INSIDE THE CHINESE DEFENSE INDUSTRY


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CHINA'S DEFENSE INDUSTRIAL TRADING COMPANIES
Defense Intelligence Reference Series VP-1920-271-90



ALL DOCUMENTS OBTAINED BY FEDERAL COURT ACTION SMITH V. COMMERCE 398CV716



SOURCE - CHINESE ARMS CONTROL ORGANIZATIONS
BY WENDY FRIEMAN - SAIC CORP. 11/18/1997

GENERAL HUAI GUOMO




SOURCE - US COMMERCE DEPT.

UNCLASSIFIED

LABORATORY-TO-LABORATORY CONTACTS
BACKGROUND

The US-China Arms Control and Nonproliferation Technical Exchange Program (a.k.a. China Lab-to-Lab) grew out of a request made in July 1994 by State DAS Einhorn to DOE NN-40 Ken Luongo to establish scientific interactions with China in support of US arms control and nonproliferation policy. The request called for contacts between scientists at the US DOE Weapons Labs (Sandia, Lawrence Livemore, Los Alamos) and their Chinese counterparts. The Lab-to-Lab charter restricted the initial scope to nuclear arms control and nonproliferation, but provides for future expansion to other topics such as chemical weapons and environmental issues on a case-by-basis.

Program Objectives: (1) To establish enduring professional relationships to facilitate US understanding of the technical capabilities, approaches and roles of the Chinese nuclear weapons scientists involved in arms control and nonproliferation efforts; (2) To influence Chinese nuclear scientists involved in arms control by demonstrating technical means of providing transparency and control while at the same time protecting national security interests; (3) To provide a positive impact on arms control and nonproliferation efforts in China through the use of modern technologies at domestic nuclear facilities.

Interlocutors: Chinese counterparts primarily come from the Chinese Academy of Engineering Physics (CAEP), whose oversight institution is the Committee on Science and Technology in National Defense (COSTIND), and whose activities involve the weaponization of nuclear technology. Two other institutes play secondary roles: the Chinese Institute of Atomic Energy (CIAE) which is involved in domestic nuclear applications (fuel cycle, waste management) and the Northwest Institute of Nuclear Technology (NINT), which is developing a key role in CTBT verifications

Program Visibility and Oversight: The program is unofficial in nature, does not include government officials, but is carefully supervised by both governments. In the US, an interagency oversight group chaired by State/PM ensures the interactions are consistent with guidance and US policy. The scope of the program is narrow and proactive -- seeking to build the basis for cooperation -- rather than remedying a crisis situation, as in the US-Russia Lab-to-Lab program. Moreover, there is no US funding of Chinese participation. The Chinese pay their own way on all of the joint projects.

Activities: The idea of regular technical level exchange grew from contacts that were initiated with exchange visits by laboratory directors in 1994. Following interagency consensus on a framework for the exchanges, a series of meetings and exploratory workshops were held throughout FY95 and 96 to identify topics for discussion. Several areas were targeted that fall into roughly two broad categories: those related to voluntary efforts for good nuclear materials management, and those related to commitments under specific arms control and nonproliferation treaties and agreements.

Technical Aspects of CTBT Verification: Three projects have been pursued to date. Their objectives include: providing mutual understanding of baseline data and confidence in data analysis of the International Monitoring System (IMS) technologies and approaches for such analysis; improving technical capabilities for enhanced participation in the CTBT verification regime; encouraging early participation in implementing and testing IMS technologies; and building Chinese confidence in their ability to participate in transparency measures without revealing national security information. The projects include: joint seismic modeling (currently on hold); collaboration on OSI technologies; and atmospheric modeling.

Nuclear Export Control: Sandia NL and Los Alamos NL collaborated on a workshop in August 1997 in Beijing entitled, "The Kole of US Scientists in the Control of Nuclear Technologies," designed to educate CAEP counterparts on the technical role of nuclear scientists in aiding government efforts at nuclear export control. Presentations covered the role of US nuclear scientists in international and domestic efforts for deciding what to control and how; the role of scientists in reviewing export licenses and in training customs officials; the process for reaching internal technical consensus; and control of international scientific interactions. The workshop received high level Chinese endorsement and coincided with PRC State Council issuance of new regulations for control of nuclear weapons technology.

