Foreign Investment: Foreign Laws and Policies Addressing National
Security Concerns (Letter Report, 04/02/96, GAO/NSIAD-96-61).

Japan, France, Germany, and the United Kingdom have the authority to
block investments for national security reasons, as does the United
States. In recent years, however, these five countries have rarely
invoked this authority.  Some of these countries have established
processes for reviewing foreign investment for national security
concerns. U.S. defense industry officials said that they had not pursued
defense-related direct investment in Japan, France, Germany, or the
United Kingdom because of economic factors, such as the size of the
defense markets in these nations, as well as informal barriers, such as
domestic company ownership structures. Most countries offer investment
incentives, but U.S. defense industry officials did not cite them as a
major inducement to invest. U.S. defense industry officials said that
they were pursuing access to overseas defense markets through strategies
other than foreign direct investment. For example, U.S. defense firms
either licensed technology to Japanese companies or made direct sales to
Japan. In the three European countries, U.S. companies formed
partnerships to compete for projects.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-96-61
     TITLE:  Foreign Investment: Foreign Laws and Policies Addressing 
             National Security Concerns
      DATE:  04/02/96
   SUBJECT:  Investments abroad
             Defense industry
             Foreign investments in US
             Foreign governments
             International economic relations
             National defense operations
             Executive powers
             Foreign sales
             Exporting
IDENTIFIER:  Japan
             France
             Germany
             United Kingdom
             
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Cover
================================================================ COVER


Report to the Chairman, Committee on National Security, House of
Representatives

April 1996

FOREIGN INVESTMENT - FOREIGN LAWS
AND POLICIES ADDRESSING NATIONAL
SECURITY CONCERNS

GAO/NSIAD-96-61

Foreign Investment

(705101)


Abbreviations
=============================================================== ABBREV

  CFIUS - Committee on Foreign Investment in the United States
  FECL - Foreign Exchange and Foreign Trade Control Law
  MITI - Ministry of International Trade and Industry
  OECD - Organization for Economic Cooperation and Development

Letter
=============================================================== LETTER


B-270033

April 2, 1996

The Honorable Floyd Spence
Chairman, Committee on National Security
House of Representatives

Dear Mr.  Chairman: 

In a prior report to you,\1 we examined implementation of the
Exon-Florio legislation\2 and related amendments by the interagency
group, the Committee on Foreign Investment in the United States
(CFIUS).  This legislation authorizes the President to suspend or
prohibit foreign acquisitions, mergers, or takeovers of U.S. 
companies when there is credible evidence that a foreign controlling
interest might threaten national security and other legislation
cannot provide adequate protection. 

As agreed with your office, for comparative purposes, we undertook a
follow-on effort examining how other countries monitor foreign direct
investment in their national security-related industries.\3 We
compared the Exon-Florio legislation with the laws of four major
investors in the United States--Japan, France, Germany, and the
United Kingdom.  Specifically, we focused on (1) the legal framework
governing foreign direct investments posing potential national
security concerns, (2) the barriers and incentives for U.S. 
companies to invest in these countries' national security-related
industries, and (3) the U.S.  companies' business activities in
response to these barriers or incentives.  In addressing the second
and third objectives, we focused on the defense industry because it
has the most direct link to a country's national security.  Details
on our scope and methodology are presented in appendix I. 


--------------------
\1 Foreign Investment:  Implementation of the Exon-Florio and Related
Amendments (GAO/NSIAD-96-12, Dec.  21, 1995). 

\2 The Exon-Florio legislation was a provision of the Omnibus Trade
and Competitiveness Act of 1988 and is part of the Defense Production
Act of 1950, 50 U.S.C.  app.  2170. 

\3 For the purposes of this report, national security-related
industries include--but are not limited to--companies that have
defense contracts or make defense sales. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Japan, France, Germany, and the United Kingdom each have the
authority to block investments for national security reasons, as does
the United States.  However, all five countries have infrequently
used this authority in recent years.  Some of these countries have
established processes for reviewing foreign investment for national
security concerns.  Japan and France review certain foreign direct
investments for national security and other concerns.  Germany and
the United Kingdom have no general screening authority that
explicitly considers national security issues related to foreign
investment, but the United Kingdom can consider harm to public
interest in its antitrust review process. 

U.S.  defense company officials we interviewed said they had not
pursued defense-related direct investment in Japan, France, Germany,
or the United Kingdom because of basic economic factors such as the
size of the defense markets in these countries, as well as informal
barriers, such as domestic company ownership structures.  The
officials said that such factors could be more important
considerations in some countries than the legal framework.  Most
countries offer investment incentives, but U.S.  defense company
officials did not cite these as a major reason for investing. 

U.S.  defense company officials said they were pursuing access to
overseas defense markets through strategies other than foreign direct
investment.  For example, U.S.  defense companies either licensed
technology to Japanese companies or made direct sales to Japan.  In
the three European countries, U.S.  companies formed partnerships to
compete for particular projects. 


   BACKGROUND
------------------------------------------------------------ Letter :2

International mergers and acquisitions have increased in recent
years, returning to the high levels of activity that characterized
the late 1980s.  Cross-border mergers in Europe in 1994 were almost
double the level of 1993 in value terms.  U.S.  firms were the most
active buyers in Europe.  Similarly in the United States, foreign
companies significantly increased their investment activity. 
However, Japanese companies decreased their overseas acquisitions in
the first half of 1994. 

According to the Organization for Economic Cooperation and
Development (OECD),\4 total foreign direct investment\5 inflows and
outflows among member countries have increased in recent years.  OECD
reported that inflows grew by almost 60 percent for selected
countries while outflows grew by 14 percent in the 1993-94 time
period.  The growth of inflows is largely attributable to massive
inflows into the United States.  However, there is a significant
variation in flows across individual countries, as shown in figure l. 

   Figure 1:  Foreign Direct
   Investment Inflows and
   Outflows, 1994

   (See figure in printed
   edition.)

Source:  Recent Trends in Foreign Direct Investment, OECD, April 3,
1995.  U.S.  data from Survey of Current Business, U.S.  Department
of Commerce, August 1995. 


--------------------
\4 OECD is a forum for monitoring economic trends and coordinating
economic policy among its
26 member countries, which include the economically developed free
market democracies of North America, Western Europe, and the Pacific. 

\5 The OECD definition of foreign direct investment is capital
invested for the purpose of acquiring a lasting interest in an
enterprise and exerting a degree of influence on that enterprise's
operations. 


      DEFENSE INDUSTRY ACTIVITIES
---------------------------------------------------------- Letter :2.1

In the defense industry, company business activities have been
affected by declining defense budgets.  As shown in figure 2, France,
Germany, the United Kingdom, and the United States have decreased
their defense budgets in real terms over recent years.  In contrast,
Japan's defense budget has been increasing but at a decreasing rate,
from a 3.8-percent increase between 1990 and 1991 to a 0.9-percent
increase between 1993 and 1994. 

   Figure 2:  Trends in Defense
   Budgets for Selected Countries,
   1990-95\ a

   (See figure in printed
   edition.)

Source:  GAO analysis based on The Military Balance, 1990-96,
International Institute for Strategic Studies. 

\a The data are adjusted for inflation and indexed using 1990 as the
base year. 

Given declining defense budgets, most defense firms worldwide are
consolidating to improve competitiveness.  U.S.  defense firms have
pursued consolidation within the United States to downsize and reduce
overcapacity.  To a certain extent, some of the European countries
have contracted and restructured their individual defense industries. 
Germany and the United Kingdom, in particular, have encouraged
numerous defense manufacturers to consolidate into unified
conglomerates or "national champions." In contrast, French defense
companies have consolidated more slowly.  Mergers and acquisitions
are uncommon in Japan's defense industry, which is restructuring by
such means as shifting resources away from defense production into
commercial sectors and reducing production lines. 

According to the Center for Strategic and Budgetary Assessments,\6
cross-border defense mergers, acquisitions, and joint ventures have
been largely intra-European, as shown in figure 3.  Transatlantic
defense investment activity has been characterized by European
acquisitions of U.S.  companies rather than U.S.  acquisitions of
European companies.  Few U.S.  companies are acquiring Japanese
companies.  The Center for Strategic and Budgetary Assessments also
reports that foreign acquisitions occurring in Japan are between
companies only marginally engaged in defense work. 

   Figure 3:  U.S.-European
   Cross-Border Defense Mergers,
   Acquisitions, and Joint
   Ventures

   (See figure in printed
   edition.)

Source:  Center for Strategic and Budgetary Assessments. 

Note:  Europe-led and U.S.-led refer to transatlantic mergers and
acquisitions. 


--------------------
\6 The Center for Strategic and Budgetary Assessments (formerly the
Defense Budget Project) is an independent research organization that
analyzes national security policies and defense budgets. 


      INTERNATIONAL AGREEMENTS
      WITH PROVISIONS AFFECTING
      NATIONAL SECURITY
---------------------------------------------------------- Letter :2.2

Agreements among countries have widely recognized the right of
sovereign nations to take measures protecting their essential
national security interests.  For example, article 223 of the Treaty
of Rome\7 states in part that European member nations may take
measures "necessary for the protection of the essential interest of
its security which are connected with the production of or trade in
arms, munitions and war material." This article essentially allows
national governments to suspend European Union free trade and
competition rules on the grounds of national security.  Also, OECD's
main foreign direct investment instruments, the National Treatment
Instrument and Codes of Liberalization, recognize that countries can
take actions based on essential security or other interests. 

