Export Controls: Sale of Telecommunications Equipment to China (Letter
Report, 11/13/96, GAO/NSIAD-97-5).

Pursuant to a congressional request, GAO reviewed the sale of advanced
telecommunications equipment to China, focusing on the: (1) civil and
military applications of the exported telecommunications equipment, its
availability, and the importance of these applications to China's
military; and (2) process and rationale for liberalizing the export of
telecommunications equipment shipped to China.

GAO found that: (1) there are numerous civil and military applications
for broadband telecommunications equipment, including
video-conferencing, remote command and control, and telemedicine; (2)
since the liberalization of exports of advanced telecommunications
equipment, such equipment is now readily available in China; (3)
synchronous digital hierarchy (SDH) equipment is being manufactured and
used to upgrade China's telecommunications networks to international
standards; (4) the Chinese military is seeking to acquire asynchronous
transfer mode (ATM) and SDH equipment, which may benefit its command and
control networks by the end of the next decade; (5) the creation of the
new general license category, GLX, by the Commerce Department in April
1994, allowed the export of ATM and SDH equipment to civil end users
without a validated license having to be issued by Commerce; (6)
determining who is a civil end user under GLX is the responsibility of
the exporting companies; and (7) as Commerce gains experience under GLX,
it may want to assess the need to provide additional information or
guidance to exporters to help them determine when they should request a
government review of an end user.

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

 REPORTNUM:  NSIAD-97-5
     TITLE:  Export Controls: Sale of Telecommunications Equipment to 
             China
      DATE:  11/13/96
   SUBJECT:  Telecommunications equipment
             Dual-use technologies
             Foreign governments
             Export regulation
             International trade restriction
             Foreign military sales policies
             Licenses
             Technology transfer
IDENTIFIER:  China
             Dept. of Commerce Control List
             
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Cover
================================================================ COVER


Report to the Chairman, Committee on National Security, House of
Representatives

November 1996

EXPORT CONTROLS - SALE OF
TELECOMMUNICATIONS EQUIPMENT TO
CHINA

GAO/NSIAD-97-5

Export Control

(707178)


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

  ATM - Asynchronous Transfer Mode
  COCOM - Coordinating Committee for Multilateral Export Controls
  COSTIND - Commission of Science, Technology, and Industry for
     National Defense
  SDH - Synchronous Digital Hierarchy

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


B-274526

November 13, 1996

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

As you requested, we reviewed the sale of advanced telecommunications
equipment to the People's Republic of China.  Specifically, you asked
about the transfer of broadband telecommunications equipment to
HuaMei, a joint venture between SCM Brooks Telecommunications, a U.S. 
limited partnership, and Galaxy New Technology, a Chinese company
primarily owned by an agency of the Chinese military.  The equipment
included Asynchronous Transfer Mode (ATM) and Synchronous Digital
Hierarchy (SDH) equipment, which were used to demonstrate the
commercial capabilities of a broadband telecommunications network
among several hotels in Guangzhou, China.  ATM and SDH operate on a
broadband network to transmit voice, data, images, and video
communications at high rates of speed. 

Our objectives were to determine (1) the civil and military
applications of the exported telecommunications equipment, its
availability, and the importance of these applications to China's
military and (2) the process and rationale for liberalizing the
export of telecommunications equipment, such as the ATM and SDH
equipment shipped to HuaMei. 


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

The U.S.  Department of Commerce controls the export of U.S. 
dual-use commodities, software, and technology by requiring validated
licenses prior to shipment unless a license exception applies.\1 A
license exception, formerly known as a general license, is a broad
grant of authority to export certain goods and technology without
prior government review.  Dual-use telecommunications items are
controlled under the Commerce Control List, which specifies the items
that require validated licenses, generally for reasons of national
security. 

During the Cold War, the United States sought international
coordination of export controls through the Coordinating Committee
for Multilateral Export Controls (COCOM), which was made up primarily
of North Atlantic Treaty Organization member countries.\2

With the end of the Cold War, COCOM members pushed for liberalization
of many dual-use items, including telecommunications equipment,
computers, and machine tools.  However, before COCOM ended on March
31, 1994, participant countries agreed to continue controlling
dual-use items, at each country's discretion, after COCOM's
expiration.  The new U.S.  export control arrangement, established in
1996, focuses export controls on several potential aggressor
countries, such as Iraq, Libya, and North Korea, and away from former
communist countries. 


--------------------
\1 "Dual use" refers to items that may be used for civil or military
purposes. 

