Export Controls: Rapid Advances in China's Semiconductor Industry
Underscore Need for Fundamental U.S. Policy Review (19-APR-02,	 
GAO-02-620).							 
                                                                 
Since 1986, China has narrowed the gap between the U.S. and	 
Chinese semiconductor manufacturing technology from between seven
to 10 years to two years or less. China's success in acquiring	 
manufacturing technology from abroad has improved its		 
semiconductor manufacturing facilities for more capable weapons  
systems and advanced consumer electronics. The multilateral	 
Wassenaar Arrangement on Export Controls for Conventional Arms	 
and Dual-Use Goods and Technologies has not affected China's	 
ability to obtain semiconductor manufacturing equipment because  
the United States is the only member of this voluntary		 
arrangement that considers China's acquisition of semiconductor  
manufacturing equipment a cause for concern. Under the Export	 
Administration Regulations pertaining to China, the general	 
licensing policy is to approve applications, except those items  
that would make a direct and significant contribution to specific
areas of China's military. Furthermore, U.S. agencies have not	 
done the analyses, such as assessing foreign availability of this
technology or the cumulative effects of such exports on U.S.	 
national security interests, necessary to justify such a practice
or serve as the basis for licensing decisions. Consequently, the 
executive branch lacks a sound, well-documented basis for making 
export-licensing decisions to China.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-620 					        
    ACCNO:   A03077						        
  TITLE:     Export Controls: Rapid Advances in China's Semiconductor 
Industry Underscore Need for Fundamental U.S. Policy Review	 
     DATE:   04/19/2002 
  SUBJECT:   Computer equipment industry			 
	     Computers						 
	     Export regulation					 
	     International agreements				 
	     International economic relations			 
	     International trade restriction			 
	     Technology transfer				 
	     Weapons systems					 
	     Air Force F-22 Raptor				 
	     Dept. of Commerce Control List			 
	     China						 

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GAO-02-620
     
A

Report to the Ranking Minority Member, Committee on Governmental Affairs, U.
S. Senate

April 2002 EXPORT CONTROLS Rapid Advances in China?s Semiconductor Industry
Underscore Need for Fundamental U. S. Policy Review

GAO- 02- 620

Letter 1 Results in Brief 2 Background 5 Rapid Advances in Semiconductor
Manufacturing Capability Have

Improved China?s Commercial and Defense Industrial Base 9 Wassenaar
Arrangement Has Not Affected China?s Ability to Acquire Advanced
Semiconductor Manufacturing Equipment 17

Export Controls on Advanced Semiconductor Manufacturing Technology to China
Lack Analytical Basis 23 Conclusions 28 Recommendations for Executive Action
29 Agency Comments and Our Evaluation 30 Scope and Methodology 33

Appendixes

Appendix I: Reasons for Controlling Dual- Use Goods and Technologies 36

Appendix II: Wassenaar Reporting Commitments by List 40

Appendix III: Comments from the Department of Commerce 41 GAO Comments 47

Appendix IV: Comments from the Department of Defense 50 GAO Comments 63

Appendix V: Comments from the Department of State 69 GAO Comments 74

Appendix VI: GAO Contact and Staff Acknowledgments 77 GAO Contact 77
Acknowledgments 77

Tables Table 1: Newest Semiconductor Manufacturing Facilities in China (as
of February 2002) 12

Table 2: Commerce Control List Categories 37 Table 3: Commerce Control List
Category Groups 37 Table 4: Frequency of Reasons for Control of Category 3

(Electronics) Items 38

Table 5: Description of Semiconductor Manufacturing Equipment and Materials
Requiring Export License to China 39

Figures Figure 1: Semiconductor Manufacturing Technology Gap Between China
and the United States (feature size measured in microns) 10 Figure 2:
Shanghai Hua Hong NEC Semiconductor Manufacturing

Facility (Completed in 2001) 14 Figure 3: German Metal Organic Chemical
Vapor Deposition Equipment at the Institute of Semiconductors, Beijing 21

Figure 4: Controlled Arsine and Phosphine Gases in Use at the Institute of
Semiconductors, Beijing 22 Figure 5: Reasons for the Control of Dual- Use
Goods and

Technologies 36

Letter

April 19, 2002 The Honorable Fred Thompson Ranking Minority Member Committee
on Governmental Affairs United States Senate

Dear Senator Thompson: The United States controls the export of certain
technology, including some of the equipment and materials used to make
semiconductors, to sensitive destinations such as China for national
security or foreign policy reasons. Semiconductors, commonly referred to as
computer ?chips,? are key components in computers, communications equipment,
and weapons systems. U. S. policy on the export of such ?dual- use? items-
goods and technologies that have both civilian and military uses- is a
subject of continuing debate. This policy strives to balance the need to
protect U. S. national security and foreign policy interests with the
objective to promote U. S. trade and competitiveness. As part of its efforts
to control exports of sensitive dual- use technology, the United States is a
member of the Wassenaar Arrangement- a forum of 33 countries established in
1996 to reach multilateral agreements about which dual- use goods merit
special scrutiny and reporting. 1

Because of your concerns about whether the United States? national security
and foreign policy interests are being adequately protected, particularly in
light of the pace at which China has been acquiring modern

semiconductor manufacturing technology, you asked that we 1. describe
advances in China?s semiconductor manufacturing capability

and the impact of these advances on its industrial base; 2. analyze how the
Wassenaar Arrangement has affected the transfer of

semiconductor manufacturing technology to China; and 1 The 33 participating
states of the Wassenaar Arrangement are: Argentina, Australia, Austria,
Belgium, Bulgaria, Canada, Czech Republic, Denmark, Finland, France,
Germany, Greece, Hungary, Ireland, Italy, Japan, Luxembourg, Netherlands,
New Zealand, Norway, Poland, Portugal, Republic of Korea, Romania, Russian
Federation, Slovak Republic, Spain, Sweden, Switzerland, Turkey, Ukraine,
United Kingdom, and the United States.

3. describe U. S. policy and practice regarding the export of this
manufacturing technology to China and assess its analytical basis.

To address these issues, we spoke to more than 170 representatives from
academia, industry, and U. S. and foreign governments. In addition, we
collected and analyzed information from the U. S. Departments of Commerce,
Defense, and State; and from various industry and trade associations. Our
work focused on China and its newest semiconductor manufacturing facilities.
We visited manufacturing facilities, government agencies, and research
organizations in China. Further, we analyzed Commerce Department licensing
review and approval data and analyzed export reporting and proposal
acceptance and rejection data provided by

the Wassenaar Arrangement Secretariat in Vienna, Austria. 2 Results in Brief
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. The multilateral Wassenaar
Arrangement on Export Controls for Conventional Arms and Dual- Use Goods and
Technologies has not affected China?s ability to obtain semiconductor
manufacturing equipment because

the United States is the only member of this voluntary arrangement that 2 We
issued a separate For Official Use Only version of this report in February
2002. U. S. General Accounting Office, Export Controls: Rapid Advances in
China?s Semiconductor Industry Underscore Need for Fundamental U. S. Policy
Review, GAO- 02- 151 (Washington, D. C.: Feb. 19, 2002). Agency comments in
this report containing information designated For Official Use Only have
been redacted.

considers China?s acquisition of semiconductor manufacturing equipment a
cause for concern. The arrangement deems only one type of semiconductor
manufacturing equipment to be sufficiently sensitive to warrant greater
information sharing among arrangement members- no export information is
shared for 97 percent of all electronics- related items covered by the
arrangement. Transparency, through exchanging information and sharing views,
is the sole means by which the arrangement tries to achieve its goals. Over
the past several years, fewer items have been subject to the Wassenaar
Arrangement, particularly electronics- related items.

U. S. policies and practices to control the export of semiconductor
technology to China are unclear and inconsistent, leading to uncertainty
among U. S. industry officials about the rationale for some licensing
decisions. Under the Export Administration Regulations pertaining to China,
the general licensing policy is to approve applications, except those items
that would make a direct and significant contribution to specific areas of
China?s military. We found that the United States approves most licenses for
exports of semiconductor manufacturing equipment and materials to China.
Although U. S. practice has been aimed at keeping China at least two
generations (about 3 to 4 years) behind global state- ofthe- art
semiconductor manufacturing capabilities, the regulations make no reference
to the level of technology that can be exported to China relative to the
current commercial state of the art. Further, U. S. agencies have not
conducted the analyses, such as assessing foreign availability of this
technology or the cumulative effects of such exports on U. S. national
security interests, necessary to justify such a practice or serve as the
basis for licensing decisions. Consequently, the executive branch does not
have a sound, well- documented basis for making export- licensing decisions
to China.

In this report, we are recommending that the secretary of commerce, in
consultation with the secretaries of defense and state, reassess and
document U. S. export policy on semiconductor manufacturing equipment

and materials to China. Specifically, we are recommending that these
agencies complete the analyses needed to serve as a sound basis for an
updated policy; develop new export controls, if appropriate, or alternative
means for protecting U. S. security interests; and communicate the results
of these efforts to the U. S. Congress and industry.

In commenting on a draft of this report, the Departments of Commerce,
Defense, and State said that our report was based on an invalid assumption
that the goal of U. S. export control policy is to keep China?s industry two

generations behind U. S. industry. These agencies said that U. S. policy for
why and how these items should be controlled can be found in the Export
Administration Regulations and is based on a sound analytical framework.

We agree with the Departments of Commerce, Defense, and State that a
description of the U. S. government?s export control policy toward China is
found in the Export Administration Regulations. We added some additional
information to the report to better describe this policy and to make a
clearer distinction between policy and practice as the current regulations
make no reference to the level of semiconductor manufacturing technology
that can be exported to China relative to the current commercial state of
the art. We found that the executive branch practice was aimed at keeping
China two generations behind the U. S. semiconductor manufacturing industry.
On March 1, 2001, the under

secretary for export administration (a policy- level official), described
this practice and reconfirmed it in a follow- up January 2002 meeting with
GAO after he left office.

Moreover, in commenting on our draft report, the Commerce Department
described this practice, noting that ?certain exports of semiconductor
manufacturing equipment to China are limited to two generations behind
state- of- the- art levels to address national security, or other concerns
related to a particular transaction.?

Regarding the Departments of Commerce, Defense, and State?s comments that
the current export licensing process is based on a sound, analytical
framework, we found that a U. S. government foreign availability analysis of
semiconductor manufacturing equipment has not been completed since 1987.
Further, the U. S. government has not conducted studies of the cumulative
effect of the export of advanced semiconductor manufacturing equipment and
materials to China on U. S. national security.

The findings, conclusions, and recommendations of our report remain
unchanged.

Background Semiconductors or ?computer chips? are critical components in
everything from automobiles to weapon systems. 3 They contain millions of
transistors

and other components that are smaller than 1/ 100 the width of a human hair.
The manufacture of integrated circuits involves a complex, 250- step process
utilizing hundreds of millions of dollars in technologically advanced
equipment and purified materials.

