Mr. John J. Fialka
Joint Economic Committee
United States Congress
June 17, 1997
CHINA AND ECONOMIC ESPIONAGE
Spies are normally associated
with wartime and the theft of military technology. In the vast
popular literature about espionage, there is hardly a mention of
peacetime economic spies. One reason may be because spy stories
tend to blossom when wars end. War is relatively clear cut: there
is a winner and an eventual loser; a beginning and an end. The
end is normally the signal for the memoir writers to begin.
But economic espionage is different.
Winners win quietly and losers are often either unconscious of
loss, or too embarrassed to admit it. My book argues that this
is like a war because war-like damage can result, but there is
no beginning, no end, and, consequently, no memoir writers. As
far as I know, my book is the first thoroughly-documented book
on the subject.
Although few Americans are aware
of it, our nation's history has been heavily influenced by economic
espionage. Shortly after the American Revolution, we were the spies.
And the richest, most industrialized part of the world at that
time--Europe--was our target. Alexander Hamilton, Thomas Jefferson
and many others among the founders' generation were involved in
it, but one American spy stands out--Francis Cabot Lowell. He managed
to steal the design of one of Great Britain's technological marvels,
a water-powered loom that was so efficient that it could produce
acres of cloth with relatively little human labor. Using this technology,
Lowell created the New England textile industry which was, in turn,
the foundation for America's industrial revolution.
One hundred and eighty four years
later, the world that Mr. Lowell knew has been stood on its head.
What he managed to start, the American industrial economy, is now
the richest in the world. As such it has become the chief target
of the world's economic spies. There are quite a number of them--from
at least 20 major countries. Meanwhile, Americans have become complacent.
Unlike our ancestors, who scoured the world for new ideas, we have
lost our hunger for that. Many of us have come to assume that the
best technology will always be here.
The thesis of my book is that
that assumption may no longer be true. Unless we can understand
the efforts currently being made against us and raise our awareness
to the point where we win at least as many episodes as we lose,
we will be in serious trouble. The National Economic Council, which
includes experts from the CIA, FBI and the Departments of Treasury,
State, Defense, Commerce, Justice and elements of the White House
prepared a secret estimate of the current situation for Congress's
intelligence committees in 1994. The report says that "economic
espionage is becoming increasingly central to the operations of
many of the world's intelligence services and is absorbing larger
portions of their staffing and budget."
This could involve a lot of people
and a lot of power because nations have brought a their Cold War
spy apparatus with them into economic espionage including giant
computer data bases, word-activated eavesdropping scanners, spy
satellites and an almost unbelievable array of bugs and wiretaps.
Economic espionage carried out
in the U.S. breaks down into three major styles. The study says
agents from China, Taiwan and South Korea are aggressively targeting "present
and former nationals working for U.S. companies and research institutions." Japan,
which does not have a formal intelligence agency but sometimes
collectively resembles one, uses Japanese industry and private
organizations to gather "economic intelligence, occasionally including
classified proprietary documents and data." The result is an exceptionally
efficient spy network that "is not fully understood" by the U.S.
Meanwhile, France has relied upon "classic Cold War recruitment
and technical operations," which generally include bribery, discreet
thefts, combing through other peoples' garbage and aggressive wiretapping.
There are recent signs, however, that France has decided to stop.
Another Cold War ally, Germany,
is described as planning to increase the number of its Federal
Intelligence Service (BND) agents in Washington to improve its
collection capabilities. And Russia and Israel also conduct economic
intelligence gathering operations in the U.S. with "varying degrees
of government sponsorship.
The most aggressive operations
against U.S. companies occur overseas, especially in home countries
where spy agencies are freer to act and where, the National Economic
Council report notes, "government controlled national phone networks" and
other electronic means can be used to slither inside company communications
and data banks. The best places to recruit foreign nationals who
work for U.S. companies overseas is said to be in third countries
where "a host country's counterintelligence services do not pose
a serious barrier to effective foreign intelligence operations
directed against U.S. targets. Furthermore, U.S. citizens tend
to be more lax about security matters when living in countries
perceived as friendly to the United States."
