Export Controls: Sensitive Machine Tool Exports to China (Letter Report,
11/19/96, GAO/NSIAD-97-4).

Pursuant to a congressional request, GAO reviewed the circumstances
surrounding the export of machine tools by the McDonnell Douglas
Corporation to the China National Aero-Technology Import and Export
Corporation (CATIC), focusing on: (1) the military and civil
applications of the equipment and whether these military applications
are important to China's military modernization plans; (2) the process
for approving the licenses and how the process addressed the risks
associated with this export; and (3) whether export control license
conditions were violated and, if so, how the U.S. government responded.

GAO found that: (1) the machine tools exported by McDonnell Douglas to
China had been used in the United States to produce parts for military
systems, but they were exported to manufacture parts for commercial
passenger aircraft; (2) China needs machine tools to upgrade both its
military and commercial aircraft production capabilities; (3) after a
lengthy interagency review, during which concerns were raised about the
need for the equipment to support Chinese aircraft production, the
reliability of the end user, and the capabilities of the equipment being
exported, the Department of Commerce approved the export license
applications with numerous conditions designed to mitigate the risk of
diversion; (4) the subsequent diversion of some of these tools to a
Chinese facility engaged in military production was contrary to key
conditions in the licenses that required that the equipment be used for
the Chinese Trunkliner program and stored in one location until the
CATIC Machining Center was built; (5) Commerce suspended licenses for
four machine tools not yet shipped to China 6 weeks after the reported
diversion and subsequently denied McDonnell Douglas's request to allow
the diverted machine tools to remain in the unauthorized location for
use in civilian production; (6) Commerce approved the transfer of the
machine tools to the Shanghai aviation facility, which is responsible
for final assembly of Trunkliner aircraft, before it could be misused;
(7) Commerce's Office of Export Enforcement did not formally investigate
the export control violations until 6 months after they were first
reported; and (8) the U.S. Customs Service and Commerce are now
conducting a criminal investigation under the direction of the
Department of Justice.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-97-4
     TITLE:  Export Controls: Sensitive Machine Tool Exports to China
      DATE:  11/19/96
   SUBJECT:  Exporting
             Export regulation
             Dual-use technologies
             Technology transfer
             International relations
             Foreign military sales
             Licenses
             Interagency relations
             Investigations by federal agencies
IDENTIFIER:  MD-80 Aircraft
             MD-90 Aircraft
             B-1 Aircraft
             C-17 Aircraft
             Peacekeeper Missile
             SU-27 Aircraft
             Beijing (China)
             China Trunkliner Program
             China
             Tianjin (China)
             
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Cover
================================================================ COVER


Report to Congressional Requesters

November 1996

EXPORT CONTROLS - SENSITIVE
MACHINE TOOL EXPORTS TO CHINA

GAO/NSIAD-97-4

Export Controls

(707165)


Abbreviations
=============================================================== ABBREV

  ACEP - Advisory Committee on Export Policy
  AVIC - Aviation Industries Corporation of China
  CATIC - China National Aero-Technology Import and Export
     Corporation
  DOD - Department of Defense

Letter
=============================================================== LETTER


B-272257

November 19, 1996

The Honorable Floyd D.  Spence
Chairman, Committee on National Security
House of Representatives

The Honorable Frank Wolf
House of Representatives

On September 14, 1994, the Department of Commerce approved an export
of machine tools to China.  These tools had been used at a plant in
Columbus, Ohio, that produced aircraft and missiles for the U.S. 
military.  The contractor, McDonnell Douglas Corporation, was closing
the plant and arranged for the sale of the tools to the China
National Aero-Technology Import and Export Corporation (CATIC) for
use at the CATIC Machining Center, a Chinese government-owned
facility.  The machine tools were to be used to produce parts for
commercial aircraft that would be built in China under a contract
with McDonnell Douglas.  However, some of the more sophisticated
machine tools were shipped to the Nanchang Aircraft Company, a
facility that produces fighter aircraft and cruise missiles for the
People's Liberation Army as well as civilian products. 

Concerned with whether the risk of a diversion was recognized and
appropriately dealt with during the export licensing process, you
asked that we review the circumstances surrounding the export of
these items.  Specifically, we addressed the following issues: 

  -- What are the military and civil applications of the equipment
     and are these military applications important to China's
     military modernization plans? 

  -- What was the process for approving the licenses and how did the
     process address the risks associated with this export? 

  -- Were export control license conditions violated and, if so, what
     was the U.S.  government's response? 


   BACKGROUND
------------------------------------------------------------ Letter :1

Commerce is responsible for licensing exports of U.S.  dual-use
items--items with both military and commercial applications--and
helps enforce controls over them.  Depending on the item involved and
the country of destination, an exporter may be required to submit a
license application to Commerce to obtain government approval for the
export.  The U.S.  government controls the export of sophisticated
machine tools for national security and nuclear nonproliferation
reasons.  Commerce, in consultation with other agencies such as the
Department of Defense (DOD),\1 reviews license applications and makes
licensing decisions.  Complex or sensitive export cases can be
escalated to interagency export licensing review committees for
discussion and resolution.  Commerce's Office of Export Enforcement,
along with the U.S.  Customs Service, is responsible for ensuring
adherence to license provisions by investigating suspected export
control violations and pursuing criminal and administrative
sanctions. 

McDonnell Douglas and CATIC entered into an agreement in 1992 to
co-produce 40 MD-80 and MD-90 aircraft in China for the country's
domestic "trunk" routes.  A contract revision signed in November 1994
reduced the number of aircraft to be built in China to 20 and called
for the direct purchase of 20 U.S.-built aircraft.  The four Chinese
factories involved in the Trunkliner program include the Shanghai
Aviation Industrial Corporation, Xian Aircraft Company, Chengdu
Aircraft Company, and Shenyang Aircraft Company.  The Shanghai
facility is responsible for final assembly of the aircraft.  All of
these factories are under the direction of Aviation Industries
Corporation of China (AVIC) and CATIC.  CATIC is the principal
purchasing arm of China's military as well as many commercial
aviation entities. 

In May 1994, McDonnell Douglas submitted license applications for
exporting machine tools to China.  The machine tools were to be
wholly dedicated to the production of 40 Trunkliner aircraft and
related work.  Under the Trunkliner program, the Chinese factories
were responsible for fabricating and assembling about 75 percent of
the airframe structure and the tools were required to produce parts
to support the planned 10 aircraft per year production rate. 

The machine tools were to be exported to the CATIC Machining Center. 
At the time the license applications were being considered, the
Machining Center did not yet exist.  McDonnell Douglas informed the
U.S.  government that the Machining Center would be located in
Beijing and construction would begin in October 1994.  Aircraft parts
production would start
14 months later.  McDonnell Douglas requested Commerce to approve
these applications quickly so that it could export the machine tools
to China, where they could be stored at CATIC's expense until the new
facility in Beijing was ready.  Appendix I contains a chronology of
key events associated with the machine tools McDonnell Douglas
exported to China. 


