Fortifying China: The Struggle to Build a Modern Defense Economy

Fortifying China

The Struggle to Build a Modern Defense Economy

TAI MING CHEUNG

Cornell University Press

ITHACA AND LONDON

This book is dedicated to Ai,

to my mother, Woo Sok Yin,

and to the memory of my late father

Contents

Preface and Acknowledgments

Abbreviations

1. Bridging the Civil-Military Technological Divide in the Information Age

Integrating the Civilian and Defense Economies

China’s Enduring Quest for Wealth and Military Power

The National Innovation Systems Framework

Examining the Defense Economy through the NIS Prism

Understanding How Defense Technological Innovation Takes Place

2. Innovation and Stagnation during the Maoist Era

The Building of the Conventional and Strategic Weapons Bases

The Defense Economy’s Relationship with the Maoist NIS

The Setup of the Conventional and Strategic Weapons Systems

The Floundering of the Conventional Defense Industrial System

Barriers to Conventional Weapons Innovation

The Flourishing of the Strategic Weapons System

The Consolidation of the Defense Economy in the Late 1970s

3. The Eclipse of the Defense Economy under Deng Xiaoping

The Defense Economy and Its Relationship with the NIS in the 1980s

Defense Conversion

The Impact of Conversion on the Defense Economy

Successes and Drawbacks of Conversion

The Struggle to Overhaul the Legacy Defense Industrial Base

Key Activities of the System

The State of the Defense Economy by the Late 1990s

4. The Revival of the Defense Economy in Twenty-first Century

Setting the Stage for Bold Reforms

The Relationship between the Defense and National Innovation Systems

Reform and Consolidation Begin

Key Activities of the Rejuvenated Defense Innovation System

The Prospects for Catching Up and Leapfrogging

5. Building a Dual-Use Economy

From Defense Conversion to Dual Use and Spin-On

Defining the Yujun Yumin Dual-Use Economy

Chinese Approaches to Civil-Military Integration and Spin-On

Building Linkages between the Civilian and Defense Economies

Harnessing Civilian High Technology Companies for Military Purposes

The Geographical Landscape of Dual Use and CMI

The Chinese Approach in Comparative Perspective

6. Can the Chinese Defense Economy Catch Up?

The Techno-Nationalist Underpinning of the Catch-Up Approach

The Debate over China’s Military Technological Catching Up

The Developmental Models for Catching Up

Conditions for Technological Catching Up and the Case of the Space Industry

Policy Challenges for the United States

Chinese Terms

Historical Official Exchange Rates between the Renminbi and U.S. Dollar, 1955–2008

Select Chinese-Language Bibliography

Preface and Acknowledgments

An ever-present danger of writing about contemporary developments in a country changing as fast as China is that your topic can disappear or become irrelevant before you finish. In the midst of my first scholarly examination of the Chinese military’s involvement in commercial activities during the 1990s, the Chinese authorities abruptly ordered the army to divest from its money-making operations. That book consequently turned from the imperious rise of the Chinese military business empire into a historical study of its entrepreneurial pursuits and ignominious demise.

This time, I sought to avoid having events overtake me again. An abiding interest in the political economy of security led me to focus on the nexus between economic development, technological innovation, and defense modernization in China—which concerns the place of the defense economy in the country’s economic, technological, and military transformation. This topic undoubtedly has staying power, but it was not so obvious at the beginning of this century because the Chinese defense industry was floundering from decades of neglect and isolation. Over the course of this decade, though, the Chinese defense economy has risen from its sickbed and appears to be returning to good health. This book charts its painful recovery and examines how the defense economy is positioning itself at the heart of the country’s long-term revitalization and its quest to become a world power.

Defense economy refers primarily to the defense technology and industrial base: the combination of people, organizations, institutional rules, technological expertise, and production capacity that provide defense-relatedand dual-use goods and services.¹ A key subcomponent is the defense innovation system, which consists of laboratories, research institutes, and academic institutions that are involved in the development, diffusion, and use of innovations for military and national security applications. Acting as a bridge between the defense economy and the broader civilian economy is the dual-use economy, in which common technologies, processes, labor, equipment, material, and/or facilities are used to meet both defense and commercial needs.² For China, a key element of the dual-use base is former defense enterprises that have converted from military to civilian production but still retain linkages and residual military capacity.

