Introduction

The "China Threat" is now a fact of life, at least if one takes seriously the conclusions of two major United States government reports issued in mid-July 2002. The two reports are the 209-page annual Report to Congress of the U.S.-China Security Review Commission (USCC)[1] and the Pentagon's smaller but still formidable 56-page Annual Report on the Military Power of the People's Republic of China.[2] They describe a vast and dynamic military establishment that is taking advantage of China's modernizing economy to modernize its armed forces and modernize its warfighting capacity.

For two decades, American foreign policy operated on the premise that trade with China would have an inevitable liberalizing effect. This persisted after the Tiananmen crisis, and even after the 1996 Taiwan Strait missile crisis when Beijing attempted to intimidate Taiwanese voters from casting ballots for President Lee Teng-hui. It was at the foundation of Clinton's China policy and apparently undergirds the Bush policy as well.[3]

The USCC paper makes the case that this premise is just a "hypothesis" and argues that American trade has helped to strengthen the PRC-not just economically but militarily as well. Indeed, throughout its entire 209-page length, the paper consistently and repeatedly makes the case that China's burgeoning defense budget, now viewed as the second-largest in the world, is directly funded by the country's export-driven "foreign direct investment."[4]

Changing Patterns of Foreign Direct Investment and Trade in Asia

Foreign Direct Investment. The impact of foreign direct investment on China's overall GDP in the past decade has been enormous, but there are a myriad gaps in the data that suggest the main effect of FDI is in modernizing China's manufacturing base, and not necessarily in raising living standards.[5] Still, there is no getting away from the fact that China has turned itself into Asia's manufacturing center, with components and raw materials converging on Chinese factories for assembly, processing, and re-export to the rest of the world. Eighty-eight percent of China's exports are bound for the United States, Japan, and the European Union.[6]

For the rest of the world, low growth and the war on terrorism cut global inflows of FDI, which fell to $735 billion in 2001, less than half the amount in 2000. FDI flows to economies in the Asia-Pacific region declined 24 percent from 2000 to 2001. Trade has suffered similarly, with growth in merchandise trade falling to an estimated 2 percent in 2001 from 12 percent in 2000. But in 2001 and 2002, China took in $100 billion in foreign direct investment, making it the number one Asian destination for all FDI-with investment levels up 16.89 percent in the first six months of 2002 alone.[7]

In the "zero-sum game" of FDI, China is sucking the oxygen out of the markets in Asia, and elsewhere for that matter. The result, in the words of one Hong Kong analyst, is that competition from China will reduce Southeast Asia's economic growth rate.[8]

Trade
Clearly, international trade drives the gross total of China's economic growth. The overall trade-to-GDP ratio went from 18.9 percent in 1980 to 34 percent in 1990 and to 49.3 percent in 2000. But China's export sector is increasingly foreign-invested, and is increasingly insulated from China's domestic economy. The effect of this is the development of a robust and advanced manufacturing sector. And increasingly, China's manufacturing base is moving from simple labor-intensive assembly up the ladder to capital-intensive fabrication of basic components.

Yearly inflows of realized foreign direct investment rose from $0.06 billion in 1980 to $3.49 billion in 1990 and $42.10 billion in 2000.[9] In 1985, these foreign-invested enterprises (FIEs) produced about 1 percent of China's exports. By 1990, 12.5 percent of China's exports came from foreign-invested production lines, and by 2000, nearly half of China's exports were from FIEs.[10]

In 1995, China began to drop its average tariffs, inducing FIEs to import increased amounts of capital goods for the establishment of new production lines and import increased amounts of components for the new production lines. Between 1995 and 1999, export-processing trade went from 49.5 percent of China's total exports to 56.9 percent.[11]

To supply this vast export sector, China imports vast amounts of production equipment, components, parts, and raw materials. But these production lines, components, and parts are not for the purpose of filling the legendary "oil for the lamps of China" demand of Chinese consumers. According to the USCC report, only 20 percent of China's total imports reach China's domestic markets, while the other 80 percent consists of capital goods and industrial inputs used for the country's export sector.[12]

Much of the capital expended in FDI projects in China, therefore, has gone into financing imported capital equipment, so it should not be surprising that China's imports grow as FDI increases. China reported a record $46.8 billion in FDI actually absorbed in 2001 and expects over $50 billion in new FDI in 2002, with much of the new FDI focused on high-tech sectors.

Even the New York Times sees China's economic presence "chipping away at the United States' position as the region's economic engine," beginning "an inescapable process of China replacing the United States as the dominant power in Asia" and becoming "already an economic and political threat to Japan." The Times quotes one analyst as explaining that "the export story for South Korea and Taiwan may not be so good because the components and parts factories will shift to China…. [A]nything with volume is likely to end up in China." And there is a pervasive fear that Southeast Asian countries will be relegated to the role of supplier of food and raw materials to China in exchange for cheap manufactured goods that will, in turn, harm their own businesses.[13]

The Affect of China's Trade and Investment Growth on Asia

These broader trends are already having their affect on labor patterns and standards of living conditions, not only in Japan, Taiwan, and Southeast Asia, but in the Western Hemisphere as well. Taiwan government figures already talk about the "hollowing out" of Taiwan's core industries as a result of an across-the-board migration of Taiwan's production lines to China.[14] Trade patterns indicate that this same phenomenon has been a major factor in the persistent economic stagnation in Japan.

As late as July 2002, several major Japanese firms announced they would close production lines in Southeast Asia to cut costs and consolidate their assembly operations in China. NEC Corp. will close a personal computer line in Malaysia and move it to China. Seiko Epson Corp. will close a scanner production line in Singapore and transfer some production to China. Minolta will close a camera assembly plant in Malaysia and move the equipment to a factory in Shanghai. And the world's largest miniature ball bearing maker, Minebea Ltd., will relocate a measuring equipment line from Singapore to China.[15] New statistics from Singapore show that the country lost more than 42,000 jobs in the past five years, most of them to China.

