Disingenuous WSJ Story on Government Restrictions on Acquisitions by Foreigners

Has the Murdoch era already begun? Two days in a row we have had page one stories in the Wall Street Journal that managed to skew the facts.

Today’s piece, “Foreign Investors Face New Hurdles Across the Globe,” is misleading in a minor and a major way. The minor way is likely to be apparent to most readers: it oversells the problem it presents.

The issue is that governments around the world are increasingly cautious about letting foreigners own critical assets:

The new wariness toward foreign acquirers reflects a variety of factors, including the perception that the U.S. — the world’s largest recipient of foreign direct investment — is erecting new barriers to foreign capital. It also comes amid a broader backlash against globalization, fueled in part by popular concerns that trade has hurt many of the world’s lower-skilled workers and has contributed to job losses and stagnant wages, particularly in rich countries.

Frankly, if not taken to excess, this is sound policy. So far, it appears that most governments are taking a restrictive rather than expansive view of where their national interest lies (Bolivia and Venezuela being noteworthy exceptions). And the US can’t cavil about it, since it forced a Dubai Ports World to divest five US port operations that were part of a UK company it was acquiring, and similarly blocked Cnooc, a Chinese oil company, from acquiring Unocal.

While the article has a mildly alarmist tone, it concedes the problem is more one of tendency than fact:

So far, the restrictions haven’t slowed the massive flows of investment capital sloshing around the globe. In fact, foreign direct investment is booming. But U.S. officials are concerned because for the first time in decades barriers to it are rising, instead of falling, a trend that could be especially painful for multinational companies.

However, the big way it misleads is failing to distinguish between foreign acquisitions and foreign direct investment. The former is a subset of the latter. Although US acquisitions of foreign companies have grown considerably, FDI also includes purchase of foreign real estate and investments in foreign subsidiaries of US companies.

And the story overlooks an inherent obstacle described by Harvard economist Dani Rodrik:

Sometimes simple and bold ideas help us see more clearly a complex reality that requires nuanced approaches. I have an “impossibility theorem” for the global economy that is like that. It says that democracy, national sovereignty and global economic integration are mutually incompatible: we can combine any two of the three, but never have all three simultaneously and in full.

Here is what the theorem looks like in a picture:

To see why this makes sense, note that deep economic integration requires that we eliminate all transaction costs traders and financiers face in their cross-border dealings. Nation-states are a fundamental source of such transaction costs. They generate sovereign risk, create regulatory discontinuities at the border, prevent global regulation and supervision of financial intermediaries, and render a global lender of last resort a hopeless dream. The malfunctioning of the global financial system is intimately linked with these specific transaction costs…..

So I maintain that any reform of the international economic system must face up to this trilemma. If we want more globalization, we must either give up some democracy or some national sovereignty. Pretending that we can have all three simultaneously leaves us in an unstable no-man’s land.

So what looks like a backlash may simple be these governments recognizing intuitively what Rodrik was able to make explicit: going further on economic integration would lead to tradeoffs they regarded as undesirable.

How does this article mislead in a more fundamental way? It says that the new security consciousness of governments will hurt US multinationals:

The risks are greatest for U.S. multinational corporations. They typically conduct a majority of their overseas business through foreign affiliates rather than through sales of exported goods made in the U.S. In 2004, the latest year for which data are available, U.S.-based multinationals exported goods valued at $400 billion but sold goods valued at $2.62 trillion through foreign affiliates, according to the U.S. Bureau of Economic Analysis.

“This really matters because U.S.-headquartered multinational firms serve foreign markets overwhelmingly through sales in their foreign affiliates, not through exports from the United States,” says Matthew Slaughter, an economist with Dartmouth College’s Tuck School of Business. Those foreign affiliates typically produce products locally, relying on local production sites and labor, as well as easy access to local customers.

Forgive me for being difficult, but US multinationals are ALREADY multinational. This new toughmindedness isn’t going to keep them from expanding an existing operation in a foreign country. It may slow them in entering a new country if they operate in a sensitive sector. They may have to establish a de novo operation or make an acquisition with a local partner.

