Mr. Chairman and distinguished members of this Subcommittee, thank you for the privilege of appearing before you today to explore some of the national security implications of S. 1315, a bill to create an Office of National Security at the Securities and Exchange Commission (SEC).
But before I begin I must qualify my testimony today. The bill being considered is designed to address possible financial threats wherever they might arise. Dr. Ariel Cohen, my colleague at The Heritage Foundation, has identified possible threats from the Russian market in a paper that I would like to submit for the record.
For my testimony, I would like to note that my work at Heritage has focused largely on the national security challenges facing the United States in Asia. My recent work has pertained largely to analysis of the implications for the United States of China's ongoing military modernization, and the growing role of foreign military technology in that modernization. I offer for submission to the record my latest paper compiling weapons and systems that China has purchased from abroad, or is seeking to purchase, to modernize its armed forces.
This work relates to the issue of this hearing in that it is my intention to underscore the importance of creating a National Security Office for the SEC as it pertains to broader American national security concerns in Asia. I do not claim to be an expert on the nature or extent of China's, or indeed the PLA's, possible activities in American or international financial markets. The activities of PLA-controlled companies in the Chinese and U. S. economies will be addressed in much greater detail in a Foreign Relations Committee hearing scheduled for tomorrow. On many occasions my organization has written that expanding trade with China, promoting greater American exports to China, and convincing China to open its economy far more than the current level can be part of a responsible relationship with China. I do not believe that S. 1315 would detract from this goal.
However, it is also clear that China is building up its military forces and is preparing for possible conflict that may arise from its goals of eventually securing control of Taiwan or the South China Sea. If the activities of Chinese or PLA-controlled companies in U.S. financial markets could contribute to China's ability to Rind its military modernization, then U.S. investors deserve to be warned of the dangers resulting from their potential transactions with certain Chinese firms.
I would like to expand on four propositions relevant to this hearing and the Bill under consideration.
First, it is clear that PLA-owned or controlled companies are a growing feature of China's economy, and they can be expected to be an increasing presence in financial markets.
Second, the profits made by PLA companies are fungible. They could benefit the modernization of China's armed forces.
Third, the PLA needs increasing amounts of hard-currency to fund modernization programs that depend on foreign weapons or military technology.
Fourth, with added funding, the PLA will try to obtain technology to improve its strategic missile systems, and the power projections capabilities of its air and naval forces.
Under the economic reforms initiated by the late Deng Xiaoping, the People's Liberation Army was forced to generate more of its own funding in a market redirected toward greater competition. Today, the PLA's role in China's economy is becoming so significant that Commerce Department officials can be heard to suggest, partially in jest, that a separate accession agreement to the World Trade Organization should be negotiated for the PLA. However, while the fact of the PLA's growing role in China's economy is readily discernible, it is more difficult to quantify its dimensions. There is a great deal of work to be done both to determine the extent of the PLA's economic influence and to identify PLA-related and affiliated companies.
Estimates of the PLA's economic impact in terms of annual revenues range from Professor David Shambaugh's 1994 estimate of $7.5 billion (1) to PLA analyst Richard Bitzinger's 1995 estimate of $20 billion. (2) A more recent estimate by PLA analyst Tai Ming Cheung puts the annual revenues of PLA companies at $7 billion to $9 billion, with a profit of $480 million to $720 million. (3)
Estimates of the number of PLA controlled or affiliated companies range from 10,000 to 2O,OOO. The majority of these companies may just be"suitcase"companies that facilitate a wide array of business but whose small size defies effective monitoring. The second largest category of PLA-related companies appear to be farms or mines affiliated with Region-level military units. All of the armed services of the PLA--the Second Artillery missile forces, the Air Force, the Navy and the Army--have related commercial enterprises. The Second Artillery's Shanhaidan Group is involved in the pharmaceutical industry. The Air Force runs an airline called United Airlines, and the Navy, as might be expected, runs a shipping company and a shipyard. The center for military research and development, the Commission for Science, Technology, and Industry for National Defense (COSTIND), runs a variety of companies, some of which involve dual-use civil-military technology like telecommunications.
There is also a category of PLA-affiliated companies that are large diversified conglomerates that increasingly rely on civilian businesses. As these companies grow they seem also to shed their military roots. However, the exact relationship between these companies and the PLA deserves further investigation. Companies such as these operating in the United States include: Poly, China Xinxing, 999 Group, and Norinco. Their U.S.-based companies tend to change rapidly, hiding from public scrutiny under layers of shell-companies.