In September 1995, OECD began negotiating a multilateral agreement on
investment.  This agreement is intended to develop high standards for
liberalization of foreign direct investment regimes and investment
protection and to include effective dispute settlement.  Exceptions
to the investment principles will be negotiated.  According to some
experts, one exception will permit each member country to exempt
certain industries or sectors from the agreement commitments due to
national security concerns. 


--------------------
\7 The Treaty of Rome established the European Economic Community. 


   BROAD AUTHORITY EXISTS TO BLOCK
   INVESTMENTS FOR NATIONAL
   SECURITY REASONS
------------------------------------------------------------ Letter :3

The Exon-Florio legislation grants the President of the United States
the authority to take appropriate action to suspend or prohibit
foreign acquisitions, mergers, or takeovers of U.S.  businesses that
threaten to impair the national security.  To exercise this
authority, the President must find that (1) credible evidence exists
that the foreign interest exercising control might take action that
threatens to impair national security and (2) provisions of law,
other than the Exon-Florio legislation and the International
Emergency Economic Powers Act, do not provide adequate authority to
protect the national security.  Since the enactment of the
legislation in 1988, the President has used this authority once when
ordering divestiture of a Chinese company's acquisition of a U.S. 
aircraft parts company. 

Japan, France, Germany, and the United Kingdom do not have laws
directly analogous to the Exon-Florio legislation, but nevertheless
have broad legislative authority to block foreign investments for
reasons of national security or national interest.  For example, the
Japanese and French laws provide the governments broad powers to
block investments that might imperil national security, public order,
and public safety.  The Japanese government has not invoked this
authority in recent years while the French government has restricted
nine investments in the past several years.\8 Germany's law also
permits restriction of private investment flows in either direction
for balance of trade considerations and foreign policy, public order,
and national security reasons, but such restrictions have not been
used to date.  The United Kingdom has never used its broad
discretionary power to block foreign investments for national
interest.  The legal investment frameworks of Japan, France, Germany,
and the United Kingdom are discussed in appendixes II, III, IV, and
V, respectively. 

In the United States, the President designated CFIUS as responsible
for reviewing foreign investment transactions.  Although
notifications are voluntary, CFIUS retains the right to review at any
time any acquisition not notified to the Committee.  The Exon-Florio
regulations also permit a CFIUS member to submit a notice of a
proposed or completed acquisition for a national security review.  A
CFIUS determination that there are no national security issues
essentially eliminates the risk that the President will at a later
time block the transaction or order a divestiture.\9

Each of the countries we examined has a reviewing mechanism that
differs in focus from CFIUS.  Japan and France both have a formal
process in which foreign investments are reviewed for several
reasons, including public order, public safety, and national
security.  The United Kingdom and Germany have no general screening
authority that explicitly considers national security issues related
to foreign investment.\10 However, as do many other nations, the
United Kingdom and Germany have antitrust screening mechanisms.  The
United Kingdom, through its antitrust process, may make
determinations based on harm to public interest.  Germany's antitrust
review mechanism does not screen for adverse impact on national
security, but antitrust decisions against a merger may be overturned
if the merger is considered to be in the public interest. 

As shown in table 1, similarities and differences exist among the
CFIUS process and selected reviewing mechanisms in Japan and France. 
For example, CFIUS and the other countries' reviewing entities are
similar in that they perform case-by-case evaluations.  These reviews
have resulted in few denied transactions based on national security
concerns.  However, significant differences exist among the reviewing
mechanisms.  Japan and France review foreign investments for national
security and other reasons.  While transactions are voluntarily
notified to CFIUS, the two countries' reviewing mechanisms require
mandatory notification for transactions meeting certain criteria. 
Also, Japan and France have a judicial appeal process, unlike the
United States. 



                                     Table 1
                     
                      Selected Countries' Foreign Investment
                              Reviewing Mechanisms\a

Characteristic
s of reviewing
mechanisms      United States   Japan           France\b
--------------  --------------  --------------  --------------------------------
Reason for      National        National        Public order, health, or
reviewing       security.       security,       security; public functions;
                                public order,   research, production, or trade
                                public safety,  in arms, ammunition, explosive
                                and economy.    powders and substances destined
                                                for military use or wartime
                                                equipment.

Reviewing body  CFIUS.          Ministry of     Ministry of Economics and
                                Finance and     Finance, consulting with
                                Ministry in     Ministries of Industry and
                                charge of       Defense.
                                industry.

Notification    Voluntary.      Mandatory.      Mandatory.

Review time     Thirty-day      Thirty days;    Up to 1 month, unless
                review;         can be          postponement rights are
                45-day          extended up to  exercised.
                investigation;  5 months.
                15-day
                presidential
                review for
                cases
                investigated.

Judicial        No.             Yes.            Yes.
appeal

Case-by-case    Yes.            Yes.            Yes.
evaluation

Outcomes and    Fifteen cases   None since      Eight rejected in 1992-93 and
time frame      investigated    1992 law        one in 1994 for public order
                since 1988;     revisions.      reasons.
                President
                blocked 1
                case.
--------------------------------------------------------------------------------
\a Germany and the United Kingdom are not included in the table
because neither country has a foreign investment specific review
mechanism that can consider national security implications. 

\b The French government changed its foreign investment law in
February 1996 to abolish prior authorization of non-European
investments meeting certain French franc thresholds.  However, prior
authorization is still required for all foreign investments in French
entities carrying out public functions or activities that may affect
public health, order, or security, or for investments involving
research, production or trade in arms, ammunition, explosive powders
and substances destined for military use or wartime equipment. 

Source:  GAO analysis. 


--------------------
\8 According to French government officials, none of the transactions
were blocked for national security reasons.  The French government
blocked the transactions for public order reasons. 

\9 The Exon-Florio regulations allow CFIUS to reopen its
consideration of a transaction if parties fail to provide material
information or submit false or misleading information. 

\10 In one case involving the foreign acquisition of a German defense
company, the German federal government established an ad hoc review
committee to examine the terms of the transactions and possible
national security implications. 


      LIMITATIONS REPORTED TO OECD
---------------------------------------------------------- Letter :3.1

All five countries impose some type of sectoral restrictions on
foreign direct investment that are notified to OECD.  For example,
the five countries impose similar restrictions on maritime transport. 
OECD members also report measures based on public order and essential
security interests that are considered limitations to the National
Treatment Instrument.\11 Of the five countries, only Germany reported
no limitations for essential security interests.  Table 2 shows the
national treatment limitations that affect defense or national
security-related areas in our selected countries. 



                                     Table 2
                     
                       Selected Public Order and Essential
                      Security-Related Measures Reported to
                                       OECD

            Foreign investment        Government purchasing
            measures based on         measures based on
            essential security        essential security        Other related
Country     considerations            considerations            measures
----------  ------------------------  ------------------------  ----------------
United      The Exon-Florio           Foreign controlled        None.
States      legislation provides the  enterprises may not be
            President power to block  granted a contract or
            foreign acquisitions      subcontract involving
            that threaten to impair   classified information,
            national security.        except under special
                                      arrangements determined
                                      on a case-by-case basis.

Japan       Specific investment       None.                     None.
            plans of foreign
            controlled enterprises
            could be altered or
            suspended when national
            security, public order,
            or public safety is
            deemed threatened in
            such industrial sectors
            as aircraft, arms,
            explosives, nuclear
            energy, and space.

France      National treatment is     Preference is accorded    None.
            not applicable to         to locally owned firms
            enterprises whose         in procurement for the
            activities are directly   armed forces with regard
            or indirectly related to  to items for military
            national defense and      purposes.
            armaments. The
            government reserves the
            right to apply
            conditions on the
            creation, extension, or
            conduct of business
            enterprises under
            foreign control or to
            obtain guarantees.

Germany     None.                     None.                     None.

United      British Aerospace PLC     In a limited number of    Certain
Kingdom     and Rolls Royce PLC       cases, foreign-           citizenship
            restrict the number of    controlled enterprises    requirements for
            foreign-held shares at    may not be granted        ex-Plessy
            any one time to 29.5      defense procurement       companies
            percent of the ordinary   contracts where           engaged in
            voting equity. The        overriding security       classified work.
            articles of association   reasons apply.            VSEL Consortium
            also provide citizenship                            PLC has
            requirements for the                                citizenship
            directors.                                          requirements for
                                                                certain
                                                                executives.
                                                                There is also a
                                                                veto over
                                                                disposal of
                                                                company assets.
--------------------------------------------------------------------------------
Source:  National Treatment for Foreign Controlled Enterprises, OECD,
1993. 


--------------------
\11 This instrument is a nonbinding agreement.  It provides that OECD
member countries will apply the same laws, regulations, and
administrative practices to foreign-owned companies as would apply to
domestic investors in like situations.  Member countries must notify
OECD of all measures constituting exceptions to this principle. 


