Canadian Security Intelligence Service

Aug 27, 2003



Weapons Proliferation and the Military-Industrial Complex of the PRC


Summer 2003

Disclaimer: Publication of an article in the COMMENTARY series does not imply CSIS authentication of the information nor CSIS endorsement of the author’s views.


Since the 1980s, China’s proliferation activities have included export of weapons and materials for the production of conventional, nuclear and chemical weapons, ballistic and cruise missiles, as well as production technology and technical assistance. This report briefly considers the relationship between the PRC’s military-industrial complex and its proliferation activities. It is based on open-source materials available in North America, which have obvious limitations given the subject matter. A second caveat is that significant changes are currently taking place in many of the relevant sectors in China, including the regulatory framework, the bureaucracy responsible for implementing regulations, and the civilian and military enterprises engaged in arms production and trade.

Improving Non-Proliferation Posture...

China’s non-proliferation posture improved considerably in the past decade. It indicated its commitment to multilateral arms control regimes through signing of agreements such as the Nuclear Non-Proliferation Treaty and the Chemical Weapons Convention. China has also signed a number of bilateral agreements, especially with the United States. It strengthened controls on arms exports through the Regulations on Export Control of Military Items in 1997 and the Export Control Laws on Dual Use Nuclear Goods and Related Technology the following year. These regulations were intended to make the Chinese arms export system more transparent and codified, to improve oversight procedures, and to signal China’s adoption of international standards. All of these steps suggest that the Chinese leadership has been taking a longer term view of China’s interests, recognizing that proliferation of weapons of mass destruction may hurt China’s own interests, diminish China’s international respectability, and threaten relations with the United States, on which China depends not only for the military technology it needs for its own military modernization, but also other technology, investment, and markets.

… but Continued Proliferation

Chinese entities, including the disarmingly named Shandong Arts and Crafts Corporation, have been accused of selling missile guidance equipment and fibre optics for air defences to Iraq as recently as 2001. The most recent unclassified CIA report on weapons proliferation, which covers the six-month period ending June 2002, indicates concern about Chinese as a supplier in virtually every category of weapons. It finds continued contact with Iran, and “cannot rule out… continued contacts” with Pakistan on nuclear weapons programs. It finds that China continues to provide chemical weapons, dual-use technology and equipment to Iran, and dual-use items, raw materials and technical assistance relating to missile production to Iran, Libya, North Korea and Pakistan. Lastly, it indicates that China continues to supply advanced conventional weapons, including fighter aircraft, to several countries. While China is not a major player in the international arms market, its proliferation activities are nonetheless troubling. Its sales contribute to the proliferation of weapons of mass destruction and to destabilizing “rogue” regimes, and China sells considerable amounts of dual-use technology.

Market Trends

Chinese arms exports have declined dramatically, both absolutely and as a percentage of total global arms sales, since the mid-1980s, when sales averaged $2 billion per year, and Iraq alone purchased $5 billion. Current sales are estimated at around $600 million per year, though that number spiked dramatically to almost $3 billion because of one-time sales in 1999. There are a number of reasons for the decline. The most important is a shift in global demand towards hi-tech weapons that China is not able to produce. Secondly, China has accepted bilateral commitments that restrict exports of its most competitive products, namely ballistic and cruise missile systems. Thus U.S. pressure on China to adhere to Missile Control Technology Regime led to the cancellation of sales of M-9 missiles to Iraq. The composition of China’s arms sales is also shifting. Whereas in the 1980s it sold a broad range of nuclear materials and equipment and complete missile systems, its sales today are mainly dual-use nuclear, chemical and missile technology. Its only real growth area is in low-end SAMs and SSMs.

China is increasingly a supplier of last resort, supplying customers who can’t afford higher quality products, or who are unable to access suppliers for political reasons. For example, Pakistan bought Chinese F-7 fighter aircraft because of a U.S embargo, because the Russian market was closed due to Moscow’s closer ties with India, and because French Mirage fighters were considered too expensive. It is also a supplier of last resort in that it supplies weapons that no other country is willing to supply, such as chemical weapons equipment to Iran.