--------------------
\1 The Defense Technology Security Administration, in consultation
with the military services, is responsible for developing DOD's
position on license applications. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

The machine tools exported by McDonnell Douglas to China have
military and commercial applications.  These machine tools had been
used in the United States to produce parts for military systems but
were exported to manufacture parts for commercial passenger aircraft. 
China needs machine tools to upgrade both its military and commercial
aircraft production capabilities. 

After a lengthy interagency review, the Department of Commerce
approved the license applications with numerous conditions designed
to mitigate the risk of diversion.  During the review period,
concerns were raised about the need for the equipment to support
Chinese aircraft production, the reliability of the end user, and the
capabilities of the equipment being exported.  Senior officials at
Commerce, State, Energy, DOD, and the Arms Control and Disarmament
Agency agreed on the final decision to approve these applications. 

Some of these U.S.  exported machine tools were subsequently diverted
to a Chinese facility engaged in military production.  This diversion
was contrary to key conditions in the licenses that required
equipment to be used for the Trunkliner program and be stored in one
location until the CATIC Machining Center was built.  Six weeks after
the reported diversion, Commerce suspended licenses for four machine
tools not yet shipped to China.  Commerce subsequently denied
McDonnell Douglas's request to allow the diverted machine tools to
remain in the unauthorized location for use in civilian production. 
Commerce approved the transfer of the machine tools to the Shanghai
aviation facility, which is responsible for final assembly of
Trunkliner aircraft.  The diverted equipment was relocated to
Shanghai before it could be misused.  Some of the amended license
conditions apply only after the equipment is installed, which has not
yet occurred.  Commerce's enforcement office did not formally
investigate the export control violations until 6 months after they
were first reported.  The U.S.  Customs Service and Commerce's
enforcement office are now conducting a criminal investigation under
the direction of the Department of Justice. 


   MACHINE TOOLS HAVE MILITARY AND
   CIVILIAN APPLICATIONS
------------------------------------------------------------ Letter :3

Advanced machine tools have military and civilian applications and
are sought by China for industrial modernization efforts.  The
McDonnell Douglas export license applications included 10 five-axis
machines and
2 coordinate measuring machines.  (See table 1 for a list of the
equipment licensed for export.) The United States controls all these
machines for national security or nuclear nonproliferation reasons. 
China has limited indigenous capability to produce comparable machine
tools and, therefore, relies primarily on foreign imports. 



                                Table 1
                
                McDonnell Douglas Machine Tools Licensed
                          for Export to China

Equipment                                                     Quantity
------------------------------------------------------  --------------
Five-axis milling machines                                           4
Five-axis gantry profilers\a                                         4
Five-axis numerical control machining center                         2
Four-axis vertical profiler                                          1
Three-axis milling machine                                           5
Three-axis coordinate measuring machine                              2
Hydraulic stretch press                                              1
======================================================================
Total                                                               19
----------------------------------------------------------------------
Note:  McDonnell Douglas submitted license applications to export 32
machine tools, of which 19 were controlled and required individual
licenses.  The remaining machine tools were exported under a general
license. 

\a Commerce suspended the licenses for the gantry profilers after the
reported diversion of some machine tools to the Nanchang Aircraft
Company.  Gantry profilers are large machines that make aircraft
structural pieces such as wing spars. 

The machine tools McDonnell Douglas exported to China had been used
at a U.S.  government-owned plant to produce parts for the B-1
bomber, C-17 military transport aircraft, and the Peacekeeper
missile.  The more advanced machine tools manufactured such items as
military aircraft wing structures, fuselage components, and landing
gear and engine parts.  For example, five-axis machine tools
simultaneously cut and form metal in five different directions
producing parts with minimal weight and maximum strength, which
improves aircraft performance (see fig.1). 

   Figure 1:  Five-Axis Machine
   Tool

   (See figure in printed
   edition.)

McDonnell Douglas sold machine tools to China to manufacture parts
for commercial aircraft.  All of these machine tools can manufacture
components for commercial aircraft and other products.  For example,
a stretch press, which forms sheet metal around a three dimensional
mold, can form relatively large parts for aircraft fuselage sections
and other aircraft structures.  Five-axis machine tools can also be
used to make tools and dies for auto body panels, medical and
industrial equipment, and molds for consumer products. 

According to DOD, the Chinese government wants to buy five-axis
machine tools and related equipment to upgrade its military aerospace
production facilities\2 as well as its commercial aviation industry. 
China's modernization program has emphasized joint military-civilian
production and self-sufficiency through the acquisition of key
Western dual-use technologies. 

China has had difficulty acquiring advanced machine tools because of
multilateral export controls.  Until 1994, the United States and
other member countries of the Coordinating Committee for Multilateral
Export Controls tightly controlled the export of five-axis machine
tools to China and other countries.  Such sales required prior
notification and unanimous consent from the other members.  In March
1994, the Committee disbanded, but former members agreed to continue
controlling the export of five-axis machine tools, but eliminated
prior notification requirements.  Industry officials said that China
has the capability to manufacture less sophisticated machine tools,
but cannot currently mass produce four- and five-axis machine tools
that meet Western standards.\3 However, they noted that Japan,
Germany, and other countries are marketing advanced machine tools in
China. 


--------------------
\2 China's military modernization efforts reportedly include plans to
coproduce Russian SU-27 aircraft--comparable to the U.S.-built
F-15--and indigenously develop an advanced fighter aircraft believed
to be comparable to the U.S.-built F-16. 

\3 According to some industry officials, it will take China 5 to 10
years to mass produce five-axis machine tools up to Western
standards. 


   RISK OF DIVERSION RECOGNIZED
   AND DEBATED DURING LICENSING
   PROCESS
------------------------------------------------------------ Letter :4

Commerce approved the export applications with conditions after about
3 months of interagency discussions and review.  During this review
process, DOD officials raised several questions about the
justification for the export.  Their concerns primarily focused on
(1) whether the stated end-use on the license applications justified
the export; (2) the legitimacy of the CATIC Machining Center, the
stated end user of the equipment; and (3) the quantity and
capabilities of the machine tools.  Prior to approving the licenses,
the reviewing agencies added numerous conditions to mitigate the
risks identified. 


      APPLICATIONS WENT THROUGH
      INTERAGENCY REVIEW PROCESS
---------------------------------------------------------- Letter :4.1

Commerce, State, Energy, DOD, and the Arms Control and Disarmament
Agency officials recognized the risk of diversion, considered it in
their deliberations, and added conditions to the licenses to minimize
this risk.  The export applications were discussed, debated, and
ultimately agreed upon at senior levels at these agencies.  Because
of the significance and complexity of the export, the case was
immediately escalated to the Advisory Committee on Export Policy
(ACEP).  ACEP is chaired by Commerce and is composed of senior
officials from Commerce, State, Energy, DOD, and the Arms Control and
Disarmament Agency.  It provides a forum for senior-level debate on
significant export licensing issues. 