\2 COCOM members included all of the North Atlantic Treaty
Organization member countries, except for Iceland, plus Australia and
Japan. 


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

There are numerous civil and military applications for broadband
telecommunications equipment, such as ATM and SDH, including
video-conferencing, remote command and control, and telemedicine. 
Since the liberalization of exports of advanced telecommunications
equipment, such equipment is now readily available in China.  SDH
equipment, in particular, is being manufactured and used to upgrade
China's telecommunications networks to international standards. 
According to U.S.  government officials, the Chinese military is
seeking to acquire ATM and SDH equipment, which may benefit their
command and control networks by the end of the next decade. 
Furthermore, these officials stated that as China's
telecommunications infrastructure is modernized, the Chinese military
will also benefit. 

The creation of the new General License category, GLX, by the
Commerce Department in April 1994, allowed the export of ATM and SDH
equipment to HuaMei without a validated license having to be issued
by the Commerce Department.  ATM and SDH equipment were two of a
number of dual-use telecommunications items that were included under
GLX.  GLX includes many items that would have been typically approved
for export to civil end users in the licensing process.  According to
U.S.  government officials, GLX was created in response to the end of
the Cold War and the expiration of COCOM, to ease export restrictions
and reduce administrative burdens on U.S.  exporters. 

Determining who is a civil end user under GLX is the responsibility
of the exporting companies.  However, this is particularly difficult
in China because of the Chinese military's significant involvement in
various commercial ventures.  There is no information readily
available to exporters on how much military involvement in a
commercial entity constitutes a military end user.  Based on this one
case, we are not making any recommendations.  However, as the
Commerce Department gains experience under GLX,\3 it may want to
assess the need to provide additional information or guidance to
exporters to help them determine when they should request a
government review of an end user. 


--------------------
\3 On March 25, 1996, GLX and several other general license
categories were consolidated into the license exception "CIV" for
exports going to civil end users.  CIV does not provide additional
guidance to exporters on how much military involvement is needed
before a commercial entity is considered a military end user.  Even
though the designation "GLX" is no longer in use, we continue to use
it throughout our report since the telecommunications equipment
exported to HuaMei was liberalized as a result of the creation of
that license exception. 


   APPLICATIONS, AVAILABILITY, AND
   IMPORTANCE OF EXPORTED
   TELECOMMUNICATIONS EQUIPMENT
------------------------------------------------------------ Letter :3

Broadband telecommunications equipment, such as ATM and SDH, have
numerous civilian and military applications and are becoming
increasingly available in China as it strives to improve its
telecommunications networks to meet international standards. 
According to U.S.  government officials, overall improvements to
China's telecommunications networks will likely benefit the Chinese
military as well. 


      CIVIL AND MILITARY
      APPLICATIONS OF ATM AND SDH
      EQUIPMENT
---------------------------------------------------------- Letter :3.1

Broadband networks employ ATM and SDH equipment to transfer data,
voice, and video communications simultaneously at high rates of
speed.  ATM is a flexible switching technique used to transfer
information over advanced telecommunications networks.  SDH
technology is used for high speed transmission of data, video, and
voice traffic.  Both ATM and SDH equipment were developed by
commercial industry for civil applications, and they are now
increasingly used worldwide on broadband telecommunications networks. 

Civil applications of ATM and SDH equipment generally allow work
groups to collaborate quickly and efficiently over a computer
network.  These applications include holding a meeting simultaneously
in several locations (video-conferencing), having people in different
locations work simultaneously on the same document (virtual
notebook), and transmitting X-rays and other medical records from one
location to another (telemedicine).  ATM and SDH equipment are
necessary to have the speed of delivery, quick data retrieval, and
clear video images that are needed for these applications to operate. 

Military applications for ATM and SDH equipment are similar to
civilian applications.  These applications include sharing of
intelligence, imagery and video between several locations, command
and control of military operations using video-conferencing, and
medical support and telemedicine between the battlefield and remote
hospitals.  When used in a military application, both types of
equipment requires encryption devices to protect communications from
interception.  The Department of Defense buys such equipment
"off-the-shelf" and is still testing it for potential military uses. 
According to Defense officials, ATM and SDH equipment will be
beneficial to military functions, such as command and control, and
will form the basis for future Defense Department communications
networks. 