No, the article completely overlooks who is being inconvenienced by these foreign restrictions: the big LBO players. The US deals as an examples were all private equity deals, all Carlyle, and all China. Carlyle had to reduce its proposed ownership in a Chinese steel tube company and was blocked in buying an 8% stake in a commercial bank. Is the assumption that if a superbly connected firm like Carlyle can’t get its way, the deck is unfairly stacked against the US?

The other affected parties in the story were corporations. For example, Spain’s Telefonica SA needed to take on local partners to make an Italian acquisition and India blocked a purchase by a Chinese telecom.

And this pattern makes sense. The US was early to establish foreign operations; other countries are catching up. And the resistance to US private equity firms trolling for deals abroad is likely to be even higher than for corporate acquirers. Private equity firms are seen as keen to fire workers and close operations to enrich a small group at the top. That’s not acceptable in countries that have stronger labor protection and more egalitarian social values. But the Journal couches this attitude as “anti-globalization” when “anti-robber-baron” would be more accurate.

From the Journal:

Governments from Canada to China have imposed or are considering restrictions on foreign purchases of companies, factories and real estate in their countries — moves U.S. officials fear could harm global economic growth if they proliferate.

The measures include bureaucratic and legal barriers to so-called foreign direct investment, in which foreigners buy a country’s physical assets such as mines or other property, rather than investing in the country indirectly through its stock or bond markets.

So far, the restrictions haven’t slowed the massive flows of investment capital sloshing around the globe. In fact, foreign direct investment is booming. But U.S. officials are concerned because for the first time in decades barriers to it are rising, instead of falling, a trend that could be especially painful for multinational companies.

In China, new regulations let officials block foreign acquisitions of Chinese companies if they deem them a danger to “economic security.” In Russia, the government is considering limits on foreign ownership in 39 “strategic” sectors of the economy, including natural-resource deposits and biotechnology.

Canada, one of the U.S.’s largest trading partners, is weighing stricter rules on who can buy its companies, in reaction to a flurry of foreign takeovers, including last year’s acquisition of Canadian steelmaker Dofasco Inc. by Arcelor SA of France.

It isn’t clear to what extent new restrictions might deter foreign buyers but, in at least a few cases, foreign bidders have been forced to settle for minority stakes in their acquisition targets. In China, for example, U.S. private-equity firm Carlyle Group had to scale back its bid for a controlling stake in Yangzhou Chengde Steel Tube Co. And in Italy, Telefónica SA of Spain had to team up with three Italian financial institutions to buy Telecom Italia after Italy’s prime minister declared that the telecom company should “remain in Italian hands.”

New Wariness

The new wariness toward foreign acquirers reflects a variety of factors, including the perception that the U.S. — the world’s largest recipient of foreign direct investment — is erecting new barriers to foreign capital. It also comes amid a broader backlash against globalization, fueled in part by popular concerns that trade has hurt many of the world’s lower-skilled workers and has contributed to job losses and stagnant wages, particularly in rich countries.

Political firestorms erupted in the U.S. last year when a Dubai-owned company tried to buy operations at five American ports and the year before when state-owned Chinese oil company Cnooc Ltd., tried to buy California-based oil giant Unocal Corp.

Both deals were ultimately scuttled amid the uproar, which prompted Congress to pass legislation to subject foreign investments to closer scrutiny by the Committee on Foreign Investment in the U.S., or CFIUS, an interagency council that screens foreign purchases of U.S. assets with national-security implications. That legislation is likely to reach President Bush’s desk this month.

“There are examples of countries — even probably the U.S. — where they have taken actions which had the either intended or unintended consequences of blocking transactions, and that causes other countries to restrict investment,” says William Parrett, chairman of the U.S. Council for International Business, which lobbies for free trade, and who was until recently chief executive of accounting firm Deloitte Touche Tohmatsu.

The risks are greatest for U.S. multinational corporations. They typically conduct a majority of their overseas business through foreign affiliates rather than through sales of exported goods made in the U.S. In 2004, the latest year for which data are available, U.S.-based multinationals exported goods valued at $400 billion but sold goods valued at $2.62 trillion through foreign affiliates, according to the U.S. Bureau of Economic Analysis.

