defence industry conversion in china: problems and prospects

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Defence industry conversion in China: Problems andprospectsDeba R. Mohanty aa Associate Fellow at IDSAPublished online: 25 Apr 2008.

To cite this article: Deba R. Mohanty (2000) Defence industry conversion in China: Problems and prospects, Strategic Analysis,24:2, 375-390, DOI: 10.1080/09700160008455218

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Defence Industry Conversion inChina: Problems and Prospects

Deba R. Mohanty

The Problem

The conversion1 of People's Republic of China's (PRC's) huge military-industrial complex (MIC)—the nuclear, ordnance, aviation, space,electronics, and shipbuilding sectors under the State Council (known as'defence industries') direction and enterprises run by the People'sLiberation Army (PLA) (known as 'PLA industries')2—to production forthe civilian market has been one of the prominent themes of the post-1978 economic reforms debate. Beginning in the late 1970s in anexperimental and unofficial way, this programme has been approvedformally and applied extensively since the mid-1980s. This programmehas received attention at the highest levels. It is accounted for in themechanisms of the Central Five-Year Plans. It is directed by a Three-Commission Liaison Group for Defence Conversion. This Commissionbrings together officials from the State Planning Commission (SPC), theState Science and Technology Commission (SSTC), the Commission onScience, Technology, and Industry for National Defence (COSTIND), anda State Counril office dealing with the problems of the "Third Frontindustries".

By mid-1990s, the Chinese proclaimed their conversion programmeto be an incredible success. Statistics, both from Chinese as well as othersources, confirm this claim According to a March 1994 article in thePeople's Daily, 77.4 per cent of the gross output value of the MIC in 1993was in civilian products, up from 8.1 per cent in 1978. In some industries,the share of civilian production has topped the 80 and even 90 per centlevels.

In 1994, the ordnance industry claimed that 90 per cent of its industrial

Deba R. Mohanty is an Associate Fellow at IDSA.This paper is a revised version of the fellow paper presentation at IDSA Fellows' Seminarheld on August 18,1999.

Strategic Analysis, Vol. XXTV, No. 2© The Institute for Defence Studies and Analyses

Defence Industry Conversion in China 375

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output in southwest China was for the civilian market. The ordnancesectors gross sales of civilian products in 1994 had reached 18.5 billionyuan with a possible annual increase of 30 per cent for the next fiveyears. The China North Industry Corporation (NORINCO), China's largestdefence equipment producer, has an ambitious development plan(according to Jhai-.g Weimin, Vice President, NORINCO): 157 large andmedium-sized factories, more than 30 research institutes, 200 salescompanies, and 60 subsidiaries trading in 100 countries are engaged incivilian production. The Group's joint ventures (JVs) produced 40 percent of the motor cycles sold in the domestic market and aimed to produce450,000 mini cars and 20,000 heavy trucks per year by the end of thecentury. The aerospace industry claims that more than 70 per cent of its1993 output value was in goods and services for the non-military market-place. The electronics industry, traditionally an integral part of China'smilitary production complex, is reported to have been completelycivilianised.3 The success record of the PLA industries has been almostsimilar. According to an official publication, in 1996, the PLA industriesmanufactured over 15,000 kinds of civilian products, and 2,500 items of.national defence technologies that had been turned over for civilian use,generating 10 billion yuan in annual output value. The PLA's share ofthe civilian production value within the arms industry has increased bymore than nine times to reach 76 per cent between 1980 and 1992 witha corresponding diversification of production lines into numerous civilianproducts ranging from household consumer goods to high-tech nuclearproducts.4 In a nutshell, these claims reflect.remarkable achievements.China's success in its conversion programme is regarded as aninternational model by countries whose conversion efforts have by andlarge failed.

Tall claims, indeed. There is no doubt that China's 'defence industry',a term that calls for more precise definition, has increased its civilianproduction dramatically. Yet, there are many doubts as to the extent towhich this increase constitutes 'conversion'. Given the economic andpolitical imperatives-7-and extreme difficulties—of conversion in the Westand elsewhere, the Chinese experience is unique and hence, worthinvestigation. In this paper an attempt has been made to examine somebasic queries that might help in understanding the problem in its totality.The queries, among others, include the origins and motivations behindChina's conversion policy; its short and long-term objectives; the uniquefeatures of conversion programme related decision-making, progress, andachievements; and problems and prospects. Analyses of all these aspectsbecause of the very complex and exhaustive nature of the problem, ifexamined in great detail, will run into a couple of hundred pages, which

376 Strategic Analysis/May 2000

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is not possible here. Hence the broad points that are relevant for thisinvestigation will be touched upon as briefly as possible.