An integrated circuit?s component size- or feature size- is measured in
microns; modern chips range from 0.35 micron to 0.13 micron. 4 Smaller
feature size allows for more components to be integrated on a single chip,
thus creating more powerful chips. The semiconductor industry also uses
feature size to define the current level of integrated circuit technology:
Each reduction in feature size, for example, from 0.35 micron to 0.25
micron, is considered a move to a new generation of technology. 5

According to Semiconductor Equipment and Materials International, the $76
billion global semiconductor equipment and materials industries ($ 48
billion and $28 billion, respectively) serve as the foundation for the $204
billion semiconductor industry, which in turn supports many other industries
including the $1.1 trillion electronics industry. 6 The equipment and
materials industries produce a variety of equipment, chemicals, gases,
films, and other materials critical to manufacturing integrated circuits. U.
S.

companies created and dominated the semiconductor equipment and materials
industries until the early 1980s, when Japan increased investment and
Japanese companies gained a greater market share in several critical 3
Semiconductor materials, such as silicon, can be used as both a conductor
and insulator of

electricity. Almost all of today?s computer chips are constructed on wafers
made of 99.9999 percent pure silicon, although other materials such as
gallium arsenide may also be used for specific applications. The term
?semiconductor? also refers to devices that are manufactured from
semiconductor materials. Semiconductors include discrete devices, such as
transistors, and integrated circuits comprising millions of transistors and
other components. For the purposes of this report, the terms semiconductor,
integrated circuit, and computer chip are used interchangeably.

4 One micron is one- millionth of a meter or 1/ 100th the width of a human
hair. 5 Each new generation of technology represents a reduction of
approximately 28 percent of the previous generation?s feature size. This
term applies exclusively to silicon- based, very large- scale integrated
circuit technology (that is, circuits with 100,000 to 1 million components).

6 Semiconductor Equipment and Materials International is the trade
association serving the global semiconductor equipment, materials, and flat
panel display industries.

equipment and materials technologies. During the 1990s, U. S. companies
regained market share and currently share worldwide leadership with Japan,
although Japan still dominates the key silicon manufacturing and lithography
markets. 7

The global semiconductor equipment and materials industries comprise more
than 2,400 small to medium- sized companies located primarily in the United
States, Japan, and Europe. Typically these companies manufacture equipment
or materials required for just one or two of the numerous processes for
making integrated circuits. In 2000, 10 companies accounted

for approximately 63 percent ($ 30.3 billion) of the equipment industry?s
$48 billion revenue. 8

One of the reasons semiconductor equipment and materials are controlled is
their potential role in improving a nation?s military capabilities. The
Export Administration Act of 1979, 9 as amended, and the implementing Export
Administration Regulations authorize the Commerce Department to require
firms to obtain licenses for the export of sensitive items that may pose a
national security or foreign policy concern. 10 The Departments of Commerce,
Defense, and State and others review export license applications. The
Commerce Control List provides detailed specifications for about 2,400 dual-
use items that require export licenses to particular destinations for
largely national security and foreign policy reasons. (See app. I for
additional information on the Commerce Control List.) Semiconductors and
related equipment and materials fall under the list?s ?Category 3?
(electronics), with manufacturing equipment and materials placed in Category
3B (test, inspection, and production equipment) and

7 Lithography is a manufacturing process used to imprint circuits on
semiconductor materials. 8 The top 10 materials companies accounted for
approximately 42 percent ($ 11.7 billion) of the industry?s $28 billion
revenue in 1999- the last year for which complete information was

available. 9 Since August 20, 1994, when the Export Administration Act of
1979 was terminated, several executive orders and one law have extended
application of the act. Most recently, application of the act has been
extended by Executive Order 13222, Aug. 17, 2001 (66 Fed.

Reg. 44025). 10 50 U. S. C. App. sections 2401 and following and 15 C. F. R.
sections 730 and following.

3C (materials), respectively. 11 Category 3 goods and technologies are
controlled primarily as a tool of U. S. anti- terrorism policy, but also to
meet nuclear nonproliferation policy objectives, control the spread of
missile technology and crime, and address general national security
concerns. 12 The primary control concern regarding China is national
security. In many

cases, items on the Commerce Control List will require a license only if
they are going to a particular country. However, some products will require
a license because (1) there is a risk of diversion to an unfriendly
destination; (2) the nature of the product makes it sensitive; or (3) the
end use or end user of the product triggers concerns. 13 As part of its
efforts to control exports of sensitive dual- use technology, the

United States is a member of the Wassenaar Arrangement. The Wassenaar
Arrangement, the successor regime to the Coordinating Committee for
Multilateral Export Controls, came into existence in July 1996. 14 It is
built on a broad international consensus that new threats to global security
from the spread of weapons of mass destruction and their delivery systems
make multilateral export controls on dual- use items necessary. The
Wassenaar Arrangement was designed to complement and reinforce, without

duplication, the other existing international export control regimes for
weapons of mass destruction and their delivery systems. 15 The arrangement
was explicitly charged in its founding documents to prevent ?destabilizing
accumulations? of dual- use goods and technologies that may be used to

11 Group B and C items are described in 15 C. F. R., Part 774, Supp. 1. 12
See C. F. R. 15 Part 774. 13 The U. S. government controls some items
unilaterally to particular countries for specific purposes. For example,
some items in Category 3B are controlled multilaterally through the
Wassenaar Arrangement but are controlled more strictly to particular
countries by the United States for antiterrorism purposes.

14 The Coordinating Committee for Multilateral Export Controls was
established early in the cold war and included all NATO countries except
Iceland, plus Japan and Australia. Members agreed not to export specified,
listed dual- use goods and technologies to Soviet

bloc countries and China and to obtain unanimous preapproval for any
nonprohibited exports. 15 Each of the other existing regimes focuses on one
general category of weapons of mass destruction. The Nuclear Suppliers Group
aims to tightly control access to nuclear exports to reduce the possibility
that such transfers could be diverted to nuclear explosive or unsafeguarded
nuclear fuel cycle activities. The Australia Group seeks to control the
spread

of chemical and biological warfare agents. The Missile Technology Control
Regime seeks to control the export of missiles or related equipment that can
be used to produce a missile with a range of at least 300 kilometers capable
of delivering any payload.

contribute to the development or enhancement of military capabilities that
would undermine regional security and stability. 16 Transparency, through
exchanging information and sharing views, is the sole means by which the
arrangement tries to achieve its goals. According to a senior State
Department official on detail to the Wassenaar Secretariat and Wassenaar
documents, members of the arrangement make a threefold political commitment
to: control exports of selected advanced dual- use goods and technologies;
refrain from exporting dual- use items that may, according to national
judgment, contribute to weapons proliferation or regional or international
instability; and inform other Wassenaar member governments

of selected approvals and denials of export licenses for these items. These
commitments may or may not lead a member state to deny an export license.
The ?control? aspect of the arrangement resides entirely in the discretion
of national governments that commit only to scrutinize selected dual- use
goods and technologies. Members have no power to veto other members? sales.
Like its predecessor regime, the arrangement does not enjoy formal treaty
status. The Wassenaar Arrangement is not directed against any state or group
of states. Although there is an informal understanding that exports to Iran,
Iraq, Libya, and North Korea bear

special scrutiny, no countries are specifically named as targets of the
arrangement. Even this informal understanding does not hold in all cases
among all Wassenaar members. The Russian representative to Wassenaar, for
example, noted that for export control purposes the Russian

government considers Iran a ?normal country.? 16 The arrangement also
provides for the exchange of information among its members on exports of
conventional munitions. We did not review this aspect of the arrangement
because it is not relevant to semiconductor manufacturing technology.

Rapid Advances in Since 1986, China?s efforts to improve its semiconductor
manufacturing

Semiconductor capability have resulted in a narrowing of the gap between U.
S. and

Chinese semiconductor manufacturing technology. Today, China?s most
Manufacturing

advanced semiconductor manufacturing facilities can produce integrated
Capability Have

circuits that are only one generation or less behind the current state of
the art. Acquiring semiconductor technology and know- how is a priority of
the Improved China?s

Chinese government. 17 The country?s improvements in semiconductor
Commercial and

manufacturing capability are the direct result of the involvement of Defense
Industrial

European, Japanese, and U. S. integrated circuit manufacturers in China,
typically through joint ventures or wholly foreign owned manufacturing Base
facilities. Currently, China has eight major integrated circuit
manufacturing facilities with substantial levels of foreign investment or
ownership. The country?s rapid advances in this sector have integrated China
into the global semiconductor industry, improved China?s commercial and
defense industrial base, and created a potential new source of sophisticated
integrated circuits for China?s industry and military.

Technology Gap Between Fifteen years ago, China was five generations of
technology behind the

United States and China Is United States? then- current commercial
production capability, according to

Narrowing Rapidly industry experts we interviewed. Today, China has narrowed
this

technology gap. Although the equipment in China?s newest manufacturing
facilities is designed to produce integrated circuits with 0.25- 0.18 micron
feature sizes, it can be fine- tuned to produce integrated circuits with
0.18- 0.13 micron feature sizes or less in some cases, according to
semiconductor manufacturing experts with whom we spoke. 18 Consequently, the
most advanced semiconductor manufacturing facilities in China today can

17 This goal was first stipulated in China?s Eighth 5- year Economic Plan
(1991-- 1995). 18 Fine- tuning the equipment to produce integrated circuits
with smaller features decreases the size of the integrated circuits and,
therefore, increases the number that can be produced on a given wafer.
However, this can only be carried so far before decreasing yields (due to
small feature size) lead to increasing overall costs. The ability to produce
smaller feature sizes by fine- tuning equipment is dependent on the
semiconductor manufacturing process used and the capability of the engineers
operating the equipment.

produce integrated circuits that are one generation or less behind current
state of the art. 19 Figure 1 shows how the technology gap between the
United States and China has narrowed since 1986.

Figure 1: Semiconductor Manufacturing Technology Gap Between China and the
United States (feature size measured in microns)

Note: Complete data for the period between 1986 and 2002 were not available.
The time scale was altered to show the years where data were available. Data
for 2002 based on estimates. Data points for the years listed are as
follows: China-- 5.00, 3.00, 0.80, 0.35, and 0.18 micron; United States--
1.00, 0.35, 0.25, 0.18, and 0.13 micron.

Source: GAO analysis of data provided by semiconductor manufacturing
facilities in China; the director of the Computer Aided Life Cycle
Engineering Electronics Products and Systems Center, University of Maryland;
Intel Corporation; and the International Technology Roadmap for
Semiconductors.

19 A microelectronics expert at the Naval Research Laboratory stated that
worldwide state- of- the- art commercial production was 0.18 micron in 2001.
Industry considered 0. 13 micron state of the art in 2001. Although China is
now capable of producing close to state- of- the- art technology, its
current domestic demand for these integrated circuits is low (about 13
percent of China?s demand is for semiconductors with feature sizes between
0.18 and 0.5 microns, while 87 percent is for older technology between 0.6
and 6 microns).

Acquiring Semiconductor China?s stated goal is to become self- sufficient in
the production of Technology and Related

semiconductors for its domestic market and to develop technology that is
Know- How Is a Priority of

competitive on the world market. This goal is being pursued for economic the
Chinese Government

and national security reasons and is directed by a series of 5- year
economic plans, and projects focused on high- technology industries. China
has pursued a number of strategies to acquire the technology to meet its
current and future semiconductor needs, including procuring semiconductors
on the open market for both commercial and military uses and developing a
domestic manufacturing capability. China also recognizes the importance of
foreign investment and has instituted numerous incentive programs, which
include free use of land and low taxes, to attract some of the world?s
leading semiconductor manufacturers and equipment suppliers. To encourage
domestic innovation, China has constructed 53 ?Silicon Valley?- style, high-
technology development zones. In addition, China is cultivating the human
capital to operate and manage semiconductor design and manufacturing
facilities, in part from students returning to China after earning degrees
at U. S. universities in semiconductor- related subjects. It also is
acquiring expertise from foreign semiconductor manufacturers who provide
their Chinese employees with advanced training and establish research and
development facilities in China.

