Introduction
After the second world war globalization and economic integration were thought of as the recipe to bring lasting peace. This belief expanded to many areas of post-war diplomacy and international commerce. Out of this agreement, certain regional and international institutions emerged with the intention of making trade the foundation of a new international regime. At the regional level talks about forming the EU started with the Steel and Coal agreement which made war between the parties not just inconvenient but strategically impossible.
At the international level the General Agreement on Tariffs and Trade of 1947 (GATT) proposed a radical steer towards free commerce in countries that had for centuries used tariffs as a tool for war and economic domination. This effort of openness was later consolidated in the Uruguay rounds with the creation of the World Trade Organization in 1995. During the same time period the international regime of foreign direct investment was also built into a complicated network of bilateral and multilateral investment agreements or trade agreements with investment chapters. The explicit goal of the regime was to connect capital supplying countries with capital demanding countries to boost international development.
Although critics of the regime criticize its push for international mobility of capital but restriction of international mobility of people, particularly refugees and nationals of developing countries, the progress towards a globalized society seemed certain. Nonetheless, openness and globalization do not seem to be a Nash equilibrium, and when real threats arrive, countries tend to rely on self sufficiency than on trust in others. Because of this, what seemed to be the end of history and the inevitable victory of open societies and democratic institutions, is now turning back towards national protectionism and restrictions to Foreign Direct Investment (FDI) with at least 37 nations worldwide implementing an FDI screening mechanism by 2023.
The National Security argument
Countries that have implemented an FDI screening mechanism have consistently argued it is necessary for national security reasons. Although in some cases those reasons are explicitly brought forward, in other cases "national security" is presented as a self-explanatory concept that needs no further justification or explanation.
With exactly the same indetermination, international law instruments mention national security as an exception to some of the rules that mandated governments to open borders and keep trade flowing. Examples of this can be found in article XXI of the GATT which allows countries to impose trade barriers when they consider it necessary for national security, or EU regulation 2019/452 which establishes the framework of FDI screening for public policy or national security issues.
The vagueness of national security is not an error in legislation or a failure to negotiate a more precise definition; it is a deliberate choice that allows these international instruments to adapt to changing realities and interpretations, but also to be used in ways that may be contrary to their original intentions. This gives countries great discretion in determining what constitutes a threat, effectively transforming an open-ended legal exception into an instrument of industrial policy.
According to Theodor Moran, there are at least three ways in which FDI can have national security implications. The first way is through the leakage of classified or sensitive information to the foreign investor. This is particularly problematic when the investor is controlled by a foreign government. The second way is through the control of a sensitive industry by a foreign entity. Once the FDI acquires a national enterprise it is possible that the new owner may use the national entity or its output to limit, or in some other way affect, the national economy or a particularly valuable production chain. Finally, the third way in which foreign direct investment may affect national security is through monitoring and using the investment as a shell for the real purpose.
To better illustrate the ways in which FDI may affect national security, it is useful to present some real world examples of each of the three threats. Regarding the first channel, the recent dispute between the US government and ByteDance over TikTok US shows how the access to personal data can be deemed a matter of national security and banned by a law specifically defined for that purpose. Regarding the second channel there are plenty of cases in which foreign investment in critical industries is scrutinized by legal authorities, of particular importance is the Chinese investments in the Port of Piraeus that was never blocked but still causes significant controversy over the control of essential infrastructure for European trade. In connection with the third channel, in 2012 President Obama blocked a Chinese investment in a wind farm in rural Oregon because of its proximity to a US naval base and the possibility it could be used for surveillance activities.
Once trust faded, "national security" was used as the legal language to justify intervention. The costs of continuing down this path are clear, and the need for a solution that in some way balances both interests is necessary. With the current mechanisms, discretion remains unchecked and the peace seeking role international commerce once played is eroding.
The economic costs of protectionism
The turn towards national protectionism using FDI screening is not without costs, the comparative advantage efficiencies that powered development in the twentieth century will diminish and economic integration will likely decrease. Using a differences-in-differences approach, one study found that the decrease in Chinese FDI in the US caused by the new investment screening can reduce the total factor productivity of firms in critical sectors up to 15%. Similar studies that analyze nearshoring and friendshoring as a direct result of stricter capital controls have found that this could have an impact of as much as a 4.5% global GDP decrease in the case of nearshoring or 1.7% in the case of friendshoring.
The costs of stronger FDI screening clearly show that the tradeoff between "national security" and growth is significant and that countries who wish to have greater control over their national economy will also have to make sacrifices over their general welfare and growth path. This result is characterized in Dani Rodrik's trilemma: we cannot have international economic integration, nation states and mass politics (broad democracies) at the same time. Before the recent turn towards national protectionism, countries seemed to be willing to cede part of their autonomy and decision making to international organizations in return for economic integration. The new suspicion of FDI shows that countries are now willing to trade economic development for protectionism and greater internal resilience.
Conclusion
The recent turn towards national protectionism that many nations are exemplifying by adopting FDI screening mechanisms is a step away from the liberal order constructed through the twentieth century. What the proliferation of screening mechanisms reveals is that the premises of economic integration are conditional on the trust that countries have on their mutual respect and the general trust that other countries will not weaponize their investments against their national interests.
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