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Date Posted: 29-Jul-2008
Jane's Defence Weekly
A morning star shines: China's military modernisation, part two
China has reversed the fortunes of its defence industry in the past 10 years by accepting the market as a generator of wealth and vision, says Timothy Hu
With bustling production lines and surging profits, China's defence industry is booming. Its weapon manufacturers are feasting on a backlog of orders from the country's armed forces and capitalising on leadership exhortations to catch up with the world's advanced military industrial powers within the next two decades by investing heavily in research and development (R&D).
These successes represent a remarkable turnaround for an industry that was on its knees only a decade ago and haemorrhaging red ink. In the intervening years, the defence industry has undergone a far-reaching restructuring and downsizing to shake off its old identity as a bloated bastion of socialist central planning and become a more market-driven and innovative sector. This has led to the shutting of several hundred factories and the loss of hundreds of thousands of jobs.
The success of this reform drive can be measured in the improving financial performance of the entire defence sector. Officially disclosed earnings in 2007 for the 11 conglomerates that sit at the top of the Chinese defence industrial pyramid totalled USD6.3 billion - a record high and an 80 per cent jump on 2006 earnings - while total revenues for 2007 posted a strong 17.6 per cent gain on the previous 12 months.
However, as more than three quarters of this income is derived from non-defence-related activities, such as the sale of civilian goods, this rosy financial picture reflects a highly diversified business portfolio that includes a robust growth in military orders.
Another indicator of the defence sector's health and vibrancy is the steady stream of new and more capable weapons that are being produced or are under advanced development. In the past two years, China has unveiled an array of new indigenous weapon platforms that are at least a generation ahead of its existing arms line-up. This includes the Chengdu J-10 combat aircraft, the WS-10 jet fighter turbofan engine, Luyang- and Luzhou-class destroyers, Song-class submarines and a ballistic anti-satellite weapon system that destroyed a satellite at an altitude of 865 km in a test in early 2007.
State planning
To meet the near-term rearmament needs of the People's Liberation Army (PLA) and at the same time satisfy the longer-term transformational aspirations of the political leadership, the defence industry is pursuing a twin-pronged approach whose priorities, goals and aspirations are set out in two different sets of planning guidance.
The immediate and short-term requirements are addressed in the 11th Five Year Defence Science and Technology (S&T) Plan that runs from 2006 to 2010 and calls for "giving impetus to the combined development of mechanisation and informatisation". This plan is practical and pragmatic in nature and is grounded in the realities of limited defence budgets, restricted access to state-of-the-art foreign technology and know-how and the overall backward state of the PLA's current technological standards.
A central goal of the 11th Five Year Plan, according to the 2006 Chinese Defence White Paper, is to "lay a solid foundation by 2010" for the country's military posture. The defence industry will be expected to assist the PLA in selectively replacing a limited proportion of its existing arsenal with new-generation naval, aviation and missile hardware.
The remaining bulk of the inventory would be upgraded cheaply through the addition of sensors, navigational positioning systems, infrared detectors, computers and other devices that would allow them, in theory at least, to conduct network-enabled operations. Another important priority for the defence industry during this period is to press ahead with structural reforms intended to improve the flow of funds, technology and knowledge into and across its system.
A far bolder vision is contained in the long-range planning guidance. The 'Development Programme of S&T for National Defence 2006 to 2020' and its civilian counterpart, the 'Guidelines for the Medium- and Long-Term National S&T Development Program 2006 to 2020', were promulgated in 2006 and, taken together, represent a comprehensive blueprint for the undertaking of ambitious technological leap-frogging efforts to 2020.
Key research and development priorities include command, control, communications, computers, intelligence, surveillance and reconnaissance (C4ISR)-related capabilities, such as information technology, laser technology, space-based technology and high-speed computer technology, as well as electronic warfare systems and integrated command automation networks.
While the specific contents of the 15-year defence S&T plan are classified, a brief published outline shows that the focus is on basic and frontier defence technologies, early and advanced-stage applied R&D of next-generation weapons and the development of dual-use high-technology industries and manufacturing technologies for the defence sector. This is likely to include conventional weapon projects such as the next-generation J-X combat aircraft, which is reportedly a stealthy, twin-engine jet powered by the WS-10 and has been undergoing R&D for the past decade, and a number of airborne warning and control systems, such as the KJ-200 and KJ-2000 aircraft.
The civilian medium- and long-term S&T development plan offers more concrete details of a number of specific dual-use and strategic high-technology projects being pursued by the defence industry that are receiving priority state funding. They include the development of a 'large-sized' passenger airliner, high-resolution earth observation systems, manned spaceflight and moon exploration projects and large-scale nuclear advanced pressurised water reactors and high-temperature and gas-cooled reactors.
