Arthur Ding, K. Tristan Tang
Since becoming China’s top leader ten years ago, General Secretary Xi Jinping has sought to sustain a three-decade effort to reform the defense industry in order to advance the development of defense technology and improve the People’s Liberation Army’s (PLA) capabilities. Recent reforms have focused on transforming defense science and technology (S&T) institutes into enterprise-like entities, but due to political and economic impediments, progress has been slow. This article examines the rationale for defense industry reform, assesses progress in implementation and explains difficulties encountered in the reform process.
Rationale
Since 1949, China has built a large-scale defense industry system with some unique characteristics. [1] The key attributes of this system include complete autarky in each defense industrial sector, from spare parts to assembled systems; total reliance on state support, which contributes to a lack of efficiency and autonomy; and a focus on mission-oriented military research without civil-military integration. Defense S&T institutes, the focus of this round of reform, have been a part of the defense industry system and share these features.
Reforms seek to address key deficiencies in defense S&T institutes, many of which stem from their designation as “public institutions” (PI) (事业单位). In China, PIs are wholly owned and financially supported by the Chinese state with their funding included in the government budget. The assets of defense S&T institutes fall under the Ministry of Finance with-day-to-day oversight managed by the State-owned Assets Supervision and Administration Commission (SASAC) (SASTIND, March 9, 2016). Consequently, these state-managed institutes have suffered from all kinds of bureaucratic restrictions, which has contributed to a lack of efficiency and autonomy. For example, decisions over eight million RMB (about $1.14 million) require approval from related government departments (People’s Daily, March 14, 2017). For years, these factors have combined to limit China’s capacity for defense technology innovation.
Reducing the fiscal burden of state assets is another priority of S&T reform. Chinese analysts point out that defense S&T institutes are valuable assets in the capital market with ample room for growth, e.g., compared to their counterparts in the U.S., where more than 80 percent of defense S&T institutes have been listed in the stock market and are responsible for their own profits and losses. [2]
Process and Content
The launch of defense S&T institute reforms was first reported in 2013, with the preliminary proposal submitted to the State Council in 2014 (Sina, October 10, 2013; SASTIND, January 4, 2015). On July 7, 2017, the State Administration for Science, Technology, and Industry of National Defense (SASTIND) issued an “Implementation Opinion on the Transformation of Defense S&T Institutes into Enterprises,” which took an important step in comprehensively deepening the reform of defense S&T institutes by announcing the first set of 41 institutes to be overhauled (People’s Daily, July 10, 2017). On May 7, 2018, a “Reply on the Implementation Plan for the Transformation of the Institute on Automation of China South Industries Group Corporation (CSIGC IA)” was jointly released by eight Chinese Communist Party (CCP) and state departments, formally approving the proposal made by CSIGC IA to transform the Institute on Automation into an enterprise (China Securities, May 8, 2018). This step indicated that the transformation of defense S&T institutes into enterprises was to be formally implemented.
The reform office of SASTIND issued a classified document that stipulates the rule and category for defense S&T institutes. All the institutes are divided into three main groups: PI I, PI II and enterprise. PI I entities are those institutes that involve national security and core secrets (涉及国家战略安全和国家核心机密的少数核心能力单位); PI II includes institutes for defense maintenance service (军工保障服务单位); and enterprises are work units that have professional advantage and provide support or stand-alone products for systems integration (具有较强专业技术优势、为系统集成提供配套分系统及单机产品的单位). Nevertheless, PI II (institutes for defense maintenance service) is further divided into two sub-groups: units for basic maintenance (从事基础性保障业务的单位) and units for publishing-related issues (从事出版发行等业务性质的单位). [3]
The entities in PI I are not included in the transformation project, while those in the enterprise list must be corporatized. As for those in PI II, a distinction exists between the two sub-groups. Those designated as units for publishing-related issues must be corporatized, but those specified as units for basic maintenance could either be maintained as PIs or be corporatized (see the below table).
Table: Groups and Rules for Defense S&T Institute Reform
(公益二类) Could either be maintained as PI or be corporatized
Units for publishing-related issues Must be corporatized
Units possessing professional advantage and supporting the overall system with subsystems and products Enterprise
The technological level of the 41 institutes is not sensitive and they are all slated to be transformed into enterprises. These institutes either deliver components or spare parts for final assembly or produce dual-use items. For instance, according to China Aerospace Science and Technology Corporation’s (CASC) official website, the 15th Institute of CASC, responsible for the rocket launcher system, is one of the 41 institutes (CALT, September 27, 2017). Its transporter erector launcher that is used for the DF-41 missile, the HTF5980A chassis, could easily be used for civilian purposes, such as special rescue and fire trucks (NetEase, October 10, 2019).
Thus far, S&T Institute reforms have followed a bottom-up approach. Institutes draft their own reform plans and submit them to the relevant authorities. To take the 20th institute of China Electronics Technology Group Corporation (CETGC) as an example, the institute inventoried its properties and developed plans for asset transformation, personnel rearrangement and defense industry credential affirmation for the corporatized element of the entity. The reform plan would then have been submitted to its parent corporation, SASTIND, the Ministry of Finance, SASAC and other relevant CCP and state agencies for approval. [4]
In brief, it is necessary to remove those 41 institutes from the PI category through mixed ownership reform (混合制改革). This entails incorporating other state-owned and civilian enterprises to join those 41 institutes so that they can be removed from PI status. If possible, those newly created enterprises would be listed on the stock market so that they could attract resources from capital markets.