      AVAILABILITY OF ATM AND SDH
      EQUIPMENT IN CHINA
---------------------------------------------------------- Letter :3.2

Both ATM and SDH equipment are considered to be advanced technologies
in the telecommunications industry and are now increasingly deployed
worldwide.  While ATM equipment has only recently become readily
available, SDH has been commercially available for at least the last
5 years.  In 1993, a U.S.  company claimed that foreign producers of
SDH equipment were marketing to China and urged the Commerce
Department to reduce its controls on such equipment.  SDH equipment
was found to be foreign available by the Commerce Department in
1994.\4 Former COCOM member countries tightly controlled the export
of such equipment until 1994, when controls on telecommunications
items were relaxed. 

Prior to the liberalization of exports of dual-use telecommunications
equipment in April 1994, the export of ATM and SDH equipment to China
would have required a validated license from the Commerce Department. 
According to company officials, since the removal of most export
restrictions on telecommunications equipment, the market for such
equipment in China has grown quickly and large quantities of SDH
equipment have been sold to China to modernize its commercial
long-distance telecommunications network.  Advanced
telecommunications equipment, particularly SDH, is increasingly used
to be consistent with the emerging international communications
standards, and it should vastly improve China's outdated and
underdeveloped telecommunications systems.  According to industry
officials, U.S.  companies sold tens of millions of dollars worth of
SDH equipment in China in 1994, and several joint ventures are
currently manufacturing SDH equipment in China to build China's
telecommunications network.  In contrast, there is little demand for
ATM equipment in China and there is no in-country production of such
equipment.  Company officials noted the demand for ATM equipment in
the United States is also limited. 


--------------------
\4 Under Export Administration regulations, when an item is found to
be foreign available, it may be removed from the Commerce Control
List and no longer controlled.  A foreign availability finding means
that the good or commodity is available to countries subject to
export controls, in sufficient quantity and comparable quality from
sources outside the United States, making denial of an export license
ineffective in achieving the purpose of the controls. 


      IMPORTANCE OF ATM AND SDH
      EQUIPMENT TO CHINESE
      MILITARY
---------------------------------------------------------- Letter :3.3

Officials at the Defense Department told us that the Chinese military
would like to improve its telecommunications capabilities.  According
to these officials, the Chinese military is seeking to acquire ATM
and SDH equipment, which may increase their operational readiness by
the end of the next decade.  Defense Department officials told us
that broadband telecommunications equipment could be used to improve
the Chinese military's command and control communications networks. 
These officials also observed that the Chinese military will benefit
from the improvements to China's overall public telecommunications
system, since they also make use of that system. 

The Chinese military may also benefit from the use of broadband
equipment in its nonmilitary activities.  For example, Chinese Army
hospitals, which also serve civilians, are interested in acquiring
high-speed telecommunications links using ATM switches to develop
telemedicine capabilities and to extend health care to rural areas. 
The Chinese military operates at least one-third of the hospitals in
China. 


   NEW GENERAL LICENSE CATEGORY
   LIBERALIZES EXPORT OF ATM AND
   SDH EQUIPMENT
------------------------------------------------------------ Letter :4

The Commerce Department created GLX in 1994, allowing nearly all
dual-use telecommunications items to be exported to Chinese civil end
users without validated licenses.  As a result, the ATM and SDH
equipment exported to HuaMei did not require prior government
approval before being shipped. 


      CREATION OF THE GENERAL
      LICENSE GLX
---------------------------------------------------------- Letter :4.1

According to U.S.  government officials, the Commerce Department
created GLX in April 1994 to ease export restrictions and reduce
administrative burdens on U.S.  exporters.  In September 1993, the
Trade Promotion Coordinating Committee, chaired by the Secretary of
Commerce, recommended removing export controls on computers and
telecommunications products to aid key U.S.  industries.  Commerce
officials noted that there was an interagency effort to determine
which items to decontrol before COCOM expired at the end of March
1994. 

The Commerce Department used the advisory notes from the Commerce
Control List as a basis for what items were to be included under GLX. 
Advisory notes are included in the list to advise exporters of the
items likely to be approved for export to certain locations.  The
Commerce Department removed the requirement for a validated license
and prior government review on all items with advisory notes because
it viewed the items as being less sensitive. 

According to a Commerce Department official, the advisory note items
included under GLX did not necessarily include the entire category of
equipment, nor did they apply to China.  For example, one advisory
note stated that licenses would likely be approved for the export of
telecommunications transmission equipment, such as SDH, to China,
provided that such equipment did not exceed certain capabilities. 
Under GLX, all SDH equipment is eligible for export to China,
regardless of capability.  Another advisory note stated that licenses
would likely be approved for the export of all controlled dual-use
telecommunications equipment, including ATM, for civil end use in
Estonia, Latvia, and Lithuania.  According to a Commerce Department
official, since ATM equipment was included in this advisory note, it
became eligible for export under GLX, even though the note did not
apply to China. 