It is perhaps these conglomerates that can be expected to become increasingly active in financial markets, issuing stocks and bonds to raise capital. PLA companies can be expected increasingly to raise capital on stock markets. PLA companies are listed in the Hong Kong, domestic Chinese, Australian and Canadian stock markets. Some analysts suggest that companies under high levels of PLA control may not yet be active in bond markets. But this could change as China's bond markets develop. The investing public could benefit from increasing information on the activities of these companies in the U.S. market.
Many observers note that the PLA benefits from affiliated companies that manage to make profits. While operating expenses and corruption consume much of the profit of PLA companies, local units are also able to increase the standard of living for troops by augmenting pay and improving quarters. So in a broad sense, money the PLA does not have to budget for pay and living quarters can be used to fund the purchase of advanced military technology. In the early 1990s, products from PLA companies were used in barter trade to purchase new Russian weapons. This trend is declining as the Russians and other countries demand hard currency for weapon sales. It also is known that foreign weapons purchases are made from special budgets not part of the main PLA budget. Little is known about the nature of these budgets or the origin of their funds. It is at least plausible that PLA-controlled or affiliated companies not subject to U.S. disclosure rules could raise funds from U.S. or international financial markets and subsequently divert those funds to help purchase foreign weapons.
To fund its modernization program the PLA will require much higher levels of foreign exchange, as the PLA relies increasingly on foreign technology to accelerate its modernization. In some cases China seeks one or a few examples of a weapon system in order to attempt to learn or copy its technology. But increasingly China is being forced to purchase significant numbers of weapon systems that is unable to develop domestically. This is the case with advanced fighter aircraft, radar aircraft, anti-aircraft and ground attack missiles for aircraft, long-range transport aircraft, advanced surface-to-air missiles, submarines, supersonic anti-ship missiles, radar satellites, military laser systems and strategic missile subsystems.
It is also noteworthy that outlays for foreign weapons only begin with the initial purchase. China also has to purchase training services, spare parts and maintenance support, all of which add significantly to the life-cycle cost of the weapon system. Again, these follow-on costs will require expenditures of foreign exchange.
To purchase these weapons China is turning primarily to Russia--which is demanding more and more hard currency to pay for its military technology. The contract to purchase production rights for 200 Sukhoi SU-27 fighters may have cost China over $2 billion. A recent contract to purchase Two Russian missile destroyers reportedly cost China $800 million. Since the early 1990s China has spent at least $ 1 0 billion on Russian weapons. Russia needs this money not only to purchase inputs from its reforming, cash-based economy, but also to fund future weapons development necessary to remain competitive.
Israel is a close competitor for PLA military contracts, which Israel uses to support its defense sector. Some Israeli systems are the best in the world, but they also are expensive. To purchase one radar aircraft equipped with the Israeli Phalcon phased array radar China will spend a reported $250 million. China could buy 5 to 7 more.
In the near future, European countries like France, Britain and Italy would like to reenter the China arms market. According to one European business source, a factor which has delayed the phasing out of the 1989 post-Tiananmen European Union arms embargo, has been China's inability to pay for significant weapons purchases. Britain has relaxed the interpretation of the EU arms embargo to allow the sale of military airborne radar to China in mid- 1 996. This deal could be worth $60 million. In late 1996, France and China reportedly discussed the sale of a then soon-to-be decommissioned French aircraft carrier--provided China purchased French weapons and systems to modify and maintain the ship--potentially worth hundreds of millions of dollars. This deal has yet to be completed.
If the PLA had the necessary funds, it would implement modernization plans that are roughly discernible today. Shocked by the success of U.S. military forces in the Gulf War, the PLA seeks to develop areas of asymmetrical advantage to exploit perceived U.S. military weaknesses. For example, the U.S. military is heavily dependent on satellites for command, communication and intelligence. So China is seeking to develop anti-satellite systems as it simultaneously seeks to make greater use of space to support its military operations. Similarly, to counter the U.S. reliance on large aircraft carriers to project power, China seeks much better submarines and difficult-to-counter supersonic anti-ship missiles.
China's principal goal is to acquire a military capability that will enable it to achieve its political-diplomatic goals. A high priority for China in coming years will be to achieve unification with Taiwan under Beijing's terms. This may require military forces that deter Washington from coming to Taipei's assistance, as inferred in the 1989 U.S. Taiwan Relations Act. The PLA also needs missile, air and naval forces necessary to prevail in military skirmishes with Taiwan so as to compel Taipei to bow to Beijing's wishes in future relations. And over the long term, should its nationalist mind set continue, China will likely seek military forces capable of dominating most other Asian countries, including Japan.