Rank and file
The Chinese authorities recognise that sustainable progress in defence technological and hardware modernisation has to go hand in hand with the upgrading of the structure, management and operations of the defence industry, which has seen a number of important reforms implemented in the past year. In March 2008 the Commission for Science, Technology and Industry for National Defence (COSTIND), which had been in charge of the military industrial complex for the past 25 years, was merged into a new super bureaucracy called the Ministry of Industry and Informatization (MII) and renamed as the State Administration for Science, Technology and Industry for National Defence (SASTIND).
Critics of COSTIND contended that this organisation should be abolished because it was a legacy of the defence industry's Soviet inheritance and hindered rather than promoted technological innovation and industrial efficiency owing to its excessive interference in enterprise affairs. Much of this criticism came from military officers who argued that COSTIND's defence-related work should be undertaken instead by the PLA's General Armament Department. They pointed out that oversight of the defence industrial complex in the US and Europe is handled by the Pentagon and defence ministries.
In the March reorganisation SASTIND was demoted from a ministry-level entity to a bureau-level outfit, which in the hierarchy-conscious Chinese bureaucracy has important implications for political influence and access to decision makers. In another blow, SASTIND lost control over its management of the nuclear energy sector, which was handed over to a new National Energy Commission.
Other government agencies merged into the MII along with SASTIND include the Ministry of Information Industries, State Council Informatization Office, portions of the National Development and Reform Commission responsible for industrial and trade issues and the State Tobacco Monopoly Administration. The new head of SASTIND, Chen Qiufa, a former COSTIND deputy director, is also a deputy minister within the new ministry. MII Minister Li Yizhong is a petroleum expert with no prior background in defence industrial affairs, which suggests that his interests and priorities are unlikely to be in the military realm.
The stated goals of the MII are to promote the co-ordinated development between traditional industrial sectors and high technology and the information and communications technology industries, play a leading role in the indigenous nurturing of key strategic industries and support civil-military integration. This would require close co-ordination between SASTIND and the rest of the MII apparatus.
Government officials say that the new ministry's role is not to intervene directly in the micromanagement of enterprises or the market but to focus on strategic planning and the drawing up of industry standards and regulations. The establishment of MII along with several other super ministries is described as a trial experiment and some analysts believe that it may take several years before these new organisations are integrated and functioning properly.
A key question is whether SASTIND will be able to retain its traditional wide-ranging autonomy and political clout or lose its independence and be fully subsumed into the new ministerial structure. With a long experience of bureaucratic infighting and organisational survival, SASTIND stands a good chance of preserving its autonomy within the new government setup.
Power struggle
However, with its diminished formal access to high-level decision-making circles, SASTIND's clout in policy-making and the internal battles over budgets is less clear. This may provide an enhanced role for the Central Special Commission (CSC); a high-powered ad-hoc committee that is formally affiliated with the State Central Military Commission - the country's top political-military decision-making body. The CSC is headed by the country's Prime Minister, Wen Jiabao, and includes representatives from the military, defence industry and other government agencies. The CSC is involved in inter-agency co-ordination and approving major strategic technology projects such as the country's manned space programme.
SASTIND's lower status could allow more room for the country's defence industrial corporations to flex their growing commercial muscle. There are presently 11 state-owned enterprises that dominate the six subsectors of the defence industry. A duopolistic arrangement has been in place since the end of the 1990s when the central government sought to break up monopolies and promote competition by establishing two companies in most of these sectors:
- In the nuclear industry China National Nuclear Corporation is responsible for the country's nuclear arsenal and civilian nuclear power programme while China Nuclear Engineering and Construction Corporation is primarily involved in the construction of nuclear power plants and defence-related nuclear facilities.
- In the shipbuilding sector, China State Shipbuilding Corporation (CSSC) is the principal equipment supplier to the PLA Navy, which includes missile destroyers, frigates, submarines, missile corvettes and auxiliary vessels for space instrumentation and replenishment. In 2007, production from CSSC accounted for 22 per cent of total Chinese shipbuilding output and the company has set its sights on becoming the world's largest shipbuilder by 2015. China Shipbuilding Industry Corporation is heavily focused on civilian shipbuilding, although it does have a sizeable naval division. It has some of the largest shipbuilding yards in China and can build vessels up to 300,000 DWT (deadweight tonnage);
- Extensive overlap exists in the space industry between China Aerospace Science and Technology Corporation (CASTC) and China Aerospace Science and Industry Corporation (CASIC). CASTC's core strengths are in launch vehicles, manned spacecraft and satellites, including communications, meteorological, earth resource and scientific experimental satellites, as well as strategic and tactical missiles, while CASIC specialises in the development and production of guided missile systems, especially surface-to-surface, air defence, cruise missiles, mini-satellites and information technology;
- The two dominant ordnance entities are split along geographical and functional lines. China Ordnance Industrial Group Corporation, known as China North Industries Corporation (Norinco), has most of its facilities located in the country's northern provinces and manufactures the bulk of the industry's tanks, armoured vehicles and munitions supplies. China Ordnance Equipment Group Corporation is concentrated in southern China and its core business is in civilian vehicle production, which accounts for more than 50 per cent of its annual revenues;
- The defence electronics sector, by contrast, has only one overarching conglomerate China Electronics Technology Group Corporation, which was established in 2002.