The Problem of Definition

Investigation of any problem must begin with its definition. Agenerally accepted definition of conversion is that it is a "permanentprogramme consisting of political, economic, and technical measures forassuring the orderly transformation of labour, machinery, and othereconomic resources now being used for military purposes to alternativecivilian uses".5 In common usage, conversion is described as turning'swords into plowshares'. Here, the question is can all swords be turnedinto plowshares? The answer is 'no'. It is simply because of the fact thatthough the global arms (sale, procurement, and production by differentstates) expenditure has witnessed a decline in recent years, it is stillslightly above the $700 million mark that the world is spending per year.Though the declining trend is partly due to a reduction in demand formilitary equipment all the world over (barring a few), no symptom hasyet emerged or is likely to emerge for a complete abandonment/stoppageof military equipment production. In this context, the eternal nationalsecurity question has been the primary bottleneck. In other words, ifnational security is a fact of life, production of weapons to ensure nationalsecurity is the corollary. Hence, conversion, a noble yet irreversibleprocess, becomes irrelevant. This is primarily the reason why it has failed(when applied) in many western countries. But, a more pragmatic questionthat follows is: if not all, can some swords be turned into plowshares?Here, the answer is 'yes'. In this regard, the definition cited above has toadd "surplus" to "military purposes". Though it is still vague as to whatsurplus military purpose connotes, it nevertheless reflects the fact thatsurplus weapons do exist. The fact that there is a reduction in demandfor military equipment, if added to this, makes a case for conversion. Ifthis is so, then conversion has to be applied rationally, though notnecessarily totally which is seemingly impossible. Even a rational elementin conversion can contribute in substantial terms to the process ofdisarmament. . • .

Conversion is a complex subject. It goes far beyond the commonplacethat defines conversion as using defence production facilities to makecivilian products. Economics, the discipline most commonly used forstudying conversion, provides only partial answers. Politics, playing anequally important role in formulating public policy, is not the total answereither. Study of conversion has to "take into account, among others,economics, management practice, public policy, national security, and

Defence Industry Conversion in China 377X

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social issues. In the conventional wisdom of economics, conversion hasa positive economic effect To put it simply, military production has alower multiplier effect than civilian products. Spending on military goodsis considered as expenditure on nonproductive capital. Hence, in amilitarised economy, opportunity costs are high. It is often argued thatconversion of surplus military capacity will compensate, to a great extent,those costs and at the same time increase the efficiency and wealth-generating capacity of the economy. Sounds good. But, more importantlyit is related to the question of national security—how much the defenceindustry provides a nation for its security needs and how much conversionis needed so that the security needs are not hampered. In this sense,conversion is part of an optimisation problem that must balance differentdemands—military, political, social, and diminishing economic resources.

Operationalisation of conversion can take place in many ways. Someof them are mentioned here.6 First, production changeover—this occurswhen the same equipment .and line that are used to produce militaryitems are used to produce civilian goods. This may completely disarm aparticular arms industry. Second, consolidation or diversification—theformer meaning merger of different production lines of the same MICfor civilian production and the latter meaning creation or acquisition ofnew lines for civilian production. Third, commercialisation of militaryR&D-—in which one may witness visible involvement of defence firms ormilitary research institutes developing technologies for potential civilianapplications. Fourth, management of surplus weapons factories—in whichone may notice a production facility, by adding or eliminating certainplant machinery, being able to produce a similar civilian item. Fifth,demobilisation and retraining—in which one may witness a successfulredirection of specialised military talents for civilian works. Sixth, closureof unused military production lines—in which, through civil industrialparticipation, new production facilities (civilian) can be built. Seventh,sale/lease of surplus or unused military real estates—whereby it cangenerate money for civilian production or other purposes. And last,reengineering of an entire sector—which involves concentration of anentire redundant defence industrial capacity (a response to diminisheddemands for certain military items). It involves rationalisation of a wholeindutrial base and reshaping its structure.

