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Statement by

Mr. John J. Fialka

before the

Joint Economic Committee
United States Congress

June 17, 1997


CHINA AND ECONOMIC ESPIONAGE

      Spies are normally associated with wartime and the theft of military technology. In the vast popular literature about espionage, there is hardly a mention of peacetime economic spies. One reason may be because spy stories tend to blossom when wars end. War is relatively clear cut: there is a winner and an eventual loser; a beginning and an end. The end is normally the signal for the memoir writers to begin.

      But economic espionage is different. Winners win quietly and losers are often either unconscious of loss, or too embarrassed to admit it. My book argues that this is like a war because war-like damage can result, but there is no beginning, no end, and, consequently, no memoir writers. As far as I know, my book is the first thoroughly-documented book on the subject.

      Although few Americans are aware of it, our nation's history has been heavily influenced by economic espionage. Shortly after the American Revolution, we were the spies. And the richest, most industrialized part of the world at that time--Europe--was our target. Alexander Hamilton, Thomas Jefferson and many others among the founders' generation were involved in it, but one American spy stands out--Francis Cabot Lowell. He managed to steal the design of one of Great Britain's technological marvels, a water-powered loom that was so efficient that it could produce acres of cloth with relatively little human labor. Using this technology, Lowell created the New England textile industry which was, in turn, the foundation for America's industrial revolution.

      One hundred and eighty four years later, the world that Mr. Lowell knew has been stood on its head. What he managed to start, the American industrial economy, is now the richest in the world. As such it has become the chief target of the world's economic spies. There are quite a number of them--from at least 20 major countries. Meanwhile, Americans have become complacent. Unlike our ancestors, who scoured the world for new ideas, we have lost our hunger for that. Many of us have come to assume that the best technology will always be here.

      The thesis of my book is that that assumption may no longer be true. Unless we can understand the efforts currently being made against us and raise our awareness to the point where we win at least as many episodes as we lose, we will be in serious trouble. The National Economic Council, which includes experts from the CIA, FBI and the Departments of Treasury, State, Defense, Commerce, Justice and elements of the White House prepared a secret estimate of the current situation for Congress's intelligence committees in 1994. The report says that "economic espionage is becoming increasingly central to the operations of many of the world's intelligence services and is absorbing larger portions of their staffing and budget."[1]

      This could involve a lot of people and a lot of power because nations have brought a their Cold War spy apparatus with them into economic espionage including giant computer data bases, word-activated eavesdropping scanners, spy satellites and an almost unbelievable array of bugs and wiretaps.

      Economic espionage carried out in the U.S. breaks down into three major styles. The study says agents from China, Taiwan and South Korea are aggressively targeting "present and former nationals working for U.S. companies and research institutions." Japan, which does not have a formal intelligence agency but sometimes collectively resembles one, uses Japanese industry and private organizations to gather "economic intelligence, occasionally including classified proprietary documents and data." The result is an exceptionally efficient spy network that "is not fully understood" by the U.S. Meanwhile, France has relied upon "classic Cold War recruitment and technical operations," which generally include bribery, discreet thefts, combing through other peoples' garbage and aggressive wiretapping. There are recent signs, however, that France has decided to stop.

      Another Cold War ally, Germany, is described as planning to increase the number of its Federal Intelligence Service (BND) agents in Washington to improve its collection capabilities. And Russia and Israel also conduct economic intelligence gathering operations in the U.S. with "varying degrees of government sponsorship.[2]

      The most aggressive operations against U.S. companies occur overseas, especially in home countries where spy agencies are freer to act and where, the National Economic Council report notes, "government controlled national phone networks" and other electronic means can be used to slither inside company communications and data banks. The best places to recruit foreign nationals who work for U.S. companies overseas is said to be in third countries where "a host country's counterintelligence services do not pose a serious barrier to effective foreign intelligence operations directed against U.S. targets. Furthermore, U.S. citizens tend to be more lax about security matters when living in countries perceived as friendly to the United States."[3]

      "Lax" is probably a polite way to describe the laid back attitudes that many Americans have toward our technology. A recent study by the National Research Council found that one way Japanese businessman collect information about the U.S. aerospace industry--one of Japan's current major targets--is to get their U.S. counterparts to brag. "Ego comes into play as engineers try to impress their foreign contacts..."[4]

      Part of Japan's approach is simple: they have many more people looking here than we do there. In 1988 Japan sent 52,224 researchers to the U.S. Meanwhile 4,468 U.S. researchers went to Japan.[5] Japanese companies invest the time and money to teach their people English and the U.S. culture. U.S. companies rarely bother.