McDonnell Douglas export applications were discussed and debated at
several ACEP meetings in the summer of 1994.  Commerce and DOD were
the primary agencies in the debate about these license
applications.\4 Many of the questions raised at these meetings were
subsequently addressed by staff at Commerce, DOD, State, or Energy,
often after requesting additional information from McDonnell Douglas. 
To assist in the interagency deliberations, the Central Intelligence
Agency and Defense Intelligence Agency were asked to provide
additional information on Chinese acquisition of machine tools and
Chinese aviation facilities.  The economic impact on McDonnell
Douglas of delaying or denying this export was also considered during
deliberations.\5

DOD's Defense Technology Security Administration distributed the
applications for comment to groups within the agency and throughout
DOD.  Initially, the Navy, Air Force, Joint Chiefs of Staff, and
Defense Intelligence Agency raised strong objections or recommended
denial of these export applications.  Senior officials in the
agencies that initially recommended denial eventually agreed to
approve these licenses once conditions were added.  Several DOD
officials noted that approving the licenses with conditions was the
best strategy for DOD since the licenses would likely be approved at
the ACEP.  DOD began to consider what conditions could mitigate the
apparent risks almost immediately after receiving the applications
from Commerce in June 1994. 


--------------------
\4 The Department of Energy also reviewed the export license
applications and determined that two machines were of insufficient
precision to raise nuclear proliferation concerns. 

\5 McDonnell Douglas said the machine tools were worth about $5
million.  However, in 1993, CATIC wrote a letter to McDonnell Douglas
stating that "whether or not this procurement project will be
successful shall have a big influence on the Trunkliner programme and
long term cooperation between AVIC [a Chinese government defense
industrial corporation] and MDC [McDonnell Douglas]." The Trunkliner
program was reportedly valued at about $1 billion. 


      COMMERCE ARGUED THE EXPORT
      HAD A LOW RISK OF DIVERSION
---------------------------------------------------------- Letter :4.2

During the interagency discussions, Commerce officials argued the
export of the machine tools involved a low risk of diversion since
McDonnell Douglas officials were to be located at the CATIC Machining
Center for at least 4 years.  They also believed that the machine
tools were needed to produce parts for Trunkliner aircraft in China. 
They noted that, according to McDonnell Douglas officials, the
machine tools were between 9 and
26 years old, were not state-of-the-art equipment, and similar or
more capable machine tools could be purchased from foreign sources. 

Commerce initially recommended that the applications be approved with
conditions restricting the end use to commercial aircraft production
and that McDonnell Douglas be required to provide a semi-annual
certification that this condition was being met.  Commerce urged the
other reviewing agencies to act quickly on these licenses.  McDonnell
Douglas claimed that the Air Force was requiring it to vacate the
plant in Ohio by July 5, 1994, and it would be forced to pay high
storage fees for the machine tools after that date.\6


--------------------
\6 According to Air Force officials, McDonnell Douglas determined the
date it had to leave the plant and was not charged storage fees until
September 1994.  McDonnell Douglas, in an August 1994 letter to DOD,
stated that "storage is running at $45,000 per month." Beginning in
September, the Air Force charged the company about $7,500 per month
for storage fees. 


      NEED FOR MACHINE TOOLS
      QUESTIONED
---------------------------------------------------------- Letter :4.3

During the interagency review of the export applications, various DOD
officials commented that there was little justification supporting
the need for the export.  Officials noted that the machine tools
would provide substantial excess production capacity to the Chinese
aircraft industry that could be directed toward satisfying military
requirements.  The Defense Intelligence Agency reported that the
machine tools represented production capacity above and beyond the
requirements necessary for exclusive production of 40 Trunkliner
aircraft.  DOD also obtained limited documentation indicating that
CATIC asked other aircraft facilities in China if they needed any of
the machine tools from the Ohio facility. 

DOD concerns were heightened in July 1994 when press reports noted
that the production of Trunkliner aircraft in China was to be reduced
from 40 to 20 aircraft.  During the summer of 1994, in response to
questions from DOD, McDonnell Douglas officials stated that they were
discussing a reduction to the Trunkliner program with CATIC.  In
August, however, McDonnell Douglas assured DOD that it had "a firm
binding contract for the coproduction of 40 aircraft with CATIC that
was agreed to and signed in March 1992."\7 In other correspondence,
McDonnell Douglas noted that in many cases the machines, including
the five-axis machine tools, were necessary to supply specific parts
whether 1 or 100 aircraft were built. 

Subsequent events indicated that not all of the exported equipment
was needed to support Trunkliner aircraft production.  After some of
the machine tools were diverted to a Chinese military facility not
involved in the Trunkliner program, McDonnell Douglas submitted
license applications to Commerce to maintain the equipment at this
facility to manufacture parts for trainer aircraft and motorcycles. 
Although all the equipment was eventually transferred to a facility
involved in the Trunkliner program, Chinese officials acknowledged
they did not need the stretch press. 


--------------------
\7 McDonnell Douglas and CATIC agreed in principle in May 1994 to
amend the Trunkliner agreement.  In August 1994, the Secretary of
Commerce acknowledged this agreement in a letter to a senior Chinese
government official and expressed hope that he could witness the
signing of the amendment during his upcoming visit that month. 


      CONCERNS ABOUT THE END USER
      RAISED
---------------------------------------------------------- Letter :4.4

DOD officials questioned the credibility of the end user of the
machine tools--the CATIC Machining Center.\8 This facility had not
been built at the time the license applications were deliberated.\9
Some officials cautioned that the tools could be used at the CATIC
Machining Center to manufacture sophisticated parts for
military-related systems.  Officials also questioned how these
machine tools would be used after the Trunkliner program ended. 

Commerce officials told us that they had previously approved other
exports of machine tools for installation at factories not yet built. 
Commerce officials said that they had done so because machine tools
are very large and are easier to install in a new building as
construction progresses.  However, they could not readily provide us
any specific examples where this had been done.  Commerce did not
perform a prelicense check\10 on the CATIC Machining Center because
it would not have been useful since the facility had not yet been
built. 


--------------------
\8 According to Shanghai aviation officials, CATIC developed the
concept of the Machining Center about 1993.  Shanghai officials told
CATIC they might not need the tools because a contract impasse with
McDonnell Douglas threatened to end the Trunkliner program. 

\9 A facility eventually was built at the location originally
designated for the CATIC Machining Center. 

\10 A prelicense check helps determine if the overseas purchaser can
be considered a suitable recipient of controlled U.S.-origin goods or
technological data. 


