To the Commission:
I am honored to be asked to address the Commission. The tasks before the Commission
are important not only for US national security, but also for the future trajectory
of US-China relations.
As agreed with Commission staff, I will restrict my focus to the questions about
the Chinese defense industry and the production of conventional weapons. Others
appearing before the Commission will deal with the additional number of issues
raised by the invitation to appear here. At the same time, I will by necessity
have to touch on some matters others will speak to. The Commission should not
be surprised should our various testimonies differ—we are dealing with
opaque subjects, and different assumptions and analytical approaches produce
different answers.
Three views
There are three ways to look at the Chinese defense industry. The Chinese defense
industrial complex (CDIC) is at once:
1. A remarkable accomplishment
2. A worst-case example of Chinese state-owned enterprises
3. A strategic failure
In order to understand the CDIC and the budgetary implications of these perspectives,
we should keep in mind that the CDIC occupies a relatively small corner of the
Chinese economy—Wang Shougang (Wang 1999) suggests that CDIC assets account
for about 4% of the Chinese state’s industrial assets; CDIC employment
of about 3 million is less than 10% of China’s declining industrial workforce1.
As a whole, the CDIC is a drag not only on the economy, but also on PLA modernization.
But first we need to consider briefly some preliminary issues, including the
imperatives that drive Chinese political behavior, the current and projected
state of the Chinese economy and the needs of the CDIC’s most important
(and often only) customer, the Chinese People’s Liberation Army (PLA).
Political imperatives
It is useful to ask what drives Chinese political behavior; it behooves us to
try to understand the Chinese point of view. As the Chinese saying goes, "Understand
yourself, understand your adversary; 100 battles, 100 victories".
Chinese elites over the past 150 years or so have been grappling with four basic
problems:
1. How to rule a large country with a large population from a single place.
2. How to make China great again.
3. How to transform Chinese society so as to assure China’ s greatness.
4. How to deal with the outside world.
This hearing is not the place for a history lesson, but we should remind ourselves
that the Opium War of the 1830s ushered in more than a century of continuous
and disastrous conflict in China, It culminated in the struggle against Japan
and the subsequent Chinese civil war. Chinese elites were and are socialized
in this aura of conflict. The first generations of Chinese communist leaders
were active participants in the wars of the 20th century. Vicious political
campaigns, often centering on these issues and sometimes verging on civil war,
followed the Communist triumph of 1949. The point I want to make here is that
these four problems are not safe, academic issues: millions of people have fought
and died in China’s various attempts to resolve them, and, I would submit,
the debate continues.
In these debates, however, there is one constant: regardless of how various
factions of the Chinese leadership struggle over questions of rule, transformation
and foreign policy, they all agree that Chinese must be strong. The slogan "Fu
guo, qiang bing"—____--"Rich country, strong army"—remains
as current today as it was when it was coined in the 19th century.
Thus, in large part, the Chinese drive to modernize its economy. We all know,
if only from headlines, the main points: GDP at US$ 1 trillion, exceptionally
high growth rates, major sectoral shifts to industry and hi-tech, monetary stability,
massive and growing foreign investment (China is the #2 destination of direct
foreign investment, surpassed only by the US), great improvements in urban standards
of living, and an openness to international trade and steady progress towards
marketization. All of these have led to a breathtaking transformation of the
Chinese economy.
Indeed, China has become a workshop to the world. It’s hard not to buy
something made in China these days, from cheap clothing to Cuisinarts. And don’t
ask where the motherboard in your laptop came from. In the political economy
of Asia-Pacific, China is no longer a technology laggard but perhaps in the
same position as 1960s Japan or 1970s South Korea2.
China’s membership in WTO will not only open up its market but also will
provide new opportunities for exports, a sector which in many ways is the most
dynamic portion of the Chinese economy.
To be sure, there are many problems: corruption, a "scissors crisis"
that has led to wide distributional disparities between city and countryside,
a very shaky banking system, a weak tax system, labor issues, including the
real lack of a social safety net, and difficulties in transforming a stagnant
state-owned industrial sector. China’s participation in the WTO regime
will no doubt accelerate all of these trends, both positive and negative. How
China, which guards its sovereignty jealously, will deal with the transparency
demands and international scrutiny of internal practices that will come with
participation in the border-eroding WTO will occupy many of us for some time.