MPC&A Demonstration: Efforts on the first major collaborative project to date will culminate in a June 1998 demonstration of a nuclear Materials Protection, Control & Accounting (MPC&A) system employing US and Chinese technologies at the CIAE Nuclear Safeguards Laboratory near Beijing. Two Chinese scientists worked at LANL and SNL to finalize the technical specifications of the project which will apply technologies to ensure physical protection and control of nuclear materials in a vault-like room.

Prospects: The technical exchange program has already generated important insights and unique- understanding of key nuclear weapons institutions in China. By the same token, efforts of US scientists have resulted in an increasing Chinese understanding and awareness of the necessity for and methods pertinent to nuclear export control and arms control treaty verification. The hope is to continue the program, eventually broadening its scope to encompass environmental security issues.

Drafted: MGMarkoff ACDA IVI/ITA
x67397 3/12/98

Clearance: IVI - OJSheaks
SEA - P.Almquist
PM - M.Curry
- G.Stacy
EAP - S.Kim

AN INTRODUCTION TO THE CHINESE DEFENSE INDUSTRY
BY LT. COL. DENNIS J. BLASKO, U.S. ARMY

Information as of 22 January 1994

LTC Blasko is a Defense Department Asian specialist. The views expressed in this article are those of the author and do not reflect the official policy or position of the Department of Defense or the U.S. Government.

A General Overview of Defense Conversion

In the past two years, senior Chinese officials knowledgeable about the PRC's defense industry have emphasized that the decision to convert much of Chinese defense industrial capacity to civilian use was made at the Third Session of the 11th Central Committee Plenum of the Chinese Communist Party in 1978. Military conversion was considered one component of the party's larger goal to make economic development its central task. To underline the peaceful intention at the foundation of this decision, Chinese often point out that their decision was made unilaterally prior to changes in the international system of the late 1980's and prior to many countries (including China) reducing their military forces. It has only been in recent years that the defense conversion phenomenon has become widespread enough to be appreciated fully by outsiders.

At first only a few factories undertook conversion, in an experimental, learning fashion -- much the same as the special economic zones were experiments at first. Toward the mid-80's momentum increased and lessons learned from early experiments were applied to other enterprises. It is likely that defense conversion got another big boost from Deng Xiaoping,s trip to the south in early 1992, after which it became finally officially acceptable for anyone and everyone in the country to go out and "just make money."

In today's international environment, most defense industries could not survive if they were to produce only military products. Only a limited number and type of factories can still afford to concentrate mainly on military production. While there will always be a need for some level of defense production, both the internal and external arms markets are significantly smaller than a decade ago. Chinese defense Production requirements that still exist remain centrally planned and assigned to factories by the State Planning Commission in conjunction with the General Staff and Logistics Departments and the Commission of Science, Technology, and Industry for National Defense (COSTIND).

In the more open and reformed China of the 1990'S, defense- related factory managers are held responsible for the success or failure of their enterprises. They are much more responsible than 10 years before for planning, production, purchasing, and marketing. However, whether economically viable or not, it appears that most defense industries are required to maintain their original capability to produce military equipment. Generally speaking, this results in some waste and inefficiency as military lines are kept ready for Production, even if only rarely used.

From a western perspective, what the Chinese call defense "conversion" might better be called "diversification," as new product lines are developed in separate areas while military production capability is retained. (Note. This distinction in terminology was first brought to my attention by John Brennan of the U.S. Consulate in Chengdu in July 1992.) New services and organizations, totally unrelated to defense products, are a major derivative of "conversion."

Unfortunately, as in many campaigns in China, defense conversion has been obfuscated in a barrage of repetitive, sometimes contradictory, announcements as well as undocumented, unverifiable, statistics. The stated goal for 1999 is 80 percent production value of civilian goods throughout the entire industry, up from about eight percent in 1979. The figure cited consistently in 1993 for percentage of civilian production throughout the entire defense industry was 70 percent. (This figure seems to reflect the current "party line." For several years this .percentage varied considerably according to the source. For example, in 1991 and 1992 the figure ranged from 65 to 76 percent).

The industry goal of 80 percent is the goal for the total sector, not necessarily for individual factories. Percentage of civilian production varies from factory to factory depending on the specific conditions at each enterprise. Some factories produce well above 80 percent civilian goods while others produce around 10 percent. Percentages for the component sectors of the industry also vary -- in 1991 those figures were 48 for the nuclear industry 63.8 for ordnance, 67 for aerospace (aerospace includes the aviation and space sectors), 80 for shipbuilding and repair, and 97 for electronics.

