CFIS 24: Paris Insights – Investment Screening and Economic Security in the Majority World

Investment Screening and Economic Security in the Majority World

By Liam McGrath, CFIS 24 Programme Sherpa 

A.   Introduction

The concept of economic security, encompassing policies which aim to promote economic growth and competitiveness while protecting national interests, is gaining traction globally.[i] This trend coincides with a rise in geopolitical tensions and growing concerns about foreign influence on strategic sectors. Many developing countries face a range of unique challenges in balancing economic growth with national security imperatives. One of the primary challenges is the need to attract foreign investment to stimulate economic development, while simultaneously safeguarding critical infrastructure and strategic assets from foreign control.[ii] Developing countries often rely heavily on foreign investment for infrastructure development and economic growth. This can make them more hesitant to implement overly restrictive screening mechanisms, fearing a decline in foreign direct investment (FDI) inflows.[iii] Conversely, lax screening can leave developing economies vulnerable to resource depletion, strategic asset takeovers, as well as the risk of foreign actors using economic tools as political leverage. This background paper explores the current landscape of economic security policy in developing countries, highlighting some key challenges they face and potential pathways for navigating this evolving landscape.

B.    Economic Security Policy in Developing Countries

For many countries, attracting FDI is an integral part of economic growth strategy. There is solid evidence that FDI supports economic growth, boosts productivity, and stimulates innovation.[iv] Despite the documented benefits, a trend of increased scrutiny of foreign investment in the form of investment screening mechanisms has been observed after the financial crisis of 2008, with another peak of regulatory activity occurring in conjunction with the COVID-19 pandemic.[v] A common concern driving this development is the prospect of foreign investors acquiring stakes in strategic industries, thereby potentially gaining access to and knowledge of new technology and political leverage in the target country.[vi]

Investment screening regimes are predominantly introduced by developed countries. In 2022, a total of 24 policy measures related to FDI screening were adopted by 16 countries, nearly all of them developed economies.[vii] By contrast, investment policies in developing countries tend to be more focused on attracting and facilitating FDI.[viii] These measures often take the form of fiscal incentives, including tax breaks and exemptions.[ix] Interestingly, some research suggests that subsidies and tax breaks targeted specifically at foreign investors are not necessarily the best way of attracting FDI. Other factors of a more general character, such as a well-functioning infrastructure and legal system, could prove to be more decisive in promoting inward FDI.[x]

It appears that, unlike developed countries, developing economies have so far prioritized increasing FDI over addressing national security implications.[xi] There may indeed be several explanations for this; possibly these countries have not considered FDI to be associated with such high risks, or they have judged such measures to be associated with more costs than benefits.[xii]  The eagerness to attract FDI might however expose nations to the risk of economic aggression and exploitation.[xiii] Developing countries may face the challenge of addressing the growing dominance exerted by large multinational enterprises (MNEs) in specific sectors of their economies due to various advantages unique to these firms. Furthermore, MNEs often wield influence over domestic economic policies in developing countries and may occasionally pursue actions that run counter to the national interests or sovereignty of the host nation.[xiv] The OECD has raised specific concerns regarding investment by foreign state-owned entities in critical infrastructure of developing economies. In this respect, Chinese state-led investment stands out because of the sheer scale and range of investments.[xv] Such initiatives may appear appealing at first, but can jeopardize security interests and compromise economic and strategic independence in the long run.[xvi]

C.   Possible Paths Forward

As developing countries navigate the intricate balance between economic growth and national security, there is a need to chart a course forward that promotes sustainable development while safeguarding vital interests. Introducing investment screening mechanisms, promoting strategic partnerships and cooperation, and investing in domestic capabilities and infrastructure are key components of advancing economic security policy in developing nations.[xvii]

I.      Introducing Investment Screening Mechanisms

One crucial step forward involves enhancing investment screening mechanisms to better protect national interests without stifling foreign investment flows. Developing countries could possibly learn from the experiences of developed economies in implementing robust screening processes while maintaining an attractive investment climate. This may entail the establishment of specialized agencies tasked with evaluating foreign investment proposals and assessing their potential impact on national security and strategic assets. Capacity building efforts aimed at strengthening the expertise and resources of these agencies should also be prioritized, enabling them to effectively carry out their mandates and adapt to evolving economic challenges.