Some see China's economic power as the beginning of "an inescapable process of China replacing the United States as the dominant power in Asia." Others call China "already an economic and political threat to Japan." Indonesia is seeking a $9 billion Chinese government liquid natural gas contract to power the industries of southern China. As the New York Times put it, "China-a hungry importer, a siphon of other nations' foreign investment and a surging exporter of cheap manufactured goods-is forcing its Asian neighbors to adjust."[16]

Advanced Technology Investment and Trade
 Ironically, the three countries with the most direct concerns about China's military modernization-Taiwan, the United States, and Japan-also have extensive direct FDI exposure in China's advanced technology industries which support modernization of China's People's Liberation Army.

By the end of 2001, Taiwan economic ministry officials say, Taiwan firms had invested an estimated cumulative US$70 billion in China,[17] while Taiwan's Central Bank of China believes over US$100 billion in Taiwan-controlled assets are in China.[18] Chinese figures are a bit more modest, showing a total of US$29.134 billion. Chinese government figures reflect that 2001 was the biggest year for Taiwan investments since 1995, with US$2.979 billion in Taiwan direct investment.[19]

But there has been a major change in Taiwan's investment patterns. No longer is the bulk of Taiwan money coming from small and mid-sized manufacturing operations in the low-tech sector. Instead, it is coming from Taiwan's largest firms. In the first seven months of 2002, Taiwan firms invested US$1.94 billion in China, and 51.9 percent of that was new investment in the electronics sector alone.[20]

The United States is a somewhat smaller investor in China than is Taiwan, but of higher quality. By 2000, American firms had invested a total of US$9.58 billion in China, with over a third in high-tech manufacturing. In 2000 alone, U.S. direct investment outflow to China and Hong Kong hit a record high of US$4.4 billion.[21]

Japan Investment in China is also quite substantial, with over US$1.5 billion in FDI estimated in the first half of 2001, 50 percent over the 2000 figure of US$995 million, which itself was 32.5 percent over the previous year.[22] Although the textile industry in China had attracted the bulk of Japanese FDI in the 1990s, since 1998 a third to a half of Japan's China-bound FDI was in the high-tech sector, particularly in electrical machinery and electronics.[23]

One important facet of this dynamic is highlighted by the rise in the proportion of "related party trade" (trade between a company and its foreign affiliate) in U.S. imports from China. In 2000, according to the U.S. International Trade Commission, over 18 percent of all U.S. imports from China were "related-party trade." This means that about US$21 billion of the US$116 billion in U.S. imports from China in 2000 were imports from U.S.-owned/affiliated production lines in China.

This phenomenon is even starker for Taiwan companies, which fill between 21 percent and 24 percent of all export orders from production lines in China.[24] Indeed, Taiwan exports to China have risen from 18 percent of total exports in 1999 to nearly 23 percent of total exports in 2002, [25] with 31 percent of exports to China being "electrical equipment and components."[26] Over 70 percent of the exports appear to be destined for export processing. Earlier statistics indicate that Taiwan firms also account for 73 percent of China's entire information technology (IT) product output.[27]

The significance of these trade patterns is that China's advanced-technology (AT) infrastructure is being built largely with foreign direct investment. Although FIE production lines heretofore had been designed to assemble imported AT components into electronic and IT hardware and appliances for subsequent export, foreign suppliers are now setting up the actual component production lines in China to be closer to their assembly lines and the assembly plants of other AT product customers.

Semiconductor technology is a prime example of this phenomenon. Already, Motorola manufactures mobile-phone specific integrated circuits-particularly global positioning ICs-at its MOS-17 waferfab in Tianjin.[28] The MOS-17 facility includes full-up R&D, design, and manufacturing centers and will employ a total of 2,400 workers by the time it begins operation in 2002. By 2001, Motorola had 10,000 employees in China, including 1,500 researchers at the company's 18 labs. With the MOS-17 fab, Motorola's total investment in China was about $3.4 billion in 2002, making it the largest foreign investor in China.[29] NEC Corp. of Japan has begun to produce 128-Mbit DRAMs at 0.25-micron linewidths (the industry standard) at its NEC Shanghai Huahong fab.[30]

The Motorola and NEC investments have prompted Taiwan's top waferfabs-Taiwan Semiconductor (TSMC) and United Microelectronics (UMC)-to petition the Taipei government to permit them to transfer existing waferfabs to China. While Taipei has agreed in principle to the TSMC and UMC requests, it has conditioned its approval on the assurances that the Taiwan waferfabs will be replaced in Taiwan by more advanced facilities. As yet, the Taipei government has not issued formal rules governing the transfer of semiconductor facilities to China.[31]

Unauthorized Taiwan Semiconductor Investments in China
Beijing, however, seeks advanced waferfab, R&D, design, packaging, and testing centers under its own control and has devoted billions of dollars to acquiring foreign technology.[32] One way China hopes to gain advanced semiconductor technology without drawing the attention of American export-control officials is to set up "false foreign devil" FIEs with nominal outside management but controlled by Beijing.