A number which has been consistent in recent years is a yearly growth rate of 20 percent since 1980. Left unexplained, however, is how this annual growth rate, when applied to percentages from 1991 and 1992, has not resulted already in reaching the goal of 80 percent. This is an example of "statistics with Chinese characteristics." In any case, the trend will easily result in the accomplishment of the stated goal at a suitable date.

While the general trend is positive, because of the vast scope of the defense industry and the difficulties encountered in conversion, success varies from factory to factory. An authoritative Chinese source said in 1993 that 30 to 40 percent of converted factories are profitable, 30 percent are breaking even, and the rest are losing money. Not all of the factories in the red are on the verge of bankruptcy and after implementation of proven conversion methods some of them may recover. (Recent information indicates that the portion in the "breaking even" category may be growing larger as some previously failing factories have recovered and a few of the previously successful factories are now on the decline because their products are becoming outdated.) However, the government and the industries must decide how to handle the laggards -- support them financially or let them go under. There are problems with either of these solutions. Some evidence exists to indicate the central government has begun to provide supplementary funding to some selected failing factories to keep them afloat.

Official Chinese sources talk about more than 470 production lines producing civilian products. New civilian products range from airplanes, railroad cars, trucks, automobiles and spare parts to food, clothing, medicine, and, literally, the kitchen sink. Civilian services vary from real estate to transportation and maintenance to space launch. Products and services are determined by local conditions (raw materials, transportation, energy, manpower, technology, etc), demand, and markets. (Note. Some sources in the aerospace industry still consider space launch a "military product." Although the launch vehicles are used for civilian purposes, they are still called "junpin" (military product). A military product is one which receives subsidies from the central government and is subject to central planning. Communications satellites are also military products.)

While defense industries in general are more technologically advanced than their non-defense related civilian counterparts, China's technology base remains considerably behind that of developed countries. Often acquisition of 10 or 20 year-old western or Japanese equipment will be a giant step forward for Chinese industries. Much of the effort the Chinese are making in wooing foreign investors is aimed at overcoming this technology gap. There is no doubt that the Chinese hope to improve their defense related technology base as they acquire new technologies through the conversion effort.

The Chinese are more open in talking about defense conversion than they are about most other military-related matters. Taking the lead in promotion of the understanding of defense conversion is a COSTIND-related organization, the China Association for Peaceful Use of Military Industrial Technology (CAPUMIT), with Mr. Jin Zhude as its Chairman. This small organization is very active in organizing exhibitions, seminars, exchanges, and conducting research on defense conversion in China and abroad.

Nevertheless, there are still many aspects about defense conversion and the defense industry that remain vague. The defense industrial sector is vast and complex, to the point where no one can state with certainty how large it is, how many enterprises or factories are included in it, or how much money it makes. To complicate matters, the defense industry is undergoing tremendous structural change and some of these developments are still unclear to many Chinese themselves.

The Chinese Concept of Defense Conversion

In China, defense conversion consists of three principal components --


The goal of defense conversion is to raise the economic level of the country and improve the people's living standards. The program calls for greater industry-local government planning and cooperation which naturally results in a decentralization of decision-making. Success benefits both the factories and the local areas. However, much greater responsibility than ever before is placed on both the factory managers and local cadre.

By transferring unused or unneeded military technologies to civilian use, Chinese officials hope that this relatively advanced technology can be used to "jump start" lagging civilian production. This is especially important in remote areas where hundreds of "third line" industries were built. Production of civilian goods for sale in the local economy has an obvious benefit to the public. Moreover, by entering into the local market, Chinese factories learn marketing skills and quality control measures needed for survival in other markets.

Factories which produce electronic goods often find it easiest to transfer not only their technology but also their product lines to civilian use. Simply stated, a very large proportion of electronic products can be immediately sold in the civilian market without having to significantly alter the product itself. This is an example of defense conversion in which only the customer changes -- rather than selling to the People's Liberation Army (PLA), the electronics are sold to civilian ministries and consumers. Defense conversion in the electronics industry has contributed greatly to the recent expansion of Chinese telephone capacity providing benefits both to the local economy and international business.

