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U.S. Export Controls and Economic Sanctions for the Oil and Gas Industry
Date: 3/8/2007

 William A. Reinsch
President, National Foreign Trade Council
March 8, 2007 

The issue of export controls is becoming hot once more – unfortunately in the worst possible way under the worst possible circumstances – the conjunction of fear of terrorism and paranoia about China.   

The result is a wave of xenophobia, which has manifested itself not only on export controls, but also in episodes like the Dubai Ports World acquisition case and our continuing disastrous visa policies.  Perhaps we should consider ourselves lucky that we had four years of benign neglect, but that changed in 2005, and now we have to deal with the consequences.   

·        Two years ago the Commerce Department published a Federal Register notice soliciting comments on what would have been significant expansion of the deemed export rule.  That followed its proposal in 2004 to change the definition of “knowledge” in a way that many believed would have lowered the bar to prosecutions. 

·        Both of those were subsequently withdrawn, although deemed exports will surely return. 

·        Last July the Commerce Department published a proposed regulation expanding the scope of controls on exports to China.   

These proposals are a misguided approach to the right problem.  They continue the movement we began toward controlling items based on the end use and end user rather than the blanket approach of the Cold War and on controlling technology more than items.  The reality of globalization is that everything is made everywhere.  A system that only controls things across the board is ineffective because of alternative sources of supply that do not adhere to our restraints and because technology is no longer contained in a convenient black box that we can simply hold onto.  Focusing on specific end uses and end users forces us to learn more about the items we are controlling and more about our adversaries’ efforts to use those items, both of which improve the system’s efficiency. 

Trying to do that through deemed exports and through the proposed China regulation is the wrong approach.  The Commerce Department processes about 1000 deemed export license applications each year and currently rejects about 1% of them.  This is not a very efficient use of limited resources.  In fact, in this area, which is about spying and not about terrorism, the talent and knowledge we are losing by keeping people out far exceeds the losses we incur by letting them in. 

Last year the NFTC led a coalition of companies and associations that opposed the deemed export proposal, and we were pleased to see Commerce throw in the towel on it.  Instead it has turned the problem over to a committee of experts, and we will simply have to wait and see what they come up with.  The appointment of the committee’s chair, Bob Gates, as Secretary of Defense will probably slow down the committee process, but on the other hand it puts someone in DOD who clearly understands this issue. 

The entire proposal, of course, demonstrated the extent to which we have lost touch with what is actually happening in the marketplace. 

Bill Perry was the first to really understand that with respect to defense technology.  Because of rapid technological change, the military has been shifting to commercial products and away from specially designed items.  That puts them in the position of relying on civilian producers whose major markets are civilian and export.  Those producers win the competitiveness race by staying ahead of their competition, and they do that by plowing their profits back into R&D on next generation products.  America’s future lies in our ability to keep on winning that race. 

That only works if they have profits, which requires exports.  Thus, Perry concluded that exporting was a key element of our ability to make advanced defense technologies and the Pentagon’s ability to buy them. 

 This was a sea change in thinking that informed the Clinton Administration’s export control policies.  Recent thinking on the subject suggests that while this is still true in the electronics sector generally, there are some circumstances where the Pentagon’s needs are so specialized and sophisticated that a return to “milspec” is necessary.  In those cases, however, I suspect the policy result will be subsidies to military contractors, or even the creation of dedicated, secure, production facilities rather than expanded export controls. 

Unfortunately, this Administration has abandoned Perry’s approach and is going down a road that threatens to harm our security rather than enhance it. 

  • Expanding the deemed export program will drive smart people away – the same smart people that have been the key to our economic success for the past 200 years.
     
  • This is also true of our visa policy for students and others, which is doing exactly the same thing.
     
  • Companies will respond by putting their research labs and other facilities off shore, creating a brain drain away from the US and ultimately not only transferring more technology offshore but setting up conditions to create the next generation offshore.
     