"Lax" is probably a polite way
to describe the laid back attitudes that many Americans have toward
our technology. A recent study by the National Research Council
found that one way Japanese businessman collect information about
the U.S. aerospace industry--one of Japan's current major targets--is
to get their U.S. counterparts to brag. "Ego comes into play as
engineers try to impress their foreign contacts..."
Part of Japan's approach is simple:
they have many more people looking here than we do there. In 1988
Japan sent 52,224 researchers to the U.S. Meanwhile 4,468 U.S.
researchers went to Japan. Japanese companies
invest the time and money to teach their people English and the
U.S. culture. U.S. companies rarely bother.
And what Japan has accomplished
in the U.S. has caused a stir of envy, especially in the Peoples
Republic of China whose collection efforts in the U.S. are likely
to be larger and, in the long run, more threatening than the Japanese
campaign, which they appear to be using as a model. Like Russia
and Japan, China's initial target has been U.S. universities. In
1991, 51 percent of all science and engineering doctorates awarded
by U.S. universities went to students from Pacific Rim nations
with the dragon's share going to the two Chinas. Many of these
students--educated largely at the expense of the U.S. government--get
jobs in the U.S. after obtaining their doctorates and a large number
of high tech companies and U.S. government research laboratories
are becoming hooked on this stream of cheaper, often smarter and
more biddable talent. Some of these students
eventually become U.S. citizens and help renew the American dream
by achieving breakthroughs that mean new jobs and new markets.
But many go back and government recruiters from their homelands
are working here to lure more back home, where they become serious
and sometimes dangerous competitors. What makes this scary is that
while the influx of foreign students has been growing, the faltering
U.S. public education system has been producing fewer and fewer
qualified applicants for graduate level science and engineering.
What this means is that many new U.S.-invented technologies that
we expect to drive our economy in the 21st century--such as biotechnology
and photovoltaics--are being quietly targeted and exported overseas.
My book shows how the Japanese,
Russians and the French do economic espionage, but I would like
to keep this testimony focused on China, which poses problems that,
I think, will become more serious over time. In this game China
is a dragon with two heads. Other competitors look for commercial
advantage, China, a nuclear power, looks for that as well as military
advantage and they often find both in the same deal. Its commercial
companies are often parts of its military. They have tank companies
that sell us teddy bears and toilet seats. Their profits from the
U.S. go to modernize a Army, Navy and an Air Force that has begun
to flex its growing military muscle in the Pacific. China's prime
intelligence agency, the Guojia Anquan Bu, or Ministry of State
Security (MSS), has flooded the U.S. with spies, sending in far
more agents than the Russians even at the height of the KGB's phenomenal
Cold War campaign. About half of nine hundred illegal technology
transfer cases being investigated on the West Coast involve the
Chinese. The MSS recruits students. When money is not persuasive,
threats against family members back home often are. And unlike
the KGB, China's spies easily find protective cover in the large
U.S. Asian population.
While the FBI makes an effort
to watch foreign students and businessmen, China's flood has simply
overwhelmed the bureau. "The FBI is ensnarled in a cess pool of
Chinese agents and their cases are all stuck at first base," says
James Lilly, former U.S. ambassador to China and former CIA station
chief in Beijing.
While the Japanese focus on things
like disc brakes and video cassette recorders, China's strategists
shop for missile guidance systems that can use signals from our
satellite-based global positioning system for precise targeting
information. They go after small cruise missile engines, night
vision equipment, upper stage rockets and nose cones for globe-spanning
nuclear weapons. These are all things that may fundamentally shift
the balance of power in the next decade and drive threatened countries
like Japan and Taiwan into full-blown nuclear weapons programs.
You will find that a lot of trade
experts and business executives don't see and don't want to see
this side of China's balance sheet. The prevailing intellectual
fashion is to regard the lowering of trade barriers and the influx
of foreign goods and students as part of a vast, multi-cultural
economic march toward a peaceful "globalism." Increasingly, sovereign
issues such as national borders, intelligence and military matters
are dismissed as old hat.