In general, two types of conversion can be contemplated—positiveand negative.7 The former is based on moral grounds—the realisationthat military prodaction comes at the expense of economic developmentand welfare of the people may make A nation turn toward conversionthus contributing not just to national development but also to internationalcooperation, peace, and disarmament. The latter, unlike a seemingly


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Utopian model (that is, the former), is pragmatic and a product of lackof choice. It may be the corollary of a certain circumstance like thetermination of war or conflict, signing of a peace treaty, a considerablerelaxation of tension, the downfall of a military regime or a leader,economic crisis or other socio-political disruptions, or shrinking of demandby arms consumers at home or abroad. Such situations may makegovernment, military enterprises, or political leaders realise that continuedlarge-scale military production is not only counterproductive and wastefulbut also impossible to attain.

Regardless of how we may define or operationalise conversion, thereare several social, economic, strategic and management issues that needto be addressed. What are the implications of conversion for employment?Will the skilled technicians be able to make the shift? How do communitiesdependent upon military support activities cope with reductions? Howdoes one reform the management and business strategy paradigms ofdefence businesses? Conversion is not only a technical problem, but alsoan organisational and commercial problem. It demands major shifts incorporate strategy and culture to focus on markets and customers. Itrequires changes in ingrained work habits and mindsets.

The Chinese Approach to Conversion

The Chinese take a pragmatic approach to conversion. It is necessaryfor them, but it must suit their objectives—hence, a conversion withChinese characteristics. Conversion, according to official Chinese sources,involves "an economic strategy of military integration that brings militaryindustrial technologies, facilities, and skilled labour into the purview ofoverall reforms".8 This strategy aims gradually to "reform and convertthe past unified military product system into an integrated military civiliannational defence scientific research and military indutrial productionsystem". Unlike the western version, it is a reversible process—meaningconversion to reconversion and vice versa, according to needs. As animportant reform process, it mixes industrial strategies as part of a largereffort to modernise the military. Thus, the approach, in contrast to whatconversion means, is "swords into plowshares...and better swords".9 Ifwe go beyond the achievement claims, for many Chinese officials, itmeans not only enhancing the civilian economy but also aiding themilitary capability. Thus, the Chinese use the term "civil-militarycombination", not "conversion" in their literature. Backed up by thepolitical leadership, though resistance is coining from certain quarters,the conversion programme is expected to contribute significantly to theoverall reform process.


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Conversion is a part of the reform process in both the economic andmilitary spheres. Economically, China is in the midst of the marketisationof a command economy which requires a shift in the mechanism usedfor the allocation of most of the resources from top-down politicallydirected administrative system of plans and quotas to the market place.This painful process has brought mixed results—the economy witnessinga spectacular consistent growth, huge GDP, growth in foreign trade andreserves, growth in FDI and above all a remarkable improvement in theChinese lifestyle on the one hand, and negative consequences like rampantcorruption, problems of inflation, unemployment, bankruptcy, problemof economic adjustments, social security, on the other. The Chineseeconomy is in transition, so is the military. Its vast MIC cannot escapethe impacts of reforms. Hence, conversion has to play an important rolein both economic as well as military spheres.

The Stages of Development

Before conversion in China became an official policy in the early1980s, attempts had been made to bring about a viable civil-militarycombination. As early as May 1952, the Central Ordnance Commission,in a report to the Party Central Committee, had concluded that everydefence factory should produce civilian goods.10 Such a conclusion by amilitary institution was quite surprising at that point of time consideringthe not-so-favourable conditions for such a proposal. Protracted civilwar, sporadic but violent domestic uprisings (which forced the leadershipto order several military operations in the name of national unification),external threats, and fragile political condition—all went against such aproposal. Such a thing probably points to the severe shortage of civiliangoods which was due to the primacy given to military construction.Support for the civil-military combination also came from leaders likeMao and Zhu De in the mid-and late 1950s.11 In May 1956, Mao,addressing a State Council meeting, urged the authorities to pay attentionto civilian goods that could be produced during peace time by the defenceindustries. In April 1957, Zhu De, one of China's revered military leaders,in a report to the PCC, stressed for a combination of civilian and militaryproduction within the defence industry to make more civilian goodsduring peace time and more military goods during war time. In otherwords, this policy may be described as "conversion to reconversion"—that is, the factories in the defence sector should be able to adjust theirproduction according to varying threat perceptions. The period understudy was not favourable for such a programme. In 1964, Zhou Enlai, atthe Third National People's Congress (NPC), vehemently stressed for areintroduction of civilian-military combination12 and peace time and war


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time production combination to help the national economy. It is importantto note here that contrary to such calls, subsequent years till early 1970ssaw what is called the "Third Front"13 military industrial construction inthe remote regions. This ambitious programme, an answer to externalthreats and a notable contribution to national defence industry, was capitalintensive (consuming more than 200 billion yuan) and exclusively meantfor military production. In brief, calls for civilian-military combinationwere often faced with contradictory actions. There were attempts to renewsuch calls in subsequent years, but considering the difficult circumstances,it was shelved till the late 1970s. Throughout this period, top prioritywas nevertheless given to military production. It was only when DengXiaoping came up with his comprehensive reform programme, reformsin the military sector were undertaken Conversion, for the first time asa matter of practice, was contemplated.