      And what Japan has accomplished in the U.S. has caused a stir of envy, especially in the Peoples Republic of China whose collection efforts in the U.S. are likely to be larger and, in the long run, more threatening than the Japanese campaign, which they appear to be using as a model. Like Russia and Japan, China's initial target has been U.S. universities. In 1991, 51 percent of all science and engineering doctorates awarded by U.S. universities went to students from Pacific Rim nations with the dragon's share going to the two Chinas. Many of these students--educated largely at the expense of the U.S. government--get jobs in the U.S. after obtaining their doctorates and a large number of high tech companies and U.S. government research laboratories are becoming hooked on this stream of cheaper, often smarter and more biddable talent.[6] Some of these students eventually become U.S. citizens and help renew the American dream by achieving breakthroughs that mean new jobs and new markets. But many go back and government recruiters from their homelands are working here to lure more back home, where they become serious and sometimes dangerous competitors. What makes this scary is that while the influx of foreign students has been growing, the faltering U.S. public education system has been producing fewer and fewer qualified applicants for graduate level science and engineering. What this means is that many new U.S.-invented technologies that we expect to drive our economy in the 21st century--such as biotechnology and photovoltaics--are being quietly targeted and exported overseas.

      My book shows how the Japanese, Russians and the French do economic espionage, but I would like to keep this testimony focused on China, which poses problems that, I think, will become more serious over time. In this game China is a dragon with two heads. Other competitors look for commercial advantage, China, a nuclear power, looks for that as well as military advantage and they often find both in the same deal. Its commercial companies are often parts of its military. They have tank companies that sell us teddy bears and toilet seats. Their profits from the U.S. go to modernize a Army, Navy and an Air Force that has begun to flex its growing military muscle in the Pacific. China's prime intelligence agency, the Guojia Anquan Bu, or Ministry of State Security (MSS), has flooded the U.S. with spies, sending in far more agents than the Russians even at the height of the KGB's phenomenal Cold War campaign. About half of nine hundred illegal technology transfer cases being investigated on the West Coast involve the Chinese. The MSS recruits students. When money is not persuasive, threats against family members back home often are. And unlike the KGB, China's spies easily find protective cover in the large U.S. Asian population.[7]

      While the FBI makes an effort to watch foreign students and businessmen, China's flood has simply overwhelmed the bureau. "The FBI is ensnarled in a cess pool of Chinese agents and their cases are all stuck at first base," says James Lilly, former U.S. ambassador to China and former CIA station chief in Beijing.

      While the Japanese focus on things like disc brakes and video cassette recorders, China's strategists shop for missile guidance systems that can use signals from our satellite-based global positioning system for precise targeting information. They go after small cruise missile engines, night vision equipment, upper stage rockets and nose cones for globe-spanning nuclear weapons. These are all things that may fundamentally shift the balance of power in the next decade and drive threatened countries like Japan and Taiwan into full-blown nuclear weapons programs.

      You will find that a lot of trade experts and business executives don't see and don't want to see this side of China's balance sheet. The prevailing intellectual fashion is to regard the lowering of trade barriers and the influx of foreign goods and students as part of a vast, multi-cultural economic march toward a peaceful "globalism." Increasingly, sovereign issues such as national borders, intelligence and military matters are dismissed as old hat.

