Should Governments Restrict Foreign Investments in Startups?

Abstract

This paper examines the evolving policy landscape surrounding foreign investment restrictions in innovative startups. Drawing on recent research, we analyze both the security benefits and economic costs of policies like the Foreign Investment Risk Review Modernization Act (FIRRMA). The evidence suggests that foreign investments do facilitate measurable cross-border knowledge spillovers that may raise legitimate security concerns. However, restricting these investments imposes significant costs on domestic innovation ecosystems, including reduced capital availability, disrupted investor networks, and potentially diminished innovation outcomes. These effects extend well beyond directly targeted foreign investors to affect domestic venture firms and startups. We explore design considerations for more effective investment screening policies, including industry targeting, investor heterogeneity, and implementation approaches, as well as complementary policies that might address security concerns while minimizing costs to innovation. We conclude by outlining promising directions for future research on this increasingly important intersection of innovation policy and national security.

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