Our analysis of the telecommunications items included under GLX
showed that each item category was covered by some advisory note on
the Commerce Control List.  Because most of the telecommunications
items on the list were covered by advisory notes, they became
eligible for export under GLX.  The only telecommunications items
covered by an advisory note that were not included under GLX were
radio frequency hopping equipment and radio receivers with certain
scanning and frequency switching capabilities.  Items included under
GLX were telecommunications transmission equipment, switching
equipment, optical fiber communication cables, and phased array
antennas.  However, technology for the development and production of
the telecommunications equipment may not be exported under GLX. 

The Commerce Department officially requested comments from other
agencies on GLX on March 17, 1994, and the creation of GLX was
announced in the Federal Register on April 4, 1994.  According to
government officials, the period of time given to other agencies to
comment on the new license category was limited due to the expiration
of COCOM at the end of March 1994.  Senior Commerce and Defense
Department officials stated that while the comment period provided to
the agencies for approving GLX was limited, the items included under
GLX were less sensitive and had been previously considered for
liberalization under earlier COCOM-related negotiations.  The
Departments of Defense, Energy, and State all approved the new
license category. 


      HUAMEI EXPORTS COVERED BY
      GLX
---------------------------------------------------------- Letter :4.2

At the time that AT&T exported U.S.  telecommunications equipment to
HuaMei in 1994, the Commerce Department had already created GLX, so
AT&T did not need to apply for a license to ship ATM and SDH
equipment to China.  In 1993, SCM Brooks Telecommunications entered
into a joint venture with Galaxy New Technology, a Chinese company
controlled by the Commission of Science, Technology, and Industry for
National Defense (COSTIND), an agency of the Chinese military,\5 to
form Guangzhou HuaMei Communications Limited.  The purpose of the
HuaMei project was to demonstrate the commercial capabilities of a
broadband telecommunications network, using several hotels in
Guangzhou.  The demonstration included video-conferencing, virtual
notebook, and teleradiology applications.  HuaMei contracted with
AT&T to provide the equipment necessary for the project.  AT&T
exported three ATM switches from the United States under a general
license and four SDH transmission systems from the Netherlands under
a Dutch validated license to Guangzhou in the fall of 1994. 


--------------------
\5 COSTIND oversees development of China's weapon systems and is
responsible for identifying and acquiring telecommunications
technology applicable for military use. 


      CIVIL END USER NOT DEFINED
      UNDER GLX
---------------------------------------------------------- Letter :4.3

GLX allows the export of ATM and SDH equipment to China without a
validated license, if the exports are going to "civil end-users for
civil end-uses." However, Commerce Department regulations do not
define a "civil end-user" or offer any guidance on how an exporter is
to determine who is a civil end user in China.  U.S.  company and
government officials stated that determining end users in China is
problematic because the Chinese military is often involved in
commercial activities.  The Chinese military invests in and owns
numerous commercial entities in China to obtain profits and to help
fund its military activities.  For example, according to industry
officials, the military has investments in such enterprises as the
Palace Hotel in Beijing, various entertainment projects, and even
restaurants. 

HuaMei, while a commercial enterprise, has as its principal Chinese
partner, a company controlled by the Chinese military.  As shown in
figure 1, SCM Brooks Telecommunications and Galaxy New Technology
each own 50 percent of HuaMei.  However, the Chinese military is the
primary shareholder of Galaxy New Technology, with two other Chinese
government agencies each holding a minority interest in the company. 
Several members of the HuaMei board of directors are military
officers or have direct ties to the Chinese military.  Such a high
degree of involvement in HuaMei could indicate a strong military
interest in this company. 

   Figure 1:  HuaMei Ownership

   (See figure in printed
   edition.)

\a Commission of Science, Technology, and Industry for National
Defense. 

U.S.  company and government officials stated that HuaMei was a civil
end user.  In determining that, company officials considered the end
use of the equipment, the location of the installed equipment, and
the customers for the equipment.  Since the equipment was being used
for video-conferencing among several Chinese hotels to demonstrate
the commercial applications of this technology, company officials
were confident that the export of this equipment would satisfy the
civil end-user requirement of GLX. 