“This really matters because U.S.-headquartered multinational firms serve foreign markets overwhelmingly through sales in their foreign affiliates, not through exports from the United States,” says Matthew Slaughter, an economist with Dartmouth College’s Tuck School of Business. Those foreign affiliates typically produce products locally, relying on local production sites and labor, as well as easy access to local customers.

While conceding that globalization creates losers as well as winners, its proponents fear the political reaction could disrupt the decades-long trend toward more-open economies that has helped spur U.S. economic growth and hold down inflation.

“Perhaps the greatest challenge is rising investment protectionism, and we have got to work very hard to keep investment barriers low,” says U.S. Deputy Treasury Secretary Robert Kimmitt, who recently visited Moscow and Beijing to urge officials to minimize restrictions on foreign investment. Mr. Kimmitt and other U.S. officials say the U.S. has crafted a reasonable review process for foreign-backed deals and that in 2006 only 8% of them were subjected to special scrutiny.

The Chinese restrictions already have had an impact. Carlyle Group had planned to take a majority position in Yangzhou Chengde Steel Tube but was limited to a minority holding after China cited Yangzhou as a strategic asset and raised concerns about a foreign company gaining control of it. China cited similar concerns in blocking a bid by Germany’s Schaeffler Group, a maker of automotive components, to acquire Luoyang Bearing Corp. (Group). Chinese regulators also just rejected an effort by Carlyle to acquire an 8% stake in Chongqing Commercial Bank Co., saying it didn’t meet regulatory requirements.

India and Germany are considering national-security screening processes for proposed foreign investments similar to those in the U.S. Germany is considering legislation to make it more difficult for foreign, government-controlled investment funds to acquire German companies. India has already rejected an investment from a Chinese telecommunications company. Some politicians and industry groups in Japan are agitating for national-security reviews. Bolivia is nationalizing its oil and gas sector.

National Security

Canadian leaders, like their counterparts elsewhere, say they are responding to national-security concerns about foreign, government-owned entities buying Canadian natural resources and other assets. “We may have to give special attention when we see situations where, directly or indirectly, state-owned enterprises or agencies of state-owned enterprises are proposing to make substantial foreign investment in Canada,” Canadian Finance Minister James Flaherty said in an interview.

“We are conscious of the need to protect our own national security and also to make sure overall substantial investment in Canada is in the net benefit of Canada,” he added.

None of the new measures has caused a major disruption in cross-border deals. There were 11,640 cross-border mergers and acquisitions last year, up from 9,875 in 2005 and the highest since the 2000 peak of 12,624, according to Thomson Financial. Total world-wide foreign direct investment reached $916 billion in 2005, up 27% from 2004, according to the United Nations Conference on Trade and Development.

But there has been a noticeable tightening. The U.N. conference found that in 2005, the most recent year for which data are available, “the number of changes making a host country less welcoming to FDI was the highest ever recorded by Unctad.” In that year, 93 countries made policy changes related to foreign investment, with 20% ranked as “less favorable” to foreign investment, up from 14% in 2004.

‘Chill on the Margins’

“There is a chill on the margins in investment, and I have seen deals that would have gone forward two years ago not go forward today because of regulatory and political uncertainty,” says David Marchick, a partner with the U.S. law firm of Covington & Burling who advises companies on foreign investment issues.

Some countries — including China — aren’t just emulating the U.S. by screening proposed foreign investments for national-security conflicts, but also are evaluating deals on “economic security” grounds.

“A number of countries have put the world on notice that they are putting in place measures that are supposed to emulate CFIUS. However, it is pretty clear that these processes go a step beyond by creating what is akin to a screening process that looks widely at industries as opposed to a national-security process that looks narrowly at risks of specific transactions,” says Clay Lowery, acting U.S. Treasury undersecretary for international affairs.

U.S. government officials and business executives, alarmed by the rising political backlash to globalization and, in particular, foreign investment, are arguing to foreign governments that, while national security is important, erecting barriers will chill investment in their homelands and potentially hurt their ability to invest abroad.

“Reciprocity is not a factor that CFIUS considers. However, investments take place inside a broader political context, and the degree to which American companies are afforded access to investment opportunities in countries abroad will be related to the opportunities available to their companies in the U.S.,” says Mr. Kimmitt, the deputy Treasury secretary.