Indeed the resolution of these tensions, including those between a nascent civil
society engendered by economic transformation and a rigid Leninist political
system, will be one of the key political and economic dramas of the coming century.
Where does the CDIC fit into this picture? Poorly. Defense industries worldwide
do not fit models of civilian economies very well. They tend to be highly concentrated,
monopsonistic and protected. International trade regimes, such as the WTO or
the single market protocols of the European Union, usually exempt national security
industrial sectors.
The CDIC as a substantial accomplishment
Still, in one sense, the CDIC, broadly defined, represents a substantial accomplishment.
In 1949 the Chinese industrial economy was an ash heap. Within 20 years, the
CDIC was able to roll out jet fighters in serial production, start down the
road toward sophisticated missiles, develop naval combatants, including submarines,
and achieve nuclear capabilities. To be sure, China’s first steps were
greatly aided by the Soviet Union: of the 156 "key projects" of Soviet
assistance, 41 were in defense. China’s nuclear forces, including its attempts
at developing nuclear-power submarines, were developed as special projects that
required extraordinary political protection. At the high point of the CDIC growth
and expansion in the 1960s, it has been estimated that the CDIC consumed 50%
of China’s industrial investment for the construction of the so-called
"Third Front", an uneconomic distribution of 55% of China’s defense
plants in the remote interior (a legacy that still plagues the CDIC). Thus there
is no doubt that given the political will, China can divert substantial resources
to the CDIC. (Frankenstein 1999, Naughton 1988)
Actual domestic production rates of China’s conventional weapons can only
be estimated by admittedly inexact methods based on inexact (and usually unsourced)
numbers. For instance, the generally accepted production rate for China’s
IRBM/SRBMs is around 50 per year, an open-source number of the number of missiles
added to those already in place opposite Taiwan. If we simply compare data for
some major weapons systems from IISS’s Military Balance for the
1990s, we see:
Chart Listing Weapons
Systems
The Institute for Defense & Disarmament Studies database suggests that
T-85 production in the 1990s ranged between 100-150 tanks per year; that J-8
inventory went from 60 in 1992 to 180 in 1999 (plus an additional 24 J-8 III
variants). While the numbers don’t quite match, the trend lines are similar
and are consonant with what we might term the "normal modernization"
of a backward military establishment; as these newer weapons systems enter the
force, obsolete systems are retired.
At the same time, new systems are entering the force in small numbers: the T-98
tank, the Luhai DDG, and the J-10 jet fighters (the power plants for the destroyers
and jets, however, come from abroad). The Western defense industry press regularly
reports on new weapons systems available from the ordnance industry—e.g.
new "Red Arrow" anti-tank missiles, a new multiple-launch rocket system,
a "fast attack" jeep-type vehicle with mounted machine guns, new types
of cruise and anti-ship missiles. Many of these appear to be demonstration models
designed as much for export as for PLA deployment. (Janes Online).
Still, there are signs that the Chinese leadership is dissatisfied with the
CDIC's performance. Since the 1980s there has been a constant chorus of commentary
urging PLA modernization and the acquisition of modern weapons systems. One
can only assume that the need has not been met. In its more extreme forms, this
commentary calls for the development of weapons that can deliver sudden knock-out
blows to a technologically superior enemy—commentary that recalls the desperation
of 19th century mandarins who, faced by overwhelming Western forces, called
for "superb and magic weapons".
However, the CDIC's weapons system production capabilities should not be written
off. Furthermore, there may be substantial unused capacity in the CDIC.3
But being able to make weapons systems is only part of the story.
CDIC as State-Owned Enterprise (SOE)
Just as the PLA requires modernizing, so does the CDIC. Despite the CDIC’s
continuing production, Chinese commentaries describe the CDIC as a worse-case
example of the state-owned enterprise system: over-staffed, burdened with obsolete
technology producing obsolescent weapons, a "closed society" isolated
from the dynamic civilian economy, poorly located ("the Third Front"),
plagued with over-capacity and duplication and with poor linkages to R&D,
declining customer and product bases, in debt, unable to attract the human resources
it needs, poorly managed, and worst of all, unprofitable.