But they are not old hat to China's
current leadership, which is using a whole range of Cold War espionage
tactics, such as the insertion of "sleepers," or long term spies,
against the U.S. Federal Court documents in Norfolk, Va., show
how one young Chinese philosophy professor, Bin Wu, was sent to
the U.S. under orders to become a successful businessman, to steal
weapons-related technology and to develop political sources in
the U.S. Senate and the White House. Before he was sent, he was
told that the U.S. was one of the major enemies of China, and that
China was preparing for a "long battle." As his U.S. career blossomed,
he was told by his MSS handlers, he would never be alone. "Someone
will always be worrying about you."
China's Ministry of State Security
was formed by combining the espionage, intelligence and security
functions of the former Ministry of Public Security with the investigations
branch of the Communist Party's Central Committee. What had been
largely an internal instrument used to hunt down and annihilate
political dissidents in China, was recalibrated to work abroad.
In its modern form it supports its budget by hunting here for technology
like its model, the Soviet Union's huge, far-flung KGB.
Bin Wu's case was a classic spy
recruitment, a process that is known in the intelligence trade
as putting an agent "under discipline." Wu, who had been under
investigation in China for political crimes, was hooked through
a combination of personal fear, threats against his family and
the other baits they had dangled before him. While many other nations
recruit spies in this process, China's operations are different
because the MSS recruits armies while other nations field platoons.
A former FBI official told me: "A lot of people are using their
intelligence agents to collect from us in the economic area, but
the Chinese do it like a fare thee well. The Chinese are a giant
Because China currently floods
the U.S. with 15,000 students a year and recruits its agents from
among the candidates being considered for student visas, a Defense
Intelligence Agency expert estimates there could be "a minimum
of several hundred long-term agents operating here."
U.S. intelligence agencies have
discovered that one of the MSS's many skills is getting the U.S.
to pay most of the costs of their espionage. China and other Far
East countries are believed to siphon money from consulting firms
they form to help U.S. companies create business ties abroad. The
money is then used to finance espionage in the U.S. "We tell U.S.
businesses this activity is going on," says Robert A. Messemer,
a former FBI counter intelligence expert in Los Angeles. "Many
of these efforts are directed at the very same companies that they
are cooperating with overseas...they're funding the operations
that are being run against them."
Another favorite Chinese tactic
is squeezing defense-related high technology out of U.S. companies
as a necessary part of business deals. One incident that is currently
being investigated by a federal Grand Jury in Washington began
on August 1993 when a group of Chinese visitors entered a U.S.
defense plant, called Plant 85 in Columbus, Ohio. One of the visitors
carried a video camera and slowly panned down the length of some
of the factory's biggest machines. They were from a subsidiary
of China's National Aero-Technology Import & Export Corp. (CATIC),
which deals in both military and civilian equipment.
This was a very bold move. The
machinery CATIC's team was eyeing amounted to an entire military
aircraft plant, the largest east of the Mississippi. It would be
impossible to steal it and smuggle it out. It would be illegal
and impolitic for China, on its own, to try to buy it and ship
it out. Some of the equipment could machine metal to tolerances
so precise that they were on the U.S. State Department's list of "very
sensitive" technology. Whoever had them had the capability of machining
state-of-the-art nuclear warheads.
But CATIC had found another way.
It was trolling an enormous bait, a $1 billion aircraft order in
front of McDonnell Douglas. The hook was that, to get the order,
the U.S. aircraft company would have to make the political case
in Washington to get the export licenses that were was necessary
to ship the machines to China.
The pull being exerted by China
on U.S. companies is enormous. For many of them, China is the moon
and they hope to ride on the tides created by a growing market
of 1.2 billion people. Because China doesn't recognize a lot of
U.S. business law, dealings there can pose enormous risks. It is
a place where business, military and criminal deals often intermingle.
By some measures China is one of the most corrupt places on the
planet. Nonetheless, business there
still remains tempting. "The only thing worse than being in China
is not being in China," Edgar S. Woolard Jr., the chief executive
officer of Dupont, once reasoned. "If your competitor catches on
there, they're going to come after you with this enormous base."
Much of what U.S. aerospace companies
have to sell has "spun off" of U.S. military technology. In China,
U.S. military experts have begun to notice something they call "spin-on." As
the Chinese learned how to make fuselages and nose cones for McDonnell
airliners, for example, emerging versions of Chinese fighter planes
had fuselages that were better made and aluminum skins that were
The team from CATIC offered to
buy Plant 85's best machines for roughly 10 cents on the dollar.