Foreign Partners Improve The narrowing gap between U. S. and Chinese
technology stems from both

China?s Integrated Circuit the Chinese government?s concentrated effort to
develop its semiconductor

Manufacturing Capability manufacturing capabilities and the direct
involvement of foreign integrated

circuit manufacturers. Since 1995, China has substantially increased its
semiconductor manufacturing capabilities through joint ventures and foreign
direct investment. Five out of China?s eight newest major integrated

circuit manufacturing facilities were established as joint ventures; the
other three are wholly- owned entities funded with foreign capital. (See
table 1 for details on the level of technology incorporated at each facility
and the level of Chinese ownership.)

Table 1: Newest Semiconductor Manufacturing Facilities in China (as of
February 2002) Minimum Year

feature size Wafer size

Approximate Foreign/

Percent Chinese Facility founded

in micron (diameter) wafers/ month Chinese partner ownership

Advanced Semiconductor 1988 0. 6 5? & 6? 40, 000 Philips

62 Manufacturing Corporation (Netherlands)/ Chinese

government Shanghai Belling 1988 0. 8 4? & 5? 13, 300 Alcatel

64 (Belgium)/ Shanghai Bell & Shanghai municipal government

Shougang NEC 1991 0. 35 6? 8, 000 NEC (Japan)/ Chinese 51 government
Motorola Corporation 1996 0. 25 8? 24,000 b Motorola (U. S.)/ none 0

Shanghai Hua Hong NEC 1996 0. 35 8? 20, 000 NEC (Japan)/ Shanghai 71 and
Chinese government

Central Semiconductor 1997 0. 3 5? & 6? 12, 000 CSMC( Hong 49 Manufacturing
Corporation Kong)/ Chinese

government Grace Semiconductor

2000 0. 25 8? 25,000 b International/ none 0 Manufacturing Corporation a

Semiconductor 2000 0. 18 8? 45,000 b International/ none 0

Manufacturing International Corporation a

a Both Grace and Semiconductor Manufacturing International are managed by
Taiwanese nationals. Funding for these companies comes from multiple
international sources. b These are planned production levels; none of the
companies are currently producing at full capacity. Source: Semiconductor
manufacturing firms listed in the table.

These joint ventures and wholly foreign owned semiconductor manufacturing
facilities provide China with access to more advanced technology than it
previously had or could produce on its own. U. S. companies have
participated in these joint ventures. This trend in joint

ventures and foreign direct investment is likely to continue since there are
plans to construct an additional 10 to 20 advanced semiconductor
manufacturing facilities in China by 2005 at an estimated cost of over $1
billion per facility. The Semiconductor Industry Association estimates that
China will become the world?s second largest market for integrated circuits
by 2010, and that the market for semiconductor manufacturing equipment in
China will grow to $7 billion by 2003. Applied Materials, which is based in
Santa Clara, California, and is the world?s largest manufacturer of
semiconductor equipment, estimates that 20 percent of its revenue in the
next decade will be derived from sales to China. 20 Moreover, since the
quality of semiconductor manufacturing equipment produced in China is not
high enough to use in modern facilities, Chinese companies have established
joint ventures with foreign semiconductor equipment manufacturing companies
in an effort to improve the semiconductor manufacturing equipment
constructed in China. Figure 2 shows one of China?s newest semiconductor
manufacturing facilities, Hua Hong NEC in Shanghai.

20 Applied Materials? total revenue in 2001 was $7.34 billion. Approximately
$147 million or 2 percent of this revenue was generated by sales to
manufacturing facilities in China.

Figure 2: Shanghai Hua Hong NEC Semiconductor Manufacturing Facility
(Completed in 2001)

Source: Shanghai Hua Hong NEC.

In addition to improving China?s semiconductor manufacturing technology, the
joint ventures and wholly foreign owned facilities have increased the
overall volume of integrated circuits produced in China by supporting the
country?s migration to larger silicon wafers. 21 This shift allows China to
produce greater numbers of integrated circuits and thus reduce their cost
per unit. Grace, Semiconductor Manufacturing International, and Motorola
will add an additional 94,000 8- inch wafers per month to China?s overall
production capacity once their facilities are fully operational in early
2002. According to the State Department, when these new fabrication
facilities are operational, they will ?multiply by several times China?s
current production capacity, putting [it] on the map both technologically
and in terms of capacity in the global market.? 22 Further, several of these
modern manufacturing facilities are designed to produce custom- made
semiconductors for any customer. Consequently, they provide China?s industry
and military with a new source of custom- made integrated circuits that are
not subject to foreign export controls. 23

Improvements in According to a senior Defense Department official, a
cutting- edge domestic

Semiconductor semiconductor industry supports military modernization in
China. 24 Manufacturing Industry

According to this official, China?s military modernization program appears
Assist China?s Military

to be focusing on ?pockets of excellence, ? where advances in select
Modernization technologies can be leveraged for disproportionate benefit in
a potential conflict. Several such ?pockets? include: preemptive long- range
precision strike capabilities; information dominance; command and control;
and

integrated air defense. In support of these efforts, Beijing has identified
the development of an indigenous semiconductor industry as one of its
highest priorities. This official added that China?s increasing emphasis on
the

21 Approximately twice as many integrated circuits can be produced on a
silicon wafer with an 8- inch diameter compared to a 6- inch wafer; 2.5
times the number of integrated circuits can be produced on 12- inch wafer
compared to an 8- inch wafer.

22 The new fabrication facilities primarily use 8- inch wafers. In contrast,
the majority of China?s older manufacturing facilities use 4- inch, 5- inch,
and 6- inch wafers. 23 Manufacturers we spoke to in Taiwan and China stated
that they would manufacture small numbers of wafers (3- 25) for a single
customer. 24 January 17, 2002, statement of the deputy under secretary of
defense for technology security and counterproliferation before the U. S.-
China Commission.

development of integrated circuits ?will have direct application in future
military systems, for example, advanced phased- array radar.? 25

Moreover, advanced semiconductor production facilities improve China?s
military industrial base by providing a conduit for technology transfer,
including transfer of technical specifications, production and process
technology, and management and marketing skills that can aid indirectly in
military production. According to the Defense Department experts we
consulted, these facilities provide China with a domestic supply of
integrated circuits that are useful in a broad range of applications
including command, control, communications, surveillance, and missile
guidance equipment that is less vulnerable to foreign disruption during a
protracted conflict.

The most sophisticated facilities in China are capable of producing
semiconductors with feature sizes that are more advanced than those used in
some of the United States? most advanced weapons. 26 For example, the

U. S. Air Force?s new F- 22 advanced tactical fighter is now undergoing
preproduction testing after a decade of development. The aircraft?s avionics
27 rely on an Intel i960MX microprocessor that has a feature size of 0.8

micron. In terms of feature size, the i960MX processor is at least four
technology generations behind the integrated circuits that China is capable
of producing today. 28 According to defense experts, the semiconductor
manufacturing technology China has acquired will enable it to produce
components to enhance current and future weapon systems. However, having the

components does not guarantee that China will be able to produce complete
weapons systems. The experts note that China has experienced

25 Phased- array radar uses a set of many small stationary radar antennas
configured to create a narrow radar beam that can be electronically steered
in any direction in a fraction of a second to track missiles.

26 The Department of Defense considers semiconductor manufacturing
capability more advanced than 0. 7 micron to be military critical. 27
Avionics refers to three major classes of airborne equipment-
communications, navigation, and interrogation. The integrated avionics
system is a major feature of the F- 22, permitting the pilot to have
substantially better control of the information regarding the surrounding
environment. 28 The i960MX processor went out of commercial production in
1999. It has a rating of 5 to 10

million theoretical operations per second and runs at a speed of 20
megahertz.

problems translating theory and design into reliable weapons systems. They
also note that China?s defense industry faces technical, structural, and
other barriers that impede its ability to absorb and utilize advanced
technologies for weapons production. For example, China?s defense industry
lacks many of the basic skills, such as making complex systems work
together, necessary to fully utilize acquired technologies. These experts
also note that the highly compartmentalized and risk- adverse hierarchical
structure of China?s defense industry make it difficult for various branches
of the industry to collaborate on weapons design or extract greater benefits
from technology.

Wassenaar The Wassenaar Arrangement on Export Controls for Conventional Arms

Arrangement Has Not and Dual- Use Goods and Technologies has not affected
China?s ability to

obtain semiconductor manufacturing equipment primarily because the Affected
China?s Ability

United States is the only member of the Wassenaar Arrangement that to
Acquire Advanced

considers China?s acquisition of semiconductor manufacturing equipment a
Semiconductor

cause for concern. One of the principal goals of the arrangement is to
prevent ?destabilizing accumulations? of advanced dual- use goods and

Manufacturing technologies through the reporting of export information by
its members.

Equipment Transparency, through exchanging information and sharing views, is
the

sole means by which the arrangement tries to achieve its goals. Yet, under
existing Wassenaar agreements, there are no commitments to provide
information on exports for 97 percent of all electronics- related items,
including semiconductor manufacturing equipment, covered by the arrangement.
In addition, a large- scale decontrol of these items has occurred since the
end of the cold war.

United States Is the Only There is a broad consensus among Wassenaar members
that the export of

Member Concerned About an item covered by the arrangement should be denied
only if it is critical for

China military purposes and destined for a state whose actions may undermine

regional or international security and stability. The United States is the
only member that considers the relationship between semiconductor
manufacturing equipment and military end uses sufficiently critical and
considers China?s acquisition of this technology a potential threat to
regional or international stability. We found that European, Japanese, and
U. S. export control authorities license sales of semiconductor
manufacturing equipment to China that is at least two generations more
advanced than the threshold stipulated in the Wassenaar and Commerce

lists (0.50 micron) and three generations more advanced than what the
Defense Department considers military critical (0.70 micron).

Wassenaar Reporting Does Member states have agreed to exchange only limited
information on items

Not Provide Enough covered by the Wassenaar Arrangement. Thus, arrangement
reporting data

Information to Assess do not provide sufficient information to determine
whether countries are

accumulating advanced dual- use semiconductor manufacturing goods and
Accumulations

technologies. 29 The Wassenaar Arrangement?s activities focus on the regular
review and updating of technical parameters for three lists of dualuse
items- basic, sensitive, and very sensitive- for which there are varying
reporting commitments. In general, no export information is shared for 76
percent of all listed items. No export information is shared among members
for 97 percent of the electronics- related items covered by the arrangement.
30 (See app. II for information on Wassenaar reporting commitments.) Metal
organic chemical vapor deposition equipment is the only type of
semiconductor manufacturing equipment that is defined as sensitive and thus
subject to arrangement reporting commitments for approved exports. This
equipment has a wide range of capabilities, some of which are applicable to
military uses. However, we found that the reporting information on approvals
for such equipment lacks enough detail to shed much light on its
capabilities or intended end use and is of little practical use for
determining the semiconductor manufacturing capability of the country to
which the equipment is exported.