  • This is magnified by episodes like DP World.  If we let xenophobia get the best of us, there will be a chilling effect on inward investment that will retard innovation here without affecting the outward investment that will facilitate it offshore.     

The threat is similar in the case of the proposed China regulation.  Ostensibly developed to fulfill a Wassenaar Arrangement requirement – even though our other major Wassenaar partners are not implementing it with respect to China – the regulation would require exporters to seek a license if they “know” their item was being exported to a “military end use” in China.  That creates several serious problems: 

  1. The definition of knowledge goes beyond actual knowledge and, in conjunction with the other provisions, creates a far-reaching liability chain.
     
  2. The definition of “military end use” is likewise extensive and ambiguous and requires companies to make a very sophisticated judgment about military use that they are not prepared to make and which should properly be the government’s, not theirs.  
     
  3. The proposed regulation’s application to reexports multiplies the compliance burden and effectively means that exporters of components will have to determine whether their customer’s product is going to a military end use.  The reexport provision will reinforce the perception of American firms as unreliable suppliers and further encourage foreign customers to design-out U.S. components.  If you have any doubts about that check out the EADS Space Transportation website.    
     
  4. Finally, of the 47 new items listed, none of which had been previously controlled for national security purposes, it appears that a good number of them are not only produced elsewhere in the world, but are produced in China itself. 

None of this is good news.  Despite having begun in 2001 with a set of promises to the high tech community and a constructive effort that same year on the EAA, 9/11 and the paranoia it has created dominate the political landscape – a wave the anti-China team is cheerfully riding. 

So, what should we do instead?  For 50 years no one has disagreed with the premise that we do not want critical technology to fall into the hands of our adversaries.  The argument has been over precisely what technology we care about.  Even today most of the key actors in this play give the same speech – we want higher fences around a smaller number of items; by trying to control everything, we end up controlling nothing.  I’m sure you’ve all heard this speech.  I gave it myself many times. 

It is still true, but there are several problems with it, the main one being that once you get past nuclear weapons components and stealth technology, there is no agreement on what else should be inside the fence.  

To attempt to deal with that, a group of associations, including the NFTC, have formed the Coalition for Security and Competitiveness and announced two days ago a program of administrative reforms that will bring some sense to both the dual use and weapons control programs.  Among the dual use proposals are: 

  • Create a license exception for the transfer of controlled items within companies
  • Certify foreign end-users with strong compliance programs for favorable treatment
  • Enhance procedural transparency in the licensing process to help companies comply
  • Enhance the Commerce Department’s role in the “commodity jurisdiction” process for determining whether dual-use products should be subject to State Department licensing
  • Ensure timely updates of the Commerce Control List to reflect market availability
  • Expand factors used to determine “foreign availability” of controlled items
  • Revise the “re-export” controls to level the playing field for U.S. companies.

The beauty of these proposals is that they don’t require legislation.  They are all things the government can do on its own, and we intend to spend the next several months persuading them to do it. 

Now let me say a few words about sanctions.  My organization believes unilateral sanctions have proven ineffective in virtually every instance in which they have been implemented.  Put simply, they do not work and often do more harm than good. 

  • US sanctions caused a reduction in US exports by nearly $20 billion annually in the mid-90s, contributing to the loss of over 200,000 American jobs in the export sector and nearly $1 billion in lost wages. (Hufbauer/Elliot, IIE – 1997 Paper)
  • According to IIE, unilateral sanctions in the 90s achieved the desired results in less than 1 in 10 cases when implemented. (2006 Elliot speech)

History shows us that sanctions rarely work to change behavior.  Instead they foster anti-American sentiment, prevent access to vital export markets, and strengthen backing for regimes hostile to the United States while harming ordinary people in the process. 

In the face of new threats, unilateral sanctions are reemerging as a way for legislator to signal that they are “doing something” to address important problems in our world.  We call this chicken soup diplomacy.  It makes you feel better but doesn’t really cure anything. 