      SIGNIFICANCE OF MACHINE
      TOOLS' CAPABILITIES
      QUESTIONED
---------------------------------------------------------- Letter :4.5

Some DOD officials raised concern that the five-axis machine tools
being exported were highly capable and that the export of 10
five-axis machines was a significant increase in capability over
earlier exports.  They noted that the exported machine tools, though
old, have long useful lives and that an older machine tool may
perform as well as a new one, even though it may lack certain
capabilities found in newer models. 

U.S.  government machine tool experts confirmed that machine tools
have long useful lives and can be easily upgraded with new
electronics and software and that many U.S.  aerospace facilities use
machine tools about the same age as those exported to China. 
Shanghai aviation facility officials said they are considering
refurbishing and upgrading some of the machine tools acquired from
McDonnell Douglas.  U.S.  and foreign companies offer refurbishing
and upgrading services in China. 


      CONDITIONS ADDED TO MITIGATE
      RISKS
---------------------------------------------------------- Letter :4.6

The reviewing agencies added conditions to the licenses to address
national security concerns.  (See app.  II for a detailed list of
these conditions.) These conditions were designed to reduce or
mitigate the risk that the equipment would be diverted to an
unauthorized location or be used to manufacture parts with military
applications.  Specifically, the license conditions

  -- required that the machine tools be stored in one location until
     the CATIC Machining Center was constructed;

  -- restricted the use of the equipment to Trunkliner-related
     production;

  -- required assurances from CATIC that the equipment would be used
     as stated;

  -- required metering devices to record equipment usage and the
     installation of password protection on some equipment; and

  -- included various reporting requirements, such as quarterly
     inspection reports by McDonnell Douglas, that were designed to
     monitor the equipment and detect unauthorized use. 

Commerce, DOD, State, Energy, and the Arms Control and Disarmament
Agency agreed to these conditions, and then Commerce obtained
concurrence from McDonnell Douglas before approving the licenses. 
Many of these conditions were copied from prior export licenses for
similar equipment, while others were added to address concerns
specific to this export. 


      PROBLEMS WITH CATIC
      ASSURANCE
---------------------------------------------------------- Letter :4.7

One of the conditions was that CATIC provide written assurance that
the Machining Center would not use the machine tools for military
applications and would use the equipment for Trunkliner-related
production.  On September 13, 1994, one day before the licenses were
approved, U.S.  Embassy officials sent Commerce and State a cable
reporting that they had met with and obtained the requested written
assurance from a senior CATIC official.  However, the Embassy cable
noted that CATIC had not determined where it would build the
Machining Center.  CATIC indicated that it may locate the Machining
Center near Beijing at a site to be determined or at the Hongxing
aircraft company, which is located in another city.\11

Commerce officials could not provide documentation on how this issue
was addressed but said they discussed it with McDonnell Douglas
before approving the licenses.  McDonnell Douglas stated that it is
aware of no evidence that Commerce officials discussed this issue
with its personnel.  DOD officials stated that they did not receive
this cable. 


--------------------
\11 As noted above, McDonnell Douglas reported in its application
material that the CATIC Machining Center was to be located in Beijing
and construction of the facility would begin in October 1994. 


      U.S.  OFFICIALS GENERALLY
      BELIEVE CONDITIONS WERE
      EFFECTIVE
---------------------------------------------------------- Letter :4.8

U.S.  government officials stated that the conditions placed on the
licenses were effective in preventing the misuse of the machine
tools.  Commerce and DOD officials noted that McDonnell Douglas's
inspection promptly detected the diversion of the equipment.  A
senior Commerce official also noted that the end-use assurances
obtained as part of one condition provided the U.S.  government with
the leverage needed to insist that the diverted equipment be
relocated to an acceptable facility before any misuse of the
equipment could occur. 

During the licensing review process, some officials had questioned
the value of some conditions.  For example, one condition called for
McDonnell Douglas personnel to report on the use of the equipment and
another condition called for metering devices to be installed on the
machine tools.  One official had noted that McDonnell Douglas
personnel would only be able to determine that non-Trunkliner parts
were being produced, not whether these parts were for a military
application or simply another commercial product.  Others had
commented that metering devices measuring usage may provide
information on how long a machine has been running but not what it is
making. 


   MACHINE TOOLS WERE DIVERTED TO
   A CHINESE MILITARY FACILITY
   CONTRARY TO LICENSE CONDITIONS
------------------------------------------------------------ Letter :5

The machine tools were shipped to three locations contrary to the
license conditions and CATIC's assurances regarding end use. 
McDonnell Douglas officials reported the diversion to the U.S. 
government after the company had inventoried the equipment on March
24, 1995, in accordance with license conditions.  Six machine
tools\12 were diverted to the Nanchang Aircraft Company, and the rest
were stored in two locations in the port city of Tianjin,\13 near
Beijing.  (See fig.  2.) McDonnell Douglas officials later visited
Nanchang and reported that the stretch press had been installed in a
new building designed specifically for this machine.\14

The press, however, was not operational.  In a letter to McDonnell
Douglas, Commerce indicated that the movement of the equipment to
Nanchang and partial installation of the stretch press was a "direct
violation of the conditions under which the equipment was originally
authorized for export to China."

   Figure 2:  Locations of
   Exported Machine Tools and
   Factories Engaged in Trunkliner
   Production

   (See figure in printed
   edition.)

Under the terms of the export licenses and CATIC's written assurance,
the machine tools were only to be used to manufacture commercial
parts for the Trunkliner and other McDonnell Douglas commercial
aircraft.  However, the Nanchang Aircraft Company,\15 which produces
military and commercial products, was not associated with these
programs.  Six weeks after learning about the diversion, Commerce
notified McDonnell Douglas that the machine tools should be
consolidated in a single storage facility in Tianjin.  Commerce also
suspended four licenses for the equipment that had not yet been
shipped to China.  This equipment included four gantry profilers that
CATIC bought from McDonnell Douglas but temporarily leased to a
supplier in New York. 


--------------------
\12 The six machine tools included one hydraulic stretch press, one
five-axis machine tool, three three-axis machine tools, and one
coordinate measuring machine. 

\13 CATIC officials informed McDonnell Douglas that they did not have
enough room to store all the machine tools at one location. 

\14 U.S.  Embassy officials did not visit the Nanchang Aircraft
Company to verify the status of the equipment because of Chinese
government objections to U.S.  post-shipment verification checks. 
For additional information on Commerce's prelicense/post-shipment
verification program in China for dual-use items, see Export
Controls:  Some Controls Over Missile-Related Technology Exports to
China are Weak (GAO/NSIAD-95-82, Apr.  17, 1995). 

\15 The Nanchang Aircraft Company produces military and civilian
aircraft, cruise missiles, and commercial products such as
motorcycles. 