29 The Final Report issued in April 2001 by the Study Group on Enhancing
Multilateral Export Controls for U. S. National Security, a joint project of
the Henry L. Stimson Center and the Center for Strategic and International
Studies, came to a similar conclusion. A Department of Commerce study, U. S.
Commercial Technology Transfers to the People?s Republic of China, January
1999, also concluded that export control reporting systems are an
ineffective mechanism for tracking accumulations of technology and
capabilities.

30 There are nonbinding arrangements to report export information for just 4
out of the 127 items (3.1 percent) in Category 3 (electronics). More
specifically, there are nonbinding arrangements to report export information
for just 1 out of 26 items or 3.8 percent in Category 3B (equipment) and no
arrangements to report information on any Category 3C (materials) items.

In addition, the time lapse between exports of items and the reporting of
these transfers further reduces the value of the minimal reporting
information. Aggregate sensitive and very sensitive item approval
information is reported twice a year.

The Arrangement Does Not The Wassenaar Arrangement lacks a ?no undercut?
rule, under which a

Have a ?No Undercut? Rule Wassenaar member would agree not to permit the
export of any listed

item( s) that had been, within a specified period, officially denied an
export license by another member. According to a senior Wassenaar
Arrangement official, implementing a no undercut rule would be the only
realistic way to relieve competitive pressures to approve certain exports.
For example, the United States denied the sale of an advanced metal organic
chemical vapor deposition machine- which can be used to manufacture compound
semiconductors for advanced military systems such as missiles and

satellites- to the Hebei Semiconductor Research Institute in China in May
1998 because of concerns about its possible diversion for military uses. 31
A German company sold equivalent equipment to the same end user. The
practical effect of the U. S. denial was the loss of a multimillion- dollar
sale by Emcore Corporation and the gain of a sale by Germany- based Aixtron
GmbH. 32 In response to this situation, the United States formally
registered its displeasure with the German government through a diplomatic
d�marche. 33

Our work identified other examples of equipment and materials being sold to
end users to whom the United States had previously denied export licenses.
For example, the Institute for Semiconductors in Beijing (see fig. 3) and
the Nanjing Electronic Device Institute both have German- made metal organic
chemical vapor deposition equipment. 34 The U. S. government 31 Information
provided by Somerset, New Jersey- based Emcore Corporation.

32 Emcore Corporation?s application to sell metal organic chemical vapor
deposition equipment to China was denied by the U. S. government on May 9,
1998. 33 A d�marche is a diplomatic protest or representation. The United
States has d�marched the Germans several times on this issue. 34 Information
obtained from the institute in Beijing and the suppliers of the equipment.
The operating parameters of the German- made equipment at these facilities
exceed the parameters deemed military critical on the Department of Defense
Military Critical Technologies List. The United States has also licensed the
sale of equipment with similar operating parameters to other Chinese
entities.

has determined that exports of semiconductor manufacturing equipment and
materials to these institutes are detrimental to U. S. national security
interests.

Figure 3: German Metal Organic Chemical Vapor Deposition Equipment at the
Institute of Semiconductors, Beijing

Source: GAO.

The United States has also denied the sale of arsine and phosphine gases to
the Institute of Semiconductors in Beijing for national security reasons. 35
However, as shown in figure 4, during our visit to the institute we found
that the institute was using these same gases in its manufacturing process.

Figure 4: Controlled Arsine and Phosphine Gases in Use at the Institute of
Semiconductors, Beijing

Source: GAO. Note: Highlighted areas indicate gas mixtures (arsine on the
left and phosphine on the right) currently being used in the production of
semiconductors.

According to an institute official, due to U. S. export controls, the gases
the institute uses are purchased from European and Japanese companies. GAO
did not independently verify this statement. It should be noted that the
Commerce Department has charged a company for illegally exporting chemicals
to China, including the chemicals in question.

35 These gases are controlled by 15 C. F. R., Part 774, Supp. 1, Category 3C
of the Commerce Control List. Information on the denial of the license was
provided by the exporter of the gases.

Large- Scale Decontrol Since the end of the cold war, there has been a trend
toward the large- scale

Raises Questions About decontrol of dual- use goods and technologies,
including semiconductor

Relevancy manufacturing equipment and materials, which has raised questions
within

government and industry about the Wassenaar Arrangement?s relevance as an
export control mechanism. For example, 50 percent of the adopted proposals
from 1997 through 2000 for Categories 3B and 3C liberalized controls on
items or decontrolled items. Only 33 percent of the proposals added new
controls. The remaining proposals clarified the text of the lists of
controlled items.

The increasingly blurred lines between civilian and military technology are
an important factor leading to more decontrol, according to officials we
interviewed. More and more advanced goods and technologies are

considered dual- use. For example, gallium arsenide- based integrated
circuits used in devices with high frequency and power requirements had only
aerospace and military applications in the past. They are now used

widely in common consumer devices such as mobile phones. Export Controls on

Under the Export Administration Regulations pertaining to China, the
Advanced

general licensing policy is to approve applications, with some exceptions.
The regulations also state that each license application is to be considered
Semiconductor

individually, which allows for some assessment of the semiconductor
Manufacturing

equipment being exported and of end users and end uses. Although the
Technology to China

regulations make no reference to the level of technology that can be
exported to China relative to the current commercial state of the art,

Lack Analytical Basis according to policy officials, U. S. practice has been
aimed at keeping China

at least two generations (about 3 to 4 years) behind global state- of- the-
art semiconductor manufacturing production capabilities. However, U. S.
agencies have not used the available analytic tools to serve as a basis for

this practice or to make decisions on export licenses. Despite the
twogenerations- behind objective, we found that the United States approves
most licenses for exports of semiconductor manufacturing equipment and
materials to China. Although these licenses contain a number of conditions

stipulating how such equipment can be used, we found that the Commerce
Department has not conducted any ?end- use? checks on the U. S.
semiconductor equipment exported to China to determine whether

licensing conditions are being met.

Industry Notes Lack of U. S. export licensing control policy toward China is
broadly described in

Clarity in Current Export title 15, sections 742.4( a) and 742.4( b)( 7) of
the Export Administration Regulations

Regulations, which state:  It is the policy of the United States to
restrict the export and reexport of items that would make a significant
contribution to the military

potential of any other country or combination of countries that would prove
detrimental to the national security of the United States. (742.4( a))

 For the People?s Republic of China, the general licensing policy is to
approve [license] applications, except that those items that would make a
direct and significant contribution to electronic and antisubmarine warfare,
intelligence gathering, power projection, and air superiority receive
extended review or denial. Each application will be considered individually.
Items may be approved even though they may contribute to Chinese military
development or the end user or end use is military. (742.4( b)( 7))

Although the regulations broadly describe U. S. export policy to China, they
do not describe the level of technology that can be exported to China
relative to the current commercial state of the art. In March 2001, the
Commerce Department?s undersecretary for export administration and the
director of the Technology and Security Directorate of the Defense Threat
Reduction Agency told us that the U. S. government?s practice, while
undocumented, has been to use export controls on semiconductor manufacturing
technology to keep China?s semiconductor manufacturing industry at least two
generations behind commercial state- of- the- art production capabilities.
In commenting on a draft of this report, officials from the Departments of
Commerce, Defense, and State said this is not U. S. policy. However, in its
detailed comments, the Commerce Department contradicted this assertion and
stated that certain exports to China are

limited to two generations behind state- of- the- art levels to address
national security or other concerns related to a particular transaction.
Industry officials we interviewed confirmed that this practice exists. They
stated that the lack of clear criteria has created a great deal of
uncertainty about

the export licensing process and raises questions about the rationale for
some U. S. government licensing decisions. We found that European, Japanese,
and U. S. companies have all exported advanced semiconductor manufacturing
equipment to China that allows manufacturing facilities to produce
semiconductors that are less than two generations behind commercial state-
of- the- art technology.

Analysis on Which to Base We also found that neither the Department of
Commerce nor Defense had

Policy Objective Is Lacking conducted the analyses that could serve as the
basis for an export control

policy objective, related export licensing decisions, or U. S. proposals to
the Wassenaar Arrangement.

 The Commerce Department has the authority to initiate ?foreign
availability? assessments that identify foreign sources of items subject to
U. S. national security export controls, such as semiconductor manufacturing
equipment. These assessments determine if items of comparable quality are
available in quantities that would render U. S. export controls on the items
ineffective. Commerce Department officials and Semiconductor Equipment and
Materials International

representatives stated that a foreign availability study has not been
conducted since 1987. Industry officials told us that they had not requested
these studies, as allowed by the regulations, because the government?s prior
effort to complete a study took several years and was outdated at issuance.
Industry officials told us that if new studies

were conducted and completed in a timely manner, the results would indicate
that U. S. export controls on the items studied have been ineffective since
all the equipment necessary to manufacture semiconductors can be purchased
from non- U. S. sources.

 The Commerce Department conducts studies of the impact of U. S. export
controls and sanctions on particular industries and overall U. S. global
trade. It conducts these studies because U. S. economic interests are major
factors in export control decisions, along with national security and
foreign policy concerns. However, we found that the Commerce Department has
not studied the impact of export controls on the U. S. semiconductor
manufacturing equipment and materials

industries.  The Commerce Department researches technology transfer issues
in order to enhance long- term U. S. economic security. In addition,

Department of Defense Directive 2040. 2 states that the department shall
?assess annually the total effect of transfers of technology, goods,
services, and munitions on U. S. security, regardless of the transfer
mechanisms involved.? 36 We found that neither the Departments of

36 Department of Defense Directive Number 2040.2, sections 5.1.7 and 7.1.15,
January 17, 1984, reissued incorporating Change 1, July 5, 1985.

Commerce nor Defense has conducted assessments of the cumulative effect of
semiconductor- related technology transfers to China. Further, Department of
Defense Directive 2040.2 has not been updated since July 5, 1985, and many
of its provisions are centered on the Coordinating Committee for
Multilateral Export Controls, the predecessor to the Wassenaar Arrangement.

 The Export Administration Act of 1979 calls for the Defense Department to
compile a list of military critical technologies. 37 The Military Critical
Technologies List describes the performance parameters of critical
technologies that the United States needs to ensure superiority of U. S.
military systems. 38 The list is intended to serve, among other purposes, as
the technical foundation for U. S. negotiators in the Wassenaar Arrangement,
and as a technical reference guide for the Departments of Commerce, Defense,
Energy, State, and Treasury licensing and export control staff. In
developing the list, defense and intelligence analysts also make related
foreign technology assessments that describe foreign countries? capabilities
to produce each of the listed technologies. 39 Despite major advances in
semiconductor- related technology in the

United States and in foreign countries, the Defense Department has not
substantively updated the Military Critical Technologies List pertaining to
semiconductor equipment and materials since 1996.

Without these analyses and assessments, the Departments of Commerce,
Defense, and State are making licensing decisions and U. S. proposals to
Wassenaar without complete and up- to- date information. According to the

Departments of Defense and State, the export licensing community is kept
informed by frequent industry briefings, intergovernmental contacts, the
international press, and information exchanges among Wassenaar Arrangement
members. Although the information obtained through these methods is useful,
it is not an adequate substitute for formal agency analysis.

