotion authority”, which ensures that Congress must vote up or down on negotiated agreements without attaching amendments, expires at the end of June. Without concessions from the White House, it is unlikely to be renewed. Democratic lawmakers are unlikely to pass on opportunities to attach new labour and environmental protections into trade agreements.

Washington agreed a trade deal with Colombia in November 2006 – though it has not yet been sent to Congress – and has made tangible progress on agreements with Panama, Peru, South Korea, and Malaysia. Support from US business lobbies and White House promises to include worker and environmental protections in future deals could help Bush persuade Congress to approve a one-year renewal of trade promotion authority, but more immediate challenges put all these agreements at risk.

In a sign of things to come, Democratic lawmakers – under pressure from trade union backers – are pushing hard to strengthen labour provisions in the Colombia and Peru agreements in line with core international labour standards. US, Colombian and Peruvian trade negotiators believe they can address lawmakers’ concerns through “side letters” to the agreements. This might not be enough to win Democratic support.

In fact, the risk is growing that Congress will not pass any of the bilateral agreements by summer and that trade promotion authority will expire. That outcome would likely freeze all remaining trade negotiations, both bilateral and multilateral. Most agreements now under consideration – with South Korea, Malaysia, Thailand, the United Arab Emirates and others – could succumb to a confluence of political pressures related to job protection and national security concerns. US lawmakers, frustrated with a rising trade deficit, could scale back duty and quota-free access under the General System Preferences for emerging markets such as India and Brazil, or again target China for punitive legislation. These moves might well spark trade retaliation, including complaints against US agriculture subsidies at the World Trade Organisation.

The more than $200 billion US-China trade deficit ensures that no state serves as a more reliable bipartisan lightning rod in US politics than does China. The US “strategic economic dialogue” with Beijing has generated pressure on Treasury Secretary Hank Paulson to win Chinese concessions on revaluation of the Chinese currency, protections for US intellectual copyrights, improved Chinese labour standards, and the trade deficit itself. Restive Democrats have expressed concern that the more than $300 billion in US treasuries China now holds will deprive Washington of the leverage it needs to win Chinese concessions on these issues.

Immigration reform has become a proxy for evolving US protectionist sentiment

Like the debates over foreign investment and trade policy, the politics of immigration reform is driven by bitter disagreement within the United States over the proper balance between economic competitiveness, national security, and protections for American workers. In fact, immigration reform has become a proxy for broader and evolving US protectionist sentiment. It is the product of anxiety that illegal immigrants will deprive Americans of jobs and depress wages, as well as fears that terrorists will infiltrate porous US borders.

But the issue could provide the president and Democratic lawmakers with ground for mutually profitable political compromise. Most congressional Democrats, like Bush, favour a comprehensive approach on immigration reform which both tightens control of the border with Mexico and provides illegal immigrants already inside the United States with a legal path toward eventual citizenship. Support for a tougher approach that refuses to “reward illegal acts” by making citizens of millions of illegal immigrants is largely limited to the Republican Party’s social conservatives.

Current political landscape encourages protectionist policies

Like protectionist sentiment in any country, demand for new restrictions on foreign investment in US assets, a belief that free trade always advantages the wealthy at the expense of workers and the environment, and anger over increases in illegal immigration, is driven by fear that the unprecedented speed with which people, information, goods and services now cross international borders is transforming society so quickly that no one can effectively manage the pace of change.

Protectionism in its various forms was a potent force in American politics before the 2006 elections passed majority control of Congress to Democrats and divided the US government. But with Democrats in control of Congress for the first time since 1994 and as the battle to succeed George W. Bush takes shape, members of both parties will openly appeal to populist and nationalist impulses within the American electorate and create new obstacles to US economic growth – and undermine the ability of foreign actors to profit from investment in, trade with, and immigration into, the United States.

Ian Bremmer, President, Eurasia Group

Ian Bremmer is president of Eurasia Group, the world’s largest political risk consultancy. He is also a columnist for Slate, a contributing editor at The National Interest, and a political commentator on CNN, Fox News and CNBC.