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When does a foreign acquisition pose a national security threat, and when not?

When does a foreign acquisition of a company constitute a national security threat? This column says analysts may start by determining how “critical” the goods or services provided by the target of the proposed acquisition are. However, when competition among rival suppliers is high and switching costs are low, there is no genuine national security rationale for blocking a proposed acquisition, no matter how crucial the goods and services the target company provides.

When does a foreign acquisition of a company constitute a national security threat to the country where the target corporation is headquartered? When does a foreign acquisition pose no national security threat whatsoever? As the world recovers from the international financial crisis, will national attempts to block foreign corporate acquisitions become a new “protectionist drift” that interferes with the free flow of capital and technology across borders, as Marchick and Slaughter (2008) warn?

All nations face the challenge of screening foreign investment in a way that separates genuine national security threats from bogus claims. Drawing on my recent book on the US experience (Moran 2009), this column suggests how nations can address the challenge.

Three types of national security threats from foreign acquisitions

Potential damage to national security from a foreign acquisition falls into three categories:

  • The first category of threat is that the proposed acquisition would make the country where the acquired firm is located dependent upon a foreign-controlled supplier of goods or services crucial to the functioning of that economy (including, but not exclusively, the functioning of that country’s defence industrial base) and the supplier might delay, deny, or place conditions upon provision of those goods or services.
  • The second category of threat is that the proposed acquisition would allow transfer of technology or other expertise to a foreign-controlled entity that might be deployed by the entity or its government in a manner harmful to that country’s national interests.
  • The third category of threat is that the proposed acquisition would allow insertion of some potential capability for infiltration, surveillance, or sabotage – via a human or non-human agent – into the provision of goods or services crucial to the functioning of that economy.
Threat I: Dependency on a foreign supplier

For there to be a credible likelihood that a good or service can be withheld at great cost to the economy, or that the suppliers (or their home governments) can place conditions upon the provision of the good or service, the industry must be tightly concentrated, the number of close substitutes limited, and the switching costs high. Evidence from the US illustrates that Threat I does not hinge merely upon whether the good or service produced by the firm to be acquired is “crucial” to the home country of the firm.

When the Russian firm Evraz, controlled by an oligarch close to the Kremlin (Roman Abramovich), proposed to acquire Oregon Steel, it was clear that steel was a “crucial” input for the US. Steel is a major component of more than 4000 kinds of military equipment, from warships, tanks, and artillery to components and subassemblies of myriad defence systems. Uninterrupted access to steel is likewise vital for the every-day functioning of the US civilian economy.

But the international steel industry is relatively unconcentrated and switching costs for non-specialised steel products are low. The top four exporting countries account for no more than 40% of the global steel trade. Alternative sources of supply are widely dispersed, with ten countries that export more than 10 million metric tons (Japan, Russia, Ukraine, Germany, Belgium-Luxembourg, France, South Korea, Brazil, Italy, and Turkey). There are twenty additional suppliers that export more than 5 million metric tons. Certainly the steel industry is vital to US national economic and security interests. But the multiplication of sources of supply around the world means that there is no realistic likelihood that an external supplier (such as Russia) – or group of suppliers – could withhold steel from or place conditions upon US purchasers (or government) in order to take delivery.

The globalisation of steel production allows US users to take advantage of the most efficient and lowest cost sources of supply without a nagging worry that somehow the US is becoming “too dependent” on foreigners. Applying these criteria to CNOOC’s proposed acquisition of Unocal makes it clear that the idea China could deny the US access to oil via the take-over of a small US oil company was simply implausible.

Threat II: Transfer of technology

The need to worry whether a foreign acquisition might enable the acquiring company or its home government to transfer some capability to a third party depends upon is the availability of the additional production or managerial expertise involved and the increased access to output provided by the acquisition.

The prototype case for Threat II can be found in the proposed acquisition of the LTV missile business by Thomson-CSF of France in 1992. Most of LTV’s missile division capabilities were sufficiently close to those of multiple alternative suppliers that Thomson-CSF could obtain them elsewhere with relative ease. However, three product lines – the MLRS multiple rocket launcher, the ATACM longer ranger rocket launcher, and the LOSAT anti-tank missile –had few or no comparable substitutes, and one – the ERINT anti-tactical missile interceptor – included highly classified technology that was at least a generation ahead of rival systems and virtually unique at the time. Thomson-CSF was 58% owned by the French government, and had a long history of following French government directives in most intimate fashion. Prior Thomson-CSF sales to Libya and Iraq revealed important differences between how France and the US defined their national interests; a Thomson-built Crotale missile had shot down the sole US plane lost in the 1986 US bombing raid on Tripoli, and Thomson radar had offered Iraq advance warning in the first Gulf War. US objections to the Thomson-CSF offer showed a legitimate concern about leakage of unique capabilities that might harm its national interests.

