3 September 1998
Source: Foreign Affairs, September/October 1998, pp. 2-9.

The Great Technology Giveaway?

Trading with Potential Foes

Michael Hirsh

MICHAEL HIRSH is Newsweek's Economics Correspondent, based in Washington.

For all its nuclear peril, the Cold War was in some ways a reassuring time. The enemy was clear, and so were America's choices, or at least it often seemed. So perhaps Congress can be forgiven for reverting to its Cold War reflexes when confronted with a sudden series of proliferation issues last spring. On May 11, India exploded several nuclear devices, becoming the first nation in three decades to declare itself a new member of the nuclear club. A few days later came the shocking allegation that two U.S. satellite companies, Loral Space & Communications and Hughes Electronics, had violated U.S. export restrictions by helping Beijing to improve its missile guidance systems--and, presumably, the aim of a handful of Chinese intercontinental ballistic missiles targeted at U.S. cities. Then on May 28, Pakistan set off its own nuclear tests, an event unconnected to the China controversy but one that seemed, nonetheless, to be insidiously linked. Pakistani Prime Minister Nawaz Sharif, after all, made a point of thanking the Chinese for their technical help on the bomb.

Suddenly, a world long decompressed from the Cold War seemed to be back on the brink. Only this time, Dr. Strangelove had a Chinese face. On May 20, the House voted overwhelmingly to ban the sale and launching of U.S. satellites in China. After the Pakistani tests, Congress also approved a $2.5 million investigation of all technology transfers to China. America's national security, declared some politicians, was being sacrificed at the altar of commerce. Both Republicans and Democrats accused the Clinton administration of carelessly liberalizing high-tech trade with China--encouraged, perhaps, by $1 million campaign donations from the likes of Loral chief Bernard L. Schwartz--and engaging Beijing with a stream of deals that were helping to transform what is still a large developing nation into a 21st century superpower.

That, anyhow, was the perception. Despite the amicable Clinton-Jiang summit in late June, it is a perception that has endured. But the truth is that such thinking is a dangerous anachronism. Demonizing China, a nation clearly in transition, may prove to be a self-fulfilling prophecy, unnecessarily fostering Cold War II. Even more important, Congress' reaction is a technological throwback; its worst mistake is not in misunderstanding China, but in failing to comprehend the transformation going on before its own eyes in the U.S. economy. The idea that national security and commercial interests trade off--that every time you sell a satellite overseas, you make a profit but lose a little bit of your military edge-- harks back to a time when CIA bean counters worried over every uptick in Soviet technology, and when the U.S. defense industry was sequestered in top-secret grandeur, spending untold billions on weapons designed exclusively for the Pentagon, with older-generation models going to America's Cold War allies.

Today the situation could not be more different. Quietly, without most Americans noticing, a revolution has turned the U.S. defense industry upside down. Very little is custom-made for the Pentagon. So reduced is its procurement budget--at about $50 billion, it is now about one-third what it was at the start of the decade--that few defense contractors could survive without a heavy diet of commercial and overseas contracts. As a result, by necessity, the defense industry has grown civilianized. Now much of the best defense technology--like naval propulsion, electronics, and command-and-control telecommunications--is coming from the commercial sector. Dual use has become the rule and not the exception. Apart from a handful of quasi-monopolistic contractors like Lockheed Martin and Newport News Shipbuilding, "the industry is reconstituting itself into a commercially oriented business that also happens to have defense customers," said John R. Harbison, a long-time defense analyst for Booz, Allen & Hamilton, in an interview in June.

NOBODY BEATS THE WIZ

What that means is that, more than ever before, national security and commerce have become mutually reinforcing, not competing, interests. America's defense edge is part and parcel of its commercial prowess. And that prowess in turn depends on exports and a global leadership role for American business. Indeed, banning Loral, Hughes, and other satellite companies from competing for business in China would probably harm America's national security more than letting their prize technologies slip into Beijing's hands, which, in any case, almost never happens.