37 50 U. S. C. App. section 2404( d)( 2). 38 The technology list covers 18
categories including electronics, under which semiconductors and
semiconductor manufacturing equipment and materials fall. 39 The technology
assessments are foreign capability assessments and do not constitute
findings of foreign availability covered by Commerce Department foreign
availability assessments.

Most Export Licenses for We found the majority of export license
applications for semiconductor

Semiconductor manufacturing equipment and materials for China are approved.
From

Manufacturing Equipment fiscal year 1997 through fiscal year 2000, 64.6
percent of export licenses for

and Materials Are Approved semiconductor manufacturing equipment (Category
3B) were approved,

and 78.3 percent of export licenses for semiconductor manufacturing
materials (Category 3C) were approved. Other data indicate that export
license denials have not had a major economic impact on the industry. 40 The
U. S. government reviewed nearly $1.6 billion worth of semiconductor
manufacturing equipment and materials licenses for export to China from
fiscal year 1997 through fiscal year 2000; only 0. 4 percent and 0. 5
percent of equipment and materials licenses, respectively, were denied as
measured by dollar value. 41 The approved licenses typically contain a
number of conditions that

stipulate the characteristics (such as feature size) of the integrated
circuits that can be produced, the types of integrated circuits that
equipment should not be used to produce, and the customers who can or cannot
purchase the integrated circuits produced with the licensed equipment, among
other things. The conditions are designed to deter the end user from using
the equipment inappropriately. Without periodic monitoring, there is no way
to verify compliance. Although monitoring is supposed to be accomplished
through end- use checks conducted by U. S. government personnel, we found
that the U. S. officials in China tasked with this job have not conducted
any of these checks on semiconductor manufacturing equipment in the last 5
years. In testimony before the U. S. China Commission on January 17, 2002,
the Commerce Department?s assistant secretary of export enforcement stated
that the schedule for conducting end- use checks is dictated by the Chinese
government. 42 This situation has

40 Semiconductor Equipment and Materials International maintains that as
license applications for China increase, the inability to quickly and
predictably obtain license approvals could have a significant negative
impact on the industry.

41 Licenses can also be returned to applicants without action. An export
license application is returned without action if the applicant does not
respond to Department of Commerce requests for additional information within
20 days. During the fiscal year 1997 through fiscal year 2000 period, 26.1
percent of Category 3B and 13 percent of Category 3C license applications
were returned without action. As measured by dollar value, 0.8 percent of
Category 3B and 27.8 percent of Category 3C license applications were
returned without action.

42 End- use checks in China are conducted based on an end- use visit
arrangement negotiated between the U. S. and Chinese governments in 1998.

caused a number of problems. Specifically, most of the end- use checks that
the United States has been allowed to conduct have been on highperformance
computers that are no longer controlled due to the liberalization of export
controls. In addition, due to delays caused by the Chinese government?s
scheduling, 700 outstanding checks remain to be completed, checks on items
other than high- performance computers continue to ?languish,? and the
Commerce Department is unable to focus its efforts on the checks it
considers the most strategic. Despite the overall high approval rates for
electronics goods and

technologies, there are a few cases where licensing denials did cost some U.
S. companies sales worth several million of dollars. We asked companies that
are members of the semiconductor equipment and materials trade association
to provide examples of cases where export license denials resulted in sales
lost to foreign competitors. Of the six cases they identified, we were able
to verify two. In May 1998, the Commerce Department denied an export license
to Emcore Corporation of Somerset,

New Jersey, to sell a metal organic chemical vapor deposition machine to the
Hebei Institute of Semiconductors. The institute later purchased a similar
machine from Aixtron GmbH of Aachen, Germany. 43 In 2001, Hayward,
California- based ETEC lost the sale of a mask pattern generating

machine (ALTA 3000) to Shanghai- based Semiconductor Manufacturing
International Corporation. Due to delays in the license approval process,
the firm canceled its ETEC order and purchased a machine from Micronic of
Taby, Sweden. The Commerce Department later approved the sale of a more
advanced machine (ALTA 3500) to Semiconductor Manufacturing International
Corporation. 44

Conclusions The current export control system has not effectively slowed
China?s ability to obtain billions of dollars worth of advanced
semiconductor equipment

as part of its national strategy to modernize its semiconductor industry and
thus needs to be reexamined. The success of export controls is predicated on
a nation?s ability to control a particular form of technology or to 43
Information on the denial of this license was provided by Emcore.

44 The ALTA 3000 is used to manufacture products with a feature size of 0.35
micron, while the ALTA 3500 manufactures products with a feature size of
0.25 micron. All information concerning ETEC, Semiconductor Manufacturing
International Corporation, and Micronic, including dispositions of licenses,
was provided by ETEC and Semiconductor Manufacturing International
Corporation.

multilateralize binding controls. However, U. S. agency efforts to control
this technology have been complicated by the globalization of the industry
and foreign competitors? views that transfers of this technology to China
are not a matter for concern. In addition, Wassenaar Arrangement reporting
does not provide enough information to allow member countries to assess
whether destabilizing accumulations of these and related dual- use goods and
technologies are occurring. While U. S. export regulations broadly describe
export licensing policy to China, they lack criteria describing the level of
semiconductor manufacturing technology that can be exported to China
relative to the current state of the art. This has led industry to perceive
that semiconductor manufacturing equipment sales to China are subject to an
ad hoc system of controls. Under the current approach, the U. S. government
continues to require licenses for semiconductor manufacturing equipment
without 1) adequate consideration of the impact of the global market forces
that are undermining its ability to control this technology, 2) the
cumulative effect of the transfer of this technology on U. S. national
security, and 3) clear justification for why the current control parameters
are maintained or how they contribute to slowing the transfer of this
equipment to China. Without an updated assessment, U. S. policymakers may
find it increasingly difficult to justify licensing decisions and to strike
the appropriate balance between national security risks and the economic
interest in promoting sales of high- technology goods to

China. Recommendations for

To improve the effectiveness of the U. S. export control system, we
Executive Action

recommend that the secretary of commerce work with the secretary of defense
and the secretary of state to reevaluate, clarify, and document export
policy on semiconductor manufacturing equipment and materials. These actions
should include:

1. conducting assessments of foreign availability, the technical parameters
necessary to ensure critical U. S. military capabilities, the impact of
export controls on U. S. industry, and the overall national and economic
security implications of China?s ability to import, produce, and develop
advanced semiconductor- related technology;

2. developing new export controls if the technology needs to and can be
controlled, and updating related regulations and policy documents including
the Military Critical Technologies List and Department of Defense Directive
2040.2. If the technology cannot be controlled using

export controls, develop alternative means for protecting U. S. security
interests; and

3. communicating the results of the assessments and the options for
controlling the technology and protecting U. S. security to the U. S.
Congress and industry.

Agency Comments and We received written comments on a draft of this report
from the

Our Evaluation Departments of Commerce, Defense, and State that are
reprinted in

appendixes III, IV, and V. The Departments of Commerce, Defense, and State
disagreed with our analysis and conclusions and said our report is based on
a flawed premise that U. S. controls on semiconductor manufacturing- related
items exported to China stem from a policy of trying to keep Chinese
industry at least two generations behind state- of- the- art semiconductor
manufacturing facilities. These agencies said that U. S. policy for why and
how these items should be controlled can be found in the Export
Administration Regulations and that

this policy specifies a case- by- case review. The Commerce Department said
that no policy- level official at the Commerce Department informed GAO of
the two- generations- behind policy. The State Department also asserted
that, contrary to our report findings, the current U. S. export

licensing process does consider the nature and extent of foreign
availability of semiconductor manufacturing equipment and the cumulative
effect of those exports to China, as well as the potential risks to U. S.
national security. The State Department asserted that these efforts are
sufficient to

meet the intent of the draft report?s recommendations concerning
establishing a sound, analytical basis for current policy. The Commerce
Department also noted that no semiconductor equipment producer or industry
association has requested a foreign availability assessment.

We agree with the Departments of Commerce, Defense, and State that a
description of the U. S. government?s export control policy toward China is
found in the Export Administration Regulations. We added some additional
information to the report to better describe this policy and to make a
clearer distinction between policy and practice as the current regulations
make no reference to the level of semiconductor manufacturing technology
that can be exported to China relative to the current commercial state of
the art. We found that the executive branch practice was aimed at keeping
China two generations behind the U. S. semiconductor manufacturing industry.
On March 1, 2001, the under

secretary for export administration (a policy- level official) described
this practice and reconfirmed it in a follow- up January 2002 meeting with
GAO after he left office.

Moreover, in commenting on our draft report, the Commerce Department
described this practice, noting that ?certain exports of semiconductor
manufacturing equipment to China are limited to two generations behind
state- of- the- art levels to address national security, or other concerns
related to a particular transaction. On a number of occasions, however,
exports of more sophisticated equipment to wholly- owned subsidiaries of

U. S. companies located in China have been approved.? In a January 17, 2002,
hearing before the U. S.- China Commission, the president of the
Semiconductor Industry Association also discussed this practice. He
testified that ?As a result of the ready availability of SEM [semiconductor
production equipment and materials] globally, the U. S. policy objective of
using export controls to keep China?s indigenous semiconductor production
two generations behind the state of the art is not being met, yet the
controls remain, hampering U. S. SEM suppliers and their ability to remain
global leaders.? U. S. industry officials complain that the lack of clearly
articulated criteria creates uncertainty about the export licensing process
and raises question about U. S. export policy toward China. That is why we
are recommending that this issue be reevaluated, clarified, and documented.
We are not suggesting that the ?two- generations- behind?

objective is the appropriate criterion; rather, we are recommending that the
executive branch devise appropriate criteria once the supporting analysis
has been completed and documented.

Regarding the Departments of Commerce, Defense, and States? comments that
the current export licensing process is based on a sound, analytical
framework, we found that a U. S. government foreign availability analysis of
semiconductor manufacturing equipment has not been completed since 1987.
Further, the U. S. government has not conducted studies of the cumulative
effect of the export of advanced semiconductor manufacturing equipment and
materials to China on U. S. national security.

The Department of Defense also questioned whether China?s semiconductor
industry has advanced as far as our analysis suggests. In particular, the
department disputed our analysis indicating that China is one generation of
technology behind the United States. The Defense Department cited a November
2001 press release issued by the Semiconductor Manufacturing International
Corporation (SMIC) to support its conclusion. We met with the senior
management team of this

corporation during our visit to China in June 2001 and verified the
information we presented in our report in follow- up discussions with
company officials. The Department of Defense also cited a 2001 RAND
Corporation study that discusses developments in China?s microelectronics
industry to support its assessment of China?s current semiconductor
manufacturing capabilities. The study was based on secondary sources
utilizing 1997 industry data. Our analysis was based on 2001 primary data
collected directly from semiconductor manufacturing industry officials in
China.