Another readily visible aspect of defense conversion is the transfer of military facilities and equipment to civilian use. Many airfields and ports, once used exclusively by the military, are now open to the public. PLA hospitals and clinics now routinely open their doors, for a fee, to the public; military uniforms, especially coats, shoes, hats, and gloves in the winter, are fairly inexpensive, of good quality, and are commonly seen being worn by civilians.

The Chinese recognize that they face many problems in the conversion process. In July 1993, Huai Guomo, a deputy director of COSTIND, identified the following problem areas facing defense conversion --

1) Change in concept -- because they are responsible for profit and loss, factory managers must change their way of thinking. Rather than being told by Beijing exactly how to conduct all aspects of their business, now factory officials must select products, develop and open markets, account for inventory, and find suppliers of raw material and subcontractors, as well as bargain for the best prices. Some factory officials gladly have taken on these new responsibilities, while some others still have not weaned themselves from the iron rice bowl mentality of the past. Those who do not change their way of thinking will find themselves and their factories in trouble as market economy practices become mere widespread throughout China.

2) Funding -- conversion costs money and large capital investment is required. The government can only provide limited funding to a limited number of enterprises -- over six billion yuan (renminbi) in loans has been planned in the 8th Five-Year Plan for use in 350 projects. (This brings the total central government contribution since 1986 to about 10 billion yuan.) Therefore, enterprises must find alternate sources of capital -- profits from sales, private loans, local bonds, foreign investment, joint venture, or perhaps even selling shares of stock. Finding sources of new investment is of foremost concern during conversations with anybody in China concerned with defense conversion.

3) Market development -- in the past defense industries had only one primary customer -- the government. Now they have to find and develop their own markets. In some cases, Chinese companies have been able to take advantage of the markets already developed by foreign companies involved in their joint ventures. In other cases, Chinese manufacturers producing goods under foreign license. have been limited by not being allowed to sell in markets which would compete with their license partner. In the mid-80's, marketing used to be the main job of the defense industrial trading companies, such as NORINCO. These trading companies now are involved in many other business ventures and cannot handle the demands of all their associated defense factories. Consequently, many factories have very little contact with established trading companies and have created their own marketing branches.

4) Operation and management -- factories must restructure themselves and train personnel to handle the challenges presented above. On the organizational side, in addition to the marketing branches already mentioned, companies have recently created sales departments, after-sales service centers, and new product development divisions (often found in associated research institutes). On the management side, for nearly three decades, management principles were largely ignored or relegated to serving political causes. As a result, many Chinese lack effective management experience and require additional training in modern techniques. Many Chinese overseas students are now studying business. Delegations travailing abroad for training seminars are common. Joint venture partners also often help provide this type of training.

One problem that Huai did not specifically mention was the resettlement and retraining of personnel formerly associated with defense industries. Most medium to large defense factories are like small cities containing their own infrastructures of schools, hospitals, dormitories, stores, restaurants, and maintenance facilities. The Chinese find it very difficult to lay off or transfer workers because it disrupts the equilibrium of this social system. Factory managers are pressured to find jobs for workers no longer needed in defense production rather than simply get rid of them. It is preferable to create new jobs than to set unneeded workers adrift in a social system that still lacks structure. This is a big factor which encourages factories to diversify their production, but also limits the degree to which the industry can be restructured-

In January 1994, Jin Zhude said that China is in a transition between the first and second stages of defense industrial conversion. The first stage took place under State planning and focused on civilian product development. Now almost every factory has made the commitment to civilian production and undertaken the effort to find appropriate civilian products. The second stage will take place under market economy rules. Management must reorganize itself to face this challenge- Factories must constantly improve their products and further develop their markets. This stage will require even greater capital investment to buy the technology necessary to keep Chinese products competitive.

General Trends in Defense Conversion

The most obvious trend brought about by defense industry conversion is greater opening to the outside world and greater integration in the regional and world economy. n order to survive, the defense industries "can no longer afford to be as closed and secretive as they were 20 years ago. This development may be somewhat taken for granted by foreigners and not fully appreciated for the change it represents in past Chinese practices.

Led by COSTIND and CAPUMIT, the industry has undertaken a full scale public relations effort to find investors and markets, Defense conversion trade shows, exhibitions, and seminars are common. Books and pamphlets advertising products and services and describing projects for which investment is sought now are available. Much of this literature has detailed information about the factories and enterprises concerned. Much of this is a result of declassification of previously sensitive material. Information centers and newspapers have been established to help spread the word about Chinese defense conversion.