      COMMERCE DENIED REQUEST TO
      KEEP MACHINE TOOLS IN
      NANCHANG
---------------------------------------------------------- Letter :5.1

On August 1, 1995, McDonnell Douglas submitted four license
applications requesting that the six machine tools at the Nanchang
Aircraft Company be authorized for use at that facility.  Commerce
subsequently denied three of these license applications covering the
five-axis and three-axis machine tools and coordinate measuring
machine.  They were denied because (1) the transfer of equipment to
Nanchang and installation of one item violated conditions placed on
the original export license applications and (2) U.S.  officials were
concerned that the equipment installed at the Nanchang facility could
be diverted to military programs. 

Commerce returned the fourth Nanchang license application for the
stretch press to the company without action.  Commerce officials said
that they should have denied this license application along with the
other three.  Officials explained that the license application for
the stretch press was processed separately because the stretch press
was controlled for different reasons.  As a result, different
technical staff reviewed these applications. 


      COMMERCE APPROVED AMENDED
      LICENSES TRANSFERRING
      EQUIPMENT TO SHANGHAI
---------------------------------------------------------- Letter :5.2

In October 1995, McDonnell Douglas submitted 12 export license
amendments requesting that all the exported equipment, now located in
Tianjin and Nanchang, be transferred to the Shanghai aviation
facility.  Commerce officials urged quick approval of the amendments
so that the equipment could be moved to a single location to
manufacture parts for the Trunkliner program. 

The amended license applications were discussed over several months
at interagency government meetings.  According to senior Commerce
officials, it took time to process the amended licenses partly
because they wanted to ensure that the Shanghai facility was an
acceptable location to transfer the equipment.\16 In response to
officials' questions, McDonnell Douglas indicated the facility had a
very small inventory of advanced machine tools and needed the
exported equipment to complete its requirements for the Trunkliner
program.  McDonnell Douglas officials also assured government
officials that they had 14 U.S.  personnel on site at the Shanghai
facility and could monitor the equipment. 

The reviewing agencies agreed in February 1996 that the 12 export
license amendments, permitting transfer of all the exported equipment
to the Shanghai facility, should be approved with certain conditions. 
The conditions were similar to those incorporated in the original
export licenses.  A new condition was added specifying that all
equipment must be placed or stored at the Shanghai facility within
120 days after license approval\17 and that McDonnell Douglas would
report on the location of the machine tools until they were made
operational. 


--------------------
\16 Discussion of the amendments also occurred over a 3-week
government furlough, which interrupted the processing of the amended
licenses. 

\17 In June 1996, McDonnell Douglas requested, and Commerce
authorized, an additional 60 days to move the stretch press from the
Nanchang Aircraft Company to the Shanghai facility.  Commerce granted
this extension subject to McDonnell Douglas providing biweekly status
reports on the movement of the stretch press. 


      EQUIPMENT NOW REPORTED IN
      SHANGHAI
---------------------------------------------------------- Letter :5.3

McDonnell Douglas and U.S.  Embassy officials reported that the
diverted machine tools were now at the Shanghai aviation facility. 
On January 31, 1996, McDonnell Douglas advised Commerce that all of
the equipment except the stretch press had been moved from Nanchang
to Shanghai.\18 In April 1996, about 1 year after the diversion was
first reported, a U.S.  Embassy official confirmed that all the
machine tools except the stretch press were in Shanghai.\19

On August 9, 1996, we toured the Shanghai aviation facility and saw
the stretch press, which plant officials said had arrived from
Nanchang several days earlier.  Shanghai officials informed us that
they already had two presses and had no plans to use this newly
acquired stretch press.  Commerce and McDonnell Douglas discussed the
possibility of finding an alternate end user for the stretch press
when the press was located in Nanchang,\20 but DOD objected,
insisting that the press be moved to Shanghai before considering
another end user. 


--------------------
\18 The equipment was moved about 1 week before the U.S.  government
approved the amended licenses authorizing the transfer to Shanghai. 

\19 The machine tools were stored in over 100 crates.  The Embassy
official was unable to inspect every crate but did confirm that the
crates contained small and large parts of all the exported machine
tools except the stretch press. 

\20 In March 1996, a Commerce official contacted a U.S.  aircraft
company about the possible use of the stretch press for commercial
helicopter component manufacturing in China. 


      SOME LICENSE CONDITIONS WILL
      NOT APPLY UNTIL EQUIPMENT IS
      INSTALLED
---------------------------------------------------------- Letter :5.4

A number of the amended license conditions will only apply after the
equipment is installed at the facility.  For example, metering
devices, which measure operating time, must be read and logged daily
once the equipment is installed.  Shanghai aviation officials said
that most of the tools will remain crated until a new machining
center is completed at the Shanghai facility.  During our visit,
Shanghai officials showed us a new building they were constructing
specifically to house the exported machine tools.  (See fig.  3.) The
building was planned for completion in September 1996.  Shanghai
officials said that the first MD-90 aircraft for the Trunkliner
program is scheduled for delivery in April 1998. 

   Figure 3:  Machining Center
   Under Construction at the
   Shanghai Aviation Industrial
   Corporation

   (See figure in printed
   edition.)


      COMMERCE BEGAN INVESTIGATION
      6 MONTHS AFTER THE REPORTED
      DIVERSION
---------------------------------------------------------- Letter :5.5

Commerce's Office of Export Enforcement, which is responsible for
investigating export control violations, did not formally investigate
the machine tool diversion until 6 months after McDonnell Douglas
reported the incident.  McDonnell Douglas first briefed Commerce and
other government officials on the status of the equipment in the
spring and then again in the fall of 1995.  In response to questions
raised in a September 1995 interagency discussion about the
diversion, a Commerce official indicated that the enforcement office
was investigating the matter.  However, the enforcement office
initiated its investigation only after DOD formally requested such
action in October 1995.  The enforcement office referred the
investigation to its Los Angeles Field Office in November 1995.  A
senior official said that they did not investigate sooner primarily
because corrective action could be taken through the licensing
approval process by suspending the licenses or modifying them to
request assurances or movement of the equipment. 

Based on its preliminary investigation, the Los Angeles Field Office
wrote a report recommending that Commerce issue a temporary denial
order against CATIC and its subsidiaries.  A temporary denial order
would have denied CATIC all U.S.  export privileges.  The Office of
Export Enforcement headquarters rejected this recommendation because
it concluded that the evidence in the report did not meet standards
necessary to issue such an order as set forth in the Export
Administration Act.  Officials explained that a temporary denial
order is used to prevent an imminent violation of export control law
rather than punish a past violation.  The Los Angeles Field Office
subsequently referred the case to the Department of Justice for
consideration.  The U.S.  Customs Service and the Office of Export
Enforcement are now conducting an investigation under the direction
of the Department of Justice. 