While it looked like the start of a commercial deal, CATIC is simply
not another widget company. It is part of China's aviation ministry.
It can apply the leverage of a government agency, which is what
it is. It has the technological knowhow of a big defense contractor,
which develops fighters and missiles for China's Air Force. It
is developing a keen sense of the world's commercial markets: CATIC
runs some 66 commercial companies, whose profit-making business
ran from making airliners to running luxury hotels and shopping
centers to making fashionable watches.
CATIC's sister agency, the Peoples
Liberation Army, runs over 10,000 private businesses. They export
a wide spectrum of commercial products, from tea sets to fork lifts,
many of which are sold in the U.S. Part of the money is then used
to modernize China's sprawling military--the largest in the world.
Just how much money flows from the commercial businesses of China's
government into the business of developing new weapons is a mystery,
but it is probably a substantial sum. U.S. analysts believe that
as much as two-thirds of China's defense budget is hidden.
McDonnell officials told Craig
M. Ziegler, an investigating U.S. Customs agent, that the plant's
most sophisticated machines, called "5-axis profilers" were not
being offered to CATIC. Then CATIC
raised the ante. It said a failure to sell the machines in Plant
85 would have a "big influence" on the $1 billion plane deal and
future deals with China.
After that, McDonnell's position
appears to have been hastily revised. "We always wanted to sell
them (China) the machines," explained Tom Williams, a spokesman
for McDonnell. As for the peculiar back-and-forth in the negotiations
and the threat imperiling the $1 billion plane deal, Williams dismissed
it as "normal." "If you have ever bargained with the Chinese, they
are always picking up and leaving the room."
Thirteen of the plant's sensitive
five-axis machines were sold after CATIC promised to use them only
to make parts for the McDonnell-designed airlines, The Clinton
Administration approved the sale on the rationale that the U.S.
needed the sale to help offset what was then a $30 billion trade
deficit with Beijing. (The deficit
is now approaching $45 billion.) Although many items in this avalanche
of imports were produced in Chinese military factories, Clinton
Administration economists ignored that.
The matter of why China needed
these machines is a question that should not be ignored because
it probably has military, not commercial significance. For reverse
engineering, you only need one machine to make copies. China's
buyers were collecting dozens of them as Cold War-era controls
relaxed. By the winter of 1993, U.S. intelligence agencies estimated
that China was in the process of importing some 40 of the big machines,
counting the ones in the McDonnell deal. It was an amount that
seemed far beyond the commercial needs of China's fledgling aircraft
industry, or any other industrial country in the world, according
to one U.S. official. What is going on?
One theory is that China is gearing
up to export a large number of airliners, sales that would compete
directly with Boeing and McDonnell. Another is that China is preparing
what U.S. defense planners call "surge capability," the capacity
to produce a large number of high technology military planes and
precision-guided missiles in a hurry. What is worrisome to experts
in the Pentagon is that, when it comes to China, the two goals
are not incompatible. There is plenty of evidence that Beijing
wants both guns and butter.
Pentagon experts, trying to block
the sale, argued that as far as high technology military equipment
is concerned, China is a sieve that steadily leaks it into the
Third World. It has sold missile guidance systems and computerized
milling machines to Iran and missiles and a jet trainer powered
by a U.S.-designed engine to Pakistan. F. Michael Maloof, the Pentagon's
director of Technology Security Operations asserted that once Plant
85 machines arrived in China, the U.S. had no way to keep them
from being put to military use.
McDonnell replied that it "has
been assured by CATIC that this factory will only produce parts
for civil aircraft." When it took an
inventory of the machines, however, it found two of them in Nanchang
at an aircraft facility not covered by the agreement. The Nanchang
factory makes cruise and ballistic missiles. "That was not a proper
end use, so that was rectified," explained Williams, the company's
spokesman. According to one government official, McDonnell's way
of rectifying matters was to ask the U.S. Commerce Department to
suspend the export license it had granted for the machines--a move
of dubious value since the machines were already in China, somewhere.