Why does China Continue to Proliferate?

In the 1980s, arms transfers were used to support Beijing’s battle with Taipei for diplomatic recognition. Large sales of arms were made to Saudi Arabia, for example, in the years leading up to that country’s granting recognition to the People’s Republic. But this battle has now largely been won. Proliferation today remains an important part of China’s foreign and security policy in other ways. For example, China has sought to strengthen Pakistan’s armed forces as a buffer against India, its main perceived threat in South Asia. It has made significant transfers to oil-rich countries of the Gulf region as a means to increase Chinese political and military influence in the region, and secure future oil supplies. This is part of China’s energy security policy, and of an overall strategy to counter U.S. power in the region. The Chinese have been particularly interested in arms trade with countries that U.S. energy companies may not invest in, such as Sudan, Iran, and formerly Iraq. In the past few years, China has also linked proliferation to other foreign policy issues, such as its opposition to U.S. plans for NMD/TMD and to U.S. arms sales to Taiwan. In other words, China has attempted to use weapons transfers as leverage to attain other security goals.

The Military-Industrial Complex

Economic considerations are another broad reason why China continues to proliferate. But the significance of arms sales to the Chinese economy as a whole is trivial. Rather, the economic significance is to individual entities within the military industrial complex, namely, entities that produce and trade arms, and the bureaucracies that regulate them. Both of these sectors are currently in a state of flux.

There are two distinct components to the production and sale of arms in China: military and former military enterprises such as Poly Group, and civilian defence enterprises, both state-owned and private, such as NORINCO and Huawei.

In order to increase funds for the military, in the 1980s the Chinese army was allowed to enter into profit-making businesses, under favourable tax and investment rules. By the mid-1990s, the so-called PLA Inc. included over twenty thousand companies in everything from agribusiness to electronics to tourism to arms exports. In 1998, because of concerns about corruption and discipline, the leadership ordered the PLA to divest itself of its profit-oriented businesses in exchange for increases to the military budget, and shortly thereafter declared the divestiture a success. But the PLA has not completely withdrawn from the economy, nor have divested firms completely severed their ties with the PLA.

These issues are best illustrated by the example of Poly Technologies, founded in the 1980s by the son of a PLA marshal, and currently headed by the son in law of Deng Xiaoping. Before 1998, Poly was one of the major exporters of weapons and technology from China. It had several U.S. subsidiaries involved in technology acquisition, and representative offices in Rangoon, Bangkok and Islamabad. Its employees were implicated in the 1996 attempt to smuggle AK-47s into the U.S. The effects of the divestiture order on Poly are not entirely clear. Its arms-trading entities are believed to have been retained by the newly created General Armaments Division of the PLA, where they are not easily subject to civilian control.

Now known as China Poly Group, the divested Poly has diversified into a broad conglomerate, active in tourism, infrastructure construction and real estate (It has even brokered a deal to buy Bombardier jets for China’s PLA run airline). China Poly Ventures Company, a Poly subsidiary, is believed by U.S. intelligence to have transferred production technology for Pakistan Ghauri medium range ballistic missile in 1999, and possibly later. Newly independent firms have strong economic incentives to continue arms sales, since their management is now responsible for profit and loss for the enterprise. Many managers of Poly and firms like it are former military officers or family members, who retain close ties to high government officials, which makes these enterprises difficult to control. On the other hand, divestiture probably weakened bureaucratic relationships which enabled proliferation activities in the past. For example, Poly is believed to have influenced defence production and procurement entities to over-supply the PLA arsenal, with Poly then selling the surplus abroad at reduced prices. It is unlikely that Poly and firms like it will continue to exercise such influence, which will make their arms exports less profitable.

The second wing of arms production in China is the civilian defence industry. This can be further divided into the state-owned and the private sector, each of which is probably involved in international arms sales in a slightly different way. The five major state-owned defence industry conglomerates have no formal links to the PLA, and are controlled by China’s State Council through the Commission of Science, Technology and Industry for National Defence (COSTIND). Protected from competition for political and security reasons, the state-owned defence industrial complex is a bloated and inefficient sector, which employs about 10% of China’s total industrial workforce.