Military modernization plans by service would include:
Second Artillery. China is now developing two new intercontinental ballistic missiles that are capable of reaching targets in the United States. These new ICBMs will be solid fueled and road-mobile. This means they will be very difficult to impossible to detect. Their mobility is being assisted by the purchase of Russian strategic missile transporter technology. China also may be seeking Russian ICBM technology to assist in the development of new missiles or the upgrade of existing ICBMs.
China is also building a new class of medium range ballistic missiles that eventually could incorporate terminal guidance warheads--conferring very high accuracy at ranges over 1,000 miles. China is seeking to improve the accuracy of its DF- 1 5 short-range ballistic missiles--the kind used off Taiwan in the 1996 exercises--with guidance inputs from U.S. Global Positioning Satellites (GPS). In addition, China is expected by the U.S. Department of Defense to field a new class of long-range cruise missiles early in the next decade. These new cruise missiles may use Israeli or Russian cruise missile technology.
China also is seeking Russian and European technology to build radar satellites useful for finding targets in all weather conditions and for finding naval formations at sea. China also will seek greater access to commercial satellite imaging companies that are increasing in number. And as it seeks to use space for military purposes, China also is seeking the means to deny the use of space to adversaries. China is very likely developing anti-satellite and anti-missile systems. Russia could be a source for such technologies. And China is known to have a great interest in developing its domestic technology base in the area of military lasers. Again, Russia could be a useful source for critical laser technologies.
Air Forces. China seeks to build a modem all-weather interdiction air force. It seeks fighters, radar control aircraft, and aerial tankers to accomplish air superiority missions near Taiwan or over the South China Sea. It also seeks modem all-weather attack aircraft with advanced precision-guided munitions to operate in the same areas. Such an air force is in part designed to deter U.S. interference by raising the cost to U.S. air assets that may be used to support Taiwan.
From Russia it has obtained the Sukhoi SU-27 fighter, one of the most capable fighter aircraft currently in service anywhere. Israel is helping China to develop its J- IO fighter with technology from the Israeli Lavi fighter program--which was subsidized with about $1.4 billion in U.S. military aid. Russia and Israel have teamed up to sell China an advanced radar control aircraft, and Russia is trying to sell China long range aerial refueling aircraft. China has purchased very capable air-to-air missiles from Russia and Israel. and has purchased air-launched supersonic anti-ship missiles from Russia.
Naval Forces China apparently is still debating the strategic merits versus the huge expense of purchasing aircraft carriers. In the meantime the PLA Navy is concentrating on improving its submarines and on obtaining better anti-ship missiles for its combat ships and subs. Again, the goal is to deter U.S. military interference by raising the cost to U.S. forces of intervention.
From Russia, China has already obtained two modem Kilo-class conventional attack submarines, and by next year likely will have four. The latter two will be of the advanced 636 model, which are rated by the U.S. Office of Naval Intelligence as very quiet and difficult to detect. Technology from this sub may help China to improve its new Song-class conventional submarine. China also is reported to be using Russian technology to build a new class of nuclear-powered attack submarines.
Russia also is helping the Chinese Navy in the area of modem combat ships and supersonic anti-ship missiles. By the end of this decade China may have two Russian Soveremenniy-class missile destroyers. These are efficient and capable warships armed with the SS-N-22 supersonic anti-ship missile. Only a few U.S. destroyers equipped with the Aegis radar system can potentially shoot down the SS-N-22. All other U.S. ships, and those of our allies, are very vulnerable to the SS-N-22. But Russia is now marketing a lighter-weight supersonic anti-ship missile, the Yakhont. This missile is even more attractive to China than the SS-N-22 because it can be fitted to a larger number of existing Chinese warships.
The Chinese have an old saying that roughly translates, "The marketplace is a
battlefield." This says much about the Chinese approach to business competition. But it has a
double meaning for this hearing. PLA-related companies in many ways can help prepare PLA
combat forces for future battlefields. The goals of S. 1315 are laudable inasmuch as the
proposed National Security Office for the SEC could help Americans decide whether to invest in
companies that may be helping China advance its military goals. There is a very clear
requirement for much greater open source data on the extent and membership of the PLA-related
economy. Perhaps such an office in the SEC could become a valuable resource to help guide
(1) David Shambaugh, [section on China] "World Military Expenditure," SIPRI Yearbook 1994, (Oxford: Oxford University Press, 1994), pp. 443-444.
(2) Richard A. Bitzinger, "China's Defense Budget," International Defense Review, February 1995, p. 36.
(3)Tai Ming Cheung, "The Chinese Army's New Marching Orders: Winning On The Economic Battlefield,"
in Jorn Bromelhorster and John Frankenstein, eds. Mixed Motives, Uncertain Outcomes, Defense
Conversion In China, (Boulder: Lynne Rienner, 1997), p. 195.
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