Let me cite some examples. 


IRAN

Our most important and visible unilateral sanctions regime affects Iran.  In addition to the domestic sanctions, the Iran-Libya Sanctions Act was amended last year and will likely be the subject of further amendments this year.  All this just as we are involved in a sensitive negotiation with the Iranians on their nuclear program.   

  • Current law calls for sanctions on foreign firms investing in the oil and gas sectors of Iran or exporting certain items that could help them develop weapons of mass destruction.
     
    A bill that would have significantly toughened the sanctions passed the House last year, but thanks to the leadership of Senators Warner, Biden, Hagel and Levin, and to Secretary Rice and the Administration what was ultimately sent to the President only extended the sanctions for 5 years, codified the executive orders already in place and provided for new penalties related to entities contributing to wmd proliferation.  The Administration retained flexibility to conduct investigations and waive sanctions.  
  • This year, the more extreme sanctions, which would expand the law to cover banks and other institutions that finance or facilitate the investments or exports and which would broaden the degree corporate parents would be liable for their subsidiaries’ actions – fondly known in Washington as the Halliburton Amendment – will be back, as will proposals for divestment legislation against Iran as well as the provisions from last year’s bill that were dropped.  Congressman Lantos recently introduced this legislation as H.R. 1400.

USA*Engage has serious concerns about this kind of legislation.

  • The timing is poor; toughening sanctions would poison the ongoing delicate efforts by the United States and its allies to dissuade Iran from embarking on a nuclear program.
     
  • It would take attention away from the behavior of the Iranians and refocus it on the actions of European and Asian companies in Iran, thereby creating divisions between the United States and our allies at the time we need them the most. 
     
  • The bills would make the United States more vulnerable to international commercial complaints by expanding the entities subject to sanctions to include insurers, creditors and foreign subsidiaries.   The United States would undoubtedly face complaints and lawsuits from our trading partners questioning their legality.    
     
  •  The bills would limit the ability of the President to conduct foreign policy.  By putting a time limit on investigations, they would require sanctions to be imposed or waived.  If they’re imposed, we would find ourselves in a difficult situation with our trading partners.  If they’re waived, Congress would complain and toughen the law further.  This is a  sledgehammer approach when a scalpel is called for. 
     

SUDAN
 
Finally, let me say a few words about state sanctions, which are rearing their ugly head just a few years after we thought we had killed them off at the Supreme Court.  

  • Seven states have enacted laws regarding public pension fund divestment from companies doing business with Sudan.  
  • This type of legislation has created a compliance nightmare for pension fund managers and investment banks, while catching a broad swath of U.S. and foreign companies with very tenuous ties to Sudan.  
  • Indeed, some legislation has identified U.S. firms who are operating legally under U.S. federal licenses as forbidden entities.  For example, the Illinois statute would punish US business involvement in southern Sudan and in Darfur, areas where our government has welcomed US investment.
  • The situation in Darfur is tragic by any measure.  The Sudanese people deserve the attention and help of the people of the United States and our leaders.  But actions by individual states are highly unlikely to benefit the people of Sudan.  
  • Both Congress and the President have spoken on the issue of Sudan.  As a result, we believe that state legislative sanctions are unconstitutional.  The Supreme Court agreed with us, in NFTC vs. Crosby in 2000 regarding Burma, that where the federal government has acted on an issue of foreign policy, states are preempted.  Just two weeks ago federal district court in Illinois also agreed with us and struck down the Illinois statute, using many of the same arguments.
  • Simply put, having 50 different foreign policies would severely limit our country’s ability deal with global issues in a constructive and efficient manner.  
  • The things that will benefit the situation there – such as increased aid or a new peacekeeping force – are hard to achieve.  Ultimately, however, they are the only policies worth pursuing – and can only be pursued at the federal level.  States cannot let their desire to do good blind them against doing what is right.