While this book primarily explores the ability of the Chinese defense economy to become a technologically innovative powerhouse over the long term, a broader but connected question is whether technological innovation can flourish in an authoritarian system. Is there a fundamental incompatibility between China’s efforts to be a world leader in technological innovation and its maintenance of a restrictive, authoritarian political system? Fundamental aspects of the Chinese system appear to be major obstacles to the nurturing of a sustainable innovation environment. They include the absence of a robust and independent legal system, highly controlled flows of information and knowledge within society, and the lack of encouragement of pluralism that would allow for greater autonomy and self-governance within the S&T community.³

Some scholars believe that intellectual and personal freedom is essential in encouraging new thinking. Although authoritarian states can cultivate and motivate scientific invention, state-controlled science is highly fragile in the information age. If China wants to become a world-class power in information technology, David Gompert argues, it will have to yield to economic and political liberalization. But if China chooses to remain an authoritarian, nationalistic, and self-sufficient state, it will find it hard to compete in the very technology on which both its economic prospects and future military power depend.⁴ The collapse of the Soviet Union and the decline of itsdefense industrial complex showed the dire consequences of the excessive rigidity of a central planning system.⁵

This claim calls into question whether China’s technological transformation can narrow the gap with its more developed and democratic competitors in the West and in East Asia. Not surprisingly, Chinese policymakers do not accept the premise that technological modernity cannot flourish in an authoritarian system. Their latest long-term S&T development plans emphasize the importance of top-down big science programs. But the central authorities are nonetheless willing to hedge their bets and integrate other, market-based approaches into their continued reliance on the state-owned defense industry. This book scrutinizes the strategic logic behind the drive to develop a dual-use economy as well as allow select portions of the defense industry to open up to the outside world.

THIS book has greatly benefited from the advice of Matt Uttley and David Betz, who carefully read the manuscript during its evolution. Others who have been helpful in providing feedback on whole or partial readings of earlier portions include Steven Tsang, Warren Chin, Barry Naughton, and Paul Godwin.

Midway through the writing of this book, I relocated from London to the sunnier shores of Southern California and the Institute on Global Conflict and Cooperation at the University of California, San Diego (UCSD). I have had the distinct honor of working with and learning from Susan Shirk, director of the institute, who is not only an outstanding China scholar but also an inspired leader and friend. I have also had the opportunity to get useful feedback from students who have taken my courses at UCSD’s Graduate School of International Relations and Pacific Studies.

In addition, many thanks go to the Smith Richardson Foundation, and especially Allan Song, for generous financial support and kind guidance for this project, especially in its early stages. My editor at Cornell University Press, Roger Haydon, also deserves praise for his insightful advice in making this book much more succinct and readable.

This book is dedicated to my wife, Ai, who has been unstinting in her love, support, and care for me, especially as we moved across three continents during the course of the writing. She has kept things moving along smoothly with exceptional grace and kindness. The book is also dedicated to my late father and to my mother, who worries that it will remove more trees from this planet.

1. See U.S. Congress Office of Technology Assessment, Adjusting to a New Security Environment: The Defense Technology and Industrial Base Challenge (Washington, D.C.: U.S. Government Printing Office, 1991), 2–3; and Gordon Boezer, Ivars Gutmanis, and Joseph E. Muckerman II, The Defense Technology and Industrial Base: Key Component of National Power, Parameters, (Summer 1997), 26.

2. This definition of the dual-use base is adapted from the U.S. Congress, Office of Technology Assessment, Assessing the Potential for Civil-Military Integration: Technologies, Processes, and Practices (Washington, D.C.: U.S. Government Printing Office, 1994), 44.

3. Richard P. Suttmeier, Assessing China’s Technology Potential, Georgetown Journal of International Studies (Summer/Fall 2004), 104–5.

4. David Gompert, Right Makes Might: Freedom and Power in the Information Age, McNair Papers (Washington, D.C.: Institute for National Strategic Studies, National Defense University, 1998), 10, 25.

