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[Research Reports] Recent Developments in the Regulation of Foreign Direct Investment: Evidence from the United States and Japan

Masako Suginohara (Professor, Ferris University)
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Research Group on Economy-Security Linkages #5

"Research Reports" are compiled by participants in research groups set up at the Japan Institute of International Affairs, and are designed to disseminate, in a timely fashion, the content of presentations made at research group meetings or analyses of current affairs. The "Research Reports" represent their authors' views. In addition to these "Research Reports", individual research groups will publish "Research Bulletins" covering the full range of the group's research themes.

Since the mid-2000s, there have been moves, particularly in developed countries, to introduce new regulations on inward foreign direct investment (FDI) as a result of rising national security concerns. Behind this is an increase in investment from emerging economies, particularly China. This paper reviews the relationship between inward FDI and national security, explores recent developments, and examines future challenges through examples of new regulations introduced in the United States and Japan.

Development of regulations on inward direct investment

The amount of FDI in the world has increased significantly since the 1990s due to capital liberalization and the development of communications technology. The share of FDI in global gross domestic product (GDP) was 7% in 1990, but it exceeded 40% in 2018. Investment targets expanded beyond the traditional mining and manufacturing industries to include a wide range of service sectors. In the 21st century, investment expanded not only from developed Western countries but also from oil-producing and emerging economies. In particular, investment from China has increased significantly since 2010.

While there have long been concerns on the part of host countries about being taken over by foreign companies, the role of foreign capital in economic growth and job creation had been widely recognized by the 1990s, leading to the global liberalization of investment. In order to promote investment, measures to protect investors from arbitrary policy changes by host countries have been also taken through bilateral investment agreements and regional trade agreements. On the other hand, there have been national security concerns regarding inward foreign direct investment, in addition to the general concerns about the economic dominance of foreign capital.

Traditionally, the main security concerns have been about the outflow of sensitive technologies to other countries through foreign investors, and the foreign control of domestic defense production bases and critical infrastructure. More recently, the spread of dual-use technologies has led to the expansion of the scope of "sensitive technologies" beyond the traditional defense industry, and the growing importance of data means that wide-ranging personal information has become essensial asset for national security purposes. As a result, the scope of enterprises and industries that may need the restriction of foreign ownership has expanded to the entire high-tech industry. The increasing investment from emerging economies has also increased possibilities for Western developed countries to accept investment from firms that are based in countries with different political and economic systems, raising new concerns that those firms may be used as a tool for the diplomatic and political goals of their countries of origin.

Regarding inward FDI, there are no overarching international organizations such as the World Trade Organization (WTO) in the field of trade or unified international rules. Article 3 of the "Code of Liberalization of Capital Movements" of the Organisation for Economic Co-operation and Development (OECD) allows a national government to take actions it considers necessary for "the protection of its essential security interests." The definition of the "essential security interests" are not specified in the Code, allowing national governments to implement the provision flexibly.

National policymakers seek a balance between economic benefits of accepting the investment and security concerns when establishing regulations on inward FDI. However, there are uncertainties in actual policy decisions. It is difficult to accurately measure security costs in advance, and the assessment of costs is greatly influenced by the perception of threats about the origin of investment held by policymakers. In addition, economic interests can also affect policy decisions: domestic companies that face competition due to the entry of foreign capital and companies that are vulnerable to hostile takeover by foreign capital have an incentive to prevent the entry of foreign capital using security threats as an excuse.

Examples of tightened regulations on inward FDI

United States

The United States has been both the world's largest foreign direct investor and the largest recipient of inward FDI. From an early stage, the US established a broad and powerful system to regulate inward FDI. The Exon-Florio Amendment to the Omnibus Trade Act of 1988 allows the review of inward FDI in almost all industries, and the president has the authority to prohibit problematic investment. The Committee on Foreign Investment in the United States (CFIUS) conducts the screening. The Foreign Investment and National Security Act of 2007 (FINSA) added factors to be considered in reviews, including the potential risk of leading to foreign control on "critical infrastructure" and "critical technologies." The 2018 Foreign Investment Risk Assessment and Modernization Act (FIRRMA) further broadened the scope of foreign investments subject to scrutiny to encompass noncontrolling investment involving "critical infrastructure," "critical technologies," and sensitive data of US citizens. It also mandates filings for certain transactions.