This growing reliance on commercial technology has been a long-term trend, one set in motion well before Bernie Schwartz ever met Bill Clinton. And it is probably irreversible, given how far ahead the commercial sector is already. "Once upon a time we had the resources in this department to lead the field," Paul G. Kaminski, the former Defense under secretary for acquisition and technology, told me in an interview shortly before he left office last year. "So if something interested us like the development of transistors or computers in missiles, we led the pack in developing it." Hence, for example, the Internet famously began as a highly classified data transmission network linking U.S. nuclear weapons labs. But three decades or so ago that balance began to change, and today it has become too expensive for the Defense Department to build new technology from scratch on "milspec," or military specifications. "I think the amount spent on research in the Department of Defense was surpassed commercially in 1965," said Kaminski. "The disparity has grown ever more since," especially since the end of the Cold War. Kaminski told of sending a Defense Science Board task force to Bosnia to examine how the U.S. military was doing in supplying intelligence to forward-based troops. "They said, 'pretty badly,"' he recalled. "They said there were better modems in the corner store. So we put in place a fix, leasing a transponder on a commercial satellite. There was a 3,000-fold improvement. The only thing we needed was encryption."

SATELLITES SCHMATELLITES

Satellites are a good example of how dramatically the Cold War order has been overturned. Once developed largely for spying and command and control, satellites have become the building blocks of an immense new commercial space industry. Last year was the first time that Vandenberg Air Force Base sent up more commercial than military payloads. "The U. S. military is now a minority user on its own ramps," Gil I. Klinger, the deputy under secretary of defense for space, told my colleague John Barry, Newsweek's defense correspondent, last spring. "Now we are chasing furiously behind the commercial users." In fact, several of the main U.S. defense satellite constellations are nearly obsolete, and intelligence sources say the Pentagon intends to go commercial to replace them. No worry there, you might think: the United States is still far and away the world leader in this $27 billion commercial industry, which could grow to be worth as much as $170 billion by 2007. But others, like the Europeans, are close behind. And competition is intense. About 1,700 commercial satellite launches are projected for the next ten years, and there is a nearly three-year global backlog for launcher space. At present only four countries--the United States, Russia, France, and China--supply it. Launch schedules are crucial to competitiveness: when customers like CNN buy satellites or time on satellites from Loral or Hughes, they pay for it up front, and they do not get revenue until the satellite is aloft. So, to stay competitive, sellers like Loral need to minimize the time lag between purchase and launch. "If you cut our guys out of one of four satellite launchers in the world, it puts them at a significant competitive disadvantage," William A. Reinsch, under secretary of commerce for export administration, said in an interview in June. "Say the nearest launch window is in two years for U.S. satellites, and the Germans come in and say, 'Oh, by the way, we'll launch on China and they've got a window 9 months from now.' That's a 15-month revenue stream I can't get if I buy the American satellite."

Some critics point out that more countries are planning to offer launch services. But few experts dispute that a competitive rush is on and that the launch bottlenecks are staggering. Any loss of business for U.S. satellite companies may translate into a lost defense edge for the Pentagon down the line--especially since military and civilian satellite technology is so similar. The message is plain: to react to the putative threat from China by banning satellite sales to that country is to cut off Uncle Sam's nose to spite his face. There are side benefits to America's commercial dominance as well: U.S. intelligence, for instance, is helped far more if the Chinese military uses U.S. commercial satellites than it would be if China developed its own hard-wired, secure military alternative.

[World map omitted of "Top U.S. Export Markets for Some Dual Use Equipment." Satellites, high performance computers, semiconductor manufacturing equipment and gas turbine engines.]

THE L.L. BEAN THREAT

The vibrancy of America's industrial base, of course, was also key to winning the Cold War. The Soviet Union was essentially bankrupted out of existence, not defeated on the battlefield. But the relationship between economics and national security was then an indirect one: a strong U.S. economy produced the taxes needed to supply the trillions of dollars plowed into defense. We all recall the hundreds of contractors who infamously slurped billions from the public trough, coughing back $2 billion stealth bombers and $600 hammers. Now that defense complex has been reduced to a handful of super-survivors like Lockheed Martin, Boeing, and a few others that emerged from the flurry of mergers and acquisitions in the 1990s. This is one reason the United States is helping itself to a peace dividend that now includes a balanced budget. Indeed, if there is any issue Congress should be examining, it is whether defense consolidation has gone too far. In some platform sectors, like heavy tanks and nuclear carriers, only one monopoly supplier effectively remains where there were once two or more. That is why the Justice Department prevented the recent merger of giants Lockheed Martin and Northrop Grumman.