      But they are not old hat to China's current leadership, which is using a whole range of Cold War espionage tactics, such as the insertion of "sleepers," or long term spies, against the U.S. Federal Court documents in Norfolk, Va., show how one young Chinese philosophy professor, Bin Wu, was sent to the U.S. under orders to become a successful businessman, to steal weapons-related technology and to develop political sources in the U.S. Senate and the White House. Before he was sent, he was told that the U.S. was one of the major enemies of China, and that China was preparing for a "long battle." As his U.S. career blossomed, he was told by his MSS handlers, he would never be alone. "Someone will always be worrying about you."[8]

      China's Ministry of State Security was formed by combining the espionage, intelligence and security functions of the former Ministry of Public Security with the investigations branch of the Communist Party's Central Committee. What had been largely an internal instrument used to hunt down and annihilate political dissidents in China, was recalibrated to work abroad. In its modern form it supports its budget by hunting here for technology like its model, the Soviet Union's huge, far-flung KGB.

      Bin Wu's case was a classic spy recruitment, a process that is known in the intelligence trade as putting an agent "under discipline." Wu, who had been under investigation in China for political crimes, was hooked through a combination of personal fear, threats against his family and the other baits they had dangled before him. While many other nations recruit spies in this process, China's operations are different because the MSS recruits armies while other nations field platoons. A former FBI official told me: "A lot of people are using their intelligence agents to collect from us in the economic area, but the Chinese do it like a fare thee well. The Chinese are a giant vacuum cleaner."

      Because China currently floods the U.S. with 15,000 students a year and recruits its agents from among the candidates being considered for student visas, a Defense Intelligence Agency expert estimates there could be "a minimum of several hundred long-term agents operating here."[9]

      U.S. intelligence agencies have discovered that one of the MSS's many skills is getting the U.S. to pay most of the costs of their espionage. China and other Far East countries are believed to siphon money from consulting firms they form to help U.S. companies create business ties abroad. The money is then used to finance espionage in the U.S. "We tell U.S. businesses this activity is going on," says Robert A. Messemer, a former FBI counter intelligence expert in Los Angeles. "Many of these efforts are directed at the very same companies that they are cooperating with overseas...they're funding the operations that are being run against them."

      Another favorite Chinese tactic is squeezing defense-related high technology out of U.S. companies as a necessary part of business deals. One incident that is currently being investigated by a federal Grand Jury in Washington began on August 1993 when a group of Chinese visitors entered a U.S. defense plant, called Plant 85 in Columbus, Ohio. One of the visitors carried a video camera and slowly panned down the length of some of the factory's biggest machines. They were from a subsidiary of China's National Aero-Technology Import & Export Corp. (CATIC), which deals in both military and civilian equipment.

      This was a very bold move. The machinery CATIC's team was eyeing amounted to an entire military aircraft plant, the largest east of the Mississippi. It would be impossible to steal it and smuggle it out. It would be illegal and impolitic for China, on its own, to try to buy it and ship it out. Some of the equipment could machine metal to tolerances so precise that they were on the U.S. State Department's list of "very sensitive" technology. Whoever had them had the capability of machining state-of-the-art nuclear warheads.

      But CATIC had found another way. It was trolling an enormous bait, a $1 billion aircraft order in front of McDonnell Douglas. The hook was that, to get the order, the U.S. aircraft company would have to make the political case in Washington to get the export licenses that were was necessary to ship the machines to China.

      The pull being exerted by China on U.S. companies is enormous. For many of them, China is the moon and they hope to ride on the tides created by a growing market of 1.2 billion people. Because China doesn't recognize a lot of U.S. business law, dealings there can pose enormous risks. It is a place where business, military and criminal deals often intermingle. By some measures China is one of the most corrupt places on the planet.[10] Nonetheless, business there still remains tempting. "The only thing worse than being in China is not being in China," Edgar S. Woolard Jr., the chief executive officer of Dupont, once reasoned. "If your competitor catches on there, they're going to come after you with this enormous base."[11]

      Much of what U.S. aerospace companies have to sell has "spun off" of U.S. military technology. In China, U.S. military experts have begun to notice something they call "spin-on." As the Chinese learned how to make fuselages and nose cones for McDonnell airliners, for example, emerging versions of Chinese fighter planes had fuselages that were better made and aluminum skins that were smoother.[12]