In a significant departure from this de-monopolisation strategy the country's two aviation industry groups are being consolidated into a single entity - a move that will be completed by the end of this month. Analysts say that a key reason behind this move was that the 1999 separation of Aviation Industries Corporation of China (AVIC) I and II was poorly conceived and had adversely weakened the Chinese aviation industry's competitiveness because of widespread duplication of activities. Additionally, the two companies were dwarfed and squeezed out of the international market place by far larger Western companies. The annual sales revenues of Boeing, for example, are four times the combined total for AVIC I and AVIC II. The merged company, which will be known as China Aviation Industry Group Corporation, will have around 200 subsidiaries and assets of USD32 billion.
An important catalyst for the aviation industry's re-organisation was the amalgamation of the commercial aviation arms of AVIC I and AVIC II in May into a separate company called China Commercial Aircraft Corporation (CCAC) that will be responsible for the indigenous development of a new large 150-seat airliner/military transport aircraft. This is intended to reduce China's reliance on Western manufacturers such as Boeing and Airbus. China so far only has experience in developing mid-sized passenger and transport aircraft, such as the 90-seat ARJ21 regional airliner.
Technology showcase
This large passenger airliner project is a leading priority in the Chinese government's medium- and long-term S&T development plan and its political importance was reflected in the appointment of former COSTIND director Zhang Qingwei as CCAC chairman.
This project will be a useful barometer to assess how much risk and new thinking the defence industry is willing to embrace in pursuing ambitious high-technology R&D projects. One pioneering approach that CCAC is preparing to take is to list on the Hong Kong stock market to raise capital to fund its development costs.
Tapping into financial markets is a new initiative by the once-secretive defence industry, which has previously relied almost exclusively on government funding. The defence industrial authorities began taking steps in 2007 to open up the country's stock and capital markets to defence industrial enterprises. A key goal is to expand the sources of funding available for defence firms to tap into and reduce their heavy reliance on the state. Chinese officials say that the limited access to investment funds has been a major factor holding back the defence industry's growth and technological modernisation.
The authorities are especially eager to attract domestic state-owned, private and even foreign firms to acquire equity stakes in defence companies as well as allow them to list on the country's two stock markets in Shenzhen and Shanghai and also in Hong Kong. COSTIND issued a series of policy guidelines and regulations last year to define the framework of this market liberalisation.
According to a senior SASTIND official involved in drafting these reforms, this policy initiative "signifies that the reform of the defence science and technology industry has entered a new historical phase, which will certainly have a far-reaching impact on the building of a new defence science and technology system". Another SASTIND official said that the defence industry could raise upwards of USD9 billion by the end of this decade.
Companies affiliated with the defence industry have been allowed to list on the stock markets since the early 1990s, but under tight restrictions that precluded entities involved in military-related work. The new, more permissive regulatory regime now allows companies with military programmes to make stock-market or private listings to outside investors as long as they satisfy secrecy regulations and their defence projects are not deemed to be too sensitive.
Within a few weeks of the passage of these new regulations in November 2007, Xian Aircraft International, a defence company listed on the Shenzhen stock exchange, won approval for a private USD970 million share placement with 10 Chinese state-owned firms to acquire civilian and defence assets from its parent Xian Aircraft Industry Corporation (XAC) - one of the country's major aircraft manufacturing outfits. XAC builds the FB-7 naval fighter-bomber and the H-6 bomber.
The willingness to reach out to the non-state sector is another important aspect of the Chinese defence industry's realignment and integration within the broader national economy. As the defence industry has significantly downsized and diversified its business activities during the past couple of decades, its core of dedicated defence enterprises has also been reduced. In response, the defence industrial authorities have sought to broaden its supporting base of secondary subcontractors that are able to supply both military and non-military components and services to the top-tier prime contractors and systems integrators.
In recognition that the private sector has now become a pivotal driver of the country's economic and technological growth, the central government in 2005 for the first time formally allowed non-state firms to bid for work from the defence industry. Informal co-operation had been taking place for some time, although this was limited to select numbers of privileged and well-connected civilian firms such as Huawei Technologies. COSTIND and its successor SASTIND have so far issued several dozen licences that allow private firms to bid for defence industrial contracts.
Allowing non-state firms to participate in defence industrial work is a key plank of a broader strategic initiative aimed at forging an integrated civil-military dual-use economy.
Defence industrial authorities are especially keen to forge close ties between the defence industry and non-state firms in the information and high-technology sectors and academic research institutions such as universities and scientific academies that possess advanced technological skills and capabilities not available in the defence sector.
