Technology Leadership, Economic Power and National Security: Dual Use Export Controls to China

February 20, 2008

 Technology Leadership, Economic Power and National Security: Dual Use Export Controls to China

John Tkacik

February 20, 2008

“Since World War II, the United States has been the main driver of the global economy. Now we have a situation in which technology products are going to be appearing in the marketplace that were not developed or commercialized here. We won’t have had any involvement with them and may not even know they are coming.”

Nils Newman, author of a Georgia Institute of Technology study of Technology competitiveness published about three and a half weeks ago.

That study tabulated indicators that predict China will soon pass the United States in the critical ability to develop basic science and technology and the equally critical capacity to turn that science into marketable products and services. In fact, the study indicates that China and the United States are already at about the same level:

The Paper's 2007 statistics show China with a technological standing of 82.8, compared to 76.1 for the United States, 66.8 for Germany and 66.0 for Japan. Just 11 years ago, China’s score was only 22.5. The United States peaked in 1999 with a score of 95.4. Now, I don't point to this study as definitive, but I do believe it reflects an underlying reality -- that China's R&D base is expanding and improving.

One might also point to new GDP figures that show China's economy as roughly the same size as Germany's -- at current exchange rates, while China's industrial and manufacturing sector could actually be the second largest in the world behind the United States -- and ahead of Japan and Germany -- at current exchange rates. I caution that the way China calculates its industrial output (in terms of output value) is different from the way most of the OECD calculates it -- in terms of consumption, but the point is that China's industrial sector is already up in the magnitude of $1.7 trillion -- compared to $3.912 trillion for the United States' industrial and manufacturing sector ; but significantly ahead of Japan's at $1.19 trillion , and Germany at about $985.5 billion.

I also noticed another interesting phenomenon. Do you all remember when China's published GDP figures broke the trillion dollar mark? In 2003, according to the Chinese Statistical Bureau pegged GDP at $1.4 trillion -- with industrial output accounting for nearly two-thirds of economy growth. For 2004, China reported GDP at $1.6 trillion. And three years later, China reported GDP at $3.4 trillion -- double the 2004 level. Double -- in three years! Now, of course, there was a change in how China calculated its GDP which gave more weight to the service sector -- and of course, the U.S. dollar has depreciated significantly. But still, from an American's point of view, China's economy has doubled in magnitude in a very, very short time.

These two perspectives -- first that the United States is losing its technology leadership to China, and second, that China's economy is growing extremely rapidly, not just vis-à-vis the United States, but in the global context -- must make us wonder.

Wonder if this is a bad thing; and if it is, whether there is anything we can do to reverse the trend. Is America's relative decline in technology and industry reflective of a systemic problem -- that will manifest itself in an absolute decline? Or is China simply growing fast, and the U.S. is growing -- but not as fast? Or is there a deeper problem that perhaps Chinese commercial -- and military -- interests are saving vast amounts of resources and time by appropriating American scientific and technological progress.

There is no question in my mind, that this latter problem is a major factor in the overall equation of technology leadership, economic power and national security. And, according to the Justice Department's assistant attorney general for national security, there appears to be strong evidence that commercial espionage is not simply the province of the Chinese state, but also a standard business practice among Chinese commercial firms and academic institutions.

Which brings us to the matter of export controls.

There has got to be a way we can approach the issue of exports of dual-use technologies to China without compromising national security or unduly binding freedom of commerce. Adam Smith, when pondering his model of free trade, found one case where some limitation should be laid on trade, and that was the case of the national defense.

But consider this little story.

Last year, in January 2007, China launched an anti-satellite weapon from a ballistic missile which rendezvoused with an orbiting weather satellite nearly 600 miles above the earth. When the rendezvous was completed, the missile's warhead fired a kinetic round at the satellite and destroyed it.