In the summer of 1995, Barbara
Shailor, an official of the International Association of Machinists
and Aerospace Workers, watched two U.S.-built five-axis machines--which,
she was told, also came from the batch shipped from Plant 85--being
installed at a plant in Xian, in China's heartland. The plant's
workers, who make approximately $50 a month, were working simultaneously
on the B-6D, a medium range, nuclear weapons-carrying bomber, making
tail sections for the Boeing 737, and planning for a new airliner,
which could be largely indigenous. She asked a technician for an
American company working at the plant whether the two-headed nature
of the plant bothered him. "Everything around here is dual use," he
The final mechanism that China
uses to find and siphon away U.S. technology is its enormous stock
of students studying here. Again, it is borrowing from Japan's
model. While Japanese students were flooding the campuses in 1981,
the Peoples Republic of China had no doctoral candidates in the
U.S. Ten years later it had 1,596.
The Chinese students tend to be
super-bright, an elite skimmed from a nation of over 1.2 billion
people. There are so many of them that
they have come to dominate the lower levels of faculties in many
universities and they regularly win highly-prized research and
teaching assistant ships, which means that they teach and have
the keys to the laboratory and that their education is subsidized
by the schools and U.S. taxpayers. It has reached the point where
American undergraduates frequently complain that they can't understand
their teacher's English.
The idea that the U.S. can manage
its growing dependency on these students is still popular on U.S.campuses.
One reason is that it fits the needs of many senior U.S. scientists,
who can select brighter researchers from overseas to do their research
papers and their teaching, often at a fraction of the cost of a
For years the myth has been that
most foreign science graduates remained in the U.S. The U.S. Immigration
and Naturalization Service kept no records on it. "It's not something
we're interested in because it doesn't help with our work," explained
a spokesman for the agency. But recently
Michael Finn, an economist at the Department of Energy's laboratory
at Oak Ridge, Tenn., found a way to test the myth. Checking students'
Social Security numbers ten years after graduation, he found that
between 50 and 60% percent of the graduates no longer worked in
"We definitely hear more anecdotal
evidence that foreign countries are putting more efforts into recruiting
students to come back," says Finn. One exception is the Peoples
Republic of China which, according to Finn, appears to have made
a decision to keep a pool of talented scientists working in U.S.
companies and university laboratories, a pool that China can draw
One reason may be that the U.S.
pays their salaries as they continue to learn. Plus, according
to Finn, the "vast majority" of Chinese students in U.S. science
and engineering schools are supported by assistant ships or other
means provided by the universities, usually through U.S. government
Mr. Finn's agency worries that
the dwindling number of U.S. scientists and engineers may mean
that the nation will no longer have enough native-born scientists
to work on classified weapons projects. When you think about it,
that is a problem that should give us all pause.
You have decided to hold these
hearings at an historic moment. For the first time in almost decade
there appears to be growing awareness among the American public
that China may not be the most exemplary trading partner. It continues
to trample the human rights of its own people. It continues to
proliferate weapons of mass destruction in the Middle East. It
sends spies to steal U.S. weapons technology--which amounts to
an act of war. At the same time, it makes secret moves to deny
U.S. companies access to its markets, such as telecommunications.
And now, in addition, we see a growing body of evidence that it
has tried to manipulate the U.S. political process to its own advantage.
The question facing you is whether
we continue to appear numb to this threat, or whether we do something
that tells China it must modify its behavior. "Trade experts" would
have you believe this is an enormously sensitive, touch-me-not
question. In its simplest form, I'm not so sure that it is. Remember
the third grade? What happened to you if you continued to appear
weak and stupid in front of the class bully? Was that complex?
No, it was predictable. You lost your lunch money.
In past history, we protected
our companies by erecting a wall of tariffs. I think that age is
past, but selected trade barriers, such as removing China's most
favored nation status, would send the message that our laws and
our commercial and political processes must be respected, not abused.
In the long run, however, I think the best defense will be an offense.