Effective economic security policy also requires robust regulatory frameworks and good governance practices. Developing countries should prioritize the rule of law, transparency, and accountability to create an enabling environment for investment and economic growth.[xviii]

II.    The Role of International Cooperation

Regional alliances and international cooperation play a pivotal role in enhancing economic security policy in developing countries. By fostering strategic partnerships with like-minded nations and international organizations, developing countries can leverage collective resources and expertise to address common challenges. Regional alliances, such as ASEAN, MERCOSUR, and the African Union, offer platforms for cooperation and information sharing on investment screening practices and economic security strategies.[xix] A common view about the need for, and more importantly, the design of investment screening regimes is also an important factor in promoting international investment, as this will minimize undue barriers to trade.[xx]

III.  Investing in Domestic Capabilities and Infrastructure

If developing countries aim to reduce their reliance on foreign investment and enhance their economic resilience, they should seek to invest in building domestic capabilities and infrastructure. By strengthening domestic industries and fostering innovation, nations can mitigate the risks associated with foreign dominance in strategic sectors. Moreover, investing in critical infrastructure, such as transportation networks and digital infrastructure, can in turn bolster economic security and promote inward FDI.[xxi]

D.   Conclusion

In conclusion, advancing economic security policy in developing countries requires a multifaceted approach that balances the imperatives of economic growth with the preservation of national interests and sovereignty. By introducing and strengthening investment screening mechanisms, promoting strategic partnerships, investing in domestic capabilities, and enhancing regulatory frameworks, developing nations can navigate the complexities of the global economic landscape and chart a path toward sustainable development and prosperity.

 

 

[i] Goodman, P M., Reynold, M., Fittipal J. (2022), Economic Security in Emerging Markets A Look at India, Vietnam, and Indonesia, Center for Strategic and International Studies (CSIS), Washington, p. 2.

[ii] OECD (2023), Supporting EMDEs in attracting more, better, and safe FDI, A strategy for action, OECD, p. 2.

[iii] Ibid.

[iv] National Board of Trade Sweden (2022), Perspectives on the Economic Effects of FDI and Investment Screening, Stockholm, pp. 12-17; Danzman, S. B., & Meunier, S. (2021), The big screen: Mapping the diffusion of foreign investment screening mechanisms, Social Science Research Network, p. 4.

[v] UNCTAD (2023), World Investment Report 2023, United Nations. Geneva, pp. 63-64.

[vi] Ibid, pp. 63-64.

[vii] Ibid, p. 63.

[viii] Ibid, pp. 61-63.

[ix] National Board of Trade Sweden (2022), p. 19; UNCTAD (2023), pp. 61-62.

[x] National Board of Trade Sweden (2022), p. 19.

[xi] Mota, E. C. (2018), A more targeted approach to foreign direct investment: the establishment of screening systems on national security grounds, Brazilian Journal of International Law, 440-468, p. 453.

[xii] OECD (2024), Managing security implications of international investment: Policy developments in a changing world, OECD, Paris, p. 21.

[xiii] Baum, A. (2020), Investment Screening for Developing Asia, Yale Journal of International Affairs, 15, 57-78, p. 66.

[xiv] Amirahmadi, H., & Wu, W. (1994), Foreign Direct Investment in Developing Countries, The Journal of Developing Areas, 28(2), 167–190, p. 186.

[xv] Babić, M. (2023), Strategies of the Competing State: Controlling Strategies, The Rise of State Capital: Transforming Markets and International Politics, Agenda Publishing, 53–80, pp. 53-55.

[xvi] OECD (2023), p. 2.

[xvii] OECD (2023), pp. 3-5; Baum (2020), pp. 65-71; Amihramadi & Wu (1994), pp. 184-187.

[xviii] UNCTAD (2023), p. 66; OECD (2009), GUIDELINES FOR RECIPIENT COUNTRY INVESTMENT POLICIES RELATING TO NATIONAL SECURITY, OECD, Paris, pp. 5.

[xix] See for example Baum (2020), pp. 68-70.

[xx] OECD (2024), p. 21.

[xxi] National Board of Trade Sweden (2022), p. 19.