      The team from CATIC offered to buy Plant 85's best machines for roughly 10 cents on the dollar. While it looked like the start of a commercial deal, CATIC is simply not another widget company. It is part of China's aviation ministry. It can apply the leverage of a government agency, which is what it is. It has the technological knowhow of a big defense contractor, which develops fighters and missiles for China's Air Force. It is developing a keen sense of the world's commercial markets: CATIC runs some 66 commercial companies, whose profit-making business ran from making airliners to running luxury hotels and shopping centers to making fashionable watches.[13]

      CATIC's sister agency, the Peoples Liberation Army, runs over 10,000 private businesses. They export a wide spectrum of commercial products, from tea sets to fork lifts, many of which are sold in the U.S. Part of the money is then used to modernize China's sprawling military--the largest in the world. Just how much money flows from the commercial businesses of China's government into the business of developing new weapons is a mystery, but it is probably a substantial sum. U.S. analysts believe that as much as two-thirds of China's defense budget is hidden.[14]

      McDonnell officials told Craig M. Ziegler, an investigating U.S. Customs agent, that the plant's most sophisticated machines, called "5-axis profilers" were not being offered to CATIC.[15] Then CATIC raised the ante. It said a failure to sell the machines in Plant 85 would have a "big influence" on the $1 billion plane deal and future deals with China.[16]

      After that, McDonnell's position appears to have been hastily revised. "We always wanted to sell them (China) the machines," explained Tom Williams, a spokesman for McDonnell. As for the peculiar back-and-forth in the negotiations and the threat imperiling the $1 billion plane deal, Williams dismissed it as "normal." "If you have ever bargained with the Chinese, they are always picking up and leaving the room."[17]

      Thirteen of the plant's sensitive five-axis machines were sold after CATIC promised to use them only to make parts for the McDonnell-designed airlines, The Clinton Administration approved the sale on the rationale that the U.S. needed the sale to help offset what was then a $30 billion trade deficit with Beijing.[18] (The deficit is now approaching $45 billion.) Although many items in this avalanche of imports were produced in Chinese military factories, Clinton Administration economists ignored that.

      The matter of why China needed these machines is a question that should not be ignored because it probably has military, not commercial significance. For reverse engineering, you only need one machine to make copies. China's buyers were collecting dozens of them as Cold War-era controls relaxed. By the winter of 1993, U.S. intelligence agencies estimated that China was in the process of importing some 40 of the big machines, counting the ones in the McDonnell deal. It was an amount that seemed far beyond the commercial needs of China's fledgling aircraft industry, or any other industrial country in the world, according to one U.S. official. What is going on?

      One theory is that China is gearing up to export a large number of airliners, sales that would compete directly with Boeing and McDonnell. Another is that China is preparing what U.S. defense planners call "surge capability," the capacity to produce a large number of high technology military planes and precision-guided missiles in a hurry. What is worrisome to experts in the Pentagon is that, when it comes to China, the two goals are not incompatible. There is plenty of evidence that Beijing wants both guns and butter.

      Pentagon experts, trying to block the sale, argued that as far as high technology military equipment is concerned, China is a sieve that steadily leaks it into the Third World. It has sold missile guidance systems and computerized milling machines to Iran and missiles and a jet trainer powered by a U.S.-designed engine to Pakistan. F. Michael Maloof, the Pentagon's director of Technology Security Operations asserted that once Plant 85 machines arrived in China, the U.S. had no way to keep them from being put to military use.[19]

      McDonnell replied that it "has been assured by CATIC that this factory will only produce parts for civil aircraft."[20] When it took an inventory of the machines, however, it found two of them in Nanchang at an aircraft facility not covered by the agreement. The Nanchang factory makes cruise and ballistic missiles. "That was not a proper end use, so that was rectified," explained Williams, the company's spokesman. According to one government official, McDonnell's way of rectifying matters was to ask the U.S. Commerce Department to suspend the export license it had granted for the machines--a move of dubious value since the machines were already in China, somewhere.