Another factor driving this revolution-- and one that is also irreversible--is that more and more countries produce the same dual-use equipment. Take another controversial export case involving state-of-the-art machine tool equipment made by McDonnell Douglas, which was diverted to a Chinese military plant in 1995, possibly for cruise missile production. You would not know it from the hue and cry in Washington, but the Germans had sold the Chinese similar milling machines years before. A similar critique can be made of the recent controversy over an encrypted circuit board supposedly stolen by the Chinese after the 1996 crash of a rocket carrying a Loral satellite. In truth, that encryption is so old and widespread it is probably worthless. One industry survey last fall found that 653 encryption products were now available from 29 different nations. Norman R. Augustine, the recently retired head of Lockheed-Martin and a key force behind the industry's consolidation, says that much of the state-of-the-art technology that drives defense is "fungible. I think it's just not possible to keep it in the box anymore."

One problem for those who do want to keep it in a box is that the line dividing military technologies from civilian ones is constantly receding. One by one, commercial uses are being found for formerly military technologies--another peace dividend. Night vision goggles are important military equipment, covered as munitions by the State Department, but they are also available in the L.L. Bean catalog. Global positioning satellites, once intended for guiding ballistic missiles, today are within reach of every backpacker and car owner; around 250,000 GPS receivers are sold each month (although here the government, in a national emergency, could seize control of the network in a wink). Or consider chips hardened to withstand radiation. Once devised because the U.S. military wanted to protect its satellites from attack, today there is a civilian clamor for them. Fearing cyclical spikes in solar activity, companies hope to use them to preempt pager blackouts.

Just as important, warfare is getting increasingly high-tech and computerized, and it will only become more so as the 21St century brings electronic battlefields. Silicon Valley is crucial to the military-industrial complex of the future. Whereas the portion of the Defense Department's R&D procurement budget devoted to electronics was just one percent a couple of decades ago, now it is nearly half. Computer technology accounts for much of this increase. In 1995 the Clinton administration authorized an independent study, which was followed by an internal administration review, that concluded that the ability to design and make nuclear weapons--a key reason for export controls on computers--had long since flown the coop. At the same time, Defense Secretary William J. Perry came to realize that top-grade supercomputers were going to be necessary for 21st century warfare-- determining everything from warhead design to weather patterns in the Adriatic Sea in the event of a NATO air strike. But "if you examine our high performance computer companies, of which there are now only seven, every single one of them gets more than 50 percent of its revenues from exports," says Reinsch. "Perry understood that if you rely on the Pentagon as your computer market you're going to go broke. The only way these guys are going to stay in business and make new-generation products that the Pentagon can buy is if they're out in the marketplace leading the way in exports." Clinton, as a result, has constantly raised the export threshold for supercomputers, allowing more and more powerful machines to be sold abroad without a license.

THE LAST SUPPER

One of the great ironies of the satellite scandal is that the Pentagon has been portrayed by press reports as the agency most worried by the national security threat allegedly posed by Loral and Hughes. But it was former Pentagon chief Perry who was the brains behind putting defense technologies up for sale. It was Perry, then deputy defense secretary, who one night in 1993 gathered the biggest names in the arms industry and announced, at what became known as the Last Supper, that about half of them would soon disappear from the Pentagon's payroll, victims of post-Cold War budget cuts. Then, in June 1994, Perry issued a momentous memo making commercial rather than military specifications the norm for Pentagon purchases. That same year he oversaw the dissolution of COCOM, the Soviet-era Coordinating Committee for Multilateral Export Controls, and opened the way to the overseas sales of almost all computer and telecommunications equipment without export licenses. Such licenses once would have made these deals illegal without U.S. government approval. As a result, the number of licensing cases involving potentially dual-use technology abroad dropped from a high of 120,000 per year under the Reagan administration to fewer than 9,000 cases by 1996.