   ECONOMIC CONDITIONS AND
   INFORMAL BARRIERS INFLUENCE
   INVESTMENT DECISIONS
------------------------------------------------------------ Letter :4

Fundamental economic conditions and informal barriers to doing
business in the selected countries can be important determinants of
whether U.S.  firms pursue foreign direct investment options. 
Officials at many of the U.S.  defense companies we interviewed were
not planning to invest abroad because of the relatively small size of
the countries' defense markets.  They frequently cited basic economic
factors and informal barriers, such as high land prices or domestic
company ownership structures, as more important to their evaluation
of investment options than the legal framework.  Furthermore, the
officials said that governments offer some incentives to invest, such
as tax breaks, but these are not a significant factor in making
investment decisions. 

Some U.S.  defense company officials we interviewed said the size of
the defense markets in the four countries often did not justify major
equity investments.  For example, the German and British defense
budgets are declining, which can make it less attractive for U.S
companies.  Although the Japanese government has one of the larger
defense budgets, it has a comparatively smaller equipment acquisition
budget.  As shown in figure 4, the U.S.  defense budget was larger
than those of the other countries reviewed. 

   Figure 4:  Defense Budgets for
   Selected Countries, 1995\ a

   (See figure in printed
   edition.)

Source:  The Military Balance, 1995-96, International Institute for
Strategic Studies. 

\a The data is not adjusted for inflation. 

U.S.  defense and commercial companies are affected by the business
environment overseas.  In weighing decisions to invest abroad, U.S. 
company officials we interviewed said certain economic or social
conditions can serve as disincentives.  For example, companies
established in France and Germany face strict labor practices and
cannot lay off workers easily.  In Japan, obstacles to doing business
include labor costs, the tax burden, and high rent and land costs. 
Such factors make investment expensive and can affect the profit
margins of established companies in these countries. 

U.S.  defense company officials we interviewed indicated company
ownership structures can deter foreign direct investment.  For
example, extensive cross-shareholdings between businesses and large
institutions exist in both Germany and Japan, which serve the
long-term investment needs of domestic companies and discourage
foreign investors.  In France, the government has majority ownership
of most of the major defense companies and significant influence over
other private defense-related companies.  Unlike France, the United
Kingdom has largely privatized most companies since 1979.  However,
the British government retains "golden shares," or special consent
rights, in certain privatized companies.  This may include placing
limits on foreign ownership as with British Aerospace PLC and Rolls
Royce PLC. 

Each of the countries has incentives to offer foreign investors, but
these incentives played a limited role in influencing the investment
decisions of the U.S.  defense company officials we interviewed. 
Most of the countries offer some form of a tax incentive, low
interest loan, or subsidy.  Regional incentives exist to attract
foreign investors to certain geographic areas.  However, none of
these investment incentives are defense specific. 

Given the defense investment climate and economic conditions, many
U.S.  defense company officials we interviewed did not view foreign
direct investment as an essential part of their strategy.  However,
some investments have been made.  For example, General Electric and
the French company, SNECMA, collaborated for over 20 years on the
CFM-56 jet engine for commercial aircraft and established an equity
joint venture in 1974 to supply propulsion systems.  In 1993, BDM
International, Inc., invested in the German company, IABG, which
conducts aerospace testing and military and environmental studies. 


   DEFENSE COMPANIES PURSUE OTHER
   STRATEGIES TO GAIN MARKET
   ACCESS
------------------------------------------------------------ Letter :5

To gain market access, U.S.  defense companies are largely seeking
project-by-project business arrangements with European companies or
selling in niche markets.  These arrangements can be less expensive
for U.S.  companies to pursue compared to capital intensive equity
investments.  Some U.S.  company officials said that having
relationships with European partners is helpful because they offer
knowledge of the regulatory environment.  Successful partnerships
include McDonnell Douglas and Westland Helicopters to produce Apache
helicopters for the British Ministry of Defense.  E-Systems joined
with three German companies in developing the Senior Guardian
recognizance program.  Motorola, through a French distributor, sells
certain electronic products in French niche markets, where the
principal French defense electronics manufacturer Thomson-CSF is not
present. 

In contrast with the European business arrangements, U.S.  defense
companies export defense products and license technology from the
United States rather than make capital investments in Japan.  This
strategy is more advantageous to pursue because direct investment in
Japan is expensive.  For example, Hughes Aircraft is licensing its
radar technology to a Japanese company for Japan's F-15s.  Also,
Japan has obtained technology and items from U.S.  firms for the FS-X
program.\12 The U.S.  Department of State had approved over 500 FS-X
munitions export licenses by March 1994.  Most of these licenses
covered hardware for the development and production of the prototype
aircraft. 


--------------------
\12 For more information on the FS-X program, see our report entitled
U.S.-Japan Cooperative Development:  Progress on the FS-X Program
Enhances Japanese Aerospace Capabilities (GAO/NSIAD-95-145, Aug.  11,
1995). 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :6

The Departments of the Treasury, Commerce, State, and Defense and the
Office of the United States Trade Representative generally agreed
with our draft report and provided minor technical comments.  The
Department of Commerce, in official oral comments, said the draft
report is an accurate and balanced representation of the facts.  The
Office of the United States Trade Representative, also in official
oral comments, said that the report will be useful for the ongoing
multilateral agreement on investment negotiations. 

Officials from Japan, France, Germany, and the United Kingdom
reviewed the appendix corresponding to their country.  Most of these
officials provided updated data or technical comments to the
appendixes.  We incorporated their comments where appropriate. 


---------------------------------------------------------- Letter :6.1

We are sending copies of this report to interested congressional
committees and to the Secretaries of the Treasury, Commerce, State,
and Defense; the United States Trade Representative; and the
Director, Office of Management and Budget.  We are also making copies
available to other interested parties upon request. 

Please contact me at (202) 512-4841 if you or your staff have any
questions concerning this report.  Major contributors to this report
are listed in appendix VI. 

Sincerely yours,

David E.  Cooper
Associate Director,
Defense Acquisition Issues


SCOPE AND METHODOLOGY
=========================================================== Appendix I

This report is a follow-on from our report that examined U.S. 
procedures for reviewing foreign investment in U.S.  national
security-related industries.  We selected Japan, France, Germany, and
the United Kingdom to review because these four countries reported
most frequently to the Committee on Foreign Investment in the United
States (CFIUS). 

During our review, we interviewed many government officials.  Within
the U.S.  government, we interviewed officials from the Departments
of the Treasury, Commerce, State, and Defense; the Office of the U.S. 
Trade Representative; and U.S.  embassies in Japan, France, Germany,
and the United Kingdom.  We also interviewed officials from the
embassies of France, Germany, and the United Kingdom in Washington,
D.C..  We also met with foreign government officials in the four
countries, as follows: 

  -- Japan

Ministry of Finance,

Ministry of International Trade and Industry, and

Ministry of Posts and Telecommunications. 

  -- France

Ministry of Economics and Finance,

Ministry of Industry, and

Ministry of Defense. 

  -- Germany

Ministry of Finance,

Ministry of Economics, and

Ministry of Defense. 

  -- United Kingdom

Ministry of Trade and Industry,

Ministry of Defense, and

the Central Statistical Office. 

While in France, we also interviewed officials from the Organization
for Economic Cooperation and Development (OECD) and the U.S.  Mission
to OECD to discuss matters pertaining to various OECD instruments and
the ongoing negotiations on the Multilateral Agreement on Investment. 
In addition, we interviewed officials at the European Commission and
the U.S.  Mission to the European Union in Belgium to obtain their
views on European Union competencies in mergers and acquisitions and
defense issues. 

To compare the legal frameworks of the four countries with the U.S. 
Exon-Florio legislation, we reviewed (1) the laws in the original
language, (2) translations of the laws and regulations, or (3)
summaries of the laws and regulations pertaining to foreign direct
investment in each of the four countries.  In addition, we discussed
our understanding of the laws with the relevant government officials
in each country.  We also reviewed legal journal articles that
addressed the same issues. 

To obtain information on the regulatory framework and the barriers
and incentives to investment and U.S.  business activities in each
country, we interviewed representatives from industry associations,
chambers of commerce, research and educational institutions, and U.S. 
and foreign embassies.  We also interviewed officials from 20 U.S. 
companies that sell defense-related products and officials from the
North Atlantic Treaty Organization and the Western European Union
about opportunities for U.S.  defense companies to invest in Europe. 
We also conducted literature searches for relevant information and
reviewed documents from various representatives and officials. 

Our work was limited in two ways.  First, we did not select a random
sample of companies; instead, we selected companies on the basis of
the type of business investment and the willingness of company
officials to speak with us.  Therefore, we cannot make any
statistically significant conclusions based on our interviews. 
Second, we could not obtain data concerning the number of U.S. 
direct investments in the defense industries of these countries
because U.S.  government sources gather the data according to
industrial categories in which defense is subsumed.  Instead, we
obtained defense investment data from the Center for Strategic and
Budgetary Assessments, which maintains a globalization database that
contains over 1,050 entries on international collaborative arms
activities, including defense mergers, acquisitions, and joint
ventures.  We did not verify the information in the database. 

We conducted our review between March and December 1995 in accordance
with generally accepted government auditing standards. 