The Origin and Motivations

To begin with, conversion has been determined by political, economic,and strategic factors. Favourable political climate came after Deng andhis reformist leaders consolidated power by gradually demoting andremoving their neo-radical opponents. Based on their 20 year old beliefthat economic backwardness is the most serious obstacle in China's pathto socialism, they avowed the modernisation agenda, according highestpriority to reforms in agriculture, industry, science and technology, andlowest priority to national defence. The economic reforms, out of whichemerged kaifang—opening to the outside world to acquire advancedtechnology and scientific information, to promote exports, and toultimately become a prominent member in the emerging global village.The long-term objective of China becoming a powerful economy was,during the initial years, hindered by a large surplus of facilities, bothproductive and obsolete, and workers, both skilled and unskilled.Obviously, it was thought that the principle of civil-military combinationwould link organically the defence building with national economicdevelopment and to use military industrial technologies for thedevelopment of peace. As an important component of the modernisationprogramme, reform in the military sector had to be undertaken on apriority basis considering the fact that the Chinese defence industrieskept producing obsolete and low-tech weapons, even rejected often bythe PLA, also there was considerable reduction in domestic orders, ahuge under-utilised production capacity as well as a substantial surplusof workforce. The other factor behind conversion was a reappraisal ofthe international balance of forces. Considerable improvement in China'srelationship with both the superpowers, and along with this a marked


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improvement in its relationships with states within the region paved theway for an orientation toward a new era of peace and stability. Emphasison an independent foreign policy and the 'peace and development line'approach14 suggest that the danger of a global confrontation entanglingChina had considerably diminished. This was not only a period ofrelatively stability but also a period conducive to economic growth andmodernisation. Anticipating at least a decade or two of peace, Chinacould think of downplaying military modernisation in the short run andconcentrate on economic development and modernisation so as to laythe foundation for military modernisation in the long run.15 In thisstrategy, the Chinese have strived hard to create a huge GDP, based onmarket economy and extensive international economic relations, only afraction of which could provide ample resources for modernisation ofthe military. In sum, a combination of internal and external incentiveshas provided an opportunity for converting useless military industrialproduction capacity to useful civilian ends.

The Features and Processes

Reform of the defence industry, in which civil-military combinationbecame a buzzword, was conducted in several steps. During the initialperiod, Beijing did not have a specific programme in place forimplementing conversion.16 As a result, the defence industrial enterprises,which had been no more than extensions of the central bureaucracy formore than thirty years and had no expertise in converting to civilianproduction were forced to do anything they could to survive. PRC sourcescontain a vivid description of the plight of these enterprises; as one writerdescribed, "At that time, it was basically a case of doing anything onecould. Some nuclear arms factories produced soft drinks, airfieldsproduced chicken soups, mirrors, dressing tables, etc."17 Examples suchas this suggest that the initial period of conversion depended entirely onshort-term market demand. Realising the mistakes, the Chinese decision-makers followed a gradual approach. The first round of reforms wasintroduced in the mid-1980s which was identical to that introduced inthe State Owned Enterprises (SOEs). Despite their military role, defenceenterprises count as state enterprises, and most regulations that governthe SOEs also apply to them. Reform objectives for both were the same—break up of old rigid planning system, more autonomy, andmodernisation. A range of major restructuring and practices were initiated,enabling the managers of defence enterprises to deal with market forces,contracts, taxes, etc. instead of plan, allocation, and quota.