The Departments of Commerce and Defense also said that, due to
confidentiality provisions of current law (e. g., section 12( c) of the
Export Administration Act of 1979, as amended), public disclosure of
information regarding individual license applications is not authorized. We
discussed these issues with agency officials and assured them that all
companyspecific

examples we used in our report were obtained from public sources or the
companies and organizations mentioned in the report. The Departments of
Commerce, Defense, and State also commented that

the report presented no evidence that the semiconductor manufacturing
facilities constructed in China provided any benefit to China?s military.
However, in a January 17, 2002, hearing before the U. S.- China Commission,
the deputy undersecretary of defense for technology security and
counterproliferation affirmed our observation. This official noted that
?China?s modernization program appears to be focusing on pockets of
excellence, where advances in select technologies can be leveraged for
disproportionate benefit in a potential conflict. Several such pockets
include: preemptive long- range precision strike capabilities; information
dominance; command and control; and integrated air defense. In support of
these efforts, Beijing has identified the development of an indigenous
microelectronics industry as one of its highest priorities. A cutting- edge
domestic microelectronics sector will support both military and commercial
modernization in China. China?s increasing emphasis on the development of
very large- scale integrated circuits will have a direct application in
future military systems, for example, advanced phased- array

radars.? Additional information was added to the report to clarify specific
points. However, the comments provided by the Departments of Commerce,
Defense, and State provide no basis for altering the findings, conclusions,
or recommendations contained in the report.

Scope and To describe China?s present semiconductor manufacturing
capability, we

Methodology met with and reviewed studies and analyses prepared by experts
from

academia, industry, the intelligence community, and the Departments of
Commerce, Defense, and State in Washington, D. C., and Beijing, China. In
addition, we met with officials from Advanced Semiconductor Manufacturing
Corporation, Central Semiconductor Manufacturing Cooperation, Grace
Semiconductor Manufacturing Corporation, Motorola Tianjin, Semiconductor
Manufacturing International Corporation, Shougang Electronics NEC, Hua Hong
NEC, and DuPont Photo Masks Incorporated in China. As part of this work, we
toured the manufacturing facilities of Advanced Semiconductor in Shanghai,
China, and Motorola in Tianjin, China. Finally, we met with officials and
toured the facilities of the Chinese Academy of Sciences? Institute of
Semiconductors in Beijing, China. In addition, to further understand
semiconductor research and development and associated manufacturing
processes and applications, we visited Semiconductor Materials Technology
International in Austin, Texas, and the Sandia and Lawrence Livermore
National Laboratories in Albuquerque, New Mexico, and Livermore, California,
respectively; the Naval Research Laboratory in Washington, D. C.; the
Defense Microelectronics Activity in McClellan, California; the Defense
Advanced Research Projects Agency in Arlington, Virginia; and BAE Systems in

Manassas, Virginia. To analyze how the Wassenaar Arrangement has affected
the transfer of semiconductor manufacturing equipment and materials to
China, we met with representatives of the Departments of Commerce, Defense,
and State and an export control expert from the Center for International
Trade and Security in Washington, D. C. In China, we met with officials from
the

Ministry of Foreign Trade and Economic Cooperation in Beijing and the Trade
and Industry Department of the government of Hong Kong. Further, we spoke to
the director of the New York office of the Japan External Trade

Organization in Washington, D. C. We also met with officials from the U. S.,
Russian, and Japanese Missions to the Wassenaar Arrangement and staff
members of the Wassenaar Arrangement Secretariat in Vienna, Austria. We
analyzed information provided by the Wassenaar Arrangement?s

Secretariat, including the Wassenaar Arrangement?s Initial Elements,
controlled items lists, and export approval and denial reports, to determine
whether the arrangement?s reporting mechanisms could be used to identify
trends in the export of semiconductor equipment and materials and other
dual- use technology from 1996 through 2000. Finally, we analyzed trend data
describing the disposition of proposals from the United States and

other members of the Wassenaar Arrangement for 1996 through 2000. We did not
verify the data obtained from the Wassenaar Arrangement?s Secretariat. To
assess the analytical basis for U. S. export control policy pertaining to
the export of semiconductor equipment and materials to China, we met with
officials from the Departments of Commerce and State in Washington, D. C.,
and Beijing, China, and the Defense Department in Washington, D. C., and
with officials at the American Institute in Taiwan in Taipei. In addition,
we convened panels of representatives from the semiconductor and
semiconductor equipment and materials industries in San Jose, California;
Hsinchu, Taiwan; and Beijing, China, to obtain their views on U. S. export
controls on semiconductors and semiconductor manufacturing equipment and
materials. These panels included representatives from Advantest, Applied
Materials, Emcore, ETEC, Hermes Systems, Hewlett- Packard, Intel,
International Business Machines, KLA- Tencor, National

Semiconductor, NEC, Novellus, Texas Instruments, Ultratech Stepper, and
Varian Semiconductor Equipment. In addition, we met directly with major U.
S. and Taiwanese firms including Advanced Micro Devices, Applied Materials,
Intel, Motorola, Silicon Laboratories, Silicon Valley Group, Taiwan
Semiconductor Manufacturing Company, United Epitaxy Company, United
Microelectronics Corporation, and VIA Technologies Incorporated.

We also met with representatives of the Semiconductor Industry Association
in San Jose, California; Semiconductor Equipment and Materials International
in Washington, D. C., San Jose, California, and Hsinchu, Taiwan; the
Taiwanese Semiconductor Industry Association in Hsinchu, Taiwan; and the
United States Information Technology Office in Beijing, China; and the
attorneys for the industry associations- Dewey Ballantine in Washington, D.
C. In addition, we analyzed license processing and approval information from
the Commerce Department?s Export Control Administrative Support System.
Finally, we attended Commerce Department Information System Technology
Advisory Committee meetings in San Diego, California, and Washington, D. C.
Statements in the report about foreign laws and regulations were derived
from secondary sources.

We performed our work from February 2001 through January 2002 in accordance
with generally accepted government auditing standards.

Please contact me at (202) 512- 8979 if you or your staff have any questions
concerning this report. Other GAO contacts and staff acknowledgments are
listed in appendix VI.

Sincerely yours, Joseph Christoff Director International Affairs and Trade

Appendi xes Reasons for Controlling Dual- Use Goods and

Appendi x I

Technologies Export controls on dual- use items are maintained for national
security and foreign policy reasons. 45 Each export control regulation is
governed by at least 1 of 13 specific concerns. (See figure 6 for a list of
the 13 reasons for controlling dual- use goods.)

Figure 5: Reasons for the Control of Dual- Use Goods and Technologies

Source: 15 CFR section 738.2

The Export Administration Regulations establish the framework for regulating
the exports of dual- use items by identifying the characteristics and
capabilities of items that may require export licenses. Exports are

45 15 C. F. R. Part 734.2, Scope of the Export Administration Regulations.

restricted by item, country, and entity. These characteristics and
capabilities are contained in the Commerce Control List, which provides
detailed specifications for about 2,400 dual- use items, divided into 10
categories (see table 2 for a list of the 10 categories); each category is
subdivided into 5 groups designated by the letters A through E (see table 3
for a list of the 5 groups).

Table 2: Commerce Control List Categories Commerce Control List categories

0 Nuclear materials, facilities, and equipment, and miscellaneous

1 Materials, chemicals, ?microorganisms,? and toxins 2 Materials processing
3 Electronics 4 Computers 5 Telecommunications and information security 6
Lasers and sensors 7 Navigation and avionics 8 Marine 9 Propulsion systems,
space vehicles, and related

equipment Source: 15 C. F. R. section 738.2

Table 3: Commerce Control List Category Groups Commerce Control List
subcategories

A Equipment, assemblies, and components B Test, inspection, and production
equipment C Materials D Software E Technology Source: 15 C. F. R. section
738.2

Semiconductors and semiconductor manufacturing equipment and materials fall
under Category 3 (electronics), with manufacturing

equipment placed in Category 3B (test, inspection, and production equipment)
and materials placed in Category 3C (materials). 46 These goods and
technologies are controlled most frequently as a tool of U. S. antiterrorism
policy, but also, as shown in table 4, to meet nuclear nonproliferation
policy objectives, control the spread of missile technology and crime, and
address general national security concerns. 47 Exports of semiconductor
manufacturing equipment and materials to China are controlled for national
security reasons. Table 5 describes the specific equipment and materials
that require a license for export to China.

Table 4: Frequency of Reasons for Control of Category 3 (Electronics) Items
National

Missile Nuclear

Crime Subcategory security technology Antiterrorism nonproliferation control

A 2217112 B 20400 C 40500 D 32701 E 23830

Total 13 7 41 14 3

Source: C. F. R. 15, Parts 300 to 799, Commerce and Foreign Trade, 2001.

46 Category 3B and 3C items are described in 15 C. F. R., Part 774, Supp. 1
of the Commerce Control List as test, inspection, and production equipment
and materials, respectively. 47 See C. F. R. 15 Part 774- The Commerce
Control List.

Table 5: Description of Semiconductor Manufacturing Equipment and Materials
Requiring Export License to China List number a Description National
security significance Primary supplier countries

3B001. a. 1 Thin layer deposition equipment Radiation- hardened electronics,
spacequalified U. S., Japan solar cells, high power radiofrequency devices,
infrared focal plane arrays

3B001. a. 2 Metal organic chemical vapor deposition U. S., Germany reactors
3B001. a. 3 Molecular beam epitaxy equipment U. S., United Kingdom

3B001. b Ion implantation equipment Used for radiation hardened circuitry U.
S., Japan 3B001. c Plasma dry etching equipment Needed for all state- of-
the- art

U. S., Japan electronics, commercial or military, enable production of
controlled analogto-

digital converters, field programmable logic devices, and application
specific integrated circuits b 3B001. d Plasma enhance chemical vapor
deposition U. S., Japan 3B001. e Cluster tools U. S., Japan 3B001. f. 1
Lithography systems U. S., Netherlands, Japan 3B001. f. 2 Mask lithography
systems U. S., Japan, Sweden 3B001. g Masks U. S., Japan 3B001. h Multilayer
masks U. S., Japan 3B002. a S- parameter testers U. S., Japan 3B002. b
Integrated circuit testers U. S., Japan, Germany 3B002. c Microwave
integrated circuit testers U. S., Japan, Germany 3C001. a Epitaxial silicon
wafers Potential starting material for devices

U. S. Japan, Europe, Taiwan outlined in metal oxide chemical vapor
deposition and molecular beam epitaxy equipment

3C001. b Epitaxial germanium wafers 3C001. c Epitaxial wafers of III/ IV
compounds 3C002 Photo resists Same as for 3B001. c U. S., Japan, Europe
3C003 Purified metal organics Gas sources for metal oxide chemical

U. S. Japan, Eurpoe vapor deposition 3C004 Purified gases

a Category number in the Commerce Control List. Some items have been
consolidated under one heading for clarity. b These items are controlled
under Export Administration Regulations, Part 774, 3A001 and 3A101 or

under the International Traffic in Arms Regulations Category XI. Source:
Department of Defense, Commerce Control List.

Appendi x II

Wassenaar Reporting Commitments by List Category / percentage of items
within each category Type of information Basic / 76. 3 percent Sensitive /
19. 3 percent Very Sensitive / 4.4 percent

Approval None Aggregate Aggregate

information  Exporting country  Exporting country  Destination country

 Destination country  Control List item number

 Control List item number  Brief description of the item

 Brief description of the item  Number of units

 Number of units Denial

Aggregate Individual

Individual

information

 Exporting country  Exporting country

 Exporting country  Destination country

 Destination country  Destination country

 Control List item number  Control List item number

 Control list item number  Brief description of the item

 Brief description of the item  Brief description of the item

 Number of licenses denied  Number of units

 Number of units  Number of units

 Intermediate consignee (name and  Intermediate consignee (name  Reason
for the denial address)

and address) (usually formulaic, not

 Ultimate consignee (name and address)  Ultimate consignee (name and

specific or detailed)  Stated end- use

address)  Reason for denial

 Stated end- use  Other relevant information

 Reason for denial  Other relevant information

Reporting

Denials Approvals

Approvals

frequency Biannually Biannually

Biannually

Denials Denials

?Preferably? within 30 days but no later ?Preferably? within 30 days but no
than within 60 days

later than within 60 days Source: GAO analysis of Wassenaar Initial Elements
and the December 1, 2000 list of Dual- Use Goods and Technologies.