A second inescapable trend is the unrelenting search for foreign investment and joint venture partners. Lack of available funds is the major limiting factor in further conversion efforts. While the Chinese are doing what they can on their own, they look to foreign sources as a near-term fix. Jin Zhude has said that China is a lucrative investment prospect where 15 to 20 percent return on investment is common.

A third trend is the expansion of old companies into new larger entities and the proliferation of new companies related to the defense industries. Several organizations which previously were defense trading companies have grown to the point that they have incorporated other entities into their structure and taken on the form of an "enterprise group." One of the most obvious examples of this trend is the China Poly (Baoli) Group Corporation which, in February 1993, was formed around the former Poly Technologies Incorporated.

Such conglomerates seek to pool assets, increase their prestige and power, and take advantage of broader markets. These groups can be found under the auspices of the PLA or run by civilian enterprises involved in defense production. According to the PLA Daily of 18 Feb 93, 20 such enterprise groups had been established within the PLA alone. In January 1994, He Shibin, a Vice President of the China Jialing Group, said that there are now 55 enterprise groups in China. The relationship of these groups and their subordinate elements is somewhat ambiguous, as is the relationship of those enterprises to their higher authority.

It has been reported that some defense enterprises have established subsidiaries which are only involved in civilian production, services, or marketing. These new civilian companies are free to sell stock and some of profits that they accrue can be remitted to their umbrella organizations.

Other new companies have been formed to provide new services to their higher authorities. For example, the General Political Department has created a company named Tiancheng in part to compete with its other subordinate company, Kaili, in order to get better deals for the GPD.

Defense industries deep in the Chinese interior have also created smaller companies in areas with better transportation and communications. These new companies are called "windows" because they can look out to the world better than their parent organizations can. It is not always possible to tell the affiliation of these companies by their names.

This last item leads to a fourth trend -- the move of third line industries out of the countryside to cities with better transportation and communications and a work force with greater technological skills. On 6 Jan 93, the PLA Daily reported that this movement is going on faster than had been expected and that 17 percent of the third line industries had already relocated. It was expected that this vast project could be completed in three to five years.

Finally, the defense conversion process will help codify business procedures throughout the industry and make Chinese methods of operation more transparent. Senior Chinese officials recognize that China currently does not conform to many international business standards, such as methods of accounting. However, if the Chinese wish to continue to attract foreign investors, they will have to operate more within the accepted code of international business practices.

As China develops laws for business operation in a socialist market economy, naturally the defense industries will be affected and some of their operations will be regularized. The new tax law which went into effect in 1994 calls for businesses to pay 33 percent tax on profits and also a 17 percent value added tax. It appears that these taxes will be paid to the local government and then the local governments will remit appropriate sums to Beijing. This is a change to the previous situation in which the industries negotiated a contract with their ministries or higher authority and were required to pay that amount no matter what their profits were. (The effects of the new tax law still are not entirely clear and further modifications and interpretations should be expected. While there have problems with its initial implementation, it appears that the central government intends for foreigners to retain considerable tax breaks in order to continue to attract investment.)

Jin Zhude also recently described a regulation concerning how profits were to be used within the defense industry -- the "5-3-2" plan -- which stipulates that 50 percent of an enterprise's profits are to be reinvested within the enterprise itself to expand production capacity, develop new products, or to buy new equipment or technology; 30 percent are to be used for public improvements such building new dormitories or facilities; and 20 percent can be used for workers' bonuses. Jin went on to say that all profits would be used solely for civilian production and that none of the profits from defense conversion would be used to support military production.

Structure of the Defense Industry

The overall defense industry Can be divided into two major sectors -- civilian-managed enterprises (subordinate to the State Council or ministries) and military (PLA) owned and managed enterprises. In May 1990, the Defense Intelligence Agency published a very useful chart, "China's Industrial Trading Companies," which explained these relationships as they existed at the time. Many journalists and scholars have used this chart as a starting point in their works on the Chinese defense industry -- variations of the chart now are found commonly throughout the literature on this subject.