Recognizing the need to reform this sector, China’s leadership announced in 1998 a plan for widespread reform. Unlike the divestiture of PLA Inc, the thrust of this reform was conversion, which really meant diversification of production to civilian products. Massive subsidies were provided to accomplish this. The best-known defence conglomerate is NORINCO, the corporation formed out of the former ordinance ministry (Fifth Ministry of Machine Building). It now has 800 000 employees working in over 200 subsidiaries, including 11 in the U.S. While it now also produces civilian products, its arms-related products include armoured vehicles, howitzers, mortars, rocket launchers, anti-aircraft weapons, anti-tank missile systems, small arms, ammunition, explosives, and nuclear, biological and chemical protection systems.

NORINCO and its subsidiaries have long been of security concern. As early as 1984, the firm was named in documents relating to attempts to smuggle military related high-tech items from the USA to China. Three employees of NORINCO were sentenced to jail terms in China in the case of smuggled AK-47s to the US in the late 1990s. NORINCO continues to engage in sales of conventional weapons abroad. In March 2000, it sold US $65.9 million in arms including anti-personnel shells and assault rifle grenades to the government of Zimbabwe. Recently announced upgrades to Pakistan’s T-59 Al Zarrar tank were the result of cooperation with NORINCO. More recently, on 23 May 2003, the U.S. State Department issued a two-year ban on imports of products from NORINCO and subsidiaries to the United States, charging that the entity had sold rocket fuel and missile components to the Shahid Hemmat Industrial Group, the Iranian government agency in charge of developing and producing ballistic missiles. The ban will affect at least US$200 million in goods, and, according to CIA estimates, as much as five times that figure if U.S. customs can identify all of NORINCO subsidiaries, which export everything from toys and shoes (Wal-Mart is a major purchaser) to auto parts and aluminum heat sinks for computers. Other firms in this category, such as China Precision Machinery Import-Export Corporation, and China Great Wall Industrial Corporation, are among those currently sanctioned by the U.S. for illegal transfers of weapons, dual-use material and technology to Iran.

State-owned defence producers are under great pressure to become profitable. But conversion has not been very successful, for many firms have been unable to find civilian products in which they are competitive. This increases the likelihood that they may engage in weapons transfers. Moreover, as part of the conversion process, the number of enterprises has proliferated greatly, making monitoring extremely difficult. Reports indicate that not even NORINCO itself is clear about the number of its subsidiaries in south China. Companies in this sector still have powerful patrons in the government, army and party. Concern about the consequences of large-scale unemployment and social unrest should state-owned enterprises become insolvent ensures continues subsidies and lax monitoring. On the other hand, for historical reasons, most of the firms in this category are not able to produce the hi-tech weapons demanded by international buyers.

Besides state-owned defence producers, China also has private companies involved in defence production, such as the telecom firm Huawei. With offices in Cuba, Iran, and Burma, Huawei has been a major supplier of dual-use telecom equipment. In 2001, its Indian subsidiary was accused of tailoring a commercial order for the Taliban regime in Afghanistan. Also in 2001, Huawei supplied Iraq with fibre optics to link its radar and anti-aircraft systems, triggering U.S. and U.K. bombings. Private defence firms often also enjoy the shielding of powerful patrons. Huawei was founded by a former PLA officer, and benefitted from early sales to the PLA. But it also receives state support in the form of tax privileges and state-sponsored credit because it has been designated a “national champion” of new technology. Its supporters have included top general Yang Shangkun and head of the China International Trade and Investment Corporation, Wang Jun (also president of Poly). Unlike state-owned defence producers, private firms are more likely to be profitable. A further level of complexity in their proliferation activity is that foreign firms seeking to do business with them may try to shield them from U.S. sanctions.