After the joint document was released in May 2018, the Chinese public had a euphoric sentiment that the transformation of the 41 defense S&T institutes could be completed by 2020 and a new milestone for defense industry reform will be achieved (Shanghai Securities News, May 8, 2018). Nevertheless, as of August 2022, no progress has been reported for the remaining 40 institutes, indicating that CSIGC IA was the only institute to complete its planned transformation (SASAC, August 3).
Trouble with Reform
Since 1978, China’s defense industry has undergone different reform measures in the context of a rapidly growing economy. The status of China’s economic conditions bears on the prospects of reform measures. Recent developments in China’s economy and politics are likely unfavorable to the success of reform. [5] First, gloomy economic trends may make the corporatization of defense S&T institutes less viable and thereby impede the reform. China is experiencing declining economic growth due to the consequences of the COVID-19 epidemic, zero-COVID lockdowns and an aging population. The slowdown has weakened consumption and driven up savings. As a result, liquidity remains in short supply in China’s capital markets at this time. Given their advanced technologies, defense S&T institutes are expected to raise more funds than in previous years. Nevertheless, given the current level of economic uncertainty, raising sufficient funds in the capital market cannot be guaranteed.
In terms of assets, the situation is also complex with many questions unanswered. Should newly transformed enterprises from defense S&T institutes pay all public utilities, including water, electricity, gas, property management and relevant taxes which were previously covered by local governments as they were categorized as PIs? Right of land disposal and use of land are also issues that central and local governments need to work out.
To take the 206th institute of CSIGC as an example, the institute assessed in 2014 that it would receive a total government-sponsored fund about 160.7 million RMB (about $ 23 million), which would be canceled after it lost the status of PI. Considering that its average annual profit was 170 million RMB (about $ 24.42 million) and it would have to bear additional pension insurance of an average of 8,000 RMB (about $ 1,149) for each employee, the institute might be unable to make ends meet following corporatization. [6] In order to avoid such an undesirable financial outcome, the institute would have devote its resources to generating revenue, which could slow progress on reform and transformation.
How to manage personnel costs, namely the “Five Insurances and One Gold” (五险一金), is another issue that defense S&T institute reform must address. [7] The “five insurances” are retirement, medical, unemployment, employment injury and maternity insurance and the one gold is the housing provident fund. If the institution is categorized as PI, insurance and pension costs are all covered by the state, but corporatized institutes are responsible for at least a portion of these costs for their employees. A related issue is the disparity in benefits between serving and retired staff, who continue to be covered by the state with better benefits, versus newly recruited staff, who have to pay their own insurance costs and generally receive subpar benefits.
Secondly, China’s current political atmosphere could also detrimentally impact progress on reforms. Due to their PI status in the party-state political system, defense S&T institutes’ reform requires inter-departmental coordination. Nonetheless, Xi’s tightening and centralization of political power could reduce political flexibility by fostering hesitation in policy coordination among bureaucrats seeking to avoid punishment for making errors or misinterpreting Xi’s will. It is reasonable to predict that Xi himself could not constantly step in and take the lead on reform details, when bureaucratic coordination stalls, so China’s political atmosphere might lead to reform stagnation.
To make matters more complicated, the administrative structure of defense S&T institutes is not unified across all sectors. For instance, corporates in the space sector have academies (院) with institutes (所) below them; while some institutes in the aviation sector report directly to their parent corporations (Twgreat Daily, April 2, 2020). Furthermore, missions vary among institutes. Some institutes are only responsible for R&D, such as the 601st Institute of Aviation Industry Corporation of China (AVIC), while others are involved in manufacturing and after-service, such as the 14th Institute of China Electronics Technology Group Corporation. These cases show that it is extremely difficult for China to develop a universal transformation program for its defense S&T institutes (NetEase, December 8, 2017).
Under the current political climate in China, progress on reform may prove difficult. Since each institute requires a unique reform plan, negotiations among the party and government apparatus are inevitable and require time-consuming coordination. However, Xi has monopolized almost every aspect of the decision-making process and utilized anti-corruption campaigns to ensure policy execution as he wishes. Given the stakes involved in reforms, which would have a profound impact on China’s defense industry, it is rational for related parties to avoid taking uncertain steps. Associated departments and corporations might even pause negotiations on the implementation of this reform plan to await further guidance from the center, which takes considerable time or could even cause deadlock as Xi cannot always intervene.
Policy Implications
In the wake of slow economic growth and a restrictive political atmosphere, the reform of defense S&T institutes has proceeded extremely slowly, if at all. As a result, long-lasting institutional problems continue to hamper the efficiency and autonomy of China’s defense S&T institutes. Especially as these defense S&T institutes cannot achieve the aspired outcomes that would boost incentives for innovation and are, therefore, conducive to advancing the PLA’s capabilities.
Nevertheless, it is vital to note that while the pace of reform of China’s defense S&T institutes is slow, this may not stop China from developing new technology and weapon platforms.
Dr. Arthur S. Ding is a Professor Emeritus at National Chengchi University (NCCU), Taipei, Taiwan. He now teaches part time at both the NCCU and Taiwan’s National Defense University. His research focuses on China security related fields, including China’s defense, party-military relations, as well as China’s defense industry. Dr. Ding holds a Ph.D. in Government and International Studies from the University of Notre Dame.
Tristan Tang is a graduate student at the Department of Political Science, National Taiwan University. His research focuses on defense economy and China’s foreign policy.
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