JAPAN
========================================================== Appendix II

Japan's Foreign Exchange and Foreign Trade Control Law (FECL) is the
primary law pertaining to foreign direct investment and provides the
authority to block or restructure an investment.  This law requires
prior notification of a proposed investment in certain industries so
that the Ministry of Finance and other ministries may review the
proposed investment to determine whether the investment might
adversely affect national security, public order, public safety, or
the Japanese economy.  This authority, however, has not been used at
least since 1992 because (1) foreign investors informally consult
with the ministries before formal notification and (2) the ministries
use administrative guidance\1 to affect any potential investments. 
Indirect barriers and economic conditions, such as the structure of
Japan's defense industry and the high cost of doing business in
Japan, discourage foreign investment in Japan, rather than Japanese
legal restrictions.  Instead of foreign direct investment, U.S. 
defense companies prefer to license technology to Japanese companies
or export directly to Japan. 


--------------------
\1 Administrative guidance refers to the suggestions or "unwritten
orders" given by Japanese government officials to firms to implement
official policies.  It is based on the broad discretionary power of
the bureaucracy rather than on specific laws. 


   BACKGROUND
-------------------------------------------------------- Appendix II:1

Foreign direct investment in Japan is small compared to investment in
the other countries we reviewed.  Japan received about 0.7 percent of
all OECD foreign direct investment inflows from 1971 to 1990, even
though Japan's economy is the second largest in the world.  Japan's
largest investor is the United States, which accounted for 42 percent
of all foreign direct investment in Japan by the end of March 1992. 
However, the dollar value of U.S.  direct investment in Japan is
small compared to Japanese direct investment in the United States. 
As of 1994, U.S.  direct investment in Japan reached $37 billion,
whereas Japanese direct investment in the United States reached
$103.1 billion, according to the U.S.  Department of Commerce.\2

Japan's overall defense budget is not declining, unlike most other
major economic powers.  Japan's defense budget has been growing for
the past
5 years, although at a steadily decreasing rate.  The budget
increased in real terms 3.8 percent between 1990 and 1991, but by
1994, the budget increased 0.9 percent from the 1993 level.  However,
Japan's defense acquisition budget has been declining for several
years.  From fiscal year 1991\3 until fiscal year 1994, Japan's
acquisition expenditures fell 17.9 percent.  As Japan's defense
industry depends on sales to the Japan Defense Agency, the industry
is experiencing economic difficulty.  The Japan Defense Agency stated
in a 1994 report that the defense industry is in a harsh environment
because of the declining acquisition expenditures and economic
depression. 

Japan's defense industry plays a small role in its economy,
accounting for about 0.6 percent of Japan's total industrial
production.  Defense contracts are heavily concentrated among a few
companies.  In fact, the top
10 defense contractors account for about 60 percent of total
expenditures.  However, even among the top defense contractors,
defense-related sales account for a small percentage of total sales
compared to U.S.  defense companies. 


--------------------
\2 Some experts argue that U.S.  investments in Japan are
undervalued.  Nonetheless, they agree that U.S.  investments in Japan
are much smaller than Japanese investments in the United States. 

\3 Japan's fiscal year begins on April 1 of that calendar year and
ends on March 31 of the following calendar year. 


   LEGAL FRAMEWORK EXISTS FOR
   REVIEWING AND BLOCKING FOREIGN
   INVESTMENTS
-------------------------------------------------------- Appendix II:2

As Japan's primary law concerning foreign direct investment, FECL
provides that the ministries may advise or order an investor to
either restructure or suspend a proposed investment if they determine
that the investment may harm national security, public order, public
safety, or the economy.  However, the Japanese government has not
used this authority at least since FECL was amended in 1992,
according to Japanese government officials.  Industry observers
indicated that the ministries are commonly consulted by companies or
their legal representatives to obtain informal approval prior to
official notification.  Ministry officials stressed that this
consultation is optional.  Nonetheless, the ministries have the
opportunity to influence investment decisions prior to formal
notification through these consultations or by administrative
guidance, according to foreign company representatives and members of
academia. 

FECL provides a broad definition of foreign direct investment.  FECL
defines foreign investment as (1) having at least 10 percent foreign
ownership of shares in a company listed on a Japanese stock exchange;
(2) having foreign ownership of any shares in an unlisted company;
(3) establishing a branch, factory, or other business office in
Japan; (4) consenting to change the corporate objectives of a
domestic company with one-third or more foreign ownership; or (5)
lending certain types of money to domestic companies. 


      NOTIFICATION PROCEDURES
------------------------------------------------------ Appendix II:2.1

FECL and its implementing documents require reporting or notification
of all foreign direct investment in Japan.  The law provides for ex
post facto, or "after the fact," reporting for investments in most
industries, which are identified in a public notice.  A foreign
investor must file a report with the Ministry of Finance and the
ministry with jurisdiction over the industry through the Bank of
Japan within 15 days after a transaction occurs.  Ministry of
International Trade and Industry (MITI) officials stated that the
reason for ex post facto reporting was for statistical purposes and
in case of an emergency, such as a financial crisis or war. 

The law requires prior notification for exceptional cases, in which
foreign direct domestic investment is proposed (1) by an investor
from a country not listed in the public notice and for which Japan
has reciprocity concerns and (2) in an industry not listed in the
public notice.  The public notice excludes industries relating to
national security, public order, or public safety, as well as
industries reserved by Japan under the OECD Code of Liberalization of
Capital Movements.  Failure to notify the ministries can result in
jail time and/or a monetary fine. 

FECL authorizes the Ministry of Finance and the ministries of
jurisdiction to review for national security and economic reasons any
proposed investments in industries requiring prior notification.  The
law provides ministerial review to determine whether the proposed
investments might (1) imperil the national security or disturb the
maintenance of public order or public safety or (2) adversely and
seriously affect the Japanese economy.  Sectors that require prior
notification include aircraft and aircraft parts, explosives and
munitions, atomic power, space development, and certain types of
telecommunications. 

Japan also requires prior notification of investments in sectors
reserved through the OECD Code of Liberalization of Capital
Movements.  Under the OECD code, Japan reserves the following
industries:  agriculture, forestry and fisheries; mining; oil;
leather and leather products manufacturing; air transport; and
maritime transport.  A Ministry of Finance official stated that these
industries are reviewed mainly for economic reasons, although some
are also reviewed for national security reasons. 


      THE REVIEW PROCESS
------------------------------------------------------ Appendix II:2.2

Ministerial reviews may extend from 30 days to 5 months.  The
ministries have 30 days to review a proposed investment after a
foreign company has notified the ministries of its intent to invest. 
If the investor has not received a response within that time, the
transaction may be completed, according to MITI officials.  The
ministries may extend the review period for up to 4 months if they
believe further inquiry is necessary.  A Committee on Foreign
Exchange and Other Transactions also may extend the review period an
additional month.\4 However, a Finance Ministry official stated that
the review period usually is less than 30 days. 

FECL and its related documents do not provide criteria to determine
whether a proposed investment will pose a national security or
economic threat.  The ministries review investments on a case-by-case
basis and therefore apply no set standards, according to MITI
officials.  The notification form requires information concerning the
percentage of shares to be acquired, the business plan of the
investing company, and the reason for the transaction.  However, the
ministries may consider information related to foreign control, such
as the number of foreign board members and the foreign company's
reputation, according to Japanese government officials. 

Investors may appeal the decision of the ministries.  FECL provides
for a public hearing if an investor wishes to contest the result of
the ministerial review.  After the public hearing, an investor may
appeal to the Japanese courts to try to overturn a decision. 


--------------------
\4 The committee is appointed by the Minister of Finance to provide
an opinion on direct investment and other matters. 


   ECONOMIC FACTORS AND INDIRECT
   BARRIERS INHIBIT INVESTMENT
-------------------------------------------------------- Appendix II:3

Economic factors and indirect barriers, rather than Japanese laws,
appear to be the primary determinants of foreign investment across
sectors.  The U.S.  company representatives that we interviewed
stated that they have encountered no legal barriers to foreign
investment in Japan in recent years.  An American Chamber of Commerce
in Japan report also indicates that legal barriers to investment in
Japan have been removed. 

The nature of Japan's defense industry acts as a deterrent to foreign
investment in that sector.  Japan's market for defense items is
considered by many observers to be too small to warrant the expense
of establishing facilities in Japan.  Establishing manufacturing
facilities in Japan would be too costly and, according to one U.S. 
defense company official, would take away from economies of scale
achieved at U.S.  production facilities.  Japan's defense market has
primarily one client, the Japan Defense Agency, because the Japanese
government basically prohibits exporting defense items to third
countries.  While the Japan Defense Agency has one of the larger
defense budgets in the world, only 18.4 percent was devoted to
equipment acquisition in fiscal year 1995.  Furthermore, the Japan
Defense Agency's preference for domestic procurement of defense items
and the prohibition on arms exports increases the acquisition costs
because of the high per unit cost of small production runs.  As a
result, the acquisition budget buys fewer items. 

The size and structure of Japanese companies that produce defense
items also discourage U.S.  defense companies from attempting to
purchase a controlling share in these companies.  Japan has few
companies dedicated solely to defense production.  Most of the Japan
Defense Agency's defense purchases are from huge Japanese
conglomerates, such as Mitsubishi Heavy Industries, Kawasaki Heavy
Industries, and Fuji Heavy Industries.  However, defense sales
provide a small percentage of sales for these companies compared to
U.S.  defense companies.  For example, defense-related sales account
for about 13 percent of Mitsubishi Heavy Industries' total sales,
even though the company is the Japan Defense Agency's top defense
contractor and is ranked as 1 of the top 20 defense companies
worldwide.  Furthermore, U.S.  company officials stated that the size
of a "heavy" makes it too expensive to try to buy a controlling
portion of one.  Some U.S.  company officials stated that, even if
they wanted to acquire a Japanese company that does defense work, the
Japanese government would discourage such action. 