To be sure, there are have been some advances: missiles, leveraging dual-use
communications technologies (which, however, are embedded in the civilian sector).
But we would note that those "pockets of excellence" are limited.
We would also observe that the two generals who have overseen the CDIC since
the 1980s--Ding Henggao and Cao Gangchuan--are both graduates of Soviet missile
academies, so it is no accident that China has made advances there.
In the early 1990s Zhu Rongji was reported as saying that the majority of SOEs
in trouble were from the defense sector. In the mid-1990s People’s Daily
noted that the number of loss-making defense plants was increasing as PLA procurement
declined. In 1996 the State Planning Commission official in charge of defense
called the situation facing the CDIC "grim", with weapons production
employing only about one-third of the sector’s capacity. After more than
a decade, the CDIC's problems have yet to be resolved—a January 2001 Xinhua
article titled "China’s Military Industry Last Year Decreased Losses
by a Large Margin" notes that in 2000 eight of the ten major CDIC enterprises
achieved "reductions in losses"; we can assume that the other two
(unidentified) did not. "Many difficulties and issues that severely constrain
development have yet to be basically resolved….the overall efficiency of
military industries is fairly poor….reform measures are relatively stagnant."
(Frankenstein 1999, Xinhua 2001)
The best the CDIC can hope for, Xinhua concluded, is to "strive in 2002
to cast off the hat of all-industry losses." In the meantime, the CDIC
will continue to receive subsidies for military production. Wang Shougang estimates
the new weapons production was subsidized to the tune of about RMB 4 billion
in the late 1990s (approximately US$482 million). But given the size of the
CDIC’s problems, including conversion, total subsidies probably were much
higher: Brommelhorster and Ng’s estimate total 1997 subsidies to run about
RMB 93 billion (US$11.2 billion). Certainly weapons production subsidies should
be factored into estimates of defense expenditures; whether subsidies for conversion—that
is, subsidies to remove plants from military production—should be counted
is open to discussion.4
CDIC as strategic failure
But perhaps the biggest problem the CDIC faces is that it has been unable to
design and produce the advanced weapons the PLA needs for its future. Thus China
has been forced to buy systems from outside suppliers—primarily Russia.
China has purchased Su-27 and Su-30 fighters, Sovremmeny DDGs and Kilo submarines,
plus assorted missiles and surveillance technologies. In addition, China has
entered into licensed production of Su-27s. It is for others to assess the military
implications of these developments, but I would caution that there is a long
road between acquisition and capability. Advanced weapons require advanced maintenance
and logistics; when we consider that China has to return Su-27 engines to Russia
for maintenance and repair we can get a sense of where China stands in that
regard.
But there is a greater issue here for China: self-reliance. If we look back
over the development of China, we see a psychological tension between borrowing
from the outside world and creating from within China. Over at least the past
twenty years Chinese leaders have been exhorting the CDIC to create and adopt
modern technologies. That this is a constant thread of commentary suggests that
the goals are not being met. Thus there is a contradiction here between dependency
on the outside world and the imperative of self-reliance. China once relied
heavily on the USSR—and China remembers what happened in 1960 when the
Soviets packed their bags. In the aftermath of 9.11 and the strategic realignments
that seem to be taking place as the Central Asian republics and Russia, all
members of China’s "Shanghai Cooperation Organization", jump
on Washington’s anti-terrorism bandwagon, might not China be abandoned
again?
Reforming the CDIC
But we should not assume that China is totally passive about the problems facing
the CDIC. Several solutions have been attempted: reorganization, "conversion"
and exports. As Figure
I shows, the CDIC has been undergoing almost constant reorganization ever
since the late 1970s when the Deng Xiaoping economic reforms were kicked off.