According to Commerce Department officials, the agency does not have
guidance for its staff to use in making civil end-user determinations
for exports under GLX (or its successor, CIV),\6

nor has it issued guidelines on end-user determination for exporters. 
For an export to China that requires a validated license, the
Commerce Department normally conducts a review of the application and
determines if the export is going to a military or civil end user on
a case-by-case basis, using available government resources such as
embassy personnel and intelligence reports.  Exporters do not have
such resources available to them when making a civil end-user
determination.  Currently, there is no guidance or criteria available
to exporters on how much military involvement in a commercial entity
is needed before it is considered a military end user. 

According to Commerce Department officials, an exporter is
responsible for knowing its end user when exporting under GLX (or
CIV).  An exporter is encouraged to come to the Commerce Department
for an end-user check if there are any abnormal circumstances in a
transaction that indicate the export may be going to an inappropriate
end user.  According to Commerce Department guidance, these
circumstances can include orders for items that are inconsistent with
the purchaser's needs or a customer declining installation and
testing when included in the sale price.  If there are no suspicious
circumstances, the exporter is not required to verify the buyer's
representations of civil end use.  AT&T officials stated that they
did not ask the Commerce Department to determine if HuaMei was a
civil end user, nor were they required to under GLX. 

Commerce officials stated that the civil end-user requirement in GLX
was specifically included to allow Commerce to review exports going
to the military.  However, in the export of telecommunications
equipment to HuaMei, the Commerce Department did not have an
opportunity to review the end user because prior government review is
not required under GLX.  Consequently, the equipment was exported to
HuaMei without Commerce review, even though the company was partially
controlled by several high-level members of the Chinese military. 


--------------------
\6 As noted above, CIV does not provide additional clarification
about how much military involvement in a commercial entity
constitutes a military end user. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :5

In commenting on a draft of this report, the Departments of Commerce,
Defense, and State generally agreed with the information we
presented.  Commerce noted that our suggestion that it assess the
need to provide additional guidance to exporters on determining civil
end users as it gains experience under CIV (formerly known as GLX)
was helpful.  Commerce also asserted that our report confirmed that
its decision to make certain telecommunications equipment available
to China without requiring a validated license was consistent with
both U.S.  national security and economic interests.  However, it
should be noted that determining consistency with U.S.  interests was
not within the scope of our work.  We made minor technical
corrections to the report where appropriate based on suggestions
provided by the Departments of Commerce and Defense.  Comments from
the Departments of Commerce, Defense, and State are presented in
appendixes I, II, and III, respectively. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :6

To obtain information about the HuaMei project--when it was created,
its purpose, and the equipment it employed--we interviewed SCM Brooks
and AT&T officials and examined company agreements and project
descriptions. 

To determine civil and military applications of ATM and SDH
equipment, availability of the equipment, and the importance of those
applications to China's military, we interviewed officials from AT&T
and SCM Brooks and obtained technical descriptions of the products
and potential applications.  We also interviewed officials from the
National Security Agency, the Defense Technology Security
Administration, the Defense Intelligence Agency, and the Defense
Information Security Agency, as well as the Commerce Department
Bureau of Export Administration to get expert assessments of advanced
telecommunications equipment and data on telecommunications equipment
availability in China.  In addition, we interviewed
telecommunications industry and U.S.  embassy officials in China to
obtain information about the applications and availability of ATM and
SDH equipment in China. 

To examine the process and rationale for liberalizing the export of
broadband telecommunications equipment, we reviewed a chronology of
the export of AT&T equipment.  We also interviewed officials from the
Departments of Defense, Commerce, and State, and the National
Security Agency to obtain data on the rationale and purposes of
creating the GLX license category, as well as agency positions on the
inclusion of telecommunications equipment under GLX.  We reviewed
Defense and Commerce Department documentation on the development of
GLX.  We also compared the items on GLX with the Commerce Control
List items covered by advisory notes to confirm the method used to
develop GLX.  We performed our review from March to October 1996 in
accordance with generally accepted government auditing standards. 


---------------------------------------------------------- Letter :6.1

As agreed with your office, 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 to
other congressional committees and the Secretaries of Defense,
Commerce, and State.  We will also make copies available to other
interested parties upon request. 

Please contact me at (202) 512-4383 if you or your staff have any
questions concerning this report.  Major contributors to this report
were Karen Zuckerstein, David C.  Trimble, and John Neumann. 

Sincerely yours,

Katherine V.  Schinasi
Associate Director
Defense Acquisition Issues




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




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



(See figure in printed edition.)Appendix III

*** End of document. ***