5. James Robinson, Technology, Change, and the Emerging International Order, SAIS Review 15, no. 1 (Winter/Spring 1995) 153–73. See also Matthew Evangelista, Innovation and the Arms Race (Ithaca: Cornell University Press, 1988).

Abbreviations

[1]

Bridging the Civil-Military Technological Divide in the Information Age

Innovation, China’s leaders assert, is the soul of a nation’s progress and the guarantee of its national security.¹ But for many years this vital source of creativity and competitiveness was lacking on the factory floors and research laboratories of the country’s sprawling defense economy. Decades of stultifying central planning, bureaucratic compartmentalization, political upheavals, and isolation from the outside world produced a sterile system that held back initiative, new thinking, and risk taking. Stagnation and backwardness took root instead, and the defense economy became a burden to the building of the country’s military power. There was little urgency in seriously addressing these shortcomings because of inadequate government funding and the reluctance of the defense industry’s leadership to carry out meaningful reforms. Moreover, after China opened its doors to economic reforms and the outside world, its security situation improved, and defense modernization dropped toward the bottom of state priorities at the end of the 1970s.

Since the 1990s, however, the situation has changed. Despite the end of the cold war, Beijing has faced major security challenges, of which the most pressing are the containment of Taiwan’s quest for autonomy and keeping pace with the global revolution in military affairs. China’s emergence as a thriving, globally connected, market-oriented, and prosperous power, coupled with a sharp acceleration in the rearmament needs of the People’s Liberation Army (PLA), has led to a concerted effort to tackle the defense economy’s deficiencies and put it on a development path with the goal of catching up with the West within a couple of decades. Bringing the defense economy into the twenty-first century by creating an environment that will allow technological innovation to flourish has been a colossal and costly challenge. But the Chinese authorities appear determined to carry out this task. They see an independent and vibrant defense economy as a core pillar of the country’s national security and standing as an emerging global power.

This book examines the complex and protracted struggle for the transformation of the Chinese defense economy since the beginning of the reform era in the 1980s and the efforts to establish a civil-military dual-use economy since the 1990s. Beijing has used a two-pronged approach. First is the internal reengineering of the defense economy. This focuses on breaking down bureaucratic barriers and paring back the role of the state in conjunction with the nurturing of a more competitively minded and entrepreneurial institutional culture that encourages the nurturing, diffusion, and absorption of technology and knowledge. The second plank of the strategy is to integrate the defense economy into the broader civilian economy to form a dual-use technological and industrial base that serves both military and civilian needs. The Chinese authorities view this move as central to the long-term modernization of the country’s military capabilities, as well as in the development of its science and technology (S&T) establishment.

INTEGRATING THE CIVILIAN AND DEFENSE ECONOMIES

The backdrop to this book is the intense technological and industrial competition among the world’s arms manufacturers in the information age and the blurring between the civilian and military pillars of their economies. It is becoming apparent that states that seek to join or remain in the top tier of military technological innovation and production in the digital era can do so only if they are able to integrate their military and civilian economies.² Those that do not vigorously pursue this goal risk falling behind in the technological race because they will be unable to exploit the synergies that arise from a growing convergence in the development of civilian and defense technologies.

The importance of civil-military integration in determining long-term military technological competitiveness is due to at least three major trends that have become increasingly influential since the 1990s. First, the advent of the information age has helped to bring about a revolution in military affairs among major powers. Information technology is profoundly transforming the nature of future wars and the makeup of armies to fight them. In a 1999 assessment, the U.S. Defense Science Board pointed out that the civilian commercial sector is now driving the development of much of the advanced technology integrated into modern information-intensive military systems, such as software and microelectronics hardware.³

Second, globalization is challenging the traditional configuration of defense industries structured along national lines. Since the 1990s, we have seen a growing trend in the global merger and acquisition of defense firms and cross-border collaboration on weapons development projects, especially between U.S. and European companies. The result is a world characterized by the routine diffusion of weapons and technology, embedded security of supply issues, and reduced national control over indigenous defense industrial bases.⁴ An important feature of this globalization is a high degree of outsourcing for components and subsystem technology to civilian firms around the world. Consequently, the majority of militarily useful technology is or eventually will be available commercially.⁵