In 2000, Winston Wen-yang Wang, son of Formosa Plastics Group (FPG) chairman Y. C. Wang, joined Chinese President Jiang Zemin's son, Jiang Mianheng, to start up a joint-venture company called Grace SMC to build an eight-inch waferfab facility in Shanghai. According to "knowledgeable sources" in Shanghai, Winston Wang's GSMC received over two-thirds of Grace's operating capital from government-directed investments in China, including a US$1.1 billion low-interest loan from Chinese banks which comprise the bulk of the US$1.65 billion up-front investment for the first phase of the project. The Chinese government also granted the venture special software development tax status, which dropped the tax rate to 3 percent from the original 17 percent.[33]

Taiwan authorities became alarmed at the potential for unauthorized leakage of advanced technology encompassed in the Grace SMC deal. Taiwan's Ministry of Justice Investigation Bureau (MJIB) interviewed Wang concerning a possible diversion of capital from Taiwan to set up the Shanghai operation. Wang reportedly told the MJIB that he agreed to become Grace SMC president due to his close personal relationship with Jiang Mianheng and that his major task was to raise capital overseas.[34] In the end, it appears that virtually all of Grace SMC's capital is coming from the Chinese government and that Winston Wang is a figurehead who gives the firm a "foreign-invested" patina.[35]

A Taiwan-invested waferfab firm in Shanghai that may indeed have some outside investment is Richard J. Chang's Semiconductor Manufacturing International Corp. Chang, a former president of Taiwan chipmaker Worldwide Semiconductor (and a former engineer at the world's leading chip foundry, Taiwan Semiconductor), launched SMIC in Shanghai, reportedly with some legitimate private funding.[36] The US$1.48 billion SMIC venture, however, seems mostly a Chinese government operation. Richard Chang reportedly complains of the strictures placed on the company when it was raising funds. In October 2001, Chang told the Financial Times, "The authorities said how much money we could borrow, and from which Chinese banks-this is very new to us." Said the FT, "Chang has noticed another difference to doing business in China compared with Taiwan; he had had to employ 11 public relations officers to keep local officials informed, compared to just one in Taiwan."[37]

SMIC reportedly purchased five 257-nanometer lithography machines made by ASML of the Netherlands, giving SMIC access to levels of technology for which the United States still denies export licenses to Chinese entities. U.S. guidelines still reportedly limit lithography equipment with capabilities under 0.35 microns, although Motorola has reportedly been granted a license to produce chips at the MOS-17 at 0.25 linewidths. SMIC is scheduled to advance to 0.13-micron production in 2004 and introduce 0.18-micron silicon germanium (SiGe) production technology soon.[38]

Chang seems also to be the rainmaker for SMIC's second new eight-inch waferfab in Beijing, a project valued at US1.25 billion for which Chinese government and government-owned businesses committed US$200 million seed money. The main investors are said to be Beijing's Capital Steel Corp. with US$50 million, the Beijing Municipal Government with US$90 million, and a group of other Beijing enterprises with US$60 million. SMIC and Richard Chang, however, are still trying to pull together another US$400 million to get the project off the ground. Reportedly a Chinese-American investor, Chang Fu-hsing, is also involved. To put the project together, Richard Chang hired Marco Mora, a noted Italian chip manager, to oversee the fab's construction, hire personnel, and organize the new operation.[39]

This migration of Taiwan's "crown jewel" technologies to China has alarmed Taipei's government. In a top-secret report entitled "An Analysis on How the Chinese Communist Party Attracts Taiwanese High Tech Investment for the Suzhou Industrial Park," Taiwan's intelligence agency reported in July 2001 that the Chinese authorities have a blueprint to actively develop semiconductor and high-tech industry "clusters" which include the entire spectrum of each industry. The result, the report said, was that China has effectively attracted the key sectors of Taiwan's computer industry, from downstream component makers like computer motherboard and monitor producers to PC cases and mouse makers. The report suggested that the Taiwan-invested high-tech sector would be a virtual "puppet" of Beijing and recommended that the Taiwan government adopt policies to curb high-tech investment in China.[40]

The one high-tech area in China from which Taiwan's government still prohibits local investors is semiconductor fabrication; but that ban, too, appears to be eroding.

The Defense Risks of a Modernizing China and Ways to Mitigate Them

Although the Chinese government has had a comprehensive science and technology R&D strategy in place since March 1986 (the so-called 863 and Torch programs), the Ninth Five-Year Plan launched in 1995 clearly identified areas where China's leadership believed its security and strategic interests would best be served. They included:

• Aerospace,
  
• Lasers,
  
• Advanced materials,
  
• Microelectronics,
  
• Biotechnology,
  
• Information technologies, and
  
• Industrial automation

The U.S. Department of Commerce noted with excitement at the time that "these technologies target areas of U.S. strength. China's emphasis on technology transfer will result in many initiatives and incentives for acquiring these technologies" and encouraged U.S. companies to vie for contracts in these areas.[41] The General Accounting Office noted in April 2002 that

Since 1986, China's efforts to improve its semiconductor manufacturing capability have narrowed the gap between U.S. and Chinese semiconductor manufacturing technology from between 7 to 10 years to 2 years or less. According to our analysis of information obtained from semiconductor manufacturing facilities in China and industry experts, China's most advanced commercial manufacturing facilities can produce chips that are only one generation behind current, commercial state-of-the-art technology. China has made improving its semiconductor manufacturing capability a priority for national and economic security reasons and plans to build as many as 20 multibillion-dollar manufacturing facilities over the next 5 to 10 years with substantial levels of foreign investment. The growing sophistication of China's semiconductor manufacturing facilities, which has improved its ability to develop more capable weapons systems and advanced consumer electronics, has been fueled by China's success in acquiring manufacturing technology from abroad.[42]

By 2002, it was clear that China's industrial modernization was focusing on "pockets of excellence" where select technologies would benefit China's military industries. China's Commission for Science and Technology Industry for the National Defense (COSTIND) reportedly identified several such "pockets" which include preemptive long-range precision strike capabilities, information dominance, command and control, and integrated air defense. As a result, Beijing identified the development of an indigenous microelectronics industry as one of its highest priorities.

The Chinese leadership believes an advanced domestic microelectronics sector will support both military modernization as well as commercial demand, and in recent months China's defense emphasis has been on development of very large-scale integrated circuits (ICs), which will have direct application in future military systems such as advanced phased-array radars, to name just one.[43] For such systems to be able to track 200 targets 100 times per second at resolutions of one meter and accurately compute trajectories, predict g-force pulls, and predict probable flight paths, ultra-high-speed semiconductors are required to store and process the data.