Introduction of responsibility system (where production andmarketisation of goods must be in tune with expected lines with the


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responsibility of both being thrust upon the manufacturing unit) allowedeach defence enterprise more freedom to choose which product tomanufacture. The factory director responsibility system (where the heador the apex management body has to be responsible for the overallperformance) made enterprise decision-making more efficient. Legalreforms, though not all comprehensive, gave them protection intransferring classified military technologies to participate in civilianeconomic activities. Financial reforms enabled them- to retain some portionof profit, thus raising funds for further development. Price reforms enabledthem to fix prices of goods along market lines. Labour reforms promotedlabour mobility and thus productivity. Foreign trade reforms enabledthem to retain a portion of their foreign exchange earnings.18

At national and regional levels, both organisational amalgamationand decentralisation were implemented to facilitate conversion. In theearly 1980s, Beijing renamed its industrial ministries and set up COSUND(whose functions included making key policy recommendationsconcerning conversion). In 1987, the entire defence industrial sector wasplaced under the State Council jurisdiction. Beijing also delegatedauthority over several centrally controlled enterprises to the provinceswhere they were located with an aim of breaking down artificial barriers,streamlining the central industrial bureaucracy, and facilitating themarketing of products produced by local defence factories. Thegovernment also began encouraging the defence industrial sector to formenterprise conglomerates19 in the early 1990s with the aim of breakingdown the vertically organised self-contained industrial system of thepast. These enterprise conglomerates have 'a fairly large degree ofautonomy and perform projects under contract to their superior units.The overall enterprise organisation of the defence industry is structuredthus: State Council—Industrial Department/General Headquarters—Provincial level General Corporations—Enterprise Conglomerates,Enterprises, and Individual Factories. It is to be noted here that thisstructure is vertical and there is very little horizontal interaction.

In addition to the above reforms, the government has offered specialassistance to the defence industrial sector, especially to the Third Frontindustries. One important measure is to relocate enterprises and factoriesfrom remote mountainous areas to urban areas in the heartland or evento the coastal provinces to bring these closer to the market-place andimprove communications. A number of regulations to facilitate relocationhave been drawn up. Transfer of these enterprises has been included inthe national plan, the cost of moving machinery and equipment as wellas providing houses for employees and schooling for their children. Allthe cost has to be shared by the state, national banks, and the enterprises


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themselves. During the Seventh Five Year Plan (1986-90), 2 billion yuanwas spent on relocation and reorganisation. This investment was spreadamong 121 enterprises and research units with a work force of l,60,000.2°There was an increase of nearly 200 per cent in the allocation in the nextplan. The Third Front is still in a very bad shape. It is estimated thatoverall reforms, including relocation, modernisation, and restructuringcould demand an investment of more than 100 billion yuan which is abig sum for the state to provide. The more the delay, the more escalationin the cost.

Another form of assistance has come in the name of technologicalrenovation. The government has encouraged defence industrial enterprisesto select products of an appropriate technological level in order to makethe most of their technology and work force. Provisions for technologicalrenovations have been introduced in the national plaru After an enterprisefulfills the minimum requirements, the government then providesnecessary capital grants and loans for the purchase of new equipmentand technology. During the Seventh Five Year Plan, the governmentgranted loans worth 4 billion yuan to renovate 296 items of technologyand construct 450 production lines for civilian items. During the nextFive Year Plan, 6.3 billion yuan in loans was spent on the renovation ofmore than 400 technology items.21 Similar assistance has come for capitalconstruction. For example, Beijing intends small cars to be one of themain production lines for the Third Front • enterprises. To ensureproduction efficiency, it has made provisions in the national plan andprovided capital to enable the provinces concerned to constructautomobile production zones.

The defence enterprises have been tried to be pushed into the marketin other forms as well. One such measure is to transfer a few large andbetter run enterprises into joint sock companies and companies limitedby shares, in which the state has a controlling or minority share. Enterpriseconglomerates can become joint stock companies and will be permittedto hold shares in other enterprises. Some defence firms have becomeLimited Liability companies. In this, the shareholder's liability isproportional to his/her investment The Company Law, coming into forcein July 1994, states that both joint stock and limited liability companieshave to register themselves with the authorities and those with monopolyrights in certain commodities will have to submit to inspection. By 1994,there were more than 200 defence firms, mostly medium-sized, whichhad been registered. Other mechanisms like management by foreigninvestors, leasing enterprises, leasing mortgaged property, employeebuyout, and selling off to private enterprises have, due to some reasonor the other, not been tried in the defence industrial sector.22


