As the global financial and economic crisis has deepened, trade officials have increasingly warned against a new wave of protectionism, fearing that governments will move to shield their industrial and service sectors from increased competition. Thus far, there is little evidence of a large upsurge in traditional border tariff protection (though the Russians have increased automobile tariffs, the Indians have hiked certain steel tariffs, and other countries have threatened future actions). At the recent G-20 meeting, world leaders promised not to introduce protectionist measures over the next year; APEC members made the same pledge a week later at their summit in Peru.

There is, however, one ominous sign of protectionism in an area that is mostly outside the scope of WTO trade rules: foreign direct investment (FDI). The leading advocate of investment protectionism is French President Nicolas Sarkozy, who has proposed the creation of a $25 billion sovereign wealth fund to shield French companies from foreign “predators,” insisting that without such a mechanism, France will “stop building trains, aircraft, cars and ships” and become a “reserve for tourists.” Sarkozy intends to use an existing state financial house, the Cassis des Dépôts et Consignations (CDC), as the vehicle to administer the fund.

The leading advocate of investment protectionism is French President Nicolas Sarkozy, who has proposed the creation of a $25 billion sovereign wealth fund to shield French companies from foreign ‘predators.’

This will utterly transform the CDC, which has traditionally served as a long-term repository for government shares in French companies. It will now be expected to seek out short-term “emergency” investments in smaller companies that are in distress because of the credit crunch or have become candidates for takeover by a foreign company. The CDC will also come under tighter government control, with the French state assuming a sizable minority position in the new fund. “I will not be the French president who wakes up in six months’ time to see that French industrial groups have passed into other hands,” Sarkozy vowed.

It is unclear whether other governments will heed Sarkozy’s siren call for investment protectionism. (Germany has severely criticized the French plan.) But even before the current economic turmoil, apprehension about foreign investment had been growing in countries around the world. According to the United Nations Conference on Trade and Development (UNCTAD), national regulatory changes to FDI guidelines were overwhelmingly favorable during the 1990s. As late as 2000, of 150 regulatory changes tracked by UNCTAD, only three were counted as unfavorable to FDI. By 2006, however, UNCTAD reported that 37 of 184 actions (20 percent) were unfavorable.

There are a number of explanations for the shift in global attitudes. The rise of sovereign wealth funds—huge pools of capital controlled by governments—has added a new layer of political complexity to FDI. Meanwhile, concerns about energy and food security have caused governments to rethink their policies toward inward and outward FDI. Now we are experiencing a potentially devastating global recession that could foster renewed economic nationalism.

Policymakers must remember that in today’s globalized economy, FDI is inextricably linked with international trade flows as a driver of worldwide economic growth. Between 1990 and 2006, cross-border inflows of FDI increased at an average annual rate of 12 percent, while total exports of goods and services grew at an average annual rate of only 8 percent and national economies expanded at a rate of only 5 percent.

The United States is both the largest single recipient of FDI (cumulative total of $l.8 trillion at the end of 2006) and the largest foreign investor in the world (cumulative total of $2.4 trillion at the end of 2006).

The United States is both the largest single recipient of FDI (cumulative total of $l.8 trillion at the end of 2006) and the largest foreign investor in the world (cumulative total of $2.4 trillion at the end of 2006). In 2006, U.S. multinational corporations and their foreign affiliates accounted for 51 percent ($532 billion) of all U.S. exports and 37 percent ($678 billion) of U.S. imports. American affiliates of foreign firms accounted for 20 percent of U.S. exports and 25 percent of U.S. imports.

The growing danger of investment protection demands both an international response and a strong statement from the incoming Obama administration. On the international front, world economic leaders must buttress their warnings against trade protection with an agenda that includes robust support for open capital markets and cross-border international investment. The recent collapse of the Doha Round of global trade talks has made this all the more urgent.

As for President-elect Obama, he must move away from some of his campaign rhetoric. While a candidate, Obama questioned whether FDI by U.S. corporations benefits the American economy. The investment community is now watching closely for signals from Obama and his top advisers and cabinet officials. Beginning with his Inaugural speech and his first State of the Union address, Obama should announce to the world that the United States welcomes and encourages foreign investment. Such a declaration would reassure investors and help prevent a new wave of protectionism.

Claude Barfield is a resident scholar at the American Enterprise Institute.

Image by Darren Wamboldt/Bergman Group.