China does not now have the design or lithography capabilities to produce such IC chips, but it will as soon as it acquires the same industrial equipment as is available at the industry standard in the United States-which is 0.25-micron linewidths with international standard design software. The advances in these technologies require micro-circuitry of increasingly finer linewidth lithographies. Up to 2000, China's domestic semiconductor fabs could only etch integrated circuits down to about 0.6 microns, and their clock speeds and parallel processing capacities were limited accordingly. Moreover, China's domestic IC design talent and capabilities were crude.

The movement of 0.25-micron lithography into China-located waferfabs like the MOS-17 and the NEC-Huaneng facilities did not directly advance China's defense modernization because they reproduced IC designs from abroad and were under the control and supervision of foreign technicians. But 0.25-micron linewidths remain-as of August 2002-the industry standard, and the Grace SMC and SMIC fabs, which will soon go into mass production at 0.25 microns, are under the complete control of Chinese entities without foreign monitoring or supervision.

Some have pointed out that these new fabs are of marginal utility to China's defense modernization without a robust IC design capability; but Motorola and NEC have already set up design laboratories in China, and Taiwan's Via Technologies has the largest design house in the country.[44] Several U.S.-based chipmakers, including Motorola, have also launched sophisticated software labs in China targeted on advanced telecommunications transmission codes, global positioning software, and IC design software.[45]

However, whether foreign IC design shops in China can actually maintain control of their own intellectual property is problematic. Either it will be pirated with impunity because it is not patented in China, or patents will be filed with the Chinese government where the military will have access to the property and utilize it for its own purposes.[46]

What is not in question is that China's military modernization will be built largely on its rapidly expanding semiconductor industry, and China's semiconductor industry will get its technology almost exclusively from abroad-particularly from the United States, Japan, and Taiwan, as well as the European Union.

Realm of Trade-Related Countermeasures Available to China's Neighbors

There is an ongoing debate surrounding Taiwan's domestic legislation related to permitting Taiwan's semiconductor industry to transfer wholesale its production, testing, packaging, design, and marketing operations to China. On the one hand, Taiwan politicians, leery of China's motives and unwilling to allow Taiwan businesses to partake actively in China's military modernization, are adamant that Taiwan chip-fabs be banned from giving China access to any technology that it doesn't already have.

On the other hand, Taiwan's semiconductor firms argue that in order to upgrade Taiwan's industrial base, they must find productive, profitable uses for their existing fabs. Upgrading to multibillion-dollar fabs utilizing 12-inch wafer production (300mm) discs, which can hold two and a half times as many chips as existing standard eight-inch (200mm) fabs, requires that construction of the new facilities be financed by profits from the old lines.

IC entrepreneurs in Taiwan also argue that China's light-industrial sector is the world's fastest-growing market for chips and that foreign fabs are moving into the China market already. The pressure on Taiwan's government to approve the migration of these key semiconductor technologies, fabrication equipment, design talent, and capital is enormous.

In March, Taiwan's Premier Yu Shyi-kun agreed in principle for local semiconductor companies to build eight-inch wafer plants in China that use 0.25-micron and less advanced manufacturing technology; but the government would allow only three eight-inch plants to migrate to China by 2005, and local chipmakers will be allowed to export only old equipment using 0.25-micron technology or below. Moreover, total investment by Taiwan's chip industry will not be permitted to exceed NT$70 billion (roughly US$2.1 billion) by 2005, with new capital investments accounting for NT$30 billion.

Taiwan's military and intelligence analysts fear Taiwan will lose its competitive edge and have urged that no technology finer than 0.25-micron goes to China.[47] The political debate in Taiwan has therefore shifted away from the previous policy of Taiwan President Lee Teng-hui of "Don't Hurry, Be Patient," which banned all semiconductor investments by Taiwan companies in China, to the more lenient policy of the Chen Shui-bian government of "Active Opening, Effective Management."

The new policy was intended, no doubt, to stress the "effective management" of key technology exports to China, not the "opening" of China as an investment destination, but the vague foundations of the new policy prevent articulation of a clear strategy of why Taiwan wants to limit such exports. Indeed, Taiwan has two good reasons to limit these exports: They are militarily sensitive, and they tend to "hollow-out" Taiwan's only industrial sector where it retains a significant international presence.

Pressures on the United States government are also significant. Despite an unofficial "policy" that "certain exports of semiconductor manufacturing equipment to China are limited to two generations behind state-of-the-art levels to address national security concerns"[48] and a determination by the Department of Defense that technology more advanced than 0.7-micron is "military critical,"[49] there is no consistent ban on U.S. exports of semiconductor technology to China.[50] U.S. firms argue that they face stiff foreign competition, and the U.S. Department of Commerce appears to agree. Apparently not discouraged by the U.S. government, Applied Materials Inc. Executive Vice President David Wang said in March 2002 that his firm sees US$500 million in sales next year and hopes the wave of investments in the Chinese chip sector will boost annual sales to China to $1 billion by 2005.[51]

Japan, itself, is also in danger of "hollowing out" its own semiconductor industry by permitting virtually any sales of chip fabrication equipment at any level of technology to China. Japan has generally followed America's lead on the control of dual-use exports to China, but in the absence of a clear U.S. policy, Japan's export-control bureaucracy is hard-pressed to deny export licenses.

This is not to say the three countries cannot reconsider their present China export policies-or lack thereof-in light of China's growing military and naval presence in the Western Pacific. America's "Tiananmen Sanctions," the Iran-Iraq Arms Non-Proliferation Act of 1992, and participation in multilateral regimes such as MTCR, Wassenaar Arrangement, Australia Group impacts, as well as the plain language of the Export Administration Act of 1979, are all adequate machinery at present to construct a new export-control regime for China.