Defence industrial enterprises hope that by leveraging the commercial technologies and business practices of civilian firms, this can lead to major productivity and efficiency gains as well as improvements in products. The design, development and testing of weapon systems, for example, especially complex equipment such as combat aircraft and warships, is a prolonged process that often takes as long as 15-20 years for the Chinese defence industry to carry out. Consequently, these weapons are prone to being overtaken by technological advances before they even enter into service. Through the use of already developed commercially available technologies and advanced manufacturing processes, this could offer substantial time savings and reduce the risk of lengthy delays.
The development of the Chengdu Aircraft Corporation's (CAC's) FC-1/JF-17 fighter shows the benefits that can be reaped by employing commercially available technology and know-how. CAC was able to shorten the time frame for the research and design of the aircraft by as much as 50 per cent through the use of computer-aided design and manufacturing software.
Substantial cost savings could be gained through the employment of commercial manufacturing processes and the joint sharing of R&D expenses. Chinese estimates suggest that joint development of civil-military projects could lead to investment savings of as much as 40 per cent.
The acceleration in the opening up and reform of the Chinese military industrial complex and a growing outflow of hardware from the domestic weapons R&D pipeline suggests that after more than a decade of leaning heavily on Russia as a key source for advanced military equipment and technology, the PLA may now look increasingly to its own defence industry to meet its needs.
This shift from reliance on Russian arms to favouring indigenous sourcing appears to be a decisive factor behind a significant slowdown in Chinese-Russian arms deals. According to the Stockholm International Peace Research Institute, Russian arms sales to China fell by 62 per cent in 2007 from the previous year. Russian estimates of the total value of Chinese arms acquisitions from Russia since the beginning of the 1990s is around USD27 billion.
The reasons behind this improvement in Chinese indigenous defence industrial capabilities have sown discord in ties between Moscow and Beijing. Russian officials allege that China's success in revamping its defence industrial capabilities has been largely due to its illicit copying and reverse engineering of key Russian weapon systems. This has allowed China to replace its arms imports from Russia with Chinese-made copies. The most prominent of these infringements include the Su-27 fighter and advanced defence electronic systems, such as radar and data-link systems for the Sovremenny II 956E destroyer and Fregat M2EM 3D and Mineral-ME radar systems.
Intellectual rights
The case of the Su-27 appears to have been the most egregious. China signed a licence agreement in the mid-1990s to produce upwards of 200 Su-27s from Russia at its Shenyang Aircraft Corporation facilities in northern China. Output of the aircraft occurred smoothly until 2004, when negotiations for shifting production to a more advanced version of the Su-27 ran into problems as China indicated that it did not want to build any more of the aircraft.
In 2005 China was discovered to have been engaged in the development of the Shenyang J-11B, which is a reverse-engineered Su-27 but with extensive incorporation of indigenously developed technologies. China also received assistance from Ukraine and Belarus, which are major Su-27 users. Improved features of the J-11B over the Su-27 include a reduced radar cross-section, improved fire-control radar, use of composite materials, a new flight control system and a digital glass cockpit. An extensive effort to incorporate the WS-10 powerplant into the J-11B is under way, but this has so far not been successful and China has had to instead acquire large numbers of AL-31FN turbofan engines from Russia.
Following public furore in Russia over this apparent Chinese copying, new Russian President Dmitry Medvedev was reported to have sought an agreement on the protection of Russian defence intellectual property rights during his inaugural state visit to China in May. At the same time, however, both sides continued to discuss future arms sales and technical co-operation, including deals for combat aircraft, naval weapons and the possible renovation of Russian weapons purchased during the 1990s.
As the Chinese defence industry seeks to reduce the PLA's dependence on Russian arms, it is also looking to become a major arms exporter again. During the 1980s and early 1990s, China was among the world's leading weapon suppliers to developing countries, but it stumbled after the mid-1990s as the domestic defence industry was unable to produce arms that could compete in the international market place.
With a burgeoning arsenal of capable and cost-effective weapons, Chinese arms manufacturers are actively marketing their products. Among China's main customers are Pakistan as well as countries in the Middle East and Africa.
However, the PLA is likely to remain the Chinese defence industry's dominant client for the foreseeable future and will drive the requirements for the industry's long-term technological development. While the gains in productivity, technological innovation and quality standards during the past 10 years have been impressive, China still lags one or two generations behind the most advanced industrial nations.
Bridging this technological gap represents a much greater challenge for the Chinese defence industry because it will need to go beyond a tried and trusted conservative strategy of making incremental improvements and pursue higher-risk R&D approaches that require extra effort if it wants to master the disruptive technologies that the US and other major military powers have or are working on, such as stealth technology and network-centric systems.
For more on China's defence industry, see the July edition of Jane's Industry Quarterly.