Across sectors, business practices, structural barriers, and economic
factors are frequently cited as major obstacles to investment.  For
example, a study commissioned by the American Chamber of Commerce in
Japan and the Council of the European Business Community cited
selective enforcement of regulations as one of the main barriers to
doing business in Japan.  Many of the representatives of U.S. 
defense companies we interviewed, as well as numerous studies, stated
that the high cost of doing business in Japan, including labor costs,
the tax burden, rent and land costs, and regulatory issues, is a
disincentive to investment.  Foreign acquisitions of Japanese
companies face barriers caused by cross-shareholding--the practice of
companies holding shares of each other's stock--and keiretsu
relationships--groups of affiliated companies in related or unrelated
fields that hold each other's shares and may also have financial
(such as bank loans) or manufacturer-supplier ties or distributor
relationships.  Cross-shareholding and keiretsu relationships lessen
the amount of shares available to buy on the stock market.  In
addition, cross-shareholding may prevent a foreign company from
taking management control of a company, even if the foreign company
is the largest individual shareholder.  The relationships among
keiretsu members make it difficult for foreign companies to buy into
a member company and also to sell products to members of the
keiretsu.\5

Recent bilateral discussions between the U.S.  and Japanese
governments have addressed some of the barriers to U.S.  investment
in Japan.  The resulting agreement, which was signed in July 1995,
detailed actions that the Japanese government has recently taken and
outlined criteria for assessing the effectiveness of these actions. 
In addition, the Japanese government has pledged to promote foreign
investment into Japan. 


--------------------
\5 For further discussion of the Japanese business environment and
some indirect barriers to investment, see Competitiveness Issues: 
The Business Environment in the United States, Japan, and Germany
(GAO/GGD-93-124, Aug.  9, 1993). 


   INCENTIVES HAVE LITTLE IMPACT
   ON INVESTMENT DECISIONS
-------------------------------------------------------- Appendix II:4

The Japanese government offers a variety of incentives to encourage
foreign direct investment.  The Law on Extraordinary Measures for the
Promotion of Imports and the Facilitation of Foreign Direct
Investment in Japan provides for tax incentives and loan guarantees
for eligible foreign companies.\6 For example, the law provides for
(1) accelerated depreciation of buildings, machinery, and equipment;
(2) extension of the carry-over period to 7 years for losses incurred
during the first 3 years of starting business in Japan;\7 and (3)
exemption from special local land-holding taxes if certain conditions
are met.  The law also provides for loan guarantees for acquiring
facilities and equipment.  In addition to the special measures
provided by the law, both Japanese national and prefectural
governments offer incentives, such as tax incentives, subsidies,
low-interest loans, and loan guarantees. 

Some U.S.  companies have used these incentive programs.  However,
the company and industry representatives that we interviewed were
unimpressed with the benefits provided by the incentives.  Also, the
1995 survey by the American Chamber of Commerce in Japan and the
European Business Council indicated that survey respondents viewed
these incentives neither positively nor negatively.  One company
representative stated that the incentives were of no real benefit
because the paperwork requirements for the incentive programs were
onerous. 


--------------------
\6 This law has been extended until 2006. 

\7 Effective fiscal year 1996, companies may carry over losses
incurred during the first 5 years, rather than 3 years. 


   U.S.  COMPANIES OBTAIN ACCESS
   TO JAPAN'S DEFENSE MARKET
   THROUGH APPROACHES OTHER THAN
   DIRECT INVESTMENT
-------------------------------------------------------- Appendix II:5

Few, if any, U.S.  companies have invested in Japan's defense
industry, according to U.S.  company, industry association, and
Japanese government officials we interviewed.  U.S.  defense company
officials have indicated that the decision not to invest in Japanese
businesses is not based on Japan's regulatory environment, but on
economic reasons.  Instead, U.S.  companies have realized sales to
Japan through exporting from the United States and licensing
technology, making the expense of investing in Japan unnecessary. 
Many U.S.  companies have established branch or representative
offices to facilitate these activities in Japan but do not have
manufacturing facilities.  When U.S.  firms that have defense
contracts in the United States have established either joint ventures
or 100 percent-owned subsidiaries in Japan, these firms target the
consumer market, not defense. 


FRANCE
========================================================= Appendix III

The French foreign investment law requires prior approval of foreign
direct investment in sectors that affect public functions, public
order, health, security, or aspects of the defense industry but
certain prior authorization requirements were recently liberalized.\1
The French Ministry of Economics and Finance has the authority to
block foreign investments made without proper authorization.  The
Ministry consults with the Ministry of Defense in cases concerning
investment in national security-related industries.  To date,
Ministry officials are unaware of any proposed investments by U.S. 
companies that were denied on national security grounds in recent
years.  Nonetheless, few of the major French defense companies are
available for U.S.  companies to acquire because most are owned by
the French government.  U.S.  companies prefer teaming with French
companies on a project-by-project basis to achieve defense sales in
France. 


--------------------
\1 A new French law and decree on foreign investment was enacted in
February 1996. 


   BACKGROUND
------------------------------------------------------- Appendix III:1

France is one of the main host countries for foreign direct
investment among OECD nations.  France has received over $87 billion
in foreign direct investment, cumulatively from 1971 through 1992. 
About 30 percent of the French economy is owned by foreign investors. 
U.S.  foreign direct investment in France reached almost $27.9
billion and French foreign direct investment in the United States
reached almost $33.5 billion in 1994, according to the U.S. 
Department of Commerce.  U.S.  investments represent about 36 percent
of total sales by foreign-owned subsidiaries in France.  The French
government characterizes much of the U.S.  investment in France as
occurring in high growth, high technology areas. 

The French defense budget has declined slightly in real terms during
the past 5 years.  From 1990 to 1994, the French defense budget
declined
4 percent after adjusting for inflation.  In addition, the French
government reduced its 1995 defense budget to $38.86 billion
following a $1.7-billion cut in procurement.  The French government
strongly supports its defense industrial base and obtains nearly 90
percent of its defense equipment from French companies.  However,
according to a French government official, the Ministry of Defense
plans to increase the percentage of the budget devoted to cooperative
efforts. 


   LEGAL FRAMEWORK EXISTS FOR
   REVIEWING FOREIGN DIRECT
   INVESTMENT
------------------------------------------------------- Appendix III:2

French law requires prior authorization from the French Ministry of
Economics and Finance for foreign investments concerning (1) public
functions, (2) public order, health, or security, or (3) research,
production or trade in arms, ammunition, explosive powders and
substances destined for military use or wartime equipment.\2 The
Ministry of Economics and Finance has the authority to block foreign
investment in these areas made without proper authorization. 
Ministry of Economics and Finance officials were unaware of any
proposed U.S.  investments being denied approval in recent years. 
However, the French government blocked eight transactions by non-U.S. 
companies in 1992 and 1993 and one in 1994 on public order grounds. 

French law defines foreign direct investment as (1) the purchase,
establishment, or expansion of a business or branch or (2) any other
transactions that enable nonresidents to acquire or increase control
over a company engaged in industry, commerce, agriculture, finance,
or real estate.  It also generally defines foreign control as
occurring when at least 20 percent of a company's shares are owned by
nonresidents or by companies under the control of nonresidents. 
However, other factors may be considered when determining foreign
control, such as whether loans, commercial ties, or licensing
arrangements result in additional control by a foreign entity.  A
company not listed on the stock exchange is considered under foreign
control when at least 33.33 percent of its voting rights are owned by
nonresidents. 


--------------------
\2 Certain foreign business transactions in these sectors will not be
subject to the notification or approval process.  These include
greenfield investments and increased foreign control in businesses
that are already at least 66.66 percent foreign controlled in terms
of capital and voting rights. 


      NOTIFICATION/AUTHORIZATION
      PROCEDURES
----------------------------------------------------- Appendix III:2.1

Foreign investors must notify the French Ministry of Economics and
Finance of the intent to invest in sectors relating to government
functions; public health, safety, or order; or defense.  The
government has up to
1 month in which to respond.  If the government does not respond, the
investment is presumed to be approved, unless the Ministry of
Economics and Finance exercises its right of postponement.  Any
investor who has failed to file the prior notification or to obtain
the required prior authorization is subject to a fine.  The Minister
of Economics and Finance is able to annul an investment that would
have been denied if the procedures had been observed. 

Until recently, French law made a distinction between European Union
and non-European Union investors in sectors not related to national
security, public health, safety, or order.  Specifically, European
Union investors were not required to obtain prior approval when
acquiring a controlling interest in a French company.  However, such
approval was required for non-European Union investors acquiring a
controlling interest in any French company if the assets were worth
at least 50 million French francs or had annual sales of at least 500
million French francs.  In February 1996, the French government
enacted legislation eliminating this prior authorization requirement
for non-European investors.  Under the new law, all investors are
required to submit administrative notification to the French
government when the investment is made.  This notification is
required for statistical purposes and to verify that the transaction
has taken place. 