The facts of China's rapid military buildup and the fact that the buildup is focused on the twofold objective of investing Taiwan and deterring American aid to Taiwan are explicated in well-documented detail by the Pentagon's Report on the Military Power of the People's Republic of China of July 12, 2002. Further evidence of China's military intentions is exhaustively presented in the USCC report. Together, the two reports are more than sufficient grounds for the Bush Administration to order a review and tightening of the slapdash and ad hoc export-control policies that now pertain to dual-use exports to China. Indeed, this much was strongly recommended by the General Accounting Office report cited above.

If the United States takes the lead in reviewing the "China Threat," Taipei's government will follow suit-and would likely breathe a sigh of relief if given the opportunity to base their investment ban on a request from Washington. Given Japan's general inclination to follow the U.S. lead on nonproliferation policies, Tokyo itself could find the political will to take a move which, though unpopular with China, would have significant political support at home, especially among trade unions and workers.

Conclusion

China has a potential to become a valuable, cooperative, constructive member of the Asia-Pacific economic community; but it could also become the opposite-a fearsome, aggressive, and militaristic power. Top Bush Administration officials have said as much in recent speeches.[52] How Beijing addresses its differences with Taiwan will be the bellwether of China's future role in Asia.

But the answer is not simply to wait and see how China turns out or watch on the sidelines China's approaches to Taiwan. As China's major trading partners, the United States, Japan, and Taiwan should be prepared to take active measures to encourage China toward cooperation and contribution. This must include a firm response to China's aggressive militarization and stronger efforts to integrate Taiwan into the Asia-Pacific economic community in its own right.

Throughout the 1990s, a tepid American response to Chinese sabre-rattling seemed only to encourage Beijing's bad behavior. Even the dispatch of two U.S. Navy carrier battle groups to the Taiwan Strait area in March of 1996 was followed by efforts by the Clinton Administration to assuage China's sensitivities on the Taiwan issue and to put increased pressure on Taipei to meet Beijing's political demands. Chinese President Jiang Zemin's visit to Washington in October 1997 resulted in the first articulation of the "Three No's" by the State Department spokesman, and Clinton's state visit to China in June-July 1998 resulted in the President's personal articulation of that policy. The lesson China learned from an accomodationist stance in Washington was that aggressive moves are effective.

The Bush Administration appears more inclined to respond to Chinese provocations with tough responses. In March 2001, the Bush Administration warned China that its threats to Taiwan would have consequences. In April, the Administration approved the single biggest arms package to Taiwan in a decade. China's military modernization continues, and the Bush Administration seems ready to respond in kind.

The preponderance of evidence demonstrates that China fully intends to use military might to force Taiwan into a political union with China as soon as it achieves the capacity to do so; but China's capacity to wage a 21st century war against Taiwan-and the United States and Japan-will depend in large part on its ability to develop 21st century weaponry. That will come only with the emergence of a 21st century industrial infrastructure-an infrastructure that must encompass the latest semiconductor technology.

Until there is convincing evidence of China's peaceful intentions toward Taiwan, source countries for China's major advanced technology imports should coordinate their export-control policies to ensure that they do not accelerate the development of China's military strength. Washington should take the lead in reviewing existing China export controls and forging a consensus with Tokyo and Taipei on implementing them. Already, Washington has cautioned Moscow on advanced arms sales to China[53] and has pressured Israel to scale back its military sales.[54] The time has come for Washington to take a similar stance with America's European allies.

But a further deterrent to China must be Taiwan's deeper economic integration into the Asia-Pacific and international trading community. The more Taiwan is accepted as a major trading nation in its own right, with full international recognition of its economic and trade strengths, the less leverage China has on Taiwan's economic partners to isolate the island, and the less legitimacy China's threats of military action have.

The time is ripe for Taiwan to join in free trade agreements (FTAs) with as many of its Asia-Pacific trading partners as possible.[55] But Taiwan's trading partners should be alert to the probability that China will attempt to lock Taiwan out of both bilateral FTAs and regional agreements.[56]

In fact, any regional FTA including China would likely be detrimental to most countries of ASEAN[57] as well as Japan and Taiwan.[58] Thus, it may be practical, with the encouragement of the United States and Japan, for Taiwan to conclude a number of bilateral FTAs with ASEAN countries, particularly with Singapore, the Philippines, and possibly Malaysia and Thailand as well.

John J. Tkacik, Jr., is Research Fellow in China Policy in the Asian Studies Center at The Heritage Foundation. He spoke at a panel on "Taiwan and U.S. Policy: Toward Stability or Crisis," hosted by Senator Joseph R. Biden, Chairman of the Senate Foreign Relations Committee, at the Russell Senate Office Building on October 9, 2002. The panel was organized by the Carnegie Endowment for International Peace, the Asia/Pacific Research Center of Stanford University, the National Committee on United States-China Relations, and the Center for Strategic and International Studies.

Endnotes

[1]Report to Congress of the U.S.-China Security Review Commission-The National Security Implications of the Economic Relationship Between the United States and China, released July 15, 2002, and available at http://www.uscc.gov/anrp02.htm. Cited hereafter as USCC Report. It should be noted that the USCC went out of its way to avoid using the word "threat" when referring to China's military posture toward the United States; however, the initial "key finding" of Chapter 9 (p. 167) is that "China's defense spending…is funding a strategic buildup that is aimed at U.S. interests in the area."

[2]Report to Congress Pursuant to the FY 2000 National Defense Authorization Act, Annual Report on the Military Power of the People's Republic of China, July 12, 2002, available at http://www.defenselink.mil/news/Jul2002/d20020712china.pdf.