   AGENCY AND COMPANY COMMENTS
------------------------------------------------------------ Letter :6

In commenting on the draft of this report, DOD and the Departments of
Commerce and State generally agreed with our findings.  (See apps. 
III, IV, and V, respectively.) Each of these agencies also provided
technical comments, which we have incorporated in the text where
appropriate. 

McDonnell Douglas also provided comments on the report.  McDonnell
Douglas stated that it would consent to public release of information
on export licenses protected by section 12(c) of the Export
Administration Act if their comments were printed in the report. 
McDonnell Douglas commented that (1) the U.S.  government knew that
the Trunkliner program might be reduced, (2) all of the machine tools
were needed for the Trunkliner program, and (3) McDonnell Douglas was
under pressure to vacate the Columbus, Ohio, plant in the summer of
1994.  After carefully reviewing their comments, as well as evidence
we obtained from other sources, we have determined that no change was
needed in our report.  McDonnell Douglas's comments are reprinted in
their entirety in appendix VI, along with our evaluation of them. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :7

To assess the civil and military capabilities of the machine tools,
we met with and reviewed analyses performed by officials at the
Defense Intelligence Agency, Central Intelligence Agency, Defense
Technology Security Administration, the Air Force's National Air
Intelligence Center, and the Department of Commerce.  We also visited
the Defense Logistics Agency's refurbishing center for machine tools
in Pennsylvania and McDonnell Douglas's Long Beach, California,
facility.  Our report only contains limited information on the
military significance of this equipment because much of the
information is classified. 

To assess the export licensing process and compliance with license
conditions, we developed a detailed case history covering what
information was available to decisionmakers, the accuracy of this
information, the reasoning behind the decisions that were made, and
the actions taken by parties involved in this export.  We interviewed
officials at all levels at DOD, the Departments of Commerce and
State, and the Central Intelligence Agency who had provided
information and analyses or participated in the decision-making
process of the original and amended licenses.  These included
officials at Commerce's Bureau of Export Administration, the Defense
Technology Security Administration, the Air Force, the Navy, the
Office of the Joint Chief of Staff, the Defense Intelligence Agency,
and the National Photographic Interpretation Center.  We reviewed
memorandums, correspondence, e-mail communication, and studies that
pertained to these licenses as well as the case files themselves.  We
also met with State Department, Foreign Commercial Service, and
Defense Attache officials at the U.S.  Embassy, Beijing and visited
the Shanghai Aviation Industrial Corporation in Shanghai.  We
attempted to ensure the accuracy of information by corroborating it
with multiple sources. 

Because of the ongoing Department of Justice investigation, we did
not interview McDonnell Douglas officials who were directly involved
in the sale of the equipment, the licensing process, or the
performance of inspections in China.  Moreover, our request to meet
with the Office of Export Enforcement investigator on this case was
not approved.  Our contact with McDonnell Douglas was limited to
meetings with legal and technical staff in Long Beach on the
capabilities of the machine tools.  A McDonnell Douglas official was
also present during our discussion with Shanghai Aviation officials. 
McDonnell Douglas did provide us with a written chronology covering
its contacts with the U.S.  government.  This information was
supplemented with information on the Trunkliner program and other
related subjects.  We did not attempt to meet with CATIC officials. 

We performed our review from March to October 1996 in accordance with
generally accepted government auditing standards. 


---------------------------------------------------------- Letter :7.1

As agreed with your offices, unless you publicly announce the
contents of this report earlier, we plan no further distribution of
this report until
10 days after its issue date.  At that time, we will send copies of
this report to other interested congressional committees; the
Secretaries of Commerce, Defense, and State; and the Director, Office
of Management and Budget.  We will also make copies available to
others upon request. 

Please contact me at (202) 512-4383 if you have any questions
concerning this report.  Major contributors to this report are listed
in appendix VII. 

Katherine V.  Schinasi
Associate Director
Defense Acquisitions Issues


CHRONOLOGY CONCERNING LICENSES FOR
MACHINE TOOLS EXPORTED TO CHINA
=========================================================== Appendix I

------------------------  ------------------------------------------------------
6/93                      McDonnell Douglas met with the Department of Commerce
                          to discuss the possible sale and export of surplus
                          equipment and machinery located at the plant in
                          Columbus, Ohio.

9/30/93                   China National Aero-Technology Import and Export
                          Corporation (CATIC) sent a letter to McDonnell Douglas
                          stating that whether the procurement of equipment from
                          Columbus "is successful shall have a big influence on
                          the trunk liner programme and long term cooperation"
                          between the Aviation Industries Corporation of China,
                          a Chinese government defense industrial corporation,
                          and McDonnell Douglas.

12/23/93                  CATIC agreed to purchase some of the surplus equipment
                          from the Columbus, Ohio, facility.

2/18/94                   Agreement for sale of equipment in the Columbus
                          facility to CATIC was executed.

5/94                      McDonnell Douglas and CATIC agreed in principle to
                          amend the Trunkliner agreement.

5/26/94                   McDonnell Douglas submitted 24 export license
                          applications for export to China of the equipment
                          purchased from the Columbus, Ohio, facility.

7/20/94                   News article reported the shifting of the production
                          of 20 Trunkliner aircraft from China to the United
                          States.

8/12/94                   The Secretary of Commerce sent a letter to the Chinese
                          Vice Premier of the State Council regarding the
                          amendment to the Trunkliner program.

9/1/94                    Commerce issued formal notices that eight of McDonnell
                          Douglas's applications were being returned without
                          action because the equipment did not require an
                          individual validated license for export to China.

9/13/94                   Embassy officials in China sent a cable indicating
                          receipt of written assurance from CATIC and noted that
                          CATIC had not yet decided whether to locate the
                          Machining Center near Beijing at a site to be
                          determined or at the Hongxing Aircraft Company.

9/14/94                   Commerce issued 16 export licenses for export of the
                          Columbus, Ohio, equipment to China. One license
                          condition required the equipment be stored in one
                          location until it was installed at the CATIC Machining
                          Center.

9/29/94                   McDonnell Douglas and CATIC reached initial agreement
                          to amend the contract to produce 20 aircraft in Long
                          Beach, California, and 20 aircraft in China.

11/4/94                   McDonnell Douglas and CATIC reached a final agreement
                          to modify the original Trunkliner agreement so that
                          the first 20 aircraft would be produced in Long Beach,
                          California with the remaining 20 aircraft to be
                          produced in China.

11/12/94 -2/18/95         The equipment covered by 12 of the 16 export licenses
                          was shipped to China.

3/24/95                   McDonnell Douglas officials investigated the location
                          of the equipment in China and discovered that six
                          pieces were stored at the Nanchang Aircraft Company
                          and that the remainder was stored in Tianjin, China.