Comments from the Department of

Appendi x III

Commerce Note: GAO comments supplementing those in the report text appear at
the end of this appendix.

See comment 1. See comment 2. See comment 3.

See comment 4. See comment 5.

See comment 6. See comment 7.

Now on p. 6. See comment 8.

Now on p. 6. See comment 9.

Now on p. 17. See comment 10.

Now on p. 17. See comment 11.

Now on p. 19. See comment 12.

Now on p. 19. See comment 12.

Now on p. 19. See comment 12.

Now on p. 19. See comment 12.

Now on p. 19. See comment 12.

Now on p. 21. See comment 12.

Now on p. 22. See comment 12.

Now on p. 22 See comment 12.

Now on p. 22. See comment 12.

Now on p. 23. See comment 13.

Now on p. 23. See comment 14.

Now on p. 24. See comment 14.

Now on p. 24. See comment 14.

Now on pp. 25 and 26. See comment 14.

Now on p. 28. See comment 15.

Now on p. 28. See comment 15.

Now on p. 28. See comment 15.

Now on p. 28. See comment 15.

Now on p. 28. See comment 16.

Now on pp. 29 and 30. See comment 16.

The following are GAO?s comments on the letter from the Department of
Commerce dated January 16, 2002.

GAO Comments 1. We have modified the text on pages 23 and 24 to better
distinguish between the policy articulated in the Export Administration
Regulations and agency practice. We agree that the regulations discuss

U. S. policy toward the export of goods and technology to China and do not
include a discussion of the ?two- generations- behind? objective. However,
in March 2001, senior executive branch officials involved in making U. S.
policy, including the undersecretary of commerce for export administration
and the director of the Technology and Security Directorate of the Defense
Threat Reduction Agency, stated that the U. S. government's practice, while
undocumented, aims at keeping China's manufacturing capability two
generations behind commercial state of the art. This view was confirmed by
the chairman of the Information Services Technical Advisory Committee- an
industry advisory committee. Further, the Commerce Department said in its
detailed written comments on this report that the ?two- generations- behind?
practice has been used in making some export licensing

decisions. 2. In discussions with U. S. government officials, we found a
lack of

understanding and information about the semiconductor manufacturing
equipment and materials industry. For example, Foreign Commercial Service
officials in Shanghai, the center of China's semiconductor manufacturing
industry, welcomed our visit as an opportunity to learn more about the
industry and meet with industry representatives and said they had been
unable to complete a study of China's semiconductor industry due to a lack
of resources.

3. We have modified the text of the report on page 25 to note that neither
the semiconductor equipment producers nor industry associations have
requested a foreign availability study. However, we further note in the
revised report that industry representatives had not requested a study
because the government's prior efforts to conduct a study took several years
to complete and were outdated at issuance. Industry

officials told us that if new studies were conducted and completed in a
timely manner the results would indicate that U. S. export controls on the
items studied have been ineffective, since all the equipment necessary to
manufacture semiconductors can be purchased from nonU. S. sources.

4. xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx

5. We met with agency officials and explained that all of the
companyspecific information cited in the report was gleaned from public
sources or was provided to GAO by the companies mentioned.

6. We have revised the highlights page to include discussion of the policy
as set forth in 15 C. F. R., section 742.4, and the U. S. government's
twogenerations- behind practice.

7. Page 24 now discuss the policy as set forth in 742.4 and the U. S.
government's two- generations- behind practice. See also comment 1.

8. ?of 1979? has been inserted on page 6 after ?Export Administration Act.?
9. No change made. The level of detail contained in the report is

sufficient. 10. No change made. The objective of the Wassenaar Arrangement
is fully described in the report.

11. No change made. The line cited is from the introductory paragraph.
Additional more detailed information follows. 12. See comment 5. 13. Change
made. Additional text added has been added on page 23 of the

report. 14. Additional information has been added to page 24 of the report
to reflect the stated U. S. government policy and the differences between

the policy and the U. S. government's practice. 15. See comment 5.

16. Additional information has been added to page 24 of the report to
reflect the stated U. S. government policy and the difference between the
policy and the U. S. government's practice.

Appendi x IV

Comments from the Department of Defense Note: GAO comments supplementing
those in the report text appear at the end of this appendix.

See comment 1. See comments 2 and 3.

See comments 4 and 5.

See comment 6. See comment 7. See comment 8.

See comment 9. See comment 10.

See comment 11.

Now on pp. 2 and 3. See comment 12.

See comment 13.

See comment 14. Now on p. 7. See comment 15

Now on p. 8. See comment 16.

See comment 17. Now on p. 9.

Now on p. 9. Now footnote 18. See comment 18.

Now on p. 10. Footnote 19. See comment 19.

Now on p. 10. See comments 20 and 21.

See comments 20 and 21. Now on p. 13. See comment 22.

Now on p. 13. Now footnote 20. See comment 23.

Now on p. 15. See comment 24.

Now on p. 17. See comment 25.

Now on p. 17. See comment 26.

Now on p. 17. See comment 27.

Now on p. 17. See comment 28.

Now on p. 18 Footnote 30. See comment 29.

Now on p. 19. See comment 30.

Now on p. 23. Now footnote 41. See comments 31and 32.

Now on p. 23. See comments 31 and 32.

Now on p. 23. See comments 33 and 34.

Now on pp. 23 and 24. See comments 33 and 34.

Now on p. 26. See comment 35.

Now on p. 27. See comment 36.

Now on p. 28. See comment 37.

Now on p. 28. See comment 38.

Now on p. 29. See comment 39.

Now on pp. 29 and 30. See comment 40.

The following are GAO?s comments on the letter from the Department of
Defense dated January 17, 2002.

GAO Comments 1. No change. The analysis and conclusions presented in our
report support the need for a fundamental review of U. S. policy related to

semiconductor equipment and materials exports to China. 2. The data
presented in the report on the current state of China's

semiconductor manufacturing capability are based on information we collected
during our visits to Chinese semiconductor manufacturing facilities in 2001.
The data demonstrate that China's most advanced

manufacturing facilities currently contain equipment capable of producing
semiconductors that are only one generation or less behind the current
commercial state of the art. The author of the RAND Corporation study
confirmed that his analysis was based on secondary information that is at
least 3 years old.

3. We have modified the text on page 24 to better distinguish between the
policy articulated in the Export Administration Regulations and agency
practice. We agree that the regulations discuss U. S. policy toward the
export of goods and technology to China and do not include a discussion of
the ?two- generations- behind? objective. However, in March 2001, senior
executive branch officials involved in making U. S. policy, including the
undersecretary of commerce for export administration and the director of the
Technology and Security Directorate of the Defense Threat Reduction Agency,
stated that the

U. S. government's practice, while undocumented, aims at keeping China's
manufacturing capability two generations behind commercial state of the art.
The chairman of the Information Services Technical Advisory Committee-- an
industry advisory committee-- also shared this view with us. Further, the
Department of Commerce stated in its detailed written comments on this
report that the ?two- generations- behind? policy has been applied in making
some export licensing

decisions. 4. Additional information has been added on pages 15 and 16 to
clarify the

relationship between China's semiconductor manufacturing facilities and its
military capabilities. However, we further note in the revised report that
in testimony delivered to the U. S.- China Commission on January 17, 2002,
the deputy undersecretary of defense technology

security policy and counterproliferation stated that a ?cutting- edge?

domestic semiconductor industry supports military modernization in China.
This official testified that ?China's military modernization program appears
to be focusing on ?pockets of excellence, ? where advances in select
technologies can be leveraged for disproportionate benefit in a potential
conflict. Several such ?pockets? include: preemptive long- range precision
strike capabilities; information

dominance; command and control; and integrated air defense. In support of
these efforts, Beijing has identified the development of an indigenous
microelectronics industry as one of its highest priorities. China's
increasing emphasis on the development of integrated circuits

will have direct application in future military systems, for example,
advanced phased- array radar.?

5. We modified the report by adding more information on pages 27 and 28
about the conditions typically imposed on approved export licenses. Although
these conditions are designed to deter the end user from using the U. S.
equipment inappropriately, these conditions should be

monitored on a regular basis. As noted in our report, the government lacks
information on whether these conditions are being met. U. S. officials in
China told us that they had not conducted any end- use checks on
semiconductor manufacturing equipment in the last 5 years. Moreover, in
testimony before the U. S.- China Commission on January 17, 2002, the
Commerce Department's assistant secretary of export enforcement noted some
problems with these checks and said the schedule for conducting end- use
checks is dictated by the Chinese government. The official testified that
most of the end- use checks that the United States has been allowed to
conduct in China have been on high- performance computers that are no longer
controlled because of

the liberalization of U. S. export controls. In addition, this official
noted that due to delays caused by the Chinese government's scheduling, 700
outstanding checks remain to be completed and checks on items other than
high- performance computers continue to ?languish.?

6. See comment 3. 7. See comment 3. 8. See comment 3 and comment 14. 9. In
discussions with U. S. government officials, we found a lack of

understanding and information about the semiconductor manufacturing
equipment and materials industry. For example,

Foreign Commercial Service officials in Shanghai, the center of China's
semiconductor manufacturing industry, welcomed our visit as an opportunity
to learn more about the industry and meet with industry representatives and
said they had been unable to complete a study of China's semiconductor
industry due to a lack of resources.

10. We modified figure 1 to give a clearer picture of China's rate of
advancement relative to the United States. However, the data points used in
the chart have not been changed as they are based on primary data sources
including the president of the Semiconductor Manufacturing International
Corporation.

11. We have added information from this table to appendix I, page 39, to
clarify the types of items the report discusses. The report generally refers
to controlled semiconductor manufacturing equipment and materials (all of
Categories 3B and 3C). 12. We agree that countries are willing to listen to
U. S. concerns pertaining

to the export of semiconductor manufacturing equipment and materials to
China. The United States is the only member that considers the relationship
between semiconductor manufacturing equipment and military end uses
sufficiently critical and considers China?s acquisition of this technology a
potential threat to regional or international stability. 13. Additional text
has been added to page 23 that includes the Defense

Department information pertaining to proposals in Category 3B and Category
3C. Although the Defense Department's chart shows that four new controls
were added, it also shows that one item was decontrolled and that controls
on five additional items were relaxed.