Arms and Arms-control Bureaucracies

Since 1998, COSTIND has had ultimate regulatory responsibility for the defence industry in China. It determines which military and nuclear goods may be exported, and monitors the process of export licensing. It is not clear however how COSTIND assesses that process, nor how it consults with other relevant agencies, such as the General Armaments Division of the PLA, and the Foreign Affairs Office of the Ministry of National Defence (there are rumours of a turf war between these latter two agencies). An even more fundamental question is the extent to which agencies in Bejing can control what the firms discussed above do. There has long been debate about this question, though as a recent Rand study points out, the Chinese government has always claimed that it does control all proliferation activities of Chinese firms, and that all exports are authorized. Certainly, the proliferation of firms caused by the divestiture of PLA Inc., the conversion of the civilian defence industry, and the growth of the non-state hi-tech sector make it much harder for the state to monitor proliferation activities. This is particularly true of dual-use technology. In the most well-known case in recent years, ring magnets were sold by the China National Nuclear Corporation to a lab linked to the Pakistani nuclear weapons project. But the magnets did not fall under an export control list, nor was the value of the transaction above the threshold to trigger other review mechanisms.

In late 2002, the PRC government issued a series of more comprehensive export control regulations, including Regulations on Export Control of Missiles and Missile-related Items and Technologies, Regulations on Export Control of Dual-use Biological Agents and Related Equipment and Technologies, and Measures on Export Control of Certain Chemicals and Related Equipment and Technologies. The measures include licensing and application systems, provisions for criminal prosecution, and guarantees from purchasers, and are intended to strengthen export controls to prevent diversion of dual-use technologies. While the timing of these documents was surely linked to the summit between Jiang Zemin and George Bush, they must nonetheless have been in the works for some time. Of course, the rigour with which these new controls are implemented and enforced, not the regulations themselves, will determine their ultimate significance. In the short term, this is likely to be a most significant issue, as the Chinese government itself is engaged in a major campaign to streamline and downsize its bureaucracy. Coupled with the uncertainties that persist about the regulatory process, this does not inspire confidence in the ability of the government to enforce its regulations.

A group of Harvard scholars who visited China in January 2003 report evidence that the Chinese government finally means business on proliferation. Besides the 2002 regulations, their evidence includes statements for reliable sources that China’s new leaders intend to delink arms-control from other security concerns in negotations with the U.S., and the transfer of the hardline Sha Zukang from the head of the arms control office of the Ministry of Foreign Affairs. Hu Jintao, they report, is committed to arms control because of the implications for China’s international reputation, the need to improve relations with the U.S., and recognition of the dangers of proliferation to China’s long-term interests.

China’s response to the NORINCO sanctions is less encouraging. The U.S. apparently issued two warnings last year about NORINCO’s ties with Iran, to which Beijing did not react. On May 27, China’s Foreign Ministry responded angrily to the sanctions, insisting that China is a responsible government that has strictly enforced its own regulations, and denying that NORINCO had provided assistance to Iran. It is too early to tell whether the tougher U.S. line on Chinese proliferation will persist, or what the long-term effects on the behaviour of both Chinese government and Chinese arms producers will be.

As the discussion above has illustrated, significant problems remain. Some security considerations continue to support proliferation, but there are also strong policy arguments against. The economic considerations are minimal to the country as a whole. However, a variety of actors within the military-industrial complex do have strong economic incentives to continue arms sales, and enjoy considerable patronage and protection from domestic and international monitoring. The bureaucratic and regulatory changes to China’s arms export regime, while promising, are not in themselves sufficient to limit proliferation. That will depend on the rigour with which the regulations are enforced, and the erosion of the close and complex ties between arms producers, the PLA, and state officials. In the short term therefore, the possibility of illicit arms sales and other forms of proliferation will probably increase, even as the long-term prospects for more institutionalized oversight have improved.

Commentary is a regular publication of the Research, Analysis and Production Branch of CSIS. Inquiries regarding submissions may be made to the Director General of the Research, Analysis and Production Branch at the following address: Box 9732, Stn. "T", Ottawa, Ont., K1G 4G4, or by fax at (613) 842-1312.

The views expressed herein are those of the author, who may be contacted by writing to: Box 9732, Stn. "T", Ottawa, Ont., K1G 4G4, or by fax at (613) 842-1312.

ISSN 1192-277X
Catalogue JS73-1/84