Third, commercialization is prompting far-reaching changes in the way that countries manage their defense industrial bases. The adoption of commercial practices requires defense industrial entities to operate according to market demands from customers and shareholders, who want products that are more cost-efficient, quicker to develop, and less prone to obsolescence.⁶ This more entrepreneurial and flexible approach is a sharp departure from the rigid, government-based procedures of the past. This situation applies to all leading military industrial powers. The United States, the United Kingdom, France, and Russia have faced the same dilemmas in restructuring the relationships between the civilian and military components of their economies in the aftermath of the cold war and the advent of the information age.⁷

In the case of China, the establishment of a vibrant dual-use economy provides a valuable opportunity for the defense economy to gain access to advanced technologies, knowledge, techniques, and practices and narrow the gap with the top tier of advanced defense industrial powers. During the cold war, the military sector in China enjoyed privileged access to economic resources that allowed it to become the most advanced pillar of the national economy. But the civilian economy has powered ahead in the post-cold war era and has enjoyed strong and sustained growth that has fueled technological modernization, rising levels of prosperity, and a highly competitive manufacturing base. The defense sector has meanwhile struggled to keep pace because of falling budgets and downsizing. Coupled with the revolution in military affairs, globalization, and other systemic changes, the commercial sector has either caught up or overtaken the defense sector in performance, expertise, and technological capabilities.

With the civilian economy in the ascendancy, the armed forces and the defense economy are actively embracing the integration of the commercial and defense sectors. To reap these benefits, the defense economy has had to overcome an insular, secretive, highly bureaucratic, and risk-adverse institutional culture that is deeply rooted in its socialist past. The outcome of this titanic struggle will determine whether the defense economy is able to close the yawning gap in technological innovation and capabilities with the world’s leading military powers.

This book addresses key questions about this epic quest to transform the Chinese defense economy:

What are the nature, role, and activities of the Chinese defense economy, and how has that economy adapted to the challenges of the post-cold war and reform era? Has the restructuring of the defense economy successfully addressed deep-seated systemic problems that have hampered technological innovation? Can these reforms be sustained over the long term?

How successful has China been in the integration of the civilian and defense economies through dual-use strategies such as spin-off and spin-on? What kinds of civil-military integration initiatives are being pursued?

How does the Chinese approach to the forging of a dual-use economy compare and contrast with policies being undertaken elsewhere by more experienced participants in civil-military integration, such as the United States and Japan?

What are the prospects that the Chinese defense economy will catch up as it becomes more innovative and is able to harness the resources of the civilian economy?

CHINA’S ENDURING QUEST FOR WEALTH AND MILITARY POWER

The relationship between the civilian and military components of the Chinese economy has often been turbulent, especially since the Communist Party took power in 1949. The quest for wealth and power has been an enduring aspiration of China’s rulers throughout the country’s long history, but finding an appropriate balance has been elusive. Whenever the pendulum has swung too far in either direction, the results have been calamitous. Excessive military spending invariably plunged the state into financial crisis, such as during the late Song Dynasty. But when military needs were neglected—especially during times of external threat, as in the late Qing period—the country was often too enfeebled to repel foreign invasion.⁸

Today’s leaders face the same conundrum of how to pursue prosperity while ensuring the country’s military might. Since embarking on the Open Door policy of economic reform and liberalization in the late 1970s, the ruling elite has emphasized economic development over defense priorities. This has led to rapid and sustained economic growth and the emergence of a competitive market-driven economy. While the military establishment and defense economy have been significantly reduced in size, national security remains a central priority for the leadership, which subscribes to the traditional view that economic progress and military strength are intimately intertwined.

Forging a mutually beneficial relationship between the competing interests of wealth and power is crucial for ensuring sustainable long-term growth and security. The country’s civilian and military leaderships consider the establishment of extensive ties between the civilian and defense economies to be one of the best means of achieving this strategic goal. But daunting obstacles exist, not the least of which is that this integrative approach goes against the traditional principle of the separation of the two economies. Nonetheless, the integration is likely to accelerate as China seeks to build up its defense capabilities to meet long-term challenges to its national security.