The French government's investment approval process is headed by the
Ministry of Economics and Finance.  However, the Ministry of
Economics and Finance consults with the Ministry of Industry on all
transactions and with the Ministry of Defense if there is a national
security concern.  The Ministry of Defense is responsible for
monitoring industry structures to ensure that strategic
defense-related supplies are not excessively concentrated in
foreign-controlled sources, when these sources are less reliable. 
Typically, sectors relating to national security could include
dual-use sectors such as chemicals and electronics, as well as
production of weapons.  Ministry of Economics and Finance officials
were not aware of any recent cases in which the Ministry of Defense
advised against approving an acquisition by a foreign investor. 

French law does not provide criteria for evaluating a proposed
acquisition.  Furthermore, if the French government were not in favor
of a proposed acquisition, it could negotiate with investors
informally.  Foreign investors have the right to appeal French
government decisions in court, but in practice that right is not
exercised.  U.S.  embassy officials stated that U.S.  companies may
be reluctant to appeal decisions to avoid the risk of impairing
future business ventures in France. 


      OTHER LIMITATIONS ON FOREIGN
      INVESTMENT
----------------------------------------------------- Appendix III:2.2

France maintains restrictions on foreign investment activity in
certain sectors of the economy.  Under the OECD Code of
Liberalization of Capital Movements, France reserves the right to
restrict foreign investment in air transport, maritime transport, and
insurance.  In addition, France takes exceptions to the OECD National
Treatment Instrument in the following areas:  agriculture, air
transport, broadcasting, insurance, maritime transport, publishing,
road transport, telecommunications, and tourism.  In the national
security-related sectors, the French government reserves the right to
restrict the creation, expansion, or operation of foreign-controlled
aerospace companies.  Furthermore, foreign-controlled defense
companies are not entitled to national treatment in defense
procurement by the French government. 


   INDIRECT BARRIERS HINDER
   FOREIGN DIRECT INVESTMENT
------------------------------------------------------- Appendix III:3

In general, the approval process for foreign investment is not
considered a significant barrier to foreign investment.  Officials
from the U.S.  Embassy in Paris stated that they have not received
complaints from U.S.  companies since 1990 and that there have been
no major investment disputes since 1984.  Indirect barriers to
investment appear to inhibit foreign investment. 

French government ownership of a company can inhibit foreign
investment.  The French government has majority ownership of most of
France's major defense companies, as noted in table III.1.  As a
result, controlling shares are not available for foreign companies to
purchase.  French defense companies were included in the 1993
privatization law, but these companies have yet to be privatized.  In
the event of privatization, French law prohibits the French
government from selling more than 20 percent equity to non-European
Union investors during the first share offering to the public.\3
Subsequently, private investors may resell their shares to
non-European Union investors.  After privatization, the French
government can control a strategically important company through a
"golden share."\4 Application of this measure has remained limited,
since few of the major French defense companies are privatized. 



                              Table III.1
                
                  French Defense Company Revenues and
                    Ownership as of 1993 (dollars in
                               billions)

Company            1993
name            revenue      Ownership
-----------  ----------  --  -----------------------------------------
Thomson-             $4      State controlled: 60% Thomson SA, which
 CSF\a                        is state-owned
DCN                   3      State controlled: 100% Ministry of
                              Defense
Dassault\b            2      State controlled: 46% French government;
                              50% Dassault family
Aerospatial           2      State controlled: 80% French government;
 e\b                          20% Credit Lyonnais\c
CEA                   2      State controlled: 100% French government
GIAT                  1      State controlled: 100% French government
Eurocopter            1      State controlled: 70% Aerospatiale; 30%
                              Daimler-Benz
Matra                 1      Privately owned (State controlled 1981-
                              87)
SNECMA              0.8      State controlled: 97% French government
Sextant             0.7      State controlled: 66% Thomson-CSF; 33%
                              Aerospatiale
----------------------------------------------------------------------
\a The French government announced that it would privatize
Thomson-CSF by the end of 1996. 

\b According to French government officials, Dassault Aviation is
expected to merge with Aerospatiale within 2 years. 

\c The French government has majority ownership of Credit Lyonnais. 

Overcapacity and restrictive labor practices serve as disincentives
to foreign investment in French defense companies.  Reducing current
overcapacity in French defense companies would require massive
layoffs.  French law provides workers with extensive compensation
packages in the event of layoffs.  As a result, several U.S.  company
officials stated that they did not see the possibility of sufficient
returns through investing in French defense companies. 

Across sectors, cross-shareholding among French corporations and
close relationships among French company and government officials can
make it difficult for foreign investors to acquire French companies. 
Often two or more French companies will hold shares of each other's
stock, thus providing a pool of stable shareholders.  According to a
U.S.  embassy report,\5 the practice of cross-shareholding arose from
the French government owning most large banks and insurance companies
in the past.  The French government used the banks and insurance
companies to invest in other companies as a way of controlling other
firms.  In addition to cross-shareholding, many French company
officials have close personal relationships with government
officials.  Most top French company and government officials are
alumni of the same universities.  In addition, many top French
company executives sit on each others' board of directors. 


--------------------
\3 In this case, the law becomes a formal barrier to foreign direct
investment.  However, French government officials said that this
restriction on non-European investors may be repealed. 

\4 This share accords the French government special rights of control
in a privatized company. 

\5 Investment Climate in France, FY95, U.S.  Embassy Paris. 


   INCENTIVES ARE NOT ATTRACTIVE
   TO U.S.  DEFENSE COMPANIES
------------------------------------------------------- Appendix III:4

The French government offers investment incentives that are based on
the proposed investment's contribution to regional development,
particularly in terms of job creation and development of the
technology base.  Accordingly, the French government created the
Delegation for Land Use and Regional Incentives, which provides
financial investment incentives, such as grants, loans, tax credits,
and support for research and development.  French national and local
governments particularly provide incentives to encourage start-up
businesses that will create new jobs.  However, French ministerial
officials acknowledge that these incentives alone may not be large
enough to attract U.S.  defense companies. 


   TEAMING ARRANGEMENTS ARE AN
   ALTERNATIVE TO FOREIGN DIRECT
   INVESTMENT
------------------------------------------------------- Appendix III:5

U.S.  defense companies generally are not interested in investing in
France to achieve defense sales.  General Electric and SNECMA have
collaborated for over 20 years on the CFM-56 jet engine for
commercial aircraft, and they formed a joint venture company in 1974
to supply propulsion systems.  U.S.  firms typically either sell in
niche markets in which French firms do not compete or team with
French firms on a project-by-project basis to sell to the Ministry of
Defense. 

U.S.  companies benefit from teaming with French defense companies
because the chances of selling to the French Ministry of Defense are
greater.  Since the French government is subsidizing overcapacity in
its defense industry, it is unlikely to award prime contracts for
major equipment procurement to a foreign contractor.  Furthermore,
French companies maintain close contacts with Ministry of Defense
officials and understand the French defense procurement process. 


GERMANY
========================================================== Appendix IV

The Federal Republic of Germany has the legal authority to restrict
foreign direct investment in its national security-related
industries, but it has no administrative controls, bodies, or
practices that overtly monitor, screen, track, or otherwise restrict
such investments.  Restrictions on foreign ownership are limited to a
few nondefense-related sectors and public monopolies.  While U.S. 
defense company officials identified disincentives to investment in
the defense sector, they indicated that they pursue market access to
Germany through project-by-project teaming arrangements rather than
through mergers or acquisitions. 


   BACKGROUND
-------------------------------------------------------- Appendix IV:1

Germany is one of the largest U.S.  trading partners in Europe.  The
United States is the largest single investor in Germany, accounting
for over
27 percent of its foreign direct investment by the end of 1992.  The
United States invested about $1.6 billion in Germany in 1992, and
Germany invested almost $1.4 billion in the United States in 1992,
according to OECD.  By the end of 1994, total U.S.  direct investment
in Germany was about $39.9 billion, and total German investment in
the United States equalled about $39.6 billion, according to the U.S. 
Department of Commerce.  While Germany exported about $6.2 billion
worth of arms between 1987 and 1991, its defense industry is of
relatively minor importance for the economy as a whole.  German arms
exports and imports accounted for no more than 0.8 percent and 0.3
percent of total exports and imports, respectively, in the 1980s. 

Germany historically has depended upon the United States and other
countries for many of its security needs through cooperation with the
North Atlantic Treaty Organization.  Furthermore, the United States
remains the largest seller of defense items to Germany; almost 74
percent of Germany's defense imports worth $2.6 billion came from the
United States between 1985 and 1989.  However, German military
procurement has declined about 48 percent from 1990 to 1995. 


   LEGAL AUTHORITY, BUT NO
   FRAMEWORK EXISTS FOR
   RESTRICTING FOREIGN DIRECT
   INVESTMENT
-------------------------------------------------------- Appendix IV:2

Germany retains the authority to regulate and/or restrict foreign
investment on the basis of national security, but it has never used
that authority.  The German Foreign Trade Law gives the government
the power to restrict foreign direct investment for reasons of
national security, public order, foreign policy, and balance of trade
considerations.  However, to date, the government has never imposed
restrictions on foreign direct investment for reasons of national
security.  The 1956 Treaty of Friendship, Commerce and Navigation
between the United States and Germany recognized the German
government's authority to take such actions necessary to protect its
national security interest.  This authority would allow the German
government to prohibit foreign direct investment by U.S.  firms for
national security reasons, but that authority has never been invoked. 