Timothy Hu is a JDW correspondent based in the US
Jane's Login
Date Posted: 29-Jul-2008
Jane's Defence Weekly
A morning star shines: China's military modernisation, part two
China has reversed the fortunes of its defence industry in the past 10 years by accepting the market as a generator of wealth and vision, says Timothy Hu
With bustling production lines and surging profits, China's defence industry is booming. Its weapon manufacturers are feasting on a backlog of orders from the country's armed forces and capitalising on leadership exhortations to catch up with the world's advanced military industrial powers within the next two decades by investing heavily in research and development (R&D).
These successes represent a remarkable turnaround for an industry that was on its knees only a decade ago and haemorrhaging red ink. In the intervening years, the defence industry has undergone a far-reaching restructuring and downsizing to shake off its old identity as a bloated bastion of socialist central planning and become a more market-driven and innovative sector. This has led to the shutting of several hundred factories and the loss of hundreds of thousands of jobs.
The success of this reform drive can be measured in the improving financial performance of the entire defence sector. Officially disclosed earnings in 2007 for the 11 conglomerates that sit at the top of the Chinese defence industrial pyramid totalled USD6.3 billion - a record high and an 80 per cent jump on 2006 earnings - while total revenues for 2007 posted a strong 17.6 per cent gain on the previous 12 months.
However, as more than three quarters of this income is derived from non-defence-related activities, such as the sale of civilian goods, this rosy financial picture reflects a highly diversified business portfolio that includes a robust growth in military orders.
Another indicator of the defence sector's health and vibrancy is the steady stream of new and more capable weapons that are being produced or are under advanced development. In the past two years, China has unveiled an array of new indigenous weapon platforms that are at least a generation ahead of its existing arms line-up. This includes the Chengdu J-10 combat aircraft, the WS-10 jet fighter turbofan engine, Luyang- and Luzhou-class destroyers, Song-class submarines and a ballistic anti-satellite weapon system that destroyed a satellite at an altitude of 865 km in a test in early 2007.
State planning
To meet the near-term rearmament needs of the People's Liberation Army (PLA) and at the same time satisfy the longer-term transformational aspirations of the political leadership, the defence industry is pursuing a twin-pronged approach whose priorities, goals and aspirations are set out in two different sets of planning guidance.
The immediate and short-term requirements are addressed in the 11th Five Year Defence Science and Technology (S&T) Plan that runs from 2006 to 2010 and calls for "giving impetus to the combined development of mechanisation and informatisation". This plan is practical and pragmatic in nature and is grounded in the realities of limited defence budgets, restricted access to state-of-the-art foreign technology and know-how and the overall backward state of the PLA's current technological standards.
A central goal of the 11th Five Year Plan, according to the 2006 Chinese Defence White Paper, is to "lay a solid foundation by 2010" for the country's military posture. The defence industry will be expected to assist the PLA in selectively replacing a limited proportion of its existing arsenal with new-generation naval, aviation and missile hardware.
The remaining bulk of the inventory would be upgraded cheaply through the addition of sensors, navigational positioning systems, infrared detectors, computers and other devices that would allow them, in theory at least, to conduct network-enabled operations. Another important priority for the defence industry during this period is to press ahead with structural reforms intended to improve the flow of funds, technology and knowledge into and across its system.
A far bolder vision is contained in the long-range planning guidance. The 'Development Programme of S&T for National Defence 2006 to 2020' and its civilian counterpart, the 'Guidelines for the Medium- and Long-Term National S&T Development Program 2006 to 2020', were promulgated in 2006 and, taken together, represent a comprehensive blueprint for the undertaking of ambitious technological leap-frogging efforts to 2020.
Key research and development priorities include command, control, communications, computers, intelligence, surveillance and reconnaissance (C4ISR)-related capabilities, such as information technology, laser technology, space-based technology and high-speed computer technology, as well as electronic warfare systems and integrated command automation networks.
While the specific contents of the 15-year defence S&T plan are classified, a brief published outline shows that the focus is on basic and frontier defence technologies, early and advanced-stage applied R&D of next-generation weapons and the development of dual-use high-technology industries and manufacturing technologies for the defence sector. This is likely to include conventional weapon projects such as the next-generation J-X combat aircraft, which is reportedly a stealthy, twin-engine jet powered by the WS-10 and has been undergoing R&D for the past decade, and a number of airborne warning and control systems, such as the KJ-200 and KJ-2000 aircraft.
The civilian medium- and long-term S&T development plan offers more concrete details of a number of specific dual-use and strategic high-technology projects being pursued by the defence industry that are receiving priority state funding. They include the development of a 'large-sized' passenger airliner, high-resolution earth observation systems, manned spaceflight and moon exploration projects and large-scale nuclear advanced pressurised water reactors and high-temperature and gas-cooled reactors.
