TCS Daily

The World Is Round: Globalization and Foreing Investment

By James V. DeLong - November 20, 2007 12:00 AM

The "world is flat" as an image for globalization is 180o askew. The essence of the contemporary world is its circularity, its roundness, as in "what goes around comes around."

This recognition of rotundity provides the necessary context for assessing issues surrounding foreign investment in the United States, an assessment made timely by a current high-profile example - the pending deal between U.S. tech firm 3COM, private equity investor Bain Capital, and Chinese telecom giant Huawei. Some reactions to the deal raise concerns that a rise in politicization and a hint of chauvinism is threatening this investment, which is an important driver of U.S. economic health.

The essence of the issue is that foreign investment is vital for American workers and the U.S. economy. Obviously, such investment can raise security concerns, and a process for addressing these issues in a professional manner has long been in place. But an increasing number of politicians see points to be scored by playing on the security fears of the post 9/11 era. This injects an inflammatory political virus into a review process that is better conducted dispassionately manner, through administrative structures established precisely to avoid sound-bit hyperbole.

If this trend toward politicization is not curbed, other nations will play tit-for-tat, to our national loss. It is in our long-term economic and geopolitical interest to re-emphasize the investment review process that has protected our country and supported economic opportunity for almost 20 years.

The Deal

Bain Capital is a U.S. private equity fund. Its business is to buy public companies, improve them, and either hold them and collect dividends or take them back public at a profit in a few years. 3Com is a respected U.S. provider of telecom equipment, one that prospered during the great tech boom and has struggled somewhat since. Huawei is a Chinese provider of telecom services and gear, and a long-time customer of 3Com's. In fact, 3Com now owns a company called H3C, a joint venture formed by it and Huawei in 2003, and bought out by 3Com in 2006. H3C provides about 60% of 3Com's revenues.

Agreement has been reached for Bain to buy 3Com, with Huawei putting up over $100 million and getting 16% of the equity.

Playing the National Security Card

Because 3Com indirectly supplies commercially-available components to the U.S. government, including network security systems designed to protect networks from intrusion, long-time China critics in Congress saw an opportunity to make a domestic political point by interfering with this deal.

This politicization of foreign investment is exactly what President Ronald Reagan was trying to prevent when he professionalized the investment review process within the Committee on Foreign Investment in the U.S. CFIUS, as it is known, looks at national security implications of foreign investments. To make sure there were no concerns with this deal, Bain Capital voluntarily submitted its, and minority investor Huawei's, purchase of 3Com for CFIUS review.

If CFIUS finds any meaningful threat, everyone involved will be seriously surprised. 3Com sells to the U.S. government only via third party integrators, and sells only general commercial products; it does not have classified projects. Nor will Huawei's decidedly minority stake give the firm any special access to underlying technological secrets, assuming there are any.

The World Is Round

The larger issue is how foreign investors - including those in sensitive technology industries - assess the investment climate in the U.S. If politics disguised as security concerns are allowed to derail potential investment deals like this one, rather than evaluating them through a stable, consistent, professional review process, investment dollars will flow elsewhere and other countries will visit these same tactics on U.S. businesses.

As the Hong Kong based investment advisor GaveKal notes, the U.S. relies on foreign investment to offset the trade deficit. There is nothing wrong with this; there is no reason why trade flows must balance at all times, but:

[T]he changing nature of its trade deficit does pose a problem for the US. In the old days, America's trade deficit was typically against France, Germany, Japan... And if Deutsche Telekom wanted to turn around and use the hard earned US$ that Germany had accumulated to buy SBC communication, . . . then American authorities tended to shrug . . . . However, in the past few years, the deterioration in the US trade deficit has been mostly against China, or oil producing countries. And when Dubai turned around and tried to buy ports in the US, or when China attempted to purchase Unocal, these non- European holders of US$ found that their US$ did not go as far as they thought.

US authorities stepped in and said: "you are Arabs/Chinese! You can't possibly buy this port, or these oil wells...". And, unsurprisingly, when the Chinese and Arabs were told that their "dollars were no good here", the US$ plunged from the low-end of its valuation trading band to new depths.

[Louis-Vincent Gave, The Ever-Falling U.S. Dollar, GaveKal Ad Hoc Comment (Nov. 6, 2007) (subscription).]

And there you have it. We need their capital, and, as U.S. Secretary of State Colin Powell lectured representatives of underdeveloped nations in 2002:

Attracting this money isn't easy; countries have to compete with each other for investment against other countries in the same region, and against the rest of the world. Money, capital, is a coward; it will go nowhere where it is put in fear. Money will fly and go away from corruption and bad policies. It does not want to be around conflicts. It does not want to be around political unpredictability or instability. (Emphasis added.)

The U.S. already has a couple of strikes on it, what with the hysterical rejection of the Dubai ports deal and the earlier uproar over Unocal. A couple more and foreigners will conclude that the U.S. is the home of corrupt politics, bad policies, and unpredictability, and that their capital is safer elsewhere. The consequences would be stark, as the GaveKal essay concluded:

[T]he one truly bearish scenario for continued dollar weakness that we can imagine: the big risk to the dollar is that Americans will refuse to sell more of their assets to foreigners.

Beyond these immediate concerns lies the long-run importance of promoting the trend toward globalization and intertwined economies. Increasing economic connection and cooperation strengthens global political stability and actually enhances U.S. economic and geopolitical interests. By supporting a consistent, professional foreign investment regime in the U.S., American companies can better penetrate foreign markets. The U.S. State Department says that approximately 21 percent of all U.S. exports come from U.S. subsidiaries of foreign companies, based on their ability to tap into multinational parents' distribution networks and knowledge of foreign tastes.

On the geopolitical side of the ledger, the U.S. can use foreign investment to draw countries like China further into the international system, as noted by Edward M. Graham and David M. Marchick in U.S. National Security and Foreign Direct Investment (2006) :

Additional investment from China would also produce important ancillary benefits for the U.S. consistent with broader US strategic and political objectives... Interactions between Chinese and western businesspersons would further integrate China into the global economy, creating greater pressure within China for democratic reform, the rule of law and cooperation with the United States and the West.

The authors agree that security is a legitimate issue, but the means are already in place to address it: "If national security concerns do arise in relation to a transaction, CFIUS agencies have a wide-array of tools, including security agreements, to mitigate their concerns."

American economic and national security interests are best served in the long-run by remembering that the world is round. We don't want foreign investors and countries to mimic the introduction of chauvinism-tinted politics into governmental investment reviews, or to use our actions as an excuse. If we want consistent, non-political investment climates for U.S. companies abroad, we must maintain a consistent, non-political investment climate in the U.S.

The CFIUS process was established to protect our security while doing just that. By taking the politics out of investment reviews, it has worked for almost twenty years and it's the process we should rely on and reinforce, whether the issue is Bain Capital's purchase of 3Com, or the next foreign investment to come along.


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