The Perry doctrine enraged the hardliners in the Defense Department's Defense Technology Security Administration, a Reagan-era body whose raison d'etre is keeping wraps on dual-use goods--and which has been mainly responsible for press leaks on the satellite issue. But the policy met with a willing audience at the Commerce Department, which began trumpeting export promotion under Secretary Ron Brown. Hence the seeds of the current scandal were sown: U.S. exporters loved the policy and began pushing for ever more market openings. Under intense corporate lobbying--by such big political donors and high-tech China exporters as Hughes, AT&T, Loral, and United Technologies--more and more equipment was redefined as dual-use rather than munitions, which puts it under the perusal of the State Department, and moved to a fast-track approval process at Commerce.

Perry had simply decided that in the post-Cold War era it was all but impossible to halt the global flow of dual-use technologies, and that America had to go with the flow to keep its industries alive. True, many of these new exports dovetailed nicely with Beijing's high-tech wish list, but they also made eminent sense in the new commercialized environment. Indeed, there was not much choice. "I think the criterion [for export control] is whether or not we are sole possessors of the technology," Perry explained in an interview last year, before the current controversy erupted. "There was a consistent effort during the whole time I was in the government to reach agreement with Western countries on a unified approach to technology control . . . We did not have much success." At the same time export fever began to overtake the Europeans, who were anxious about their own ailing defense industries. The government did manage to replace COCOM in 1996 with something called the Wassenaar arrangement, a less formal accord among Western countries for keeping a lid on military-related exports. But with the exception of a few targeted rogue nations such as Libya, it is proving to be mostly a paper tiger.

ONE STEP AHEAD

None of this means the West should just drop efforts at export control. Nor does it belie the potential seriousness of the allegation against Loral and Hughes. Both weapons sales and dual-use technologies that clearly contribute to missile, nuclear, or biochemical weapons production need to be assiduously monitored, even with all the headaches of doing so. And they are, at least under law: if it is true that these two satellite companies evaded the required State Department approval before passing on missile guidance information to China, that would be an indisputable violation of U. S. export controls. But it is important to remember that for now the allegation remains a singular one, hardly something that would justify banning all satellite exports to China. Contrary to reports, the Pentagon is sharply divided over whether national security was harmed at all.

The changing nature of technology and geopolitics also means that Washington must keep refining export controls. A General Accounting Office report on another dual-use controversy--involving the sale of AT&T switching equipment to a People's Liberation Army-affiliated company--criticized the Commerce Department on this score in November 6. It pointed out that, under loosened Commerce rules, companies are pretty much on their own in determining who is a civilian versus a military end user in China, but it concluded that Commerce does not "offer any guidance on how" to do so. Before high-tech exports were liberalized, when companies were forced to apply for an export license, the GAO report noted, the Commerce Department would conduct its own review "using available government resources such as embassy personnel and intelligence reports." It noted that exporters "do not have such resources available to them when making a civil end-user determination." Commerce has responded, creating a blacklist with 28 suspect end users.

The larger point, however, is that America's export control policy can no longer be to close down its borders. In an era of open technology transfer, the centerpiece of any viable strategy must be to keep one's industries running faster than the next economy's. U.S. policy should be twofold: to promote U.S. commercial leadership in dual-use technologies, and to maintain tough but reasonable export monitoring that will slow--even if it does not stop-- the acquisition of those technologies by potential enemies. America's national security will be assured as long as the Chinese (or, through them, the Iranians or Pakistanis) are always lagging a few product cycles behind. But that is about all that can be done. "There's going to be a lot more slippage and leakage," says former Assistant Defense Secretary Joseph S. Nye, Jr. "This technology is broadly shared, and the sense of threat [about China] isn't broadly shared."

Unfortunately, the Clinton administration has done a wretched job of articulating this new reality. It is another example of how the president's essential centrism--and, perhaps, the taint of scandal--have prevented him from breaking new conceptual ground and seizing the mantle of real leadership. FDR described great presidents as "leaders of thought at times when certain ideas in the life of the nation had to be clarified." Clinton continues to justify his technology transfer policy by pointing out that he is only following what President Bush did, an irony much noted to his detriment, since Clinton notoriously attacked Bush's engagement policy, and by focusing on the negative-- in other words, what the United States does not allow China to have. Or he makes the same droning point about China trade being crucial to U.S. jobs. What no one has explained is that trade--yes, trade with China--may well be crucial to U.S. national security. Maybe that is why the comprehension of this new paradigm is sinking in so slowly, especially on Capitol Hill.