4/4/95                    McDonnell Douglas submitted a written report to
                          Commerce and the Department of Defense (DOD) informing
                          them of the results of its March 24, 1995,
                          investigation.

4/20/95                   McDonnell Douglas briefed a U.S. government
                          interagency group on the location of the equipment in
                          China, advising Commerce that CATIC's plans to build a
                          new factory in Beijing had not materialized.

8/1/95                    McDonnell Douglas submitted export license
                          applications requesting permission to allow the
                          equipment diverted to Nanchang to remain at the
                          Nanchang Aircraft Company.

8/23/95                   McDonnell Douglas reported to Commerce by telephone
                          that it had discovered after visiting the Nanchang
                          facility that the stretch press at Nanchang had been
                          uncrated and placed inside a building, but the press
                          was not operational and the building had no
                          electricity.

9/28/95                   McDonnell Douglas was told that Commerce would not
                          permit transfer of the equipment at Nanchang to the
                          Nanchang Aircraft Company.

10/95                     McDonnell Douglas submitted 12 export license
                          amendment requests to permit all the equipment in
                          Tianjin and Nanchang to be transferred to the Shanghai
                          Aviation Industrial Corporation in Shanghai.

10/4/95                   DOD sent a memorandum to Commerce asking for the
                          diversion to be investigated.

11/7/95                   Commerce's Office of Export Enforcement initiated
                          official investigation.

11/28/95                  Commerce's Los Angeles Field Office sent its
                          investigative report to Commerce and recommended a
                          temporary denial order against CATIC, suspending its
                          export privileges. Commerce's Office of Export
                          Enforcement returned the recommendation, citing
                          insufficient evidence.

1/31/96                   McDonnell Douglas advised the Department of Commerce
                          that five of the six machines at Nanchang Aircraft
                          Company had been moved from Nanchang to the facility
                          in Shanghai.

2/3/96                    Commerce denied three of the four export license
                          applications filed by McDonnell Douglas on August 1,
                          1995, requesting approval to transfer the equipment in
                          Nanchang to Nanchang Aircraft Company; the fourth,
                          pertaining to the stretch press, was returned to the
                          applicant without action.

2/6/96                    Commerce approved with conditions the 12 export
                          license amendment requests filed by McDonnell Douglas
                          in October 1995, permitting transfer of all the
                          equipment to the Shanghai Aviation Industrial
                          Corporation in Shanghai.

2/10/96                   McDonnell Douglas inspected the one piece of
                          equipment, the stretch press, remaining in Nanchang
                          and observed that, although it was partially
                          assembled, it was not connected to either electrical
                          or hydraulic power sources and was not operational.

3/96                      Commerce contacted a U.S. aircraft company about the
                          use of the stretch press for commercial helicopter
                          component manufacturing in China.

4/23/96                   A U.S. Embassy official visited the Shanghai aviation
                          facility and inspected the crated machine tools.

4/29/96                   A McDonnell Douglas letter sent to Commerce reported
                          that the machines at the Shanghai aviation facility
                          were in their original crates or were being removed
                          and installed.

6/7/96                    Commerce granted McDonnell Douglas's request to extend
                          the time authorized to move the stretch press from 120
                          to 180 days.

6/21/96                   A McDonnell Douglas letter confirmed that two pieces
                          of the stretch press had arrived in Shanghai.

8/5/96                    The remaining pieces of the stretch press arrived at
                          the Shanghai aviation facility.

8/9/96                    GAO toured the Shanghai aviation facility and observed
                          the stretch press and a new building being constructed
                          reportedly to house the machine tools.
--------------------------------------------------------------------------------

CONDITIONS FOR EXPORTING MACHINE
TOOLS TO THE CATIC MACHINING
CENTER
========================================================== Appendix II

Commerce placed 14 conditions on the export of McDonnell Douglas
machine tools to CATIC.  Later, it subsequently approved relocating
the equipment to the Shanghai aviation facility with similar
conditions. 

1.  The only parts programs authorized to be loaded and run in the
numerical control device are those authorized for "Trunkline"
aircraft and "offset" from McDonnell Douglas project as negotiated
with McDonnell Douglas Corporation. 

2.  Where applicable, the numerical control device (machine control
unit) must be modified to provide password protection.  Password
access is granted to authorized personnel only for authorized parts. 

3.  The machine tools approved for export must be installed at the
CATIC Machining Center.  McDonnell Douglas must provide written
certification of delivery and installation to Commerce.  Should the
CATIC facility not be ready when the equipment arrives, the equipment
will be stored in one facility.  That facility will be subject to the
inspection requirements stated in condition no.  5.  McDonnell
Douglas will notify the U.S.  government of the location of the
machine tools and notify it if the equipment is moved before the
plant is completed. 

4.  The machines must have a metering device that measures operating
time (e.g., a Hobbs Meter).  The elapsed operating time will be read
and logged into a production logbook on a daily basis.  The logbook
will be furnished to DOD and the Office of Export Enforcement on a
quarterly basis. 

5.  After installation of the machines, McDonnell Douglas must submit
quarterly reports for the next 2 years to the Office of Export
Enforcement and DOD.  The reports must include information as to
whether the equipment is still being used for the purposes approved
under the conditions of the licenses, and any discrepancies must be
noted in the use of the timing device, password, or other security
requirements.  A McDonnell Douglas representative will have the right
of access to inspect the equipment at any time, wherever located,
during normal working hours and whenever the equipment is in
operation.  Should McDonnell Douglas wish to withdraw its personnel,
it must notify the U.S.  government well in advance.  As agreed with
arrangements with the Chinese government, a U.S.  government
representative will conduct a post-shipment verification visit to the
facility after the equipment is installed. 

6.  None of the equipment may be resold, transferred, or reexported
without prior written approval from the U.S.  government. 

7.  This equipment is licensed exclusively for the civilian use of
implementing the MD80/90 series McDonnell Douglas design for the
development of the Chinese Trunkline and offset from McDonnell
Douglas. 

8.  The equipment will not be used by or for military or nuclear end
users or uses. 

9.  These licenses do not authorize transfer of technical data other
than that required for normal maintenance, repair, and operation of
the equipment.  Note:  The export of McDonnell Douglas proprietary
data concerning plant layout for the manufacture of MD80/90 airframe
parts may require an individual validated license under the
provisions of the export administration regulations. 

10.  McDonnell Douglas must inform the end user of all conditions. 

11.  The licenses will be approved only after senior CATIC officials
provide assurance that these machines will be used only by the end
user for the end uses specified in these licenses. 

12.  Employees of or contractors to McDonnell Douglas who visit the
CATIC facility will report on the use of the equipment as observed
during their visits.  Such reports will be available to Commerce. 
Those who observe unauthorized use of the equipment must report these
discrepancies immediately to Commerce. 

