How far can China’s defense technology reforms go? – The diplomat

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“We will improve the system and structure of science, technology and industry related to national defense and promote capacity building in these areas,” Chinese leader Xi Jinping stressed in his report to the 20th National Congress of the Communist Party of China ( CCP). on October 16th. Shortly thereafter, on October 25, the State Administration of Science, Technology and Industry for National Defense (SASTIND) held a cadre conference at which its director, Zhang Kejian, repeated Xi’s remarks on China’s defense technology and demanded that his subordinates take the vital instructions meet by Xi. It is clear that defense technology reform remains a priority for the CCP, and China will continue to push this to make the PLA a “world-class military.”

However, China has already pushed for reforms at the core of China’s defense industry – its Institutes of Defense Science and Technology (军工科研院所) – with very limited results. As long as the causes of this stagnation persist, efforts to reform the Chinese defense technology sector are unlikely to be successful in the foreseeable future.

The nature of China’s defense science and technology institutes

Although China’s technological R&D system includes state research units, universities and enterprise research departments, Defense Science and Technology (S&T) institutes are the main source of China’s defense technology. These institutes, which own the core defense technologies and employ related scientists, are the research element of China’s major defense arms and equipment enterprises. They are the main force behind the development of China’s defense technology, not their parent companies or universities.

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For example, the Beijing Aerospace Automatic Control Institute of China Aerospace Science and Technology Corporation, established in 1958, has been responsible for researching China’s missile control systems for decades, and participates in the research and development of the remarkable “Two Bombs, One Satellite” program and many other types of Dongfeng missiles. In another example, the 701st Institute of the China State Shipbuilding Corporation has been in charge of warship design since its establishment in 1961 and has been involved in the construction of China’s first aircraft carrier, Liaoning. Undoubtedly, defense S&T institutes are at the core of China’s military capabilities.

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But while these institutes are vital to China, problems have long existed. Beijing needs to solve these problems through a real systems overhaul to strengthen its defense technology research capabilities.

Defense Research Institutes: Problems and Associated Reform Efforts

Similar to their parent companies, China’s defense S&T institutes suffer from inefficiency and a lack of incentives for innovation. Based on the socialist system, they were called “public institutions (事业单位)”, meaning their property, finances and personnel are controlled by the Chinese government. In particular, the funds and salaries of the institutes are provided by the government, and their research results cannot be sold commercially without official approval. The implication is that both the institute and individual researchers lack the flexibility needed to innovate.

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As public institutions, defense S&T institutes are plagued by complicated bureaucratic processes and low profitability, leading to inefficiency and a lack of motivation to innovate. Since the beginning of the economic reform era in the 1980s, many production units of defense companies responsible for civilian products have been listed on the stock exchange, but defense S&T institutes with sensitive technologies have remained public institutions.

Xi began reforming defense S&T core institutions five years ago to transform them from public institutions into enterprises. In 2017, SASTIND published the “Implementation Opinions on the Transformation of Defense S&T Institutes into Enterprises” and explained the first wave of reforms affecting 41 institutes. In 2018, eight state and party ministries jointly issued the “Response to the Implementation Plan for the Transformation of the Institute of Automation of the China South Industries Group,” which is the formal start of the reform. Some Chinese industry analysts proclaimed that this reform would be carried out quickly.

The aim of the reform was to make these defense S&D institutes accountable for their own wins or losses, increase their efficiency and motivation to innovate, and relieve the government of financial burdens. The reform comprised four aspects: wealth, accounting, financing and social benefits.

First, the assets of the institutions belong to the Treasury, not the institutions or their parent companies. Except for some of the assets that would be transferred to the corporatized institutions, as part of the reform effort, the government would liquidate the assets and transfer them to other government entities, or sell them and return the profits to the treasury.

Secondly, different accounting rules apply to a public body than to companies. In general, the rules for corporations are much stricter than for public bodies, which means that corporate institutions would have to be more discreet than in the past when it comes to financial management. On the other hand, they would also have more accounting flexibility as they would have more control over their remaining assets.

Third, the funding of public institutions comes entirely from the government, while the corporatized institutions must raise funds themselves through product sales, stock listing, and/or bond financing. They would also have to pay tax on their profits.

Fourth, the salaries and pensions of a public institution are paid entirely by the state. After the reform, the newly established institutes would be responsible for the salaries and benefits of their employees, while the employees would also contribute part of the pension payments. Still, researchers could make additional gains through stock distribution and technology commercialization.

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These changes would reduce overall government control and burdens while increasing the freedom and flexibility of corporatized institutes, which would be conducive to China’s innovation in defense technology.

However, the reform has not yet made any noticeable progress. After announcing the first list of 41 institutions to be converted in 2017, the Chinese government has not announced reforms for the remaining 40 institutions. The stalled reform process for institutions on the first list was reported in 2019. On August 3 of the year, a news published on the website of the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) showed that only the Institute on Automation of China South Industries Group had completed the reform, which was suggesting that this critical project of Xi-backed Chinese defense technology reform has still not succeeded after five years of efforts.

Political Implications

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Staff agreements at the 20th Congress suggest that Xi should be able to dictate China’s political direction. This implies that no political force could object to the reform of defense technology. This means that two factors could be at the root of the stalled reform effort.

First, China’s economic slowdown would lead to reduced motivation for reform. The reform intended to allow corporatized institutions to accept market investment and technology-related profits while ending their reliance on government funding. However, China’s economic slowdown is so evident that these institutions may fear being unable to extract enough investment and profits from the market, leading to defaults or even bankruptcy. Therefore, this situation would dampen their enthusiasm for reform and lead to their reluctance to start a business, which would indirectly affect the reform progress of defense S&T institutes.

More crucially, Xi’s strengthening of the CCP’s leadership in all fields could damage the atmosphere for innovation. Xi has micromanaged almost every policy with frequent party and administrative instructions. In addition, he has organized anti-corruption and anti-trust campaigns to ensure his policies are enforced. For example, Alibaba — a private company that became a model for innovation because it received less government support and guidance than large state-owned companies, but has nevertheless become a leading technology company — has been violently targeted by the Chinese government on antitrust grounds. Although the Chinese government may have specific policy goals in mind, the bottom line is that all innovation must follow the CCP’s lead, and any project that does not directly meet the government’s expectations will be curbed. This is very detrimental to the reform of S&T Defense Institutes.

As the reform of defense science and technology institutes includes various issues, many issues require interdepartmental coordination, and their consequences could be profound. For example, the reform of the China South Industries Group’s Institute on Automation — the only institute to date to have successfully completed the process — required the approval of eight party and government agencies. To avoid punishment, the institutes and related officials may not take the initiative to resolve the deadlock themselves before Xi intervenes and issues further policy directions, leading to stagnation of reforms.

Due to the bleak reform outlook created by China’s economic slowdown and Xi’s long rule, the factors hampering reform efforts will remain, meaning the transformation of defense S&T institutes is unlikely to succeed any time soon.

Undoubtedly, China will continue to invest a lot of resources in defense technology and will improve its weapons and equipment, but the prospects for defense technology development in China are not promising. Although China’s missiles, warplanes, and AI have made significant strides recently, most of that progress has actually been catching up with Western countries’ technology, not true innovation. To encourage innovation, China needs to reform its current system, of which defense S&T institutes play a crucial role. Still, China’s shrinking economy and difficult political environment could hamper reform efforts.

With the containment of US technology and the slow progress of China’s S&T defense reform, it will be difficult for China to access foreign advanced technology and encourage domestic technology innovation. Consequently, China’s defense technology R&D potential is still limited, and the results may not live up to expectations.