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The PLA Case

One of the most dramatic examples of the new commercial spirit hascome in the expansion of PLA activities into the commercial domesticand international market. It is not possible to narrate a historical accountof PLA's commercial activities. However, recent trends merit attention.Its commercial activities, it seems, have gone beyond what the decision-makers had visualised because of its size, autonomy and the rapid pacewith which it undertook commercial ventures. In recent times, there havebeen debates as to whether the PLA should indulge in commercialactivities or not, and in July 1998, the CCP's Political Bureau in its fifthexpanded session reviewed its performance and sought to curb themimmediately.23 The decision to hand over all PLA commercialestablishments to the civilian authorities provides ample evidence thatall is not well with the PLA. Growing signs of corruption and considerableerosion of military ethics have invaded the smart but closed militarysystem. At the same time there are very few signs that the PLA hasshown till now to retreat from the commercial front. The large corporationsrun by the top command and many local operations under the militaryregions and group army control look as if they will be around for awhile. This inevitably has brought a power tussle between the civilianand military authorities.

MIC organisations and the PLA have established several specialeconomic zones like in Guangdong. Jingan, the commercial branch ofPeople's Armed Police, has marketing operations for ammunition andsmall arms in the US. Units connected with China's strategic missileservice arm run ice cream parlours in Beijing. Companies affiliated withPoly Group are active in the Hong Kong market. Some of the operationsare quite substantial. The General Logistics Department (GLD) runs twoof the largest operations: the Xinxing and the 999 Corporations. Xinxingwas set up in 1984 with the explicit aim of becoming one of China's topbusiness giants. It was incorporated as the Xinxing Group in 1989 andhas close to 100 enterprises spread over several provinces. Its range ofbusiness includes import-export, marketing, industrial development,minerals and chemicals, real estate, hotel, tourism, and advertising. The999 corporation is primarily involved in pharmaceuticals. It operates 34enterprises, has branches in Germany, US, Russia, Thailand, andelsewhere. It has recently expanded its operations to include real estate,electronics, food, clothing, securities, and trust investment services. Large'999' advertising displays appear worldwide: not only do they decoratethe flight tower at the capital airport of Beijing, they also add a distinctivetouch to Hong Kong's spectacular harbour side. Even these displays can


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be found amid the billboard clutters of Times Square in Manhattan. Inbrief, it is noted that the PLA has entered into both civilian and commercialsectors and it seems that the latter has overshadowed the former—not ahealthy sign. By doing this, it has not only defied some of the PRC'sfundamental principles, but also created a situation which is fast goingbeyond the state authorities.24 Commercial activity of the PLA haspowerful lobbies to protect which worries the civilian authorities. FromMao to Jiang—all political leaders have been urging the PLA to restrict'itself to only productive civilian construction, not to venture into cheapcommercialism, but what the PLA is doing only reflects what is happeningin China now.

The Balance Sheet

The claims made and the evident diversity and scope of activitiesattributed to conversion are certainly impressive. There is no doubt thatthe MIC can produce goods and services for the civilian market, and itis evident that the defence sector's managerial and financial sophistication,though far from a satisfactory level, is increasing. But we must go beyondthe obvious impacts of the reform in MIC and the resulting tactics ofdiversification.

Conversion has more problems than solutions. The Chinese do notadmit it but it is quite visible when one looks into the problems faced bythe civil industrial sector. To begin with, the MIC is part of the statesector which is in serious decline and now accounts for less than 50 percent of China's total industrial output. By late 1995, some Chineseeconomists estimated that nearly 70 per cent of the SOEs were in the red.Zhu Rongji himself has admitted that the majority of the SOEs in troubleare from the defence sector, especially the Third Front—their plantcapacity utilisation is between 10 to 30 per cent.25 If we examine therecord since 1979, we find an interesting dialogue in progress: Beijingcalls for greater effort for conversion and the industry responds with anassertion of successs. This has been going on for well over a decadewhich suggests that all is not well with conversion which has been resistedespecially by the local as well as industrial groups. This is due to manyreasons—primary among them being a tussle between local and regionalversus big industries, differential treatment to defence industry by thestate, violations of rules by the defence industries in. many cases, andothers. The state has allocated 20 billion yuan for defence conversionsince 1979 which constitutes only 2 per cent of the total allocation for thestate sector which shows that despite Beijing's urging, conversion appearsto receive paltry direct financial support. The reform has pushedmanagerial responsibility down into the system and much of the


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converting units have been placed under local authorities that has led toproblems like central-local tussle, local resistance due to market insecurity,subsidies for only defence firms, etc. Using macro economic analyticaltechniques, some Chinese economies point out that the profitability ofconversion is about half that found in the civilian sector. Though theMIC's output is increasing, the overall economic contribution ofconversion is less than 2 per cent of the total industrial production value.The most important factor that hinders conversion is social cost which isestimated to be consuming nearly half of the investment, thus even makingthe previously profitable units to lose.