Equally important, as Figures
II and III
show, the internal lines of control have changed considerably following the
1998 9th National People’s Congress, when the Commission on Science, Technology
and Industry for National Defense was "civilianized", the defense
industrial ministries were abolished (as indeed, all other industrial ministries
in the civilian economy were abolished) and the various defense producers were
organized into ten separate enterprise groups. Figure
IV, drawn from a Chinese defense industrial website, gives an indication
of the size of these industrial groups
The logic of this last reorganization is to make these defense enterprise groups
subject to market forces (thus the introduction of contracts and similar practices)
and, hopefully, competitive. The proliferation of firms under each enterprise
group is in part a result of the diversification that arose from China’s
"defense conversion" effort and in part from China’s taking the
Korean chaebol as a model for industrial organization. But the reorganization
goes against the worldwide trend of consolidation and rationalization. One suspects
that the preservation of jobs and bureaucratic fiefdoms played a major role
in the outcome. In any event, how the money flows in these organizations is
unknown to this writer, and while no doubt these firms can generate revenues,
whether they actually produce profits is a question perhaps best left to the
more creative in the accounting profession.
"Conversion" the answer?
"Defense conversion" is another strategy adopted by the CDIC in its
attempts to reform itself. The original strategy proposed to manufacture civilian
goods using defense industrial assets so as to generate funds to upgrade the
CDIC. Deng Xiaoping's famous and somewhat Delphic "16-Character Slogan"—"Combine
the military and the civil, combine peace and war, give priority to military
products, let the civil support the military"—was the mantra. The
outcome, however, was both less and more than the strategy envisaged.
There is no doubt that the "converted" CDIC can produce goods for
the civilian market. (Some 80% of the CDIC’s "output value"—a
command economy account term, not a measure of physical output--is in civilian
goods. Wang Shougang notes that about 40% of the CDIC has entirely converted
to civilian production, with an additional 40% split between civilian and military
production, and only 10% producing solely for the PLA.) But whether "conversion"
could be accomplished at a profit remains a question, but an important one,
since the process has to be looked at as a business proposition.
In fact, defense plant managers found their market savvy and their production
technologies inadequate to serve the civilian market. The upshot was the creation
of separate production lines, if not entire factories, to serve the cash-generating
civilian market—an arrangement termed by some "One factory, Two Systems".
Who could blame the managers when the choice was between small, irregular defense
orders at fixed prices or the potential of large production runs for the market?
Whether profits were made became secondary to the generation of cash flow—since
cash flow could go to payroll.
Thus "defense conversion" in the Chinese case really was diversification.
And, with the aim of maintaining China’s precious "social stability",
"conversion" is credited with saving many jobs. Still, a macro-economic
analysis of the effort suggests that the economic results were modest—conversion
us estimated to contribute less than 2 percent of total production (Fu &
Cheng, 1997). Ironically, defense needs became further separated from civilian
production. In the Chinese case, "conversion" is a good case demonstration
of how strategic intent and practical outcome often do not match.
The CDIC and Globalization: Foreign Cooperation and Exports
Although foreign investment in the CDIC's military production is not allowed,
parts of the CDIC have become enmeshed in global chains of civilian production
through cooperative production, licensing and joint ventures. AVIC provides
civilian aircraft assemblies for Boeing and BAE. Harbin Helicopters has licensed
"Dauphine" helicopter production from Aerospatiale. Parts of NORINCO
have been involved with motorcycle and automobile production with licenses from
Japan and investment from Thai entrepreneurs. While no doubt the money so earned
has been good, the real benefit has come in exposure to modern management and
manufacturing technologies. It is thought that most of the funds earned from
these deals is retained by the plant doing the work, though no doubt a substantial
portion is remitted to provincial and central authorities.
Exports, however, have been problematic. During the 1980s China outfitted both
sides of the Iran-Iraq war, and since then has continued to sell to both countries.
Missile sales to Iran and Pakistan (not to forget transfer of nuclear technology
to Pakistan) have raised more questions about proliferation and China’s
international citizenship than they have about cash flow.
