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) and the Pentagon's smaller but still
formidable 56-page Annual Report on the Military Power of the
People's Republic of China. 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
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.
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
Changing Patterns of Foreign Direct Investment and Trade in
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. 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
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
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.
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. 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.
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
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.
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
The Affect of China's Trade and Investment Growth on
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. 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. 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."
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, while Taiwan's Central Bank of China believes over
US$100 billion in Taiwan-controlled assets are in China.
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.
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
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.
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. 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
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. Indeed, Taiwan exports to China have
risen from 18 percent of total exports in 1999 to nearly 23 percent
of total exports in 2002,  with 31 percent of exports to China
being "electrical equipment and components." 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
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. 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. 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.
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.
Unauthorized Taiwan Semiconductor Investments in
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. 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.
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. 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.
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. 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
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.
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.
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
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
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.
- Advanced materials,
- 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.
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
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. 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. 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
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.
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
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
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
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. 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,
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" and a determination by the Department of
Defense that technology more advanced than 0.7-micron is "military
critical," there is no consistent ban on U.S. exports of
semiconductor technology to China. 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
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
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
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.
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. How Beijing addresses its differences
with Taiwan will be the bellwether of China's future role in
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
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
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
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 and has pressured Israel
to scale back its military sales. The time has come for
Washington to take a similar stance with America's European
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.
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.
In fact, any regional FTA including China would likely be
detrimental to most countries of ASEAN as well as Japan and
Taiwan. 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.
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
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."
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
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
See especially USCC Report, Chapter 9.
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.
USCC Report, p. 40.
"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
Hugo Restall, "Asia's Giant Sucking Sound," Asian Wall Street
Journal, June 20, 2002, p. 14.
Arvind Panagariya, "Why We Lag Behind China," Economic Times,
published by the University of Maryland, May 22, 2002, at
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.
Yuh-jiun Lin, "Reflections on the Eve of the Great Deluge of
Mainland Imports," China Affairs, Taipei, April 2002, p. 128 (in
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.
Jane Perlez, "China Races to Replace US as Economic Power in
Asia," The New York Times, June 28, 2002, p. A1, available at
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
"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
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).
Perlez, "China Races to Replace US as Economic Power in
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).
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
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
"Taiwan's Indirect Investment in Mainland China up 47% in
April," China Economic News Service, Taipei, May 21, 2002.
USCC Report, Chapter 2, Figure 2.5.
Jetro White Paper on Foreign Direct Investment 2002, pp. 34 and
"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
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).
"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.
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
See "Mainland China to Replace Taiwan as World's 3rd Largest IT
Supplier," China Economic News Service, Taipei, November 6,
"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
Anthony Cataldo, "Motorola Cleared to Build 0.25-micron Fab in
China," EE Times, August 21, 2000, Web-posted at 12:19:57 PM
Joyce Huang, "NSC Forms Rules for High-tech R&D," Taipei
Times, September 3, 2002, available at
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
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).
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.
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
"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
Richard McGregor, "Apec-Asian Pacific Cooperation-New Plants
Open on Fertile Ground-Technology in China," Financial Times,
October 16, 2001.
GAO, Export Controls, p. 47.
"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).
Dan Nystedt, "Top Secret Report Sets off Alarms in the Tech
Sector," Taipei Times, July 4, 2001, at
See U.S. Department of Commerce, Technology Administration,
China to Triple Its R&D Investment, August 1995, available at
GAO, Export Controls, p. 2 (emphasis added).
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
"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
"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
Intel China Research Center press release, at
Dan Nystedt, "TSMC Moves to Protect Intellectual Property in
China," Taipei Times, May 24, 2002, at
"Cabinet Gives Go Ahead for Chip Investments in Mainland
China," China Economic News Service, Taipei, April 1, 2002.
GAO, Export Controls, p. 4.
Ibid., p. 16.
Ibid., p. 3, says that "the United States approves most
licenses for exports to China of semiconductors manufacturing
equipment and materials."
Edwin Chan, "Applied Materials Sees USD500 mln China Orders,"
Reuters, March 26, 2002.
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
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
"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).
"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."
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."
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.'"
"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).