We must make ourselves better, more world-savvy competitors. Companies
should understand when they lose, we all do. Like some companies
do now--notably Kodak and Motorola--they must be willing to take
the fight overseas, studying foreign cultures to find legal means
to learn what their competition is doing. Here, companies must
also become more willing to bring cases to court, using new laws
such as last year's Economic Espionage Act to create a body of
case law and an actuarial basis for risk can be used by insurance
companies to help protect people. Lessons are not learned if you
Companies and the government must
also be made aware that reliance on foreign scientists to develop
and guard our secrets is--as the Romans once discovered--a short-run
fix. In the long run we will either fail as a leader of technology,
or we will have to restore our broken public school system so our
students can continue to compete with the best in the world. As
a body, China's students here are exemplarily people that we can
learn much from, but among them are some spies, people whose assigned
mission is our downfall. As Francis Cabot Lowell once vividly demonstrated,
we should never lose sight of that. Nations that take their technological
edge for granted have a great deal to lose.
1. Report on U.S. Critical Technology
Companies, Report to Congress on Foreign Acquisition of and Espionage
Activities against U.S. Critical Technology Companies, 1994,
2. Report on U.S. Critical Technology Companies,
3. Ibid, p. 25.
4. "High-Stakes Aviation: U.S.-Japan Technology
Linkages in Transport Aircraft," p. 88.
U.S.-Japan Technology Linkages in Biotechnology, National
Research Council, 1992, pp. 34-35.
6. North, David S., Soothing the Establishment;
The Impact of Foreign-born Scientists and Engineers on America.
p. 78 & ff.
7. Eftimiades, Nicholas, "Chinese Intelligence
Operations," Naval Institute Press, 1994, p.17 and p. 27.
8. The account of Wu's meeting at the Old
Cadre's club comes from the trial transcript of U.S. vs.
Bin Wu, Jing Ping Li and Pinzhe Zhang, CR 92-188-N, U.S.
District Court for the Eastern District of Virginia, Norfolk,
Va. The trial was held in May, 1993.
9. Eftimiades, op. cit., p. 67.
Transparency International, a Berlin-based group dedicated
to curbing corruption in international business transactions,
ranks 41 countries on a "corruption index," based on polls,
reports of businessmen and business journalists. With a possible
high score of 10, China scored 2.16, ranking it just above
Indonesia, which was in last place.
11. Woolard made his remark in November 1995
at a symposium on international security issues at the State
12. "Civil-Military Integration; The Chinese
and Japanese Arms Industries," a background paper published
by the Office of Technology Assessment, a branch of the U.S.
Congress, in 1995, p.142.
13. "CATIC; United, Realistic, Competitive,
Innovative," brochure produced by CATIC, undated.
14. "Impact of China's Military Modernization
in the Pacific Region," U.S. General Accounting Office, June
1995, p. 18.
Report by Ziegler to the director of the Strategic Investigations
Division, U.S. Customs Service, Oct. 4, 1993.
16. Letters exchanged during the negotiation
were later released by the Pentagon.
17. Interview with Williams, October, 1995.
18. "China Swiftly Becomes An Exporting Colossus,
Straining Western Ties," Wall Street Journal, Nov. 13, 1995,
19. China's position, according to Li Daoyu,
its ambassador in Washington, is that it has "all along adopted
a serious and earnest attitude toward the issue of non-proliferation
and opposed the proliferation of all weapons of mass destruction
pending their complete elimination globally." Arms Control
Today, op. cit., p. 9.
Machining Co. Ltd.," part of McDonnell's application for
an export license for the Plant 85 machinery submitted to
the U.S. Commerce Department.
21. "Foreign Participation in U.S. Academic
Science and Engineering: 1991," special report by the National
Science Foundation, February 1992, pp. 28 and 85.
22. Some come from China's military elite.
Gen. James A. Williams, former head of the Defense Intelligence
Agency, recalls a chat with a number of lieutenant colonels
in the Peoples Liberation Army during a visit to Beijing
in 1983. They spoke with American-accented English and talked
about their days on U.S. college campuses. When he returned
to the U.S., Gen. Williams, now retired, had their names
checked against U.S. immigration records. There were no records. "All
I can figure is that they must have come in under different
names," says Williams.
23. Interview with INS spokesman, April 4,
24. Interview with Finn, Sept. 1995.