Many authoritative critiques of conversion have been voiced in recentyears. They are:

1. Lack of capital for conversion. When conversion iscontemplated, the defence industries being capital intensive,financial constraints become a headache.

2. Low quality of converted products. Barring a very fewtechnologically superior products, most of the products are forgeneral consumer market. The profit ratio in the former is lessand market is limited, but the latter fails to impress becausethe wide market is very competitive where quality mattersmost.

3. Because production cost is high for the converted items, itsprice fixation becomes a major worry. Uncompetitive pricecannot survive in the market.

4. Lack of market research makes converted products chase otherproducts, copy them and hence become secondary to others.

5. Lack of consumer consciousness and lack of understanding ofthe market.

6. Lack of cost consciousness.7. Poor financial shape.8. Management and organisational problems.9. Social costs.

10. Inappropriate approach adopted—leaders look for atechnological quick fix and go for short term gains whereasconversion is time consuming and demands a complete changein corporate culture.

All these observations come from Chinese sources. Yet, many aretypidal of remarks made about conversion around the world. They reflectproblems not only of conversion but also of conversion of a commandeconomy to one mat is responsive to the post-modem market place.


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The Future Issues

The future of defence conversion depends on the future course of thelarger reform programme in China. Alongwith efforts have come problemssuch as corruption, opportunism, profiteering, powerful interest clashes.The MIC is vast and overcrowded. There is a surplus even in the skilledmanpower sector including scientists, engineers, and technicians. Onereport suggests that even half the present size of the MIC will produceno less than the expected level. Despite Beijing's calls for conversion, itis clearly evident that the military production has never been ignored.The Chinese press continues to print both calls for 'self-reliance' and'strengthening leadership in military production' on the one hand andemphasis on R&D, development of modern weapons, army building (aleaner, meaner fighting machine) in the new era on the other. At thesame time, one should not forget that the conversion effort is embeddedin the larger Chinese economy. It is subject to the effects of the Chinesebusiness cycle which is uneven. But conversion being important, itsurgency and lacunae call for a list of tasks to be undertaken by the stateto make it a success. They are:

1. Dealing with the problems of social security.2. Uniformity in formulation and implementation of industrial

laws. Specific clauses can be of help to defence industries. Lawsrelated to property and ownership rights of the industrialenterprises have to be dearly defined. Special care has to betaken in the governance of local, provincial and national laws.

3. Moving from capital-intensive (heavy and medium) totechnology and information-intensive industry.

4. International standard of accounting and quality control.5. Improvement in managerial and organisational efficiencies..6. Developing 'pockets of excellence' zones and pillar industries.7. Integration of conversion first to regional economic

development and then moving up.8. Expansion of export base for key industries.9. Development of international cooperation.

10. Autonomy and minimum interference from the state.The outcome of defence conversion in China is mixed. It has its

success which can at best be described as partial. It has its failures. Abalance sheet in the short term reflects positive results but this is notwhat the leadership wants. Conversion is a long term strategy primarilyfor military modernisation which can also contribute to national economic


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health. Going by this, one may say that the Chinese have lagged behindin their objectives. The difficulty of matching practical results withstrategic intentions is certainly what the leadership is experiencing, butit still persists which might make the road ahead moire arduous. It wouldbe more accurate to describe this programme as an uneven and perhapscontradictory response to the economic reforms launched in the late 1970s.The way it was contemplated, programmed, and implemented showsinconsistencies. The result is visible—the recent call by the President ofthe PRC to the PLA to stop commercial activities and hand over all suchenterprises to the civilian authorities is an ample testimony to it. Confusingindications have been coming from the state and industrial sectors as tohow and where to move from here. Indeed, reforms and conversion haveunleashed conflicting forces: maintaining a huge labour force or buildingsleek modern enterprises, building national defence or contributing tolarger economy. To solve these is not easy. It seems that the road toChina's wealth and power is not as easy as the Chinese leadership thought.

NOTES1. As is explained elsewhere, the Chinese do not use the term 'conversion', instead

they use 'civil-military combination'. However, the operational modes havemany similarities. Hence, I have used both terms.