A host of strategic, economic, political, military, institutional, personality, and developmental factors and concerns explains why Deng Xiaoping, the father of the Open Door policy and reform era, and his successor, Jiang Zemin, were so enthusiastic in promoting spin-off and spin-on initiatives to assist in realigning the relationship between the civilian and military economies. Under Deng, the strategic rationale for the continued militarization of the economy faded as he switched strategic and domestic priorities from cold war confrontation to economic engagement. This led to a significant easing in military tensions. Harnessing the strengths of the civilian economy has been considered an important mechanism for China to promote self-reliance and mitigate its dependence on foreign sources, especially for critical technologies. Indigenization has become a crucial component of Chinese thinking on the relationship between technology, national security, and economic prosperity, which is sometimes referred to as techno-nationalism.⁹

Decisions makers, especially senior military leaders, have become increasingly reluctant to rely exclusively on the defense economy to meet the needs of the military establishment, particularly because of its poor track record in weapons development and innovation. Leaders have also argued that dual-use transfers of technology, research, and production capacity, especially through the conversion process, are a cost-efficient and effective means of making use of surplus defense industrial capabilities. Official Chinese statistics claim that around 80 percent of the production output value of the defense industry in the late 1990s were civilian goods compared with less than 10 percent in the late 1970s.¹⁰ The actual experience may not be as clear-cut because much of the military-to-civilian output came from newly added rather than converted production facilities. Nonetheless, the result is a defense economy that today is decidedly dual-use in nature.

The dual-use strategy has been developed and implemented over the last three decades. The military-to-civilian conversion initiative—known as the Combine the Military and Civilian Sectors, or Junmin Jiehe strategic guidance—was first put forward by Deng in 1978 and subsequently adopted as state policy.¹¹ The strategy, also referred to as the sixteen character guideline, was initially a political response by a new leadership seeking an alternative approach to tackling the burdens of excessive militarization that had contributed to stifling the growth of the civilian economy during the Maoist period. The actual definition of this slogan was left deliberately ambiguous because it served more as a political statement of intent than a detailed policy announcement. One of the key political purposes of the guidelines was to allay the concerns of the powerful military and defense industrial establishments that the shift from military industrialization to civilian economic development would lead to a serious erosion of the country’s defense industrial base.

The four original phrases contained in the Junmin Jiehe guidance addressed a number of key issues pertaining to the country’s transition from cold war preparedness to economic construction:

Combining military and civilian activities (Junmin Jiehe): The original meaning of this term was that defense enterprises should engage in both civilian and military production rather than focus exclusively on military output. Since the 1990s, though, it has been reinterpreted to mean the development of an integrated dual-use technological and industrial base.

Combining peacetime and wartime preparations (Pingzhan Jiehe): This phrase refers to the need to ensure that wartime mobilization requirements are taken into consideration during peacetime economic construction. The concern at the beginning of the 1980s was that the focus on economic development might lead to the neglect of the country’s military preparedness, especially as the cold war threat from the Soviet Union had still not receded.

Giving priority to military products (Junpin Youxian): This term was added to the sixteen-character guideline in 1982 and called on the defense economy as well as the rest of the civilian economy to ensure that military research and development (R&D) and production requirements were put ahead of commercial interests.

Letting the civilian sector support the military sector (Yimin Yangjun): The meaning behind this saying was that the military establishment would benefit from the growing prosperity and progress that would come from overall economic development. The implication was that civilian economic priorities would come before military security considerations, which was in line with the Four Modernizations program that set out the country’s national priorities when the sixteen-character policy was drawn up.

The Junmin Jiehe strategy can be divided into three phases of evolution. The first period covered the 1980s, when the authorities adopted a hands-off ad hoc approach by encouraging firms in the defense industry to convert from military to civilian production to fill the gap left by the sharp fall in defense spending. These entities were generally left on their own to respond to these changed circumstances. The government provided more direct support and guidance in the mid-1980s for the establishment of a strategic high-technology project known as the 863 program, which included the development of dual-use technologies.