Lenovo’s acquisition of IBM’s PC business benefits from the same Threat II assessment, while leading to the opposite conclusion. Might Lenovo’s acquisition represent a worrisome outflow of tightly held capabilities to China? Competition among personal computer producers is sufficiently intense that basic production technology is considered “commoditised” – more than a dozen producers compete for 50% of the PC market, with no one showing a predominant edge for long. PC assembly is much less concentrated than some hardware or software components. An as-yet imaginary proposed foreign acquisition of Intel or Cisco would – and should – arouse serious US national security concerns. But the offer to acquire a PC assembler – even by a Chinese company with close ties to the home government – should not. It is farfetched to think that Lenovo’s acquisition of IBM’s PC business represented a “leakage” of sensitive technology or provided China with military-application or dual-use capabilities that are not readily available elsewhere.

Threat III: Infiltration and sabotage

The Dubai World Ports case raised concerns about Threat III, namely, that a foreign acquisition might provide a setting in which the new owner (a company with close ties to the leadership of the United Arab Emirates) was less than vigilant in preventing hostile forces from infiltrating the operations of the acquired company or might even be complicit in facilitating surveillance or sabotage. In 2005 Dubai World Ports sought to acquire the Peninsular and Oriental Steam Navigation Company (P&O), a British firm. P&O’s main assets were terminal facilities owned or leased in various ports around the world, including facilities at six US ports—in Baltimore, Houston, Miami, New Orleans, Newark, and Philadelphia.

The Committee on Foreign Investment in the US initially approved the acquisition, but only after the Department of Homeland Security (DHS) negotiated a “letter of assurance” with DP World headquarters stipulating that Dubai Ports would operate all US facilities with US management, would designate a corporate officer with DP World to serve as point of contract with DHS on all security matters, would provide requested information to DHS whenever requested, and would assist other US law enforcement agencies on any matters related to port security, including disclosing information as US agencies requested. But hostile furore in the US Congress led DP World to withdraw the proposed acquisition.

Threat III figured prominently in the assessment of Bain Capital’s 2007 proposal to acquire 3Com, a leading US hardware and software network company, with 16.5% minority shareholding by Huawei (including the right to appoint three of eleven Board members). Huawei was founded by in 1988 by a former Chinese Army officer, Ren Zhengfei. The Rand Corporation reports that Huawei maintains close ties with the Chinese government, in particular the People’s Liberation Army (Evan et al. 2005). The DOD 2008 Annual Report to Congress on the Military Power of the People’s Republic of China identifies Huawei as working closely with the PLA on techniques of cyber warfare (US Dept. of Defense 2008).

Addressing Threat I first, could the Bain purchase, with the Huawei minority stake, lead to circumstances (perhaps during a US-China crisis over Taiwan) in which critical 3Com capabilities were withheld from US users? It would appear implausible that a minority interest acquired by Huawei Technologies would be enough to allow Chinese interests – or, ultimately, the Chinese government – to dictate how 3Com goods and services were offered for sale in the market.

Turning to Threat II, would the Bain purchase, with the Huawei minority stake, allow the “leakage” of sensitive technology or other capabilities to Chinese users that they would not otherwise have access to? The evidence indicates that most of the router, switches and inter-net card capabilities of 3Com products are rather widely available commercially for Chinese use, many involving hardware and software already produced in China.

Threat III considerations focus on whether a Huawei ownership stake (and three Huawei Board Members) might enable the Chinese to engage in espionage or sabotage of US infrastructure. A special case of Threat III is that the proposed acquisition might provide insight into a system’s weak points of which even purchasers and users (including US government users) might not be fully aware. Some analysts asserted that a manufacturer like 3Com would have special modes of entering or manipulating its own systems, potentially allowing China, via Huawei, to identify vulnerabilities to which the US government, US military, and other buyers might be unwittingly exposed, especially in 3Com’s integrated security and intrusion-protection system. Others disagreed. Before the empirics were settled, Bain withdrew its offer.


In sum, to assess whether a foreign transaction poses any or all of these three threats, analysts may start by determining how “critical” the goods or services provided by the target of the proposed acquisition are – that is, what the costs would be if provision were denied or manipulated, how much advantage the foreign purchaser and its government would gain through the acquisition of specialised knowledge or technology, or how extensive the damage would be from surveillance or disruption in the acquired company or network. But this column shows that this analysis of “criticality” must be combined in each case with a second assessment to determine the availability of alternative suppliers and the ease of switching from one to another. When competition among rival suppliers is high and switching costs are low, there is no genuine national security rationale for blocking a proposed acquisition no matter how crucial the goods and services the target company provides.


David M. Marchick and Matthew J. Slaughter. 2008. Global FDI Policy. New York: Council on Foreign Relations, June.
Theodore H. Moran. 2009. Threat Threats: An Analytical Framework for the CFIUS Process. Washington, DC: The Peterson Institute for International Economics.
Evan S. Medeiros, Roger Cliff, Keith Crane, James C. Mulvenon. A New Direction for China’s Defense Industry. Santa Monica, CA. Rand, 2005.
US Department of Defense. 2008 Annual Report to Congress: Military Power of the People’s Republic of China.

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