Since the publication of the DIA chart, however, many changes have occurred. As complicated as the original chart seemed, it is a vision of simplicity when compared to the structure of today's Chinese defense industry. On the civilian side, three major changes can be identified --

In the past three years, the Ministry of Energy Resources; the Ministry of Machine Building and Electronics Industry (MMBEI); and the Ministry of Aerospace (MAS) have all been eliminated. Previously all the components of the civilian side of the defense industry could be found within those three ministries -- nuclear, ordnance, electronics, shipbuilding, space, and aviation. Now, with the exception of the electronics industry, each of these defense industry components currently has a "group" or corporation which manages the factories and conducts sales and marketing for their products. These new organizations are outgrowths of previous smaller defense trading companies and appear to be an initial step to break the state-owned factories free from complete government control.

These new corporations are now directly subordinate to the State Council -- they have attained a position equal to the status formerly granted to only a few corporations such as the China International Trust and Investment Corporation (CITIC). This new position gives their general managers de facto ministerial rank, although they are not called "minister" in public. Unlike the older trading companies which only marketed~ products, these new corporations also have responsibility for the factories in their systems. The older trading companies still exist and, like before, still only have marketing responsibilities. The defense industry corporations subordinate to the State Council are --

(Note. The main source of this information is the "China Daily" newspaper chart, "Government Organization Chart of the People's Republic of China," published in the summer of 1993 with information current as of 20 July 1993. Variations in the translations of these names can lead to confusion. For example, the NORINCO(G) is sometimes referred to as the Ordnance Industry Group. It is common practice in China to refer to a new organization by its old name; sometimes this occurs even after many years and several reorganizations.)

Subordinate to each of the above corporations are myriad smaller subsidiaries, factories, research institutes, and related companies. Many of the previously identified trading companies, such as NORINCO and Great Wall Industry Corporation, to name only two, now 'belong to one of these larger corporations. At the same time, many civilian factories also have formed larger enterprise groups among themselves based on geographic or regional relationships or production capabilities-

Contrary to the general trend, the Ministry of Electronics Industry (MEI) still retains control of its subordinate factories and some research institutes. According to one MEI factory manager and a COSTIND source, MEI factories have dual management -- one leader is appointed by the industry and one leader is a local government representative. Such a team leadership concept is not found in other sectors of the defense industry. The China Electronics Industry Corporation (Chinatron or CEC) controls only research institutes associated with electronic industry. (This information contradicts an article by John Frankenstein on the Chinese defense industry which appeared in the book "Arms Industry Limited" published by SIPRI in 1993. At the time of the writing of that article, it appeared that Chinatron was growing in power and could have assumed a new status directly subordinate to the State Council. However, that move did not occur and Chinatron (CEC) still is part of MEI.) The China National Electronic Import-Export Corporation (CEIEC) remains subordinate to MEI and acts as the marketing arm of the industry.

Other civilian ministries, such as the new Ministry of Machinery Industry, still have a few factories engaged in production of small defense items such as spare parts. However, relatively speaking, this seems to be a small portion of the greater defense industrial sector.

While all these changes have gone on, the Commission of Science, Technology, and Industry for National Defense (COSTIND) has remained largely unchanged in position and function as the bridge between the State Council/civilian side and the Military Commission/PLA side of the defense industry. On an organizational level, COSTIND is equal to the Ministry of National Defense and other ministries, but above the level of the corporations subordinate to the State Council. Recent experience has demonstrated that COSTIND is the ultimate decision point for decision concerning defense conversion. Both the Civilian and military sides of the defense industry defer to COSTIND. The State Planning Commission also works with COSTIND on production goals and funding decisions.

COSTIND, too, has subordinate trading companies -- China Xinshidai (New Era) Development Corporation, China Yuanwang (Group) Corporation, and the Galaxy New Technology Corporation -- as well as the "think tanks" or information centers -- China National Defense Science and Technology Information Center (CDSTIC) and China Association for Peaceful Use of Military Industrial Technology (CAPUMIT). These latter two organizations serve to promote public relations, provide information, develop connections with other countries, and sponsor exhibitions and seminars. (Note. Previously, the Xiaofeng Technology and Equipment Corporation was considered to be under COSTIND's direct control. Recently, sources both in Xiaofeng and COSTIND have denied a subordinate relationship between the two organizations; however, the actual linkage, if any, between the two organizations still is unclear.)