In the second phase in the early to late 1990s, the authorities took a more involved role in the management and funding of the defense conversion process by incorporating the program into its five-year development plans. Financial assistance was earmarked for key projects, and efforts were made to foster linkages and partnerships to assist defense firms to find financing, markets, and information for their products. Since the late 1990s, a third phase has seen the focus of the government, military, and defense economy switch from conversion to spin-on activities. The integration of the civilian and defense technology and industrial bases has become a central priority for the defense economy. In the Tenth Five-Year Plan of the Commission of Science, Technology, and Industry for National Defense (COSTIND), which began in 2001, one of the key policy objectives was to actively promote the development of two-way civil-military technology cooperation, transfers, promotions, and joint development. COSTIND considered that the transfer of military industrial technology for civilian use and the transfer of advanced civil high technology for military use are of great importance . . . [and China] must establish a capable civil-military industrial foundation.¹²

This intensifying discussion of dual-use strategy eventually led to the adoption of a new set of guiding principles that superseded Deng’s original Junmin Jiehe strategic guidance in 2003.¹³ This new sixteen-character list of principles included Junmin Jiehe (Combining Civil and Military Needs), Yujun Yumin (Locating Military Potential in Civilian Capabilities), Dali Xietong (Vigorously Promoting Coordination and Cooperation) and Zizhu Chuangxin (Conducting Independent Innovation).¹⁴ The most important of these concepts was Yujun Yumin, which refers to the forging of an integrated dual-use system, especially the establishment of a civilian apparatus that has the technological and industrial capabilities to meet the needs of the PLA and defense economy. At the third plenum of the Sixteenth Party Congress in 2003, a decision was made to construct a new civilian technological and industrial base with embedded military capabilities. This called for the building of an innovative Junmin Jiehe, Yujun Yumin - based system that focused on the mutual promotion and coordinated development of the defense and civilian technological sectors.¹⁵ Thus, Yujun Yumin became the strategic outline for the future dual-use economy.

THE NATIONAL INNOVATION SYSTEMS FRAMEWORK

At the heart of this book is the relationship among technology, innovation, national security, and a country’s developmental trajectory. How innovation takes place in the military-security sphere has been examined through organizational, societal, business management, structural realist, diffusion, and military doctrinal frameworks of analysis.¹⁶ Another useful approach, especially in its application to late-industrializing states, is the concept of the national innovation system (NIS), which views technological development and innovation as a constantly evolving process.¹⁷ Because innovation is a highly complex and little-understood process, competing views abound as to what constitutes an NIS. In general terms, though, there is broad agreement among scholars that it includes all important economic, social, political, organizational, institutional and other factors that influence the development, diffusion and use of innovations.¹⁸

Under this definition, the key components of an NIS are organizations and institutions. Organizations are formal structures that are consciously created and have an explicit purpose, such as firms, universities, and government agencies that are involved directly or indirectly in supporting the innovation process.¹⁹ In this book, entities that are directly engaged in innovation such as research institutes, enterprises, and universities will be referred to as primary actors, and those that are indirectly involved, such as government agencies, are termed secondary actors. Institutions are, as Douglass North points out, akin to the rules of the games, which refer to sets of common habits, norms, routines, established practices, rules or laws that regulate the relations and interactions between individuals, groups and organizations.²⁰ The different ways that organizations and institutions are set up within countries help to explain the variation in the national style of innovation. Research universities, for example, play an important role in the NIS in the United States but are more peripheral in Japan and Germany.²¹

Much of the research conducted on the NIS has concentrated on the components of the system, but understanding the systems-level functions and activities is equally as important. According to Steven White and Liu Xielin, these functions are related to the creation, diffusion and exploitation of technological innovation within a system.²² Activities that they and others have identified as fundamental to nurturing innovation include R&D, implementation for manufacturing use, end use, education, and linkages to bring together complementary knowledge.²³

In late-industrializing states such as China, the focus of technological development and innovation diverges markedly from that in industrialized economies. These states emphasize absorption and incremental innovation rather than the development of new or radical products or processes.²⁴ Absorptive