[3]For example, during his State of the Union Message on January 29, 2002, President Bush said, "America is working with Russia and China and India, in ways we have never before, to achieve peace and prosperity. In every region, free markets and free trade and free societies are proving their power to lift lives. Together with friends and allies from Europe to Asia, and Africa to Latin America, we will demonstrate that the forces of terror cannot stop the momentum of freedom." See http://www.whitehouse.gov/news/releases/2002/01/20020129-11.html.

[4]See especially USCC Report, Chapter 9.

[5]See Thomas G. Rawski, "What Is Happening to China's GDP Statistics?" China Economic Review, Vol. 12 (2001), pp. 347-354. See also Alwyn Young, "Gold into Base Metals: Productivity Growth in the People's Republic of China During the Reform Period," National Bureau of Economic Research, NBER Working Paper No. 7856, August 2000, available at http://www.nber.org/papers/w7856.

[6]USCC Report, p. 40.

[7]"Mainland's Attractiveness to Foreign Capital Returns, Last Year Neared US$46.8 Billion," China Times, Taipei, January 16, 2002 (in Chinese). In fact, China is a top investment destination for most Asian outbound FDI. In July, the South Korean Ambassador to China noted that ROK firms had invested US$12 billion in China since 1992. See "Mainland Is South Korea's No. 2 Investment Destination," China Times, Taipei, July 14, 2002 (in Chinese). According to Singaporean government statistics, the biggest recipient of Singapore FDI outflow was China, which received S$12.63 billion as local manufacturers shifted production to China in search of lower costs. See Jetro White Paper on Foreign Direct Investment 2002, published by the Japan External Trade Organization, January 2002, p. 35, available at http://www.jetro.go.jp/it/e/pub/whitepaper/invest2002.pdf. See also "China to Absorb Nearly US$50 Billion in Foreign Investment This Year," Commercial Times, Taipei, Internet version, July 12, 2002 (in Chinese).

[8]Hugo Restall, "Asia's Giant Sucking Sound," Asian Wall Street Journal, June 20, 2002, p. 14.

[9]Arvind Panagariya, "Why We Lag Behind China," Economic Times, published by the University of Maryland, May 22, 2002, at http://www.bsos.umd.edu/econ/panagariya/apecon/ET/et40-May22-02.htm.

[10]U.S.-China Security Review Commission, "Technical Briefing on Business, Trade and Economic Issues," Oral Testimony of Nicholas Lardy, May 9, 2001, p. 177; cited in USCC Report, p. 42.

[11]Yuh-jiun Lin, "Reflections on the Eve of the Great Deluge of Mainland Imports," China Affairs, Taipei, April 2002, p. 128 (in Chinese).

[12]U.S.-China Security Review Commission, "U.S.-China Current Trade and Investment Policies and Their Impact on the U.S. Economy," Oral Testimony of Kevin Kearns, June 14, 2001, p. 125; cited in USCC Report, p. 42.

[13]Jane Perlez, "China Races to Replace US as Economic Power in Asia," The New York Times, June 28, 2002, p. A1, available at http://www.nytimes.com/2002/06/28/international/asia/28ASIA.html.

[14]Of course, the most prominent proponent of this view is former Taiwan President Lee Teng-hui. See Zeng Hongru and Cai Zhongxun, "Lee Teng-hui: Investment in PRC Hollows Out Taiwan Industry," Taipei Liberty Times, August 11, 2002, Internet edition (in Chinese).

[15]"Japanese Firms Will Shift Production Lines to China," reported by Agence France-Presse

from Tokyo on July 26, 2002, and available at Taipei Times on-line at http://www.taipeitimes.com/news/2002/07/26/story/0000153539. Beijing Xinhua reported the same day that three other Japanese raw materials suppliers had moved operations from Japan to Shanghai's Waigaoqiao zone to be closer to customers. See also "Japan Investors Shutter Plants in Southeast Asia and Move to the Mainland," China Times, Taipei, July 26, 2002 (in Chinese).

[16]Perlez, "China Races to Replace US as Economic Power in Asia."

[17]Ing-wen Tsai, Ph.D., "A New Era in Cross-Strait Relations? Taiwan and China in the WTO," Heritage Foundation Lecture No. 726, January 14, 2002 (delivered December 13, 2001).

[18]See "Central Bank Says that Taiwan Investment in Mainland Estimated to Top US$100 Billion," China Times, Taipei, November 10, 2000 (in Chinese). On May 31, 2002, the Taipei Times cited a PRC report, which claims Taiwan businesses have US$140 billion invested in China. See "Taiwan Businesses Have US$140 Billion Invested in China," at http://www.taipeitimes.com/news/2002/05/31/story/0000138441.

[19]See "PRC Statistics Show Taiwan Investments in China Are at Highest Level Since 1995," China Times, Taipei, April 5, 2002 (in Chinese). See also "Taiwan's Total Mainland Bound Investments Amount to USD29.56 Bn.," China Economic News Service, Taipei, April 16, 2002.

[20]"Taiwan's Indirect Investment in Mainland China up 47% in April," China Economic News Service, Taipei, May 21, 2002.

[21]USCC Report, Chapter 2, Figure 2.5.

[22]Jetro White Paper on Foreign Direct Investment 2002, pp. 34 and 36.

[23]"Japan Invests More in China to Beat Recession at Home," reported by Bloomberg business news service from Tokyo AND cited in Taipei Times, June 15, 2002, at http://www.taipeitimes.com/news/2002/06/15/story/0000140502.

[24]See "Export Orders Filled Overseas Ratio of Traditional Firms Output Abroad Dipped in March 2002," China Economic News Service, Taipei, May 20, 2002. See also "Taiwan Businesses 'Taiwan-takes-order, Mainland-ships-goods' Ratio Rises over Years," China Times, Taipei, March 6, 2000 (in Chinese).