13.  No parts produced by this equipment that are on the U.S. 
commodity control list for national security or nuclear
nonproliferation reasons can be exported by CATIC to Libya, Cuba, or
North Korea (country groups S or Z). 

14.  McDonnell Douglas must advise the U.S.  government of any
changes in the negotiated contract for 40 Trunkline aircraft. 
Notification must include any increase or reduction in aircraft or
offset production requirements.  If the McDonnell Douglas Trunkline
contract is renegotiated below 40 aircraft, these machine tools could
still only be used to produce parts for the Trunkline aircraft and
McDonnell Douglas offsets.  Any machining capacity freed up by a
reduction in the production requirements will be viewed as excess
capacity by the U.S.  government and considered in any future Chinese
machine tool licensing actions. 




(See figure in printed edition.)Appendix III
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
========================================================== Appendix II




(See figure in printed edition.)Appendix IV
COMMENTS FROM THE DEPARTMENT OF
COMMERCE
========================================================== Appendix II



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on the Department of Commerce's
letter dated October 11, 1996. 

GAO COMMENTS

1.  The report accurately notes that the equipment was relocated
before it was misused.  The diversion of the machine tools to
Nanchang, a facility engaged in military production, does not support
Commerce's statement that concerns over the military utility of this
equipment was overstated.  The Chinese were only able to partially
install the stretch press and did not uncrate the other equipment
because the diversion was discovered. 

2.  We have modified the text of the report to address this comment. 

3.  We agree that a court of law may ultimately examine whether a
legal violation occurred and who was responsible and have modified
the report accordingly.  However, Commerce, in a letter to McDonnell
Douglas, indicated that the movement of the equipment to Nanchang and
the partial installation of the stretch press was a "direct violation
of the conditions under which the equipment was originally authorized
for export to China."

4.  Commerce stated that its top priority was to quickly relocate the
equipment to an acceptable facility.  As discussed in our report, all
the equipment was relocated to an approved facility about 17 months
after the diversion was first reported.  Commerce also noted in its
comments that it needed to continue the investigation in a way that
did not adversely affect cooperation from McDonnell Douglas.  As
discussed in our report, Commerce's enforcement office did not begin
an official investigation until 6 months after the reported diversion
and only after requested by DOD.  During this time, Commerce's
licensing group worked with McDonnell Douglas on export license
amendments to transfer the equipment to an acceptable facility. 

5.  This report is not restricted by section 12(c) of the Export
Administration Act.  McDonnell Douglas consented to waive its
confidentiality rights under section 12(c) with respect to the
information contained in this report. 




(See figure in printed edition.)Appendix V
COMMENTS FROM THE DEPARTMENT OF
STATE
========================================================== Appendix II


The following are GAO's comments on the Department of State's letter
dated October 21, 1996. 

GAO COMMENTS

1.  We made changes to the report to clarify that five-axis machine
tools were controlled by the Coordinating Committee for Multilateral
Export Controls to other countries in addition to China. 

2.  We made changes to the report to reflect State's comments. 




(See figure in printed edition.)Appendix VI
COMMENTS FROM MCDONNELL DOUGLAS
========================================================== Appendix II



(See figure in printed edition.)



(See figure in printed edition.)


The following are GAO's comments on McDonnell Douglas's letter dated
November 12, 1996. 

GAO COMMENTS

1.  McDonnell Douglas makes this generalized statement several times
in its letter.  However, we have carefully reviewed its specific
comments as well as the evidence we obtained from multiple sources
and continue to believe that the presentation in the report is
accurate. 

2.  Although the amendment to the Trunkliner agreement was signed in
November 1994, Commerce documents clearly indicate that an agreement
in principle to amend the contract had been reached as early as May
1994.  DOD licensing officials first learned of the possible
reduction in the Trunkliner program in July 1994 from press reports,
not McDonnell Douglas.  However, McDonnell Douglas in an August
letter to DOD, assured DOD that it had a firm binding contract for
the coproduction of 40 aircraft. 

3.  The reduction in the number of aircraft to be built in China is
relevant to CATIC's need for the machine tools.  The amendment to the
Trunkliner agreement calling for the direct purchase of 20 U.S.-built
aircraft meant that most of the parts for these aircraft would come
from existing McDonnell Douglas suppliers, not from new production
facilities to be built in China.  According to a government official,
one of the reasons for the contract amendment was to speed up
deliveries of aircraft to Chinese airlines rather than wait until the
Chinese Trunkliner factories were able to produce complete aircraft. 
By August 1996, deliveries of the 20 U.S.-built aircraft had already
begun under this amended contract even though none of the exported
machine tools were yet operational. 

The report acknowledges that McDonnell Douglas noted in its export
applications that the machine tools would also be used by CATIC to
perform related offset work (i.e., production of parts for U.S.-built
McDonnell Douglas aircraft).  However, during the licensing review
process, neither McDonnell Douglas nor the reviewing agencies took
the position that offset work was the major justification for
approval of these export license applications. 

4.  The observation that not all of the equipment was needed to
support Trunkliner aircraft production is supported by more than just
the observation that existing Trunkliner factories had stretch
presses with sufficient capacity to perform Trunkliner work.  As
noted in the report, CATIC, McDonnell Douglas' partner in producing
Trunkliner aircraft in China, diverted not only the stretch press but
also one five-axis machine tool, three three-axis machine tools, and
one coordinate measuring machine to the Nanchang Aircraft Company--a
factory not involved in Trunkliner production.  McDonnell Douglas
then asked the Commerce Department to allow these machine tools to
remain at Nanchang for production unrelated to the Trunkliner
program.  The diversion of the tools to Nanchang and the submission
of license amendments to permit the tools to remain in a
non-Trunkliner factory do not support the statement that all of these
tools were required for Trunkliner production as McDonnell Douglas
indicated during the export application process. 

5.  We agree that McDonnell Douglas was to vacate the Ohio plant in
the summer of 1994.  However, as noted in the report, McDonnell
Douglas told the reviewing agencies that the Air Force, not McDonnell
Douglas, was requiring it to leave the plant in Ohio by July 5, 1994,
and it would be forced to pay high storage fees for the machine tools
after that date.  Further, in August 1994, McDonnell Douglas told DOD
that "storage is running at $45,000 per month" and urged action on
the licenses so that "mounting storage costs can be curtailed." As
noted in the report and acknowledged by McDonnell Douglas in its
comments, McDonnell Douglas, not the Air Force, set the dates it had
to leave the plant in Ohio.  Further, as noted in our report,
beginning in September 1994, the Air Force actually charged the
company about $7,500 per month for storage fees. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix VII

NATIONAL SECURITY AND
INTERNATIONAL AFFAIRS DIVISION,
WASHINGTON, D.C. 

Karen S.  Zuckerstein
David C.  Trimble
Anne-Marie Lasowski
John Neumann


*** End of document. ***