Germany has no other administrative controls, bodies, or practices
that restrict foreign investment in its national security-related
industries.  German officials stated that their government neither
screens nor tracks foreign direct investment in German national
security-related industries.  U.S.  government analyses concur with
this assessment. 

The German government's Federal Cartel Office has the authority to
review mergers and acquisitions, including foreign direct investment,
for violations of German antitrust laws.  However, the Cartel Office,
an independent government agency that administers German antitrust
laws, does not screen for adverse impact to national security.  If
the Cartel Office prohibited a proposed merger on the grounds it
would have a detrimental impact on competition, the Minister of
Economics could override the Cartel Office's decision if it deemed
the merger to be in the public interest.  Public interest can include
job preservation or military necessity. 

Germany imposes no limitations on national treatment for foreign
investors in the national security-related sectors or other sectors. 
Germany extends national treatment to any foreign firm that
establishes itself in Germany, whether or not it is in the national
security-related sector.  Under German law, any foreign firm
registered as a limited liability company (GmbH) or a joint stock
company (AG) is regarded as a domestic company.  It also imposes no
currency or administrative controls on foreign direct investment. 

Germany generally allows 100 percent foreign ownership of any company
within the country, except for a few sectors.  Germany reserves the
right to restrict investment in air transport, maritime transport,
and broadcasting under the OECD Code of Liberalization of Capital
Movements.  Germany also takes exceptions to the OECD National
Treatment Instrument for foreign investment in air and maritime
transport.  OECD reported that Germany has no other informal measures
that may impede foreign investment. 


      GERMANY LACKS A
      SELF-SUFFICIENT DEFENSE
      INDUSTRY TO PROTECT FROM
      FOREIGN INVESTORS
------------------------------------------------------ Appendix IV:2.1

German and U.S.  officials stated that historical and economic
factors account for Germany's lack of restrictions on foreign
investment in its defense industrial sector.  Germany has accepted
its dependence on the United States and the other North Atlantic
Treaty Organization nations for its national security.  Moreover,
Germany has always been economically more dependent on outside
sources for its supply of strategic minerals and fuels than the
United States, according to one Ministry of Finance official. 

The post-war German defense industry has also been open to foreign
collaboration and investment because it has never been
self-sufficient.  Germany, unlike the United States or France, does
not have a great power status to preserve through protecting a
self-sufficient defense industrial base, according to a U.S. 
government official.  A Ministry of Defense official concurred,
estimating that about 70 percent of Germany's military weapon systems
are made in cooperation with other countries.  Furthermore, Germany
does not limit foreign direct investment through any defense
industrial base policies or economic security policies. 


      SECURITY AND INDUSTRIAL BASE
      CONCERNS RAISED IN FOREIGN
      ACQUISITION
------------------------------------------------------ Appendix IV:2.2

German and U.S.  officials know of only one case where national
security-related concerns were raised in an unsuccessful attempt to
block the acquisition of a German firm by a U.S.  defense company. 
The German government organized a review team headed by the Ministry
of Finance to examine the proposed sale's terms and the U.S. 
company's ties to the U.S.  government.  Both German and U.S. 
officials stressed that this was an ad-hoc procedure, on a one-time
basis.  The Ministry of Defense was one of the first agencies to
approve the sale.  The Ministry of Defense had been subsidizing the
German company at a loss and wanted to privatize it, according to a
U.S.  defense company official. 

The German federal government approved of the sale, but others tried
to block it.  Members of the Bundestag (Federal Parliament) and
German defense companies that were organizing a consortium to buy the
company objected on the grounds that the United States would obtain
German defense secrets.  The French government also objected to a
U.S.  company testing sensitive technology that the German company
and French companies shared through cooperative projects. 
Furthermore, the state government objected to the potential loss of
high-technology jobs within the German state and pressured the
federal government to reverse its decision. 

In response to these objections, the U.S.  company modified its
acquisition offer and attained a significant minority share in the
German firm.  It also worked out arrangements with the federal
government to safeguard both sensitive defense data and German jobs. 
For example, the federal government agreed to establish a Defense
Oversight Board consisting of personnel from the Ministry of Defense
and the German company to review security procedures and determine
whether there are problems with foreign influence and control to be
resolved. 


   ECONOMIC FACTORS AND GOVERNMENT
   REQUIREMENTS IMPEDE INVESTMENT
   IN NATIONAL SECURITY- RELATED
   INDUSTRIES
-------------------------------------------------------- Appendix IV:3

U.S.  government and company officials we interviewed cited both
economic factors and German government requirements as disincentives
to invest in Germany's national security-related industries. 
Germany's high labor costs and tax rates can limit foreign direct
investment.  Moreover, Germany's strict business regulations give the
government authority over both foreign and domestic companies. 
Companies established in Germany face rigid labor practices; they
cannot lay off workers easily and cannot move or alter facilities
without government permission.  This tight control of the business
environment constitutes more of an investment disincentive than any
government body or screening practice, according to one U.S. 
official. 

German business relationships and corporate structure also inhibit
foreign direct investment.  The close and long-term business
relationships German firms maintain with their suppliers are
difficult for foreign firms to penetrate.  In addition, German
corporations have interlocking relationships with banks that make it
difficult for outsiders to invest.  In 1988, banks and insurance
companies owned more than 20 percent of Germany's publicly traded
companies.\1

U.S.  government and defense company officials cite the unfavorable
investment climate in Germany as reasons not to invest.  The
declining German defense budget and the relatively low rates of
return on investment in the shrinking European defense sector are
among the most important factors influencing investment decisions. 

German export controls, procurement regulations, and classified
information security procedures can also pose barriers to investment
in the defense sector, according to U.S.  defense company officials. 
German conventional weapon export controls have become particularly
strict recently.  German procurement regulations are complicated and
difficult to understand, according to some U.S.  company officials. 
One German industry representative pointed out, however, that every
country has such regulations that give an advantage to the domestic
firms most familiar with them. 

Germany's classified information security procedures were mentioned
as a possible barrier to investment, but these procedures were also
characterized as less rigorous in comparison to those of other
countries.  According to a German official, the Ministry of Economics
is not concerned about foreign ownership of German defense companies. 
The government maintains control of classified materials and
information through an "access check" of prospective buyers performed
by the Ministry of Economics.  In this official's view, these checks
present no problems to firms from the North Atlantic Treaty
Organization countries. 


--------------------
\1 For further information on the German business environment, see
Competitiveness Issues:  The Business Environment in the United
States, Japan, and Germany (GAO/GGD-93-124, Aug.  9, 1993). 


   INCENTIVES TO INVEST ARE TOO
   LIMITED TO ATTRACT U.S. 
   DEFENSE COMPANIES
-------------------------------------------------------- Appendix IV:4

Germany encourages foreign direct investment in all economic sectors,
including its defense industry, and grants national treatment to all
foreign companies.  Germany places no restrictions on foreign
companies seeking access to state-funded research and development
funds and other incentive programs.  A U.S.  embassy document states
that U.S.  companies legally established in Germany are eligible for
research and development technology funds from the German federal
government.  Moreover, German ministries pursue the involvement of
foreign-based companies to facilitate international cooperation. 
However, U.S.  government and defense company officials and German
industry representatives indicated that the research and development
subsidies are generally too limited to attract U.S.  defense firms. 

The German government allotted $12 billion for civilian research and
development in 1993, according to U.S.  embassy figures.  The
incentives are concentrated in basic and applied sciences, aerospace
technology, energy research and development, and information
technology.  U.S.-affiliated firms are also eligible to participate
in the Ministry of Research and Technology's priority "Technologies
of the 21st Century" programs, such as artificial intelligence and
sensor technology.  While no formal barriers exist to U.S. 
affiliates' participation in these programs, few make use of these
programs either in the national security-related sector or in other
sectors.  A State Department document reported that U.S.  companies
participate in only 8 of approximately 6,000 federally funded
projects.  Moreover, a Department of Commerce report estimates that
Germany awards approximately 85 percent of total military spending
(including research and development, procurement, and maintenance
spending) to domestic firms. 


   U.S.  DEFENSE COMPANIES USE
   OTHER MEANS TO OBTAIN MARKET
   ACCESS IN GERMANY
-------------------------------------------------------- Appendix IV:5

U.S.  defense company representatives and embassy officials in
Germany stated that U.S.  defense firms seek market access through
cooperative ventures with German firms on a project-by-project basis
rather than pursue longer term direct investment in Germany.  Most of
the U.S.  defense companies we contacted use this approach, including
one company that has acquired a small German defense-related firm. 

Some company representatives stated that their U.S.-produced goods
remain sufficiently competitive to generate sales in niche markets
(i.e., fulfill a German demand for subsystems they lack the
capability to produce themselves).  They stated that to successfully
compete, U.S.  firms enter partnerships with German firms to allow
German participation, gain influence with the German government, and
acquire knowledge of the procurement process through their German
partners. 