In the legislative process of establishing FIRRMA from 2017 to 2018, the bill was passed with bipartisan support, which was rare in the increasingly polarized US politics, and with the cooperation of the administration. The commonly shared view among US policymakers that China was a threat played a major role in the process. Behind the hardline stance toward China were various motives, including a desire for decoupling to prevent China's further technological development, an intention to use it as a bargaining chip to win concessions in bilateral negotiations, and concern over China's human rights issues. The fact that the need to actively invite FDI in the US diminished during the period due to good economic conditions and active domestic investment may have also encouraged policymakers to support the legislation.

The regulatory framework does not strictly define key concepts such as "national security" or "critical infrastructure" and allows restrictions to be placed on a wide range of acquisitions. Under the Trump administration, which was inaugurated in 2017, the president issued two orders banning foreign takeovers and issued several executive orders to require companies, many of them Chinese, to sell some of the businesses they had already purchased in the US. One of the bans was on the hostile takeover of Qualcomm Inc. by Broadcom. As Singapore-based Broadcom was to be relocated to the US, it was unclear whether the purchase constituted a "foreign acquisition" in the first place. Qualcomm, however, brought the case to the CFIUS for review, and the hostile takeover was eventually blocked. In other cases of post-acquisition intervention, Chinese companies were ordered to divest business units dealing with personal information. This reflects the growing recognition of the importance of personal data in national security, although the information handled in these cases was not military-related and, thus, it had been considered unlikely that CFIUS would prevent foreign ownership in the past.

Such regulatory system enables flexible responses to the changing environment. For example, the protection of personal information from foreign capital, which was implemented in the United States recently, is an area in need of international harmonization of regulations. At the same time, it should be noted that arbitrary interventions may undermine the strengths of the US system of innovation, which have evolved through internationalization. In some cases, restrictions on inward investment were used to prevent hostile takeovers. Furthermore, the growing recognition of the "China threat" in policymaking circles can lead to overly strict regulations based on a perception that goes beyond the real threat. This is reminiscent of the late 1980s and early 1990s, when a growing number of US politicians viewed Japan as a threat, forcing some Japanese companies to abandon their plans to acquire US high-tech companies.


Although Japan has a large stock of outward FDI, its acceptance of inward FDI has been remarkably low among developed countries. However, based on the recognition that inward FDI promotes economic growth, the promotion of inward FDI has been set as a policy objective since 2003. On the other hand, security-related regulations have been strengthened since 2007. Originally, the Foreign Exchange and Foreign Trade Act (FEFTA) stipulates that foreign investments in security-related industries be subject to prior notification and review. In 2007, through the revision of a ministerial ordinance, dual-use technology was added as a security-related sector. Furthermore, the FEFTA was amended in October 2017 and the public notice and cabinet order were revised in 2019 to widen the scope of targeted industries. In addition, another revision of the FEFTA in November 2019 lowered the threshold for the prior-notification requirement from 10% to 1% when foreign investors acquire shares of listed companies in sectors related to national security.

In the case of Japan, revisions of the regulations on inward FDI were led by the administration, and the regulatory changes were made based on requests from the business sector. The tightening of regulations in 2007 and 2019 is said to have been in part a response to shareholder activism, in addition to the growing sense of caution about Chinese investment. Since 2000, hostile takeovers, which had been rare in Japan, started to increase and foreign funds have entered the market. The 2007 revision was considered to be reflecting the apprehension about these moves. While shareholder activism subsided in the wake of the 2008 global financial crisis, it intensified again around the mid-2010s. In the second wave, investment funds made management proposals and increased their influence on companies by gaining support of other investors. When the FEFTA was revised in November 2019, there was speculation that the main purpose was to curb shareholder activism, since the new threshold for prior notification set at 1% of shares was the amount necessary for the submission of proposals at shareholders meetings. If it were to become widespread, such speculation could undermine the government's policy goal of attracting FDI to Japan. For Japan, it is necessary to establish a mechanism for ex post facto intervention so that individual cases can be properly addressed without imposing uniform restrictions on investment.


In regulating inward FDI, flexibility is indispensable for addressing national security concerns. However, flexible regulations can be politically abused. It should be noted that, if this happens, the balance between economic benefits and national security risks can be disrupted, resulting in economic losses and undermining the foundation of national power, which is the opposite of the original purpose of such regulations.


Organisation for Economic Co-operation and Development (OECD), "Acquisition- and ownership-related policies to safeguard essential security interests," 15 May 2020