      In the summer of 1995, Barbara Shailor, an official of the International Association of Machinists and Aerospace Workers, watched two U.S.-built five-axis machines--which, she was told, also came from the batch shipped from Plant 85--being installed at a plant in Xian, in China's heartland. The plant's workers, who make approximately $50 a month, were working simultaneously on the B-6D, a medium range, nuclear weapons-carrying bomber, making tail sections for the Boeing 737, and planning for a new airliner, which could be largely indigenous. She asked a technician for an American company working at the plant whether the two-headed nature of the plant bothered him. "Everything around here is dual use," he shrugged.

      The final mechanism that China uses to find and siphon away U.S. technology is its enormous stock of students studying here. Again, it is borrowing from Japan's model. While Japanese students were flooding the campuses in 1981, the Peoples Republic of China had no doctoral candidates in the U.S. Ten years later it had 1,596.[21]

      The Chinese students tend to be super-bright, an elite skimmed from a nation of over 1.2 billion people.[22] There are so many of them that they have come to dominate the lower levels of faculties in many universities and they regularly win highly-prized research and teaching assistant ships, which means that they teach and have the keys to the laboratory and that their education is subsidized by the schools and U.S. taxpayers. It has reached the point where American undergraduates frequently complain that they can't understand their teacher's English.

      The idea that the U.S. can manage its growing dependency on these students is still popular on U.S.campuses. One reason is that it fits the needs of many senior U.S. scientists, who can select brighter researchers from overseas to do their research papers and their teaching, often at a fraction of the cost of a U.S. student.

      For years the myth has been that most foreign science graduates remained in the U.S. The U.S. Immigration and Naturalization Service kept no records on it. "It's not something we're interested in because it doesn't help with our work," explained a spokesman for the agency.[23] But recently Michael Finn, an economist at the Department of Energy's laboratory at Oak Ridge, Tenn., found a way to test the myth. Checking students' Social Security numbers ten years after graduation, he found that between 50 and 60% percent of the graduates no longer worked in the U.S.

      "We definitely hear more anecdotal evidence that foreign countries are putting more efforts into recruiting students to come back," says Finn. One exception is the Peoples Republic of China which, according to Finn, appears to have made a decision to keep a pool of talented scientists working in U.S. companies and university laboratories, a pool that China can draw on later.

      One reason may be that the U.S. pays their salaries as they continue to learn. Plus, according to Finn, the "vast majority" of Chinese students in U.S. science and engineering schools are supported by assistant ships or other means provided by the universities, usually through U.S. government funding.[24]

      Mr. Finn's agency worries that the dwindling number of U.S. scientists and engineers may mean that the nation will no longer have enough native-born scientists to work on classified weapons projects. When you think about it, that is a problem that should give us all pause.

      You have decided to hold these hearings at an historic moment. For the first time in almost decade there appears to be growing awareness among the American public that China may not be the most exemplary trading partner. It continues to trample the human rights of its own people. It continues to proliferate weapons of mass destruction in the Middle East. It sends spies to steal U.S. weapons technology--which amounts to an act of war. At the same time, it makes secret moves to deny U.S. companies access to its markets, such as telecommunications. And now, in addition, we see a growing body of evidence that it has tried to manipulate the U.S. political process to its own advantage.

      The question facing you is whether we continue to appear numb to this threat, or whether we do something that tells China it must modify its behavior. "Trade experts" would have you believe this is an enormously sensitive, touch-me-not question. In its simplest form, I'm not so sure that it is. Remember the third grade? What happened to you if you continued to appear weak and stupid in front of the class bully? Was that complex? No, it was predictable. You lost your lunch money.

      In past history, we protected our companies by erecting a wall of tariffs. I think that age is past, but selected trade barriers, such as removing China's most favored nation status, would send the message that our laws and our commercial and political processes must be respected, not abused. In the long run, however, I think the best defense will be an offense. We must make ourselves better, more world-savvy competitors. Companies should understand when they lose, we all do. Like some companies do now--notably Kodak and Motorola--they must be willing to take the fight overseas, studying foreign cultures to find legal means to learn what their competition is doing. Here, companies must also become more willing to bring cases to court, using new laws such as last year's Economic Espionage Act to create a body of case law and an actuarial basis for risk can be used by insurance companies to help protect people. Lessons are not learned if you hide them.