Rank and file
The Chinese authorities recognise that sustainable progress in defence technological and hardware modernisation has to go hand in hand with the upgrading of the structure, management and operations of the defence industry, which has seen a number of important reforms implemented in the past year. In March 2008 the Commission for Science, Technology and Industry for National Defence (COSTIND), which had been in charge of the military industrial complex for the past 25 years, was merged into a new super bureaucracy called the Ministry of Industry and Informatization (MII) and renamed as the State Administration for Science, Technology and Industry for National Defence (SASTIND).
Critics of COSTIND contended that this organisation should be abolished because it was a legacy of the defence industry's Soviet inheritance and hindered rather than promoted technological innovation and industrial efficiency owing to its excessive interference in enterprise affairs. Much of this criticism came from military officers who argued that COSTIND's defence-related work should be undertaken instead by the PLA's General Armament Department. They pointed out that oversight of the defence industrial complex in the US and Europe is handled by the Pentagon and defence ministries.
In the March reorganisation SASTIND was demoted from a ministry-level entity to a bureau-level outfit, which in the hierarchy-conscious Chinese bureaucracy has important implications for political influence and access to decision makers. In another blow, SASTIND lost control over its management of the nuclear energy sector, which was handed over to a new National Energy Commission.
Other government agencies merged into the MII along with SASTIND include the Ministry of Information Industries, State Council Informatization Office, portions of the National Development and Reform Commission responsible for industrial and trade issues and the State Tobacco Monopoly Administration. The new head of SASTIND, Chen Qiufa, a former COSTIND deputy director, is also a deputy minister within the new ministry. MII Minister Li Yizhong is a petroleum expert with no prior background in defence industrial affairs, which suggests that his interests and priorities are unlikely to be in the military realm.
The stated goals of the MII are to promote the co-ordinated development between traditional industrial sectors and high technology and the information and communications technology industries, play a leading role in the indigenous nurturing of key strategic industries and support civil-military integration. This would require close co-ordination between SASTIND and the rest of the MII apparatus.
Government officials say that the new ministry's role is not to intervene directly in the micromanagement of enterprises or the market but to focus on strategic planning and the drawing up of industry standards and regulations. The establishment of MII along with several other super ministries is described as a trial experiment and some analysts believe that it may take several years before these new organisations are integrated and functioning properly.
A key question is whether SASTIND will be able to retain its traditional wide-ranging autonomy and political clout or lose its independence and be fully subsumed into the new ministerial structure. With a long experience of bureaucratic infighting and organisational survival, SASTIND stands a good chance of preserving its autonomy within the new government setup.
Power struggle
However, with its diminished formal access to high-level decision-making circles, SASTIND's clout in policy-making and the internal battles over budgets is less clear. This may provide an enhanced role for the Central Special Commission (CSC); a high-powered ad-hoc committee that is formally affiliated with the State Central Military Commission - the country's top political-military decision-making body. The CSC is headed by the country's Prime Minister, Wen Jiabao, and includes representatives from the military, defence industry and other government agencies. The CSC is involved in inter-agency co-ordination and approving major strategic technology projects such as the country's manned space programme.
SASTIND's lower status could allow more room for the country's defence industrial corporations to flex their growing commercial muscle. There are presently 11 state-owned enterprises that dominate the six subsectors of the defence industry. A duopolistic arrangement has been in place since the end of the 1990s when the central government sought to break up monopolies and promote competition by establishing two companies in most of these sectors:
- In the nuclear industry China National Nuclear Corporation is responsible for the country's nuclear arsenal and civilian nuclear power programme while China Nuclear Engineering and Construction Corporation is primarily involved in the construction of nuclear power plants and defence-related nuclear facilities.
- In the shipbuilding sector, China State Shipbuilding Corporation (CSSC) is the principal equipment supplier to the PLA Navy, which includes missile destroyers, frigates, submarines, missile corvettes and auxiliary vessels for space instrumentation and replenishment. In 2007, production from CSSC accounted for 22 per cent of total Chinese shipbuilding output and the company has set its sights on becoming the world's largest shipbuilder by 2015. China Shipbuilding Industry Corporation is heavily focused on civilian shipbuilding, although it does have a sizeable naval division. It has some of the largest shipbuilding yards in China and can build vessels up to 300,000 DWT (deadweight tonnage);
- Extensive overlap exists in the space industry between China Aerospace Science and Technology Corporation (CASTC) and China Aerospace Science and Industry Corporation (CASIC). CASTC's core strengths are in launch vehicles, manned spacecraft and satellites, including communications, meteorological, earth resource and scientific experimental satellites, as well as strategic and tactical missiles, while CASIC specialises in the development and production of guided missile systems, especially surface-to-surface, air defence, cruise missiles, mini-satellites and information technology;
- The two dominant ordnance entities are split along geographical and functional lines. China Ordnance Industrial Group Corporation, known as China North Industries Corporation (Norinco), has most of its facilities located in the country's northern provinces and manufactures the bulk of the industry's tanks, armoured vehicles and munitions supplies. China Ordnance Equipment Group Corporation is concentrated in southern China and its core business is in civilian vehicle production, which accounts for more than 50 per cent of its annual revenues;
- The defence electronics sector, by contrast, has only one overarching conglomerate China Electronics Technology Group Corporation, which was established in 2002.