UNITED KINGDOM
=========================================================== Appendix V

British law provides no legal framework specifically designed to
monitor foreign direct investment for national security reasons. 
However, the U.K.  government has the authority to block or
restructure takeovers of U.K.  companies by foreign or domestic
companies for national or public interest reasons.  The United
Kingdom restricts foreign direct investment in certain sectors of the
economy, which are registered under the OECD Code of Liberalization
of Capital Movements.  Also, the government retains a special share
in key privatized companies, which in some cases limits foreign
ownership and also accords certain veto powers to the government. 
U.S.  company officials in the United Kingdom believe that the legal
and regulatory climate presents no obstacle to investments and that
U.S.  defense firms are more likely to enter into teaming
relationships with U.K.  companies rather than engage in mergers or
acquisitions. 


   BACKGROUND
--------------------------------------------------------- Appendix V:1

Overall foreign direct investment in the United Kingdom has increased
significantly over a 15-year period.  Foreign direct investment in
the United Kingdom has risen from $28 billion in 1978 to over $195
billion by the end of 1993.  The United States is the largest foreign
investor in the United Kingdom.  U.S.  foreign direct investment in
the United Kingdom reached about $102.2 billion in 1994, according to
U.S.  Department of Commerce figures.  U.S.  firms have established
some 4,200 branches, subsidiaries, and affiliates in the United
Kingdom, while German and Japanese firms each have established over
1,000 entities.  U.S.  investments in the United Kingdom represented
43 percent of all its investments in the European community by year
end 1993.  The United Kingdom had the largest share of foreign direct
investment in the United States in 1992, accounting for
37 percent of its total foreign direct investment abroad.  By
comparison, the other European Union countries combined account for
26 percent of all foreign direct investment in the United States. 
U.K.  foreign direct investment in the United States reached about
$113.5 billion by 1994. 

The U.K.  defense budget has declined some 25 percent in real terms
over the past 10 years, prompting significant consolidation of the
defense industry.  Defense spending in the United Kingdom is expected
to decline by around 14.5 percent between 1992-93 and 1997-98, but
the U.K.'s defense expenditures remain above those of other European
North Atlantic Treaty Organization countries. 


   LEGAL FRAMEWORK CAN CONSIDER
   NATIONAL SECURITY ISSUES
--------------------------------------------------------- Appendix V:2

The United Kingdom has no general notification requirements that
specifically govern all forms of foreign investment.  The Industry
Act of 1975 provides the U.K.  government with the authority to
intervene when the takeover of important manufacturing concerns by
nonresidents is against the national interest.  The law does not
define the term "important." However, manufacturing industries are
defined under the Standard Industrial Classification Orders and
include defense-related sectors such as ordnance and aerospace
equipment manufacturing.  The U.K.  government has never used the
authority provided under this act. 

The Fair Trading Act of 1973 provides an anticompetitive review of
both foreign and domestic mergers and acquisitions.  The act includes
provisions permitting review of transactions that meet a certain
threshold\1 for adverse effect on competition and the public
interest.  The Director General of Fair Trading initially performs
the review and advises the Secretary of State for Trade and Industry
whether the merger or acquisition should be investigated further by
the Monopolies and Mergers Commission, an independent body.  Under
the law, the Secretary of State for Trade and Industry has the
authority to block or force divestiture of mergers and acquisitions
that the Monopolies and Mergers Commission investigated and found to
be against the public interest.  A Department of Trade and Industry
official said that acquisitions can be blocked for national interest
reasons.  The Secretary has 6 months after a merger to request that
the Monopolies and Mergers Commission investigate the merger.  The
commission has up to 6 months to investigate the merger, but the
Secretary may authorize an additional 3 months.  Companies can appeal
the Secretary's decision to the judicial system. 

The Fair Trading Act broadly defines the term "against the public
interest." The law requires that the commission consider such factors
as (1) effect on competition in the United Kingdom, (2) consumer
interests, (3) development of new products, (4) cost reduction, (5)
balancing the distribution of industry and employment, and (6)
promotion of competitive activities of U.K.  companies abroad. 
However, the commission is not limited to consideration of these
factors. 

The Ministry of Defense provides input to the commission when mergers
of defense companies are under investigation, regardless of whether
the companies are national or foreign-owned, according to a Defense
Ministry procurement policy official.  The Ministry of Defense's
objective is to ensure that the investigation's results do not
adversely affect its ability to obtain value for money on procurement
or inhibit competition for defense procurement. 


--------------------
\1 This act sets a threshold for acquisitions of both publicly held
and privately owned companies as follows:  (1) the gross value of the
U.K.  company being acquired exceeds 30 million pounds or (2) the
transaction would result in 25 percent or more of goods and services
of the same description being supplied by one enterprise. 


      OTHER LIMITATIONS ON FOREIGN
      INVESTMENT
------------------------------------------------------- Appendix V:2.1

The United Kingdom maintains restrictions on foreign investment
activity in certain sectors of the economy.  Under the OECD Code of
Liberalization of Capital Movements, the United Kingdom reserves the
right to restrict foreign investment in air transport, broadcasting,
and maritime transport.  In addition, the United Kingdom reports
limitations to the OECD National Treatment Instrument based on public
order and essential security considerations in the following areas: 
investment in aerospace and maritime transport and obtaining
government defense procurement contracts.  The National Treatment
Instrument also lists further measures taken by the United Kingdom
affecting corporate structure in certain defense firms. 


   GOVERNMENT INVOLVEMENT MAY
   INHIBIT FOREIGN DIRECT
   INVESTMENT IN SOME U.K. 
   COMPANIES
--------------------------------------------------------- Appendix V:3

Company officials we interviewed stated that the legal and regulatory
framework in the United Kingdom is not a barrier or disincentive to
foreign investment.  However, one U.S.  company official stated that
the involvement of the U.K.  government in some U.K.  defense
companies could inhibit foreign investment.  After it privatized
three major defense companies, the U.K.  government maintained limits
on foreign ownership for public order and essential security reasons. 
This government control and authority is not rooted specifically in
law.  Instead, this involvement arises from government ownership of a
"golden share" established in the articles of incorporation of these
companies.  This share does not give the U.K.  government control
over the companies' routine business activities, investment
decisions, or appointments.  In each case, the articles provide
British citizenship requirements for the companies' board of
directors.  Other limitations are the following: 

  -- The articles of incorporation for British Aerospace PLC limits
     foreign ownership of voting stocks to 29.5 percent. 

  -- The articles of incorporation of Rolls Royce PLC also limits
     foreign ownership of voting stocks to 29.5 percent. 
     Furthermore, the U.K.  government has the power to veto major
     disposal of assets. 

  -- The articles of incorporation of VSEL restrict the size of any
     shareholding interest (domestic or foreign) but also provide the
     government a veto on major asset disposal decisions.  The recent
     acquisition of VSEL by GEC was accompanied by an amendment to
     the articles of incorporation of VSEL to allow GEC alone to
     exceed the 15-percent limitation on individual shareholdings. 
     The U.K.  government does not hold a golden share in GEC, but it
     will continue to hold the VSEL golden share. 


   UNITED KINGDOM OFFERS
   INVESTMENT INCENTIVES
--------------------------------------------------------- Appendix V:4

The national and local governments offer incentives to both foreign
and domestic companies to invest in designated areas in the United
Kingdom to promote economic development.  For example, incentives to
invest in Northern Ireland include grants of up to 50 percent of
project cost and corporate tax relief.  In one nationwide program,
companies making investments related to technology innovation or
introduction into the United Kingdom are eligible for government
grants.  General economic factors also serve as incentives and
include labor costs and corporate tax rates that are lower than in
many other European countries and no restrictions on sending capital
and profits abroad. 


   U.S.  COMPANIES USE APPROACHES
   TO DEFENSE PROCUREMENT OTHER
   THAN FOREIGN DIRECT INVESTMENT
--------------------------------------------------------- Appendix V:5

U.S.  defense company officials generally did not see direct
investment as an essential part of their strategy to gain access to
the U.K.  defense market.  Rather, companies pursue access through
the common practice of forming project-by-project teaming
arrangements with U.K.  companies to gain access to defense
procurement contracts.  For example, McDonnell Douglas teamed with
Westland to win a recent competition to supply the British army with
attack helicopters.  In another case, Lockheed was awarded a contract
to deliver 25 C-130J transport planes to the Royal Air Force.  In
this instance, Lockheed was the prime contractor and was part of a
consortium of 36 U.K.  companies that was formed to successfully
compete for this procurement. 

One U.S.  defense company, however, became a U.K.  company by
incorporating in the United Kingdom.  Company representatives
indicated that, for business reasons, it was important to adopt a
British identity.  However, the U.S.  company is not investing in a
manufacturing facility in the United Kingdom.  Furthermore, the U.S. 
company teams with other U.K.  firms to compete for contracts.  For
example, in one case the U.S.  company acted as prime contractor, but
in another case, a U.K.  company acted as prime contractor. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================== Appendix VI

NATIONAL SECURITY AND
INTERNATIONAL AFFAIRS DIVISION,
WASHINGTON, D.C. 

Davi M.  D'Agostino
Maria Cristina Gobin
Paula J.  Haurilesko
Anne-Marie Lasowski
Karen S.  Zuckerstein

OFFICE OF GENERAL COUNSEL

Raymond J.  Wyrsch

EUROPEAN OFFICE

B.  Patrick Hickey
Mary R.  Offerdahl

*** End of document. ***