[25]"January Export Reliance on Mainland Is 23.1%, a New High", China Times, Taipei, March 28, 2002 (in Chinese); see also "First Two Months' Export Reliance on Mainland Is 21.5%," China Times, Taipei, April 30, 2002 (in Chinese). According to "May Imports and Exports Both Grow for First Time in 15 Months," China Times, Taipei, June 8, 2002 (in Chinese), 29 percent of May 2002 Taiwan exports went to China and Hong Kong.

[26]Taiwan-China trade statistics are taken from "Analysis of the April 2002 Cross Strait Trade Situation, June 27, 2002," available at http://www.trade.gov.tw/prc&hk/bi_ch/mo_index.htm (in Chinese).

[27]See "Mainland China to Replace Taiwan as World's 3rd Largest IT Supplier," China Economic News Service, Taipei, November 6, 2000.

[28]"Waferfab" is a term of art for a semiconductor manufacturing complex whose final product is silicon wafers with multiple copies of integrated circuit chips etched on them. These multibillion-dollar factories produce the actual "chips" for industrial applications. ASIAN TECHNOLOGY INFORMATION PROGRAM (ATIP) REPORT: ATIP97.04 states that "Chinese GPS companies are manufacturing products for advanced navigation and positioning systems that are designed, developed, and integrated wholly in China using a wide range of GPS receivers from Rockwell, Motorola, GarMin, Trimble, etc." The report is available at http://www.atip.or.jp/services.html.

[29]Anthony Cataldo, "Motorola Cleared to Build 0.25-micron Fab in China," EE Times, August 21, 2000, Web-posted at 12:19:57 PM EDT.

[30]Ibid.

[31]Joyce Huang, "NSC Forms Rules for High-tech R&D," Taipei Times, September 3, 2002, available at http://www.taipeitimes.com/news/2002/09/03/story/0000166646.

[32]Andrew Batson, "Chine Watch: Tech Industry Helps to Modernize Military," Dow Jones International News, April 14, 2002. See also Lian Junwei, "The West Indirectly Aids Chinese Military Science and Technology Improvements," Commercial Times, Taipei, April 16, 2002 (in Chinese).

[33]Bai Dehua, "Groundwork for Grace Factory Begun, Chinese Side to Provide at Least US$1.1 Billion in Low Interest Loan," Commercial Times, Taipei, November 21, 2000 (in Chinese).

[34]Taiwan Weekly Business Bulletin for November 16 to November 23, 2000. The Taiwan Weekly Business Bulletin is a publication of the USA-ROC (Taiwan) Business Council.

[35]See U.S. General Accounting Office, Export Controls: Rapid Advances in China's Semiconductor Industry Underscore Need for Fundamental U.S. Policy Review, April 2002, available at http://www.gao.gov/new.items/d02620.pdf. The GAO appears to have been told (p. 12) that both Grace SMC and SMIC have no Chinese investment, but this is clearly false. Indeed, there is no evidence that they have anything but Chinese government financing at this stage.

[36]"Semiconductors Mainland Chipmakers Aim to Outpace Taiwan Counterparts by 2004," China Economic News Service, Taipei, March 20, 2002. U.S. investors were listed as Goldman Sachs and Hambrecht & Quist.

[37]Richard McGregor, "Apec-Asian Pacific Cooperation-New Plants Open on Fertile Ground-Technology in China," Financial Times, October 16, 2001.

[38]GAO, Export Controls, p. 47.

[39]"Settling in the Yizhuang Economic Development Zone, SMIC's Beijing 8-inch Fab Moves in and Sets up Shop," Commercial Times, Taipei, June 17, 2002 (in Chinese).

[40]Dan Nystedt, "Top Secret Report Sets off Alarms in the Tech Sector," Taipei Times, July 4, 2001, at http://ww.taipeitimes.com/news/2001/07/04.

[41]See U.S. Department of Commerce, Technology Administration, China to Triple Its R&D Investment, August 1995, available at http://www.ta.doc.gov/Reports/intlS&T/InterS&T.pdf.

[42]GAO, Export Controls, p. 2 (emphasis added).

[43]See Lisa Bronson, Deputy Under Secretary of Defense for Technology Security Policy and Counterproliferation, prepared statement for United States-China Commission hearing on

U.S. Export Control Policy Toward China, January 17, 2002. A transcript of the USCC testimony is available at http://www.uscc.gov/trn117.pdf.

[44]"Japanese Waferfab R&D Centers Westward Move En Masse," China Times, Taipei, April 22, 2002 (in Chinese). See also "Taiwan IC Designers Clamor for Mainland Investment Rights," China Economic News Service, Taipei, April 16, 2002. "VIA Tech to Have More Employees in Mainland Than Taiwan," China Economic News Service, Taipei, April 29, 2002, notes that VIA's payroll in China "has ballooned to 450, making it the company with the largest team of IC designers on the mainland." But the Taipei Times notes that several Taiwan design firms will not use chip-manufacturing services in China; nor will they set up R&D facilities there in the near future, partially because of the lack of intellectual property protection in China. See Dan Nystedt "Chip Design Houses Eye China Market," Taipei Times, March 15, 2002, available at

http://www.taipeitimes.com/news/2002/03/15/story/0000127844.

[45]"Motorola Builds Software Center in Chengdu," Commercial Times, Taipei, May 20, 2002 (in Chinese). See also Motorola Asia Pacific Semiconductor Products Sector press release, "Motorola Opens China Predictive Technology Laboratory in Beijing," at http://apspg.motorola.com/press/press/012999/beijing.html, and Intel China Research Center press release, at http://www.intel.com/jobs/china/crcenter.htm.

[46]Dan Nystedt, "TSMC Moves to Protect Intellectual Property in China," Taipei Times, May 24, 2002, at http://www.taipeitimes.com/news/2002/05/24/story/0000137449.

[47]"Cabinet Gives Go Ahead for Chip Investments in Mainland China," China Economic News Service, Taipei, April 1, 2002.