14. We modified our report on page 24 by adding language from Export
Administration Regulation 742.4( b)( 7). This regulation provides a general
statement of U. S. export policy for China. However, as noted in our report,
it does not specify the level of semiconductor

manufacturing technology that can be exported to China relative to the
current state of the art. Although Department of Defense Directive 2040.2
establishes policy, assigns responsibility, and prescribes procedures for
international transfer of defense- related technology, goods, services, and
munitions, it has not been updated since July 5, 1985, and a number of its
provisions are centered on the now defunct

Coordinating Committee for Multilateral Export Controls (COCOM), the
predecessor to the Wassenaar Arrangement. 15. We modified page 7 of the
report to clarify why this technology is

controlled. 16. No change. The updating of control lists and other efforts
to improve

these lists are all aspects of transparency. Adding or deleting items from
the lists simply alters the reporting requirements for those items. 17. See
comment 4.

18. Footnote 18 has been reworded to clarify the information presented. 19.
Footnote 19 has been reworded to clarify the information presented. 20. See
comment 10. 21. See comment 10. 22. No change. The statement made in the
report refers to China's efforts

to develop an indigenous semiconductor manufacturing equipment industry, not
to efforts to improve its facilities.

23. No change. The 2 percent refers to the total sales to China. 24. See
comments 4 and 5. 25. The text on pages 16 and 17 has been modified to
clarify the

characterization of the problems facing China's defense industry. The
information presented was obtained from papers published by defense experts,
GAO interviews with defense experts, and the RAND Corporation study cited in
the Defense Department comments on a draft of this report.

26. See comment 16. 27. Additional information pertaining to Categories 3B
and 3C was added

to footnote 30. 28. xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx

xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx

xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxxxxxxxxxxxxxx

29. Additional information was added to footnote 30 pertaining to Categories
3B and 3C. 30. The information presented in the report pertaining to
specific

companies was obtained from the companies or from public sources. 31. xxxxxx
32. xxxxxxxxxxxxx 33. See comment 3. 34. See comment 3. 35. The Internet
site does indicate that some revisions were made to the

electronics section in 1999. However, the analyst responsible for the list
stated that the list had not been substantively updated since 1996.

36. Information was added to page 27 of the report to indicate that the
information presented pertains to China.

37. The information presented in the report pertaining to specific companies
was obtained from the companies or public sources.

38. See comments 4 and 5. 39. See comment 3. 40. The report clearly
illustrates the contrast between formal U. S. export

control policy articulated in the Export Administration Regulations and
practice. It also reveals the lack of an analytical basis for export control
licensing decisions and proposals for the Wassenaar Arrangement. The report
also highlights the continuing ineffectiveness of the Wassenaar Arrangement
as a means for controlling the export of semiconductor manufacturing
equipment and materials to China. Meanwhile, China's defense industrial base
continues to obtain benefits from the modernization of China's semiconductor
manufacturing industry that is driven by the acquisition of advanced
semiconductor manufacturing equipment and materials from foreign sources,

including the United States. A fundamental reevaluation of U. S. policy on
export controls on semiconductor manufacturing equipment and materials to
China is, therefore, necessary to correct weaknesses in the current system.

Appendi x V

Comments from the Department of State Note: GAO comments supplementing those
in the report text appear at the end of this appendix.

See comment 1. See comments 1 and 2. See comment 3.

See comments 4 and 5. See comment 6.

See comment 7. See comment 8. See comment 9.

The following are GAO?s comments on the letter from the Department of State
dated January 9, 2002.

GAO Comments 1. We have modified the text on page 24 to better distinguish
between the policy articulated in the Export Administration Regulations and
agency

practice. We agree that the regulations discuss U. S. policy toward the
export of goods and technology to China and do not include a discussion of
the ?two- generations- behind? objective. However, in March 2001, senior
executive branch officials involved in making U. S. policy, including the
undersecretary of commerce for export administration and the director of the
Technology and Security Directorate of the Defense Threat Reduction Agency,
stated that the

U. S. government's practice, while undocumented, aims at keeping China's
manufacturing capability two generations behind commercial state of the art.
This view was confirmed by the chairman of the Information Services
Technical Advisory Committee- an industry advisory committee. Further, the
Department of Commerce said in its detailed written comments on this report
that the ?two- generations- behind? practice has been used in making some
export licensing

decisions. 2. During our visit to the Motorola facility in Tianjin, China,
we found that

the U. S. government approved export licenses allowing the sale of 0.25-
micron equipment. The equipment in the Motorola facility is two generations
behind commercial state of the art, which is 0.13 micron.

3. We modified the report to clarify existing export control policy for
semiconductor manufacturing- related items on page 24. We also describe the
reasons for controlling dual- use goods further in appendix I, page 36.

4. We agree that no single piece of semiconductor manufacturing equipment
exported to China will make a ?significant contribution? to China's
military. Rather, it is the cumulative effect of these exports that raises
national security concerns. According to defense experts, the newest
semiconductor manufacturing facilities constructed in China represent a
significant improvement to China's military industrial base. It is the
cumulative effect of exports of semiconductor manufacturing equipment from
the United States and other Wassenaar members that

has allowed China to improve its military industrial base. This is a
scenario that was overlooked in the State Department's comments.

5. We modified pages 27 and 28 by adding more information about the
conditions typically imposed on approved export licenses. Although these
conditions are designed to deter the end user from using the U. S. equipment
inappropriately, these conditions should be monitored on a regular basis. As
noted in our report, the government lacks information on whether these
conditions are being met. U. S. officials in China told us that they had not
conducted any end- use checks on semiconductor manufacturing equipment in
the last 5 years. Moreover, in testimony before the U. S. China Commission
on January 17, 2002, the Commerce Department's assistant secretary of export
enforcement noted some problems with these checks and said the schedule for
conducting enduse

checks is dictated by the Chinese government. The official testified that
most of the end- use checks that the United States has been allowed to
conduct in China have been on high- performance computers that are no longer
controlled because of the liberalization of U. S. export controls. In
addition, this official noted that due to delays caused by the Chinese
government's scheduling, 700 outstanding checks remain to be completed and
checks on items other than high- performance computers continue to
?languish.?

6. In discussions with U. S. government officials, we found a lack of
understanding and information about the semiconductor manufacturing
equipment and materials industry. For example, Foreign Commercial Service
officials in Shanghai, the center of China's semiconductor manufacturing
industry, welcomed our visit as an opportunity to learn more about the
industry and meet with industry representatives and said they had been
unable to complete a study of China's semiconductor industry due to a lack
of resources. Furthermore, the information sources mentioned by the State
Department, such as information exchanges and international press articles,
are not adequate substitutes for a formal, comprehensive study.

7. As our report notes, weaknesses in Wassenaar reporting make it difficult
to assess whether any exports covered by the arrangement were ?contrary to
the purposes of the Arrangement.? Also, since all export control decisions
of Wassenaar members are based on the national discretion of member
countries, judgments of whether particular exports are contrary to the
purposes of the arrangement are matters subject to a member state's
interpretation.

8. The report discusses some of the overall weaknesses in U. S. export
control policy and practice, of which the Wassenaar Arrangement is one part,
and recommends that the executive branch consider new ways of controlling
this technology, if appropriate. It is not appropriate to speculate on the
consequences of not having U. S. export controls or the Wassenaar
Arrangement.

Appendi x VI

GAO Contact and Staff Acknowledgments GAO Contact Stephen Lord (202) 512-
4379 Acknowledgments In addition to the individual named above, David M.
Bruno, Janey Cohen,

Julie Hirshen, Richard Seldin, Kevin Tarmann, and Hai Tran made key
contributions to this report.

(320110)

a

GAO United States General Accounting Office

Why GAO Did This Study

The United States controls the export of certain technology, including some
of the equipment and materials used to make semiconductors, or computer
?chips,? to sensitive destinations such as China for national security or
foreign policy reasons.

In light of China?s efforts to acquire modern semiconductor manufacturing
technology, GAO was asked to assess (1) advances in China?s manufacturing
capability, and (2) U. S. export control policy for this technology and its
analytical basis.

April 2002 EXPORT CONTROLS Rapid Advances in China?s Semiconductor Industry
Underscore Need for Fundamental U. S. Policy Review

This is a test for developing Highlights for a GAO report. The full report,
including GAO's objectives, scope, methodology, and analysis is available at
www. gao. gov/ cgi- bin/ getrpt? GAO- 02- 620. For additional information
about the report, contact Joseph Christoff at (202) 512- 8979. To provide
comments on this test Highlights, contact Keith Fultz (202- 512- 3200) or e-
mail [email protected] gao. gov.

Highlights of GAO- 02- 620, a report to the Ranking Minority Member,
Committee on Governmental Affairs, U. S. Senate

What GAO Recommends

GAO recommends that the secretaries of commerce, defense and state reassess,
document, and update as necessary U. S. policy and practices on exporting
semiconductor manufacturing equipment and materials to China.

The agencies disagreed with this recommendation stating that their current
policies and practices are sufficient for making export licensing decisions
to China.

We disagree. U. S. export regulations governing China contain inherent
inconsistencies and are based on outdated government assessments of the
availability of technology from non- U. S. sources. Accordingly, our
recommendations remain unchanged.

United States General Accounting Office

What GAO Found

Since 1986, the gap between U. S. and Chinese semiconductor manufacturing
technology has rapidly narrowed (See chart). Today, China?s advanced
manufacturing facilities can make chips that are less than one generation
behind the current, commercial state of the art.

The gap between U. S. and Chinese semiconductor manufacturing technology, as
measured in the feature size of the semiconductors produced, rapidly
diminished in recent years. A semiconductor?s feature size is measured in
microns and is used to define the current level of technology.

U. S. policies and practices to control the export of semiconductor
technology to China are unclear and inconsistent leading to uncertainty
among U. S. industry officials about the rationale for U. S. government
licensing decisions.

While export regulations restrict certain sales that would make a direct and
significant contribution to China?s military capabilities, the United States
generally approves most exports of semiconductor manufacturing equipment and
materials to China.

Although the stated practice of U. S. export agencies has been to keep China
two generations behind state of the art semiconductor production
capabilities, U. S. regulations do not describe the level of allowable
technology that can be exported to China relative to the commercial state of
the art.

The Departments of Commerce and Defense have not conducted recent national
security and economic assessments to form a sound analytical basis for
exporting semiconductor technology to China. G A O Accountability Integrity
Reliability

Highlights

Page i GAO- 02- 620 Export Controls

Contents

Contents

Page ii GAO- 02- 620 Export Controls

Page 1 GAO- 02- 620 Export Controls United States General Accounting Office

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Appendix I

Appendix I Reasons for Controlling Dual- Use Goods and Technol ogi es

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Appendix I Reasons for Controlling Dual- Use Goods and Technol ogi es

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Appendix I Reasons for Controlling Dual- Use Goods and Technologies

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Appendix II

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Appendix III

Appendix III Comments from the Department of Commerce

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Appendix III Comments from the Department of Commerce

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Appendix III Comments from the Department of Commerce

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Appendix III Comments from the Department of Commerce

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Appendix III Comments from the Department of Commerce

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Appendix III Comments from the Department of Commerce

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Appendix III Comments from the Department of Commerce

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Appendix III Comments from the Department of Commerce

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Appendix IV

Appendix IV Comments from the Department of Defense

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Appendix IV Comments from the Department of Defense

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Appendix IV Comments from the Department of Defense

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Appendix IV Comments from the Department of Defense

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Appendix IV Comments from the Department of Defense

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Appendix IV Comments from the Department of Defense

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Appendix IV Comments from the Department of Defense

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Appendix V

Appendix V Comments from the Department of State

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Appendix VI

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