In any event, in the 1990s the value of China’s arms exports dropped from
its high points in the 1980s when Iraq alone bought US$5 billion worth of Chinese
arms. During the 1990s, according to the Congressional Research Service, China’s
contracted arms sales to the developing world—virtually its only market--fell
to less than US$ 1 billion per year, although it hit $2.7 billion in 1999. The
following year, however, China’s arms sales agreements dropped to US$400
million. The fall-off may be attributed to poor quality but more likely many
former customers are buying Russia’s much more capable (if expensive) arms
offerings. Still, China continues to have some loyal customers: in Africa, North
Korea, Myanmar, Thailand and, most of all, Pakistan. Islamabad has reached agreements
to produce the K-8 jet trainer, T-69 tanks and some anti-tank and anti-aircraft
missiles. Precisely where the funds from these agreements go is not clear. As
a source of support for the industry, however exports probably do not provide
much cover for general industry shortfalls.
So what?
The reforms attempted by the CDIC had mixed results. The proliferation of separate
firms under the "Big Ten" enterprise groups is a logical outcome at
attempts to "convert" and to introduce market forces into the system.
We would not deny some successes in reform—shipbuilding, electronics, parts
of the aviation industry. Indeed, defense managers anticipate the competition
China’s entry to the WTO regime. In a series of press interviews published
in Liberation Army Daily in the spring of 2000, they said that while increased
competition will impact their "pillar products" such as automobiles
and motorcycles (in the case of the ordnance industries), they are confident
about meeting the challenge. Some defense managers have suggested that WTO membership
will be an overall plus, providing opportunities for increased access to foreign
technology, perhaps even allowing ways around technology-export restrictions.
Our open-source understanding of CDIC finance does not allow us to say much
more than the CDIC's inefficient defense production will continue to be subsidized.
Over the past twenty years CDIC financial results have been announced in vague
terms, usually in obfuscating terms announcing fewer loss-markers with declining
losses. This burden will continue.
Yet there is another more important source of burden: the requirement for the
Chinese state to acquire foreign technologies and weapons systems. Most analysts
would agree that the funds for these acquisitions are "off-budget".
But perhaps there is a more important htmect of this requirement to go abroad--if
the PLA has to depend on foreign technologies, then the PLA faces a future of
small-scale acquisitions and slower modernization. The pressure is on the CDIC
to upgrade, and the quick-fix paths open to the CDIC—reverse engineering,
licensed production—are not only expensive paths, but ones with no guarantee
of success.
A modernizing PLA, no longer content with its status as a "junkyard army",
is forcing the CDIC to consider its own modernization. Chinese procurement spending
is increasing at a slightly higher than over all defense spending: An analysis
of Chinese defense budget numbers provided in China’s Defense White Papers
reveals that while overall announced defense spending grew nominally by about
50% 1997-2000, the equipment budget was up 52%. The successes of China’s
dynamic IT industry in both civilian and defense areas may bring new models
and impetus for change in the traditional CDIC5
**. But institutional change will come hard. The problems and burdens of the
past and present weigh heavily on the CDIC. Despite China’s desires, we
would anticipate these issues, outlined and discussed above, will continue to
impede CDIC development well past 2002.
_______
Endnotes
1. Like many official Chinese numbers, this figure is open to dispute. The
3 million employed is cited by at least two Chinese sources (Chen 1993; Zhu
2000), but defense industry officials say that attempts at conversion "stabilized"
the situation for 12 million people (Ng, 1997). Overall Chinese industrial employment
has fallen drastically over the past several years--in 1995 the total industrial
work force was about 54.4 million; by 1999/2000, it had fallen to 34.4 million
(State Statistical Bureau, 2000) No doubt the CDIC has been affected as much
as any other sector.
2. Some political economists suggest that Asia-Pacific economic development
has followed a "flying geese" model. Just as migrating geese fly in
a V, following a leader, so too Asia-Pacific economies have followed the US
(or Japan), with technologies cascading down through the ladder of development
as they go through their product-life cycle in the various economies of the
region. Thus automobile, steel, shipbuilding and consumer electronics technologies
cascaded from the US to Japan to Korea and Taiwan and now to China; VCRs first
made in Japan are now made in Korea and Taiwan; shoes from Taiwan to China,
etc. In other words, as a "first generation" technology is supplanted
in the leaders by even more advanced technology, it migrates downward. But the
important point here is not so much that technologies migrate, as it is that
the model describes continuous forward technological advance. China used to
be at the tail end of the V—it is there no longer, and is raising economic
anxieties among its Asian neighbors---see, for instance, Andrew Ward, "China’s
economic might strikes fear in Seoul", Financial Times, 20 Nov 2001;
James Brooke, "Tokyo Fears China May Put an End to ‘Made in Japan’",
New York Times, 20 Nov 2001.