The military side of the defense industrial sector also has undergone changes. There has been no change to the government structure which places the Military Commission on top with the Ministry of National Defense and the General Staff Department, General Political Department, and General Logistics Department subordinate. However, the trading companies which belong to the PLA have proliferated and expanded, many taking on the form of "enterprise groups" or "corporations" themselves. New companies have been established, some subordinate to the former trading companies, some directly subordinate to departments.

Further complicating the issue is the wholesale entrance of PLA units into the business arena, far beyond the traditional realm of sideline production. Much of this type of activity falls under the rubric of defense conversion. PLA units have been encouraged to help in the development of the local economy. Previously this often was done free of charge, now they are more likely to contract with local governments for construction and transportation projects, as well as selling their services, such as vehicle repair or medical service, directly to the public. Investments of much larger dimensions have been made by units of group army size and higher in areas such as automobile production, operation of restaurants and hotels, and real estate development. Until very recently, units of division size and below also were engaged in significant business ventures. Recent directives from Beijing have required these smaller units to divest themselves of their business activities which fall outside the boundaries of sideline production.

(For a more detailed look at the current structure of the defense industry, see the appendix.)

Potential Ramifications

The PLA has made attempts to control the spread of business activities within the military because..the danger exists that too much emphasis on money making may detract from the its warfighting capability. Perhaps even more important from its perspective is another obvious by-products of military-run businesses -- the potential for corruption. Fighting corruption is one of the party's main tasks as it pursues economic development. There is only time and space here to identify corruption as a major problem facing both the military and civilian sides of defense industry and the economy as a whole.

Corruption implies a loss of control. That, in fact, is the case as military-related companies proliferate and the center loses its former tight hold on all defense-related activity. A potential major shortcoming in the defense conversion process is a loss of centralized control over arms exports as companies expand and have only the goal of making money. According to one COSTIND source, only 10 companies in China can sell arms. (He would not specify which ones.) However, with more enterprises having more and more access to military or dual use equipment, technology, or raw material, proliferation concerns cannot be ignored. It is always possible that a rogue element, operating in contravention of government orders and/or unbeknownst to the authorities will attempt sales that are not in China's, the region's, or the world's best interest.

While Chinese officials consistently deny that profits from defense conversion will be applied directly to military production, concerns remain among some observers that profits from arms sales conducted by defense trading companies will be plowed back into the defense budget to make a stronger Chinese military. Additionally, as a by-product of the defense conversion process, through acquisition of new technologies and manufacturing techniques, defense-related production no doubt will be enhanced to some extent. This will result in a more modern Chinese military -- but a more modern military is not necessarily a more threatening Chinese military. Whether or not Chinese military modernization threatens U.S. interests, however, is beyond the scope of this introduction to the defense industry conversion process.

Conclusion

China is committed to modernizing its military; however, it understands that military modernization is a long process which depends upon success of the overall Chinese economy. While China is committed to military modernization, it is also committed to military modernization, it is also committed to defense conversion. These two efforts are not mutually exclusive, nor are they necessarily mutually supportive of each other. Military modernization will be pursued whether or not China has support from foreign countries. Defense conversion, on the other hand, is a process well underway that, in order to be successful, requires large foreign technological support and and financial investment. China will continue to publicize its successes in this field and seek foreign assistance. Opportunities exist for the prudent investor.

The Chinese senior military leadership has accepted the subordination of military modernization to the overall development of the national economy. The logic of this decision has been proven in recent years valid as government defense spending has increased -- especially since 1990 -- as the Chinese economy has grown.

Some of the monetary profits which accrue from defense conversion undoubtedly have found their way back into the overall funds available for defense spending, whether officially listed as part of the budget or not. These additional funds naturally have given the military leadership greater options in how they spend the monies available. However, the exact mechanism which leads to the development of the Chinese defense budget is not well understood and is open to much speculation. It cannot be denied that the portion of the Chinese defense industry that remains committed to military production has benefited, and will continue to benefit to some degree, from technology acquired through the defense conversion process.

It is certain that some profits from defense conversion could be used to buy prohibited technology. This is not enough evidence, however, to determiner how often, or to what extent, this occurs. However, to imply, as some journalists have done recently, that all Chinese defense conversion leads directly to a more threatening Chinese military is an exaggeration and a misrepresentation of the entire process.