[48]GAO, Export Controls, p. 4.

[49]Ibid., p. 16.

[50]Ibid., p. 3, says that "the United States approves most licenses for exports to China of semiconductors manufacturing equipment and materials."

[51]Edwin Chan, "Applied Materials Sees USD500 mln China Orders," Reuters, March 26, 2002.

[52]Secretary of State Colin Powell said on June 10, 2002, that "an arms build-up, like those new missiles opposite Taiwan, only deepen [sic] tensions, deepen [sic] suspicion. Whether China chooses peace or coercion to resolve its differences with Taiwan will tell us a great deal about the kind of relationship China seeks not only with its neighbors, but with us…. How China deals with Taiwan to resolve its differences will be the bellwether for China's future role in the Region. See "Colin Powell Remarks at Asia Society Annual Dinner," New York City, June 10, 2002, available at the U.S. Department of State Web site, http://www.state.gov/secretary/rm/2002/10983.htm. See also "Remarks by Secretary of State Colin L. Powell and Australian Minister of Foreign Affairs Alexander Downer After Their Meeting," July 11, 2002. Powell noted that "we also know that some of it [China's wealth] will be used to modernize Chinese military forces. That is not in and of itself frightening, as long as it is clear it is a modernization that doesn't reflect any kind of new strategic purpose or represent any sort of threat to the region." At a briefing with foreign reporters at the Foreign Press Center in Washington, D.C., on May 29, 2002, Deputy Secretary of Defense Paul Wolfowitz also asked what kind of force China would prove to be in Asia: "the real issue is will China develop into a powerful force for peace in the East Asia region, which it has the potential, or will it develop into a new, threatening power? It seems almost certain that China is going to be more powerful, certainly on the trajectory that it's on. The question is to what end is that applied? And I think it's extremely important for everyone-Chinese and non-Chinese-to try to do everything we can to ensure that it takes the first course and not the second." See http://www.defenselink.mil/news/May2002/t05312002_t0529dsd.html.

[53]See U.S. Ambassador to the Russian Federation Alexander Vershbow's "sweeping speech" of July 22, 2002, at http://usembassy.state.gov/moscow/wwwhop8.html. The speech was given on the second day of a week-long conference at the Moscow School of Political Studies at Golitsyno near Moscow. Vershbow expressed concern about Russia's weapons sales to China. "Could the massive amounts of weaponry that Russia sells to China-for understandable commercial reasons-add to the instability of Asia?" he asked. "If war broke out in the Taiwan Straits, this would lead to serious instability on Russia's eastern border." See Angela Charlton, "Vershbow: Iran and Chechnya Worry U.S.," Associated Press, in Moscow Times, July 23, 2002, p. 1, available at http://www.themoscowtimes.com/stories/2002/07/23/003.html.

[54]"U.S. Cautions Israel Not to Sell Military Materiel to Beijing," China Times, Taipei, June 22, 2002 (in Chinese), citing Agence France-Presse reports from Jerusalem that immediately following PRC Vice Foreign Minister Yang Wenchang's call on Prime Minister Ariel Sharon, the U.S. ambassador called on Sharon to warn that "any arms sales to China would be detrimental to Taiwan." See also "White House: If Israel Sells Aircraft to China, US Will Delay Economic Aid," Central Daily News, Taipei, April 9, 2000 (in Chinese), and "Israel AWACS Sales to China Face Reversal," Central Daily News, Taipei, June 17, 2000 (in Chinese).

[55]"Japan Wants Free Trade Agreement With Taiwan," Taipei Central News Agency, July 18, 2002 (in English), cites Japan's minister in charge of the economy and industry Takeo Hiranuma as saying that Japan hopes to sign a free trade agreement with Taiwan to enhance bilateral economic and trade relations. Taipei's Commercial Times for May 19, 2002 (in Chinese), reported that "Chen Shui-bian hopes to sign FTAs with the US, Japan and Singapore." See also "Taiwan Sets Signing FTA's with US, Japan and NZ as Priority," China Times, Taipei, November 13, 2001 (in Chinese). According to Deborah Kuo, "New Zealand Interested in Forging Free Trade Zone Accord with Taiwan," Taipei Central News Agency, September 30, 2001, "New Zealand recently expressed its intention to the BOFT to consider forming a free trade zone with Taiwan after Taiwan is formally admitted into the World Trade Organization."

[56]See "Chinese Minister Warns Countries Not to Sign Free Trade Agreements with Taiwan," Associated Press, June 21, 2002. Chinese Foreign Trade Minister Shi Guangsheng said China would consider free-trade agreements with Taiwan a breach of the "one-China" policy and warned that "If such countries sign free-trade agreements with the Taiwan authorities, they are bound to bring political trouble to themselves."

[57]See "ASEAN Leaders Split over FTA with China," Kyodo News, November 5, 2001, which reports that some "ASEAN countries such as Malaysia, Indonesia and Vietnam are cautious" about an ASEAN-China free trade zone and would like to study it further. "ASEAN sources said 'Malaysia, Vietnam and Indonesia are quite reluctant because…they feel threatened. Only Singapore is enthusiastic. So far the rest said they will study it.'"

[58]"Koizumi Denies Japan Left Behind by China ASEAN FTA," Kyodo News, filed from Bandar Seri Begawan, November 6, 2001. See also "Japanese Stunned by Koizumi Impotence [in Brunei]," China Times, Taipei, November 7, 2001 (in Chinese). The report from Japan says the Japanese fear that an ASEAN+1 free trade zone threatens Japan's economic interests and that public sentiment was for Koizumi to oppose it. See also "P.K. Chiang Worries that ASEAN Free Trade Area Threatens to Affect WTO Entry of China, Taiwan," Commercial Times, Taipei, November 14, 2001 (in Chinese).