3. The issue of unused capacity is complex. The combination of conversion and
declining procurement resulted in the CDIC retaining about one-third of its
production capacity for military goods by 1990; Brommelhorster & Ng estimate
that only 15% of total CDIC capacity is required for current defense needs.
But it is an open question whether idle plants could economically shift back
to defense work since many, if not most, have been shuttered and not maintained.
Converted plants, still active, might more easily shift back to defense work.
That at least would seem to be the Chinese view, for whom "conversion"
swings both ways. See Wang Li, 1993
4. An OCED study of Chinese defense conversion reports that conversion subsidies
between 1978-1995 were about RMB 20 billion, of which 9 billion came from provincial
sources. This, however, represented only about 2% of what China spent for upgrading
the entire state sector. See Frankenstein, 1997, and OECD 1995
5. ** My thanks to Dick Bitzinger and James Mulvenon for sharing these insights
with me.
Major sources drawn upon
Brömmelhörster, Jörn & K.P. Ng, "Changed Priorities
in China’s Military Expenditures" in Jörn Brömmelhörster,
ed., Demystifying the Peace Dividend, Nomos Verlagsgesellschaft, 2000.
Chapman, Rich, et al, "PRC Military Weapons Sales", CINCPAC Virtual
Information Center, 2001
Frankenstein, John, "China’s Defense Industry Conversion: A Strategic
View" in Jörn Brömmelhörster & John Frankenstein, eds.,
Mixed Motives, Uncertain Outcomes: Defense Conversion in China, Lynne
Rienner Publishers, 1997.
Frankenstein, John. "China’s Defense Industries: A New Course?"
in James Mulvenon & Richard H.Yang, eds., The People’s Liberation
Army in the Information Age, RAND Corporation, 1999.
Fu Feng-Cheng & Chi-Keung Li, "An Economic Analysis" in Jörn
Brömmelhörster & John Frankenstein, eds., Mixed Motives, Uncertain
Outcomes: Defense Conversion in China, Lynne Rienner Publishers, 1997.
Grimmett, Richard F. Conventional Arms Transfers to Developing Nations,
Congressional Research Service, 16 August 2001.
Institute for Defense & Disarmament Studies China database www.idds.org
Janes Online, 2001 (various entries)
The Military Balance, IISS, London, various dates.
Naughton, Barry "The Third Front: Defense Industrialization in the Chinese
Interior", China Quarterly, September 1988.
Ng, K.P., "Defense Conversion in the Chinese Press", in Jörn
Brommelhorster & John Frankenstein, eds., Mixed Motives, Uncertain Outcomes:
Defense Conversion in China, Lynne Rienner Publishers, 1997
OECD, (J-C Barthelemy & S. Deger), Conversion of Military Industries
to Civilian Production in China: Prospects, Problems & Policies, (draft)
OECD Development Center, 1995.
State Statistical Bureau, Beijing, website: http://www.stats.gov.cn
(data from the Statistical Yearbook 2000..
Techinfo web portal www.techinfo.gov.cn
A portal to CDIC sites run by the China Ordnance Industry Advanced Technology
Generalization Institute in Beijing
Wang Li, et al, Bandai Shogun de Bangui Gonged [The Contemporary Chinese
Ordnance Industry], Bandai Shogun Consul, Bandai Shogun Cubans, 1993
Wang Shougang, "Military Expenditure of Chinese, 1989-98" in SIPRI
Yearbook 1999, Oxford University Press, 1999.
Xinhua, "China’s Military Industrial Industry Last Year Decreased
Losses by a Large Margin", in FBIS-CHI-2001-0105, 5 January 2001.
Zhu Chenghu, "Transformation of China’s Defence Industry", IISS/NIC
Conference on Transformation in Global Defence Markets and Industries, 2000.