Coincidentally, Dr. Michael Pillsbury had completed a lengthy report on China's Antisatellite capabilities. To demonstrate that China had been long in developing an antisatellite, kinetic kill vehicle (KKV) capability, Dr. Pillsbury cited a number of Chinese academic papers. One, by a scientist at the Harbin Institute of Technology (Harbin Gongye Xueyuan) astronautics faculty, a Ms. Yu Xiaohong, was entitled “Error Analysis of Orbit Transferring Velocity Increment on KKV in Space.”

Also coincidentally, Ms. Yu Xiaohong was at the time at the University of Michigan engaged, in the words of the University of Michigan "engage[d] in the abstract study of rendezvous and transfer orbits" with a noted UMich professor. The professor had visited China six months earlier in July 2006, to give three lectures at the Harbin Institute of Technology on asteroidal rendezvous problems -- or the problems of mating orbits of two separate bodies. The Federation of American Scientists, which monitors the arms race and weapons of mass destruction, describes the Harbin Institute as ‘the key university in the Chinese missile and space industry.’ A DoD study says that Harbin is aggressively involved in cruise missile research for the People’s Liberation Army.

Countries that pose national security concerns to the United States could upgrade their military forces with U.S. civilian technologies. The Department of Commerce deems certain domestic transfers of such technologies to foreign nationals to be exports. U.S. firms may be required to obtain a “deemed export” license before they may transfer technology to foreign national employees. GAO was asked to assess Commerce efforts to ensure that firms (1) apply for these licenses when required to do so and (2) comply with security conditions in the licenses.

GAO did so in 2002 , and found two key weaknesses.

• To detect foreign nationals potentially subject to deemed export licensing, Commerce annually screens tens of thousands of overseas visa applications selected by Department of State visa officials. However, GAO found that this screening process does not include thousands of immigration change-of-status applications from foreign nationals already in the United States who may seek work in U.S. high tech firms.

• Because it rejects very few deemed export license applications, Commerce relies on security conditions in the licenses to help ensure that foreign nationals do not obtain unauthorized access to controlled technologies. These conditions are jointly developed by Commerce, the Department of Defense, and other agencies involved in the licensing process. However, GAO found that Commerce does not have an effective monitoring program in place to determine whether firms comply with these conditions.

There are no published figures on deemed export licenses, but the GAO study -- five years ago -- indicated that over 70% of the license requests are for Chinese, and in fiscal year 2001, Commerce approved 822 deemed export license applications and rejected 3. Almost all deemed export licenses include security conditions. For example, standard conditions bar foreign nationals from

• unmonitored use of high-performance computers,

• involvement in the design of computers that exceed a specified performance limit,

• accessing technical data on advanced microprocessors19 or certain types of lithography equipment; or

• accessing classified data or munitions data licensed by the Department of State.

However, as of 2003, Commerce still did not have a monitoring process in place to ensure compliance, thus undermining the value of the conditions. I am not sure whether one exists now.

I hate to sound negative -- but I wonder how the current process of end-user visits and challenge inspections on Chinese end-users of U.S. dual-use items is coming along. How many inspections or end-user visits are there each year? How many actually turn up anything suspect? If the Commerce Department conducts 20 visits a month, or 240 a year, what percentage is that of the total annual licenses issued? How many are return and follow-up visits? And if the Commerce Department must give a 45-day notice to arrange an end-user visit, does the long lag time afford an end user the opportunity to tidy up before the visit?

I don't know whether these figures are actually kept by Commerce Department. But if they do exist, they would help Commerce -- and the Congress -- in managing the process more efficiently.

But I'm not very sanguine about the effectiveness of the current licensing process or the inspection procedures.

Let me make some other observations. The latest export control regulations on China -- particularly the VEU or validated end user program, identifies five end-users in China who are 1) supposed to be non-military end-users and 2) end-users who do not have a problem with the further proliferation of dangerous technologies to rogue nations -- I'm sorry, (ahem) "States of concern."