The advantages of defense conversion -- improvement in the standard of living for Chinese citizens, increased business opportunities for foreigners, greater integration of the Chinese economy into the regional and world economies, more openness, and further development of market-economy business and management practices in China -- appear to outweigh its potential dangers. If clear and well-defined policy guidelines for U.S. investment in this process are established, then it is possible that American businesses could profit from the Chinese program, too. The alternative to defense conversion is in no one's best interest.


Appendix: A Closer Look at the Defense Industry

It is not possible to outline every element of the defense industry in this report. However, its major organizations and structures are listed below. A few affiliated enterprises are provided as examples. The information below is derived primarily from company brochures and promotional literature.

Commission of Science, Technology, and Industry for National Defense (COSTIND) has at least three companies and two think tanks subordinate to it --

China National Nuclear Corporation (CNNC) consists of more than 200 enterprises. Among them are --

China North Industries Group, NORINCO (G), has over 300 subelements including factories (157 medium to large factories), research institutes, and trading companies. It has established over 100 joint ventures and has more than 20 overseas offices and 60 branches. Among the best known elements are --

(It is worth emphasizing that the factories listed in this paragraph are subordinate to NORINCO(G), not NORINCO. NORINCO(G) has departments which manage its subordinate factories. NORINCO, now, as before, is an import-export trading company which markets products of NORINCO(G) factories. This kind of structure is found in all the defense corporations directly subordinate to the State Council.)

China Electronics Industry Corporation (CEC), also known as Chinatron, remains subordinate to the Ministry of Electronics Industry. The corporation's structure is still relatively unclear, while it is believed to only control research institutes of the industry, some sources show factories under CEC administration. Enterprises affiliated with MEI include --

China State Shipbuilding Corporation (CSSC) enterprises has 161 enterprises consisting of 27 shipyards, 67 marine equipment factories, and 40 research and development institutes. A few of its enterprises are --

China Aerospace Corporation (CASC) has over 75 commercial enterprises plus research institutes and factories. A few of its affiliated enterprises are --

Aviation Industries of China (AVIC) consists of over 200 manufacturing enterprises and trade companies, ever 30 research institutes, and six colleges and universities. Among them are --

Conglomerates which have been formed, and are probably part of the civilian side of the defense industries, include --

The Hainan Heping Industrial Shareholding Company was described by Xinhua news service on 18 May 1993 as the first "transdepartmental shareholding company of China's ordnance manufacturing system." Significantly, its president is Jin Zhude, director general of CAPUMIT. It is not certain, but with Jin as its president, this organization would seem to affiliated with COSTIND.

On the military side, the general structure remains the same, but many new companies or groups are found.

Although it does not like to be considered a part of the GSD, the new China Poly (Baoli) Group Corp still appears to be the military's main weapons and equipment trading arm. Subordinate to Poly Group are --

Without a doubt, there are other enterprises subordinate to the GSD. One is Yuhe Machinery Plant in Nanjing. Previously identified, but current status unknown, were --

Two companies are currently known to be subordinate to the General Political Department --

The major enterprise subordinate to the General Logistics Department continues to be the China Xinxing Corp (Group). It has nearly 100 large and medium sized enterprises. Primary products are food, clothing, medicines, camping equipment, logistics equipment, and fuel handling equipment. Its marketing arm is known as the China Xinxing Import and Export Corp. Other PLA factories, outside the Xinxing umbrella, are subordinate to the GLD.

The "999 Enterprise Group" (or "Three Nines Group") was founded in 1992 by order of the Military Commission and the GLD. It consists of 34 enterprises centered around the Nanfang Pharmaceutical Factory. Its logo can be seen facing the Hong Kong harbor and on the Beijing Capital Airport control tower. It is not certain if the 999 Group reports to the GLD or is independent.

The major enterprise subordinate to the PLA Air Force is the China Lantian (Blue Sky) Industrial Corp. Also affiliated to Lantian is the Tian Ma (Sky Horse) Brand of vehicles and vehicle repair parts and facilities. China United Airlines (CUA) is a commercial entity of the PLA Air Force.

The PLA Navy's trading arm previously was identified as the Xinghai Corp.

Subordinate to the PLA Second Artillery is the Shanhaidan Enterprises Group Corp with over 50 medical research, treatment, production, and marketing subordinate elements.

An example of an enterprise group subordinate to a group army is the Changcheng Industrial Conglomerate which reportedly belongs to the 42 Group Army headquartered in Huiyang, Guangdong Province.



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