In a significant departure from this de-monopolisation strategy the country's two aviation industry groups are being consolidated into a single entity - a move that will be completed by the end of this month. Analysts say that a key reason behind this move was that the 1999 separation of Aviation Industries Corporation of China (AVIC) I and II was poorly conceived and had adversely weakened the Chinese aviation industry's competitiveness because of widespread duplication of activities. Additionally, the two companies were dwarfed and squeezed out of the international market place by far larger Western companies. The annual sales revenues of Boeing, for example, are four times the combined total for AVIC I and AVIC II. The merged company, which will be known as China Aviation Industry Group Corporation, will have around 200 subsidiaries and assets of USD32 billion.
An important catalyst for the aviation industry's re-organisation was the amalgamation of the commercial aviation arms of AVIC I and AVIC II in May into a separate company called China Commercial Aircraft Corporation (CCAC) that will be responsible for the indigenous development of a new large 150-seat airliner/military transport aircraft. This is intended to reduce China's reliance on Western manufacturers such as Boeing and Airbus. China so far only has experience in developing mid-sized passenger and transport aircraft, such as the 90-seat ARJ21 regional airliner.
Technology showcase
This large passenger airliner project is a leading priority in the Chinese government's medium- and long-term S&T development plan and its political importance was reflected in the appointment of former COSTIND director Zhang Qingwei as CCAC chairman.
This project will be a useful barometer to assess how much risk and new thinking the defence industry is willing to embrace in pursuing ambitious high-technology R&D projects. One pioneering approach that CCAC is preparing to take is to list on the Hong Kong stock market to raise capital to fund its development costs.
Tapping into financial markets is a new initiative by the once-secretive defence industry, which has previously relied almost exclusively on government funding. The defence industrial authorities began taking steps in 2007 to open up the country's stock and capital markets to defence industrial enterprises. A key goal is to expand the sources of funding available for defence firms to tap into and reduce their heavy reliance on the state. Chinese officials say that the limited access to investment funds has been a major factor holding back the defence industry's growth and technological modernisation.
The authorities are especially eager to attract domestic state-owned, private and even foreign firms to acquire equity stakes in defence companies as well as allow them to list on the country's two stock markets in Shenzhen and Shanghai and also in Hong Kong. COSTIND issued a series of policy guidelines and regulations last year to define the framework of this market liberalisation.
According to a senior SASTIND official involved in drafting these reforms, this policy initiative "signifies that the reform of the defence science and technology industry has entered a new historical phase, which will certainly have a far-reaching impact on the building of a new defence science and technology system". Another SASTIND official said that the defence industry could raise upwards of USD9 billion by the end of this decade.
Companies affiliated with the defence industry have been allowed to list on the stock markets since the early 1990s, but under tight restrictions that precluded entities involved in military-related work. The new, more permissive regulatory regime now allows companies with military programmes to make stock-market or private listings to outside investors as long as they satisfy secrecy regulations and their defence projects are not deemed to be too sensitive.
Within a few weeks of the passage of these new regulations in November 2007, Xian Aircraft International, a defence company listed on the Shenzhen stock exchange, won approval for a private USD970 million share placement with 10 Chinese state-owned firms to acquire civilian and defence assets from its parent Xian Aircraft Industry Corporation (XAC) - one of the country's major aircraft manufacturing outfits. XAC builds the FB-7 naval fighter-bomber and the H-6 bomber.
The willingness to reach out to the non-state sector is another important aspect of the Chinese defence industry's realignment and integration within the broader national economy. As the defence industry has significantly downsized and diversified its business activities during the past couple of decades, its core of dedicated defence enterprises has also been reduced. In response, the defence industrial authorities have sought to broaden its supporting base of secondary subcontractors that are able to supply both military and non-military components and services to the top-tier prime contractors and systems integrators.
In recognition that the private sector has now become a pivotal driver of the country's economic and technological growth, the central government in 2005 for the first time formally allowed non-state firms to bid for work from the defence industry. Informal co-operation had been taking place for some time, although this was limited to select numbers of privileged and well-connected civilian firms such as Huawei Technologies. COSTIND and its successor SASTIND have so far issued several dozen licences that allow private firms to bid for defence industrial contracts.
Allowing non-state firms to participate in defence industrial work is a key plank of a broader strategic initiative aimed at forging an integrated civil-military dual-use economy.
Defence industrial authorities are especially keen to forge close ties between the defence industry and non-state firms in the information and high-technology sectors and academic research institutions such as universities and scientific academies that possess advanced technological skills and capabilities not available in the defence sector.