But one of the five companies is Shanghai Hua Hong NEC Electronics Company, Ltd.
(HHNEC). It is majority-owned by China Electronics Corporation (CEC), a Chinese government-owned conglomerate that produces a large array of military equipment, in addition to consumer electronics. But still, CEC, is directly under the Commission for Science Technology and Industry for the National Defense (COSTIND) -- which in turn answers to the Central Military Commissions Armaments Department. So, one has to scratch the old head and think very deeply to come up with some rationale that says CEC is going to take care that technology acquired by its subsidiary will not leak accidentally to the Chinese People's Liberation Army . . .

A second company the Commerce Department approved is BHA Aerocomposite Parts
Co., Ltd., partially owned by AVIC I, another COSTIND directed conglomerate that produces fighters, nuclear-capable bombers, and 90% of the aviation weapon systems used by the People’s Liberation Army. AVIC's export arm has already been sanctioned several times over the past decade for proliferating -- well something -- to Iran and/or Syria -- Federal Regulations do not require that the State Department need be too specific on the issue. The fact that Boeing is engaged in a joint venture with AVIC I to produce aviation composites certainly leaves Boeing with a great deal of responsibility to see that the technology and/or equipment licensed to its j/v does not inadvertently find its way to China's fighter aircraft or cruise missile fabrication shops . . . Because AVIC certainly has no interest in protecting the technology. One might ask who the employees are in BHA who would oversee this responsibility. Are they American citizens? Or are they Chinese citizens?

The three other Chinese companies named "validated end-users" in October are Applied Materials China, a subsidiary of Applied Materials, the maker of advanced semiconductor fabrication equipment in the world; National Semiconductor Corporation of Japan which has wholly-owned factories in China: and the "Semiconductor Manufacturing International Corporation," based in Shanghai.

Applied Materials, however is now suing four of its former top officers of Applied Materials China for "misappropriating trade secrets". It seems that the four Chinese-American engineers, all with over ten years residence in the U.S. and long employment with Applied Materials, left Applied Materials China in 2004 to start a new company called Advanced Micro-Fabrication Equipment (AMEC) in Shanghai, and the four men used trade secrets from their old employer to build etching and CVD (Chemical vapor deposition) tools -- used in making microcircuits -- in China. They now compete directly with Applied . . . Now, how does a conscientious legislator on Capitol Hill draft a statute that could prevent this? Perhaps we already have sufficient laws on the books to punish offenders via IPR piracy and patent laws and commercial secrets laws. But what happens if no one enforces those laws? And what happens if violators suffer no consequences? Worse, still: what happens if the victimized U.S. corporation simply accepts its fate?

Finally, SMIC, in Shanghai -- called a "U.S. corporation" by The New York Times -- is a creature of the Chinese State Council. A Taiwanese-American electronics engineer who had worked in Taiwan's largest wafer fab set up SMIC in Shanghai, evidently with some private funding. However the US$1.48 billion SMIC venture seems mostly a Chinese government operation. Richard Chang reportedly complained of the strictures placed on the company by the Chinese government investors when it was raising funds. In October 2001, Chang told the Financial Times, “The authorities said how much money we could borrow, and from which Chinese banks—this is very new to us.” Said the FT, “Chang has noticed another difference to doing business in China compared with Taiwan; he had had to employ 11 public relations officers to keep local officials informed, compared to just one in Taiwan.”

SMIC’s second new eight-inch waferfab in Beijing was a project valued at US$1.25 billion for which Chinese government and government-owned businesses committed at least US$200 million seed money. The main investors are said to be Beijing’s Capital Steel Corp. with US$50 million, the Beijing Municipal Government with US$90 million, and a group of other Beijing enterprises with US$60 million. SMIC reportedly obtained $400 million in backing from a Chinese-American investor named Chang Fu-hsing, but I can't locate any further information on such a person. By March, 2004, SMIC managed to arrange a listing on the New York Stock exchange, and it's quite possible that the Chinese government investors have been able to recoup most of their initial investment and still maintain significant control of the company via their representatives on the board of directors.