      Companies and the government must also be made aware that reliance on foreign scientists to develop and guard our secrets is--as the Romans once discovered--a short-run fix. In the long run we will either fail as a leader of technology, or we will have to restore our broken public school system so our students can continue to compete with the best in the world. As a body, China's students here are exemplarily people that we can learn much from, but among them are some spies, people whose assigned mission is our downfall. As Francis Cabot Lowell once vividly demonstrated, we should never lose sight of that. Nations that take their technological edge for granted have a great deal to lose.








Endnote

1. Report on U.S. Critical Technology Companies, Report to Congress on Foreign Acquisition of and Espionage Activities against U.S. Critical Technology Companies, 1994, p.5

2. Report on U.S. Critical Technology Companies, p.23.

3. Ibid, p. 25.

4. "High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft," p. 88.

5. U.S.-Japan Technology Linkages in Biotechnology, National Research Council, 1992, pp. 34-35.

6. North, David S., Soothing the Establishment; The Impact of Foreign-born Scientists and Engineers on America. p. 78 & ff.

7. Eftimiades, Nicholas, "Chinese Intelligence Operations," Naval Institute Press, 1994, p.17 and p. 27.

8. The account of Wu's meeting at the Old Cadre's club comes from the trial transcript of U.S. vs. Bin Wu, Jing Ping Li and Pinzhe Zhang, CR 92-188-N, U.S. District Court for the Eastern District of Virginia, Norfolk, Va. The trial was held in May, 1993.

9. Eftimiades, op. cit., p. 67.

10. Transparency International, a Berlin-based group dedicated to curbing corruption in international business transactions, ranks 41 countries on a "corruption index," based on polls, reports of businessmen and business journalists. With a possible high score of 10, China scored 2.16, ranking it just above Indonesia, which was in last place.

11. Woolard made his remark in November 1995 at a symposium on international security issues at the State Department.

12. "Civil-Military Integration; The Chinese and Japanese Arms Industries," a background paper published by the Office of Technology Assessment, a branch of the U.S. Congress, in 1995, p.142.

13. "CATIC; United, Realistic, Competitive, Innovative," brochure produced by CATIC, undated.

14. "Impact of China's Military Modernization in the Pacific Region," U.S. General Accounting Office, June 1995, p. 18.

15. Report by Ziegler to the director of the Strategic Investigations Division, U.S. Customs Service, Oct. 4, 1993.

16. Letters exchanged during the negotiation were later released by the Pentagon.

17. Interview with Williams, October, 1995.

18. "China Swiftly Becomes An Exporting Colossus, Straining Western Ties," Wall Street Journal, Nov. 13, 1995, p. A1.

19. China's position, according to Li Daoyu, its ambassador in Washington, is that it has "all along adopted a serious and earnest attitude toward the issue of non-proliferation and opposed the proliferation of all weapons of mass destruction pending their complete elimination globally." Arms Control Today, op. cit., p. 9.

20. "Background--CATIC Machining Co. Ltd.," part of McDonnell's application for an export license for the Plant 85 machinery submitted to the U.S. Commerce Department.

21. "Foreign Participation in U.S. Academic Science and Engineering: 1991," special report by the National Science Foundation, February 1992, pp. 28 and 85.

22. Some come from China's military elite. Gen. James A. Williams, former head of the Defense Intelligence Agency, recalls a chat with a number of lieutenant colonels in the Peoples Liberation Army during a visit to Beijing in 1983. They spoke with American-accented English and talked about their days on U.S. college campuses. When he returned to the U.S., Gen. Williams, now retired, had their names checked against U.S. immigration records. There were no records. "All I can figure is that they must have come in under different names," says Williams.

23. Interview with INS spokesman, April 4, 1994.

24. Interview with Finn, Sept. 1995.