Defence industrial enterprises hope that by leveraging the commercial technologies and business practices of civilian firms, this can lead to major productivity and efficiency gains as well as improvements in products. The design, development and testing of weapon systems, for example, especially complex equipment such as combat aircraft and warships, is a prolonged process that often takes as long as 15-20 years for the Chinese defence industry to carry out. Consequently, these weapons are prone to being overtaken by technological advances before they even enter into service. Through the use of already developed commercially available technologies and advanced manufacturing processes, this could offer substantial time savings and reduce the risk of lengthy delays.
The development of the Chengdu Aircraft Corporation's (CAC's) FC-1/JF-17 fighter shows the benefits that can be reaped by employing commercially available technology and know-how. CAC was able to shorten the time frame for the research and design of the aircraft by as much as 50 per cent through the use of computer-aided design and manufacturing software.
Substantial cost savings could be gained through the employment of commercial manufacturing processes and the joint sharing of R&D expenses. Chinese estimates suggest that joint development of civil-military projects could lead to investment savings of as much as 40 per cent.
The acceleration in the opening up and reform of the Chinese military industrial complex and a growing outflow of hardware from the domestic weapons R&D pipeline suggests that after more than a decade of leaning heavily on Russia as a key source for advanced military equipment and technology, the PLA may now look increasingly to its own defence industry to meet its needs.
This shift from reliance on Russian arms to favouring indigenous sourcing appears to be a decisive factor behind a significant slowdown in Chinese-Russian arms deals. According to the Stockholm International Peace Research Institute, Russian arms sales to China fell by 62 per cent in 2007 from the previous year. Russian estimates of the total value of Chinese arms acquisitions from Russia since the beginning of the 1990s is around USD27 billion.
The reasons behind this improvement in Chinese indigenous defence industrial capabilities have sown discord in ties between Moscow and Beijing. Russian officials allege that China's success in revamping its defence industrial capabilities has been largely due to its illicit copying and reverse engineering of key Russian weapon systems. This has allowed China to replace its arms imports from Russia with Chinese-made copies. The most prominent of these infringements include the Su-27 fighter and advanced defence electronic systems, such as radar and data-link systems for the Sovremenny II 956E destroyer and Fregat M2EM 3D and Mineral-ME radar systems.
Intellectual rights
The case of the Su-27 appears to have been the most egregious. China signed a licence agreement in the mid-1990s to produce upwards of 200 Su-27s from Russia at its Shenyang Aircraft Corporation facilities in northern China. Output of the aircraft occurred smoothly until 2004, when negotiations for shifting production to a more advanced version of the Su-27 ran into problems as China indicated that it did not want to build any more of the aircraft.
In 2005 China was discovered to have been engaged in the development of the Shenyang J-11B, which is a reverse-engineered Su-27 but with extensive incorporation of indigenously developed technologies. China also received assistance from Ukraine and Belarus, which are major Su-27 users. Improved features of the J-11B over the Su-27 include a reduced radar cross-section, improved fire-control radar, use of composite materials, a new flight control system and a digital glass cockpit. An extensive effort to incorporate the WS-10 powerplant into the J-11B is under way, but this has so far not been successful and China has had to instead acquire large numbers of AL-31FN turbofan engines from Russia.
Following public furore in Russia over this apparent Chinese copying, new Russian President Dmitry Medvedev was reported to have sought an agreement on the protection of Russian defence intellectual property rights during his inaugural state visit to China in May. At the same time, however, both sides continued to discuss future arms sales and technical co-operation, including deals for combat aircraft, naval weapons and the possible renovation of Russian weapons purchased during the 1990s.
As the Chinese defence industry seeks to reduce the PLA's dependence on Russian arms, it is also looking to become a major arms exporter again. During the 1980s and early 1990s, China was among the world's leading weapon suppliers to developing countries, but it stumbled after the mid-1990s as the domestic defence industry was unable to produce arms that could compete in the international market place.
With a burgeoning arsenal of capable and cost-effective weapons, Chinese arms manufacturers are actively marketing their products. Among China's main customers are Pakistan as well as countries in the Middle East and Africa.
However, the PLA is likely to remain the Chinese defence industry's dominant client for the foreseeable future and will drive the requirements for the industry's long-term technological development. While the gains in productivity, technological innovation and quality standards during the past 10 years have been impressive, China still lags one or two generations behind the most advanced industrial nations.
Bridging this technological gap represents a much greater challenge for the Chinese defence industry because it will need to go beyond a tried and trusted conservative strategy of making incremental improvements and pursue higher-risk R&D approaches that require extra effort if it wants to master the disruptive technologies that the US and other major military powers have or are working on, such as stealth technology and network-centric systems.
For more on China's defence industry, see the July edition of Jane's Industry Quarterly.
Timothy Hu is a JDW correspondent based in the US
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