2. This paper examines conversion in the 'defence industries' run by the StateCouncil only as not much information is available about the operational aspectsof conversion in the 'PLA industries'. The latter has only occasionally beendiscussed.

3. Most of the above mentioned data can be found in various editions of ForeignBroadcasting Information Service (FBIS): Daily Report China. See, FBIS-CHI-95-133, July 12, 1995, pp. 47-48; FB1S-CHI-94-204, October 21, 1994, p. 35; FBIS-CHI-96-004, January 5, 1996, pp. 21-25; and FBIS-CHI-96-026, February 7, 1996,p. 46.

4. For details, see Srikanth Kondapalli, China's Military: The PLA in Transition(New Delhi: Knowledge World & IDSA; 1999), pp. 194-98.

5. Lloyd J. Dumas and Marek Thee (eds.), Making Peace Possible: The Promiseof Economic Conversion (Oxford: Pergamon Press; 1989), p. 7. Also, see SeymourMelman and Lloyd J. Dumas, "Planning for Economic Conversion", The Nation,April 1990, p. 509.

6. For details, see Jorn Brommelhorster and John Frankenstein (eds.), MixedMotives, Uncertain Outcomes: Defence Conversion in China (London: LynneRienner; 1997), pp. 5-6.

7. These two types have been explained in detail by Yitzhak Shichor. See, YitzhakShichor, "Conversion and Diversion: The Politics of China's Military IndustryAfter Mao" in Efraim Inbar and Benzion Zilberfarb (eds.), The Politics andEconomics of Defence Industries (London: Frank Cass; 1998), pp. 144-47.

8. This official definition (by COSTIND) is cited in Mel Gurtov, "Swords intoMarket Shares: China's Conversion of Military Industry to Civilian Production",The China Quarterly, No. 134, June 1993, pp. 213-14.


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9. Paul Humes Folta, From Swords to Plowshares? Defence Industry Reform inthe PRC (Boulder, Colorado: Westview Press, 1992), p. 1.

10. Chai Benliang, "Conversion and Restructuring of China's Defence Industry" inn. 6, p. 67.

11. Brommelhorster and Frankenstein, n. 6, p. 68.12. Brommelhorster and Frankenstein, n. 6, p. 68.13. For a detailed description on Third Front defence industrialisation, see, Barry

Naughton, "The Third Front: Defence Industrialisation in the Chinese Interior",The China Quarterly, no. 115, September 1988, pp. 351-86.

14. This approach was contemplated during the late 1970s period. It suggests thatworld peace and economic development are mutually supportive and shouldbe pursued. See, A Doak Barnet, China's Economy in Global Perspective(Washington D.C.: The Brookings Institution, 1981).

15. Shichor, n. 7, p. 148.16. Arthus S. Ding, "Mainland China's Defence Industry in the Context of the

Central-Local Relationship", Issues and Studies, vol. 32, no. 7, July 1996, p. 12..17. Sun Zhenhuan, Zhongguo Cuofang Jingji Jianshe (The Development of China's

Defence Economy) (Beijing: Junshi Kexue Chubanshe, 1991), p. 28. Cited in n.16, p. 12.

18. Reforms in the defence sector are described in detail by Folta. See, n. 9, pp. 87-109.

19. The Chinese enterprise conglomerate consists of any group of companies linkedby some form of cooperation: for example, a core plant and a number ofsatellite plants. It does not include the Western concept of the conglomerate asa collection of enterprises linked by a holding company. In other words, theChinese concept expands the term.

20. Ding, n. 16, p. 9.21. Ricky Tung, "Market-Oriented Reform of State-Owned Enterprises in Mainland

China", Issues and Studies, vol. 31, no. 2, p. 11.22. For details, see, Tung, n. 21, pp. 1-20.23. Cited in Srikanth Kondapalli. See, n. 4, p. 195.24. PLA's commercial activities are described in detail by Stacey Solomone. See,

Stacey Solomone, "The PLA's Commercial Activities in the Economy. Effectsand Consequences", Issues and Studies, voL 31, no. 3, March 1995, pp. 20-43.Also see, Thomas J. Bicford, "The Chinese Military and its Business Operations:The PLA as Enterpreneur", Asian Survey, voL XXXIV, no. 5, pp. 460-74.

25. See, Tai Ming Cheung, "On Civvy Street: China's Lumbering Arms MakersFace Market Rigours", Far Eastern Economic Review, February 6, 1997, p. 40.


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defence industry conversion in china: problems and prospects

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