As a foreign-owned company in China, SMIC apparently was able to get export licenses for state-of-the-art U.S. semiconductor machinery, including most recently a deal with IBM to utilize IBM's 45 nanometer complimentary metal oxide (CMOS) technology. I don't know if export licensing guidelines would permit the export of state of the art semiconductor fabrication technology to a Chinese-owned company, but I understand that U.S. guidelines still limit exports to China to technology that is at least two years behind the state-of the-art here.

In the end, U.S. export control policy must be based on a fundamental judgment of the risk inherent in letting our technology leak off to countries where 1) it will be used in weapons to harm the United States; 2) will be allowed to proliferate to third parties who would do so; and 3) where it will be used in violation of the intellectual property rights of the U.S. persons who own those rights.

Clearly the first two concerns are the most urgent -- and ultimately, U.S. policy makers and political leaders must reach a consensus on America's global interests, whether China is emerging as a national security challenge to those interests, and how much it's worth to protect those interests.

VolkswirtschaftlicheGesamtrechnungen/Inlandsprodukt/Tabellen/Content75/BWSnachBereichen,templateId=renderPrint.psml (19.94 billion euros for Agriculture; 563.12 for industry (including energy) and 88.24 billion for construction. - 672.30 billion euros - at an exchange rate of 1.4.
See Report on the Work of the Government - " China's GDP in 2004 reached 13.65 trillion yuan, an increase of 9.5% over the previous year." (Delivered at the Third Session of the Tenth National People's Congress on March 5, 2005), Wen Jiabao, Premier of the State Council, at
Ariana Eunjung Cha, "Even Spies Embrace China's Free Market, U.S. Says Some Tech Thieves Are Entrepreneurs, Not Government Agents," The Washington Post, February 15, 2008, p. D01, at, (February 20, 2008).
Michael P. Pillsbury, "An Assessment of China’s Anti-Satellite and Space Warfare Programs, Policies and Doctrines," Prepared for the U.S.-China Economic and Security Review Commission, 19 January 2007, p. 42 at (February 14, 2008). Keith Crane, Roger Cliff, Evan Medeiros, James Mulvenon, William Overholt, Modernizing China’s Military Opportunities and Constraints," The RAND Corporation, Arlington, 2005, p. 170. China's Commission on Science and Technology for the National Defense (COSTIND) directly administers seven universities and colleges engaged in defense research and development. Harbin Institute of Technology is one.
See U.S. General Accounting Office, EXPORT CONTROLS; Department of Commerce Controls over Transfers of Technology to Foreign Nationals Need Improvement, Report GAO-02-972, September 2002.
“Semiconductors Mainland Chipmakers Aim to Outpace Taiwan Counterparts by 2004,” China Economic News Service, Taipei, March 20, 2002. U.S. investors were listed as Goldman Sachs and Hambrecht & Quist.
Richard McGregor, “Apec–Asian Pacific Cooperation—New Plants Open on Fertile Ground—Technology in China,” Financial Times, October 16, 2001.
(No author cited), "Settling in the Yizhuang Economic Development Zone, SMIC's Beijing 8-inch Fab Moves in and Sets up Shop," China Times (Taipei), June 17, 2002 (in Chinese).
However, the Wuhan Evening News describes Zhang Fuxing as a "Chinese visitor in the United States" (旅美華人張復興) and suggests that Zhang is not investing, he is merely "arranging funding". See an internet-archived version of that article at (April 18, 2003).
David Lammers, " SMIC to Expand With Two Fabs in Shenzhen," Semiconductor, January 30, 2008, at
General Accounting Office, EXPORT CONTROLS; Rapid Advances in China's Semiconductor Industry Underscore Need for Fundamental U.S. Policy Review, Report GAO-02-620, April 2002.



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