News & Insights

It’s nice to be back with you.  I think I did this event seven years in a row and then slipped into the obscurity I no doubt deserved.  My resurrection, as it were, suggests that 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 follows its proposal in 2004 to change the definition of “knowledge” in a way that would probably have lowered the bar to prosecutions. 

·        Both of those were subsequently withdrawn, although deemed exports will surely return. 

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

In some ways these proposals are both a step forward and a step backward. 

They are a step forward that I predicted before I left office in 2001 – a continuation of 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. 

What will really matters now is not so much the things themselves as the ability to make them and to develop new generations of them – in other words, the technology.  Of course, I also predicted technology controls would be much harder to maintain and enforce – and then I left office.  Probably good timing.  Now, after four years of relative inactivity, the issue has heated up – exemplified by the deemed export issue, impelled by 9/11 but really focused on China.

This is tackling the right issue – the transfer of technology – but through the wrong means.  The Commerce Department processes about 1000 deemed export license applications each year and, during my tenure, rejected one or two of them annually, a number that is only slightly higher now – about 1%, according to the last data made available.  This is not a very efficient use of limited resources.  

Last year the NFTC led a coalition of companies and associations that commented negatively on the Commerce Inspector General’s “country of origin” proposal, and we were pleased at the end of 2005 to see Commerce throw in the towel and announce it was not going to pursue the country of birth issue.  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, flew completely in the face of global market realities.  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 – with some success on the dual use side and less on the ITAR side, but not for lack of effort.  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” might be necessary.  In those cases, however, I suspect the policy result will be subsidies to military contractors, or even the creation of a dedicated production facility 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. What does “know” mean?   After initial assurances that the term would be defined to mean actual knowledge and no more, the published version instead returns to the more expansive existing definition.  As the debate has evolved, companies have focused their efforts on seeking clearer due diligence guidance rather than trying to change the definition.
   
    
2. What does “military end use mean”?  The expansive definition used attaches considerable liability to a broad range of industries and raises numerous questions.  For example, if an exporter has information that a product could be used for the design of both military and civilian products, would the “military end use” definition apply?  What if an exporter knew that at the present time the item would be used for the production of civilian items, but that they might be used in the future to produce a military product?  Does “deployment” include simple transportation of military items (or the possibility of transportation of such items)?  Does BIS expect exporters to interpret the USML the same way the Department of State does currently, in that items not specifically described but that are specially designed, modified, adapted or configured for military use could be subject to their jurisdiction?  If read broadly, these definitions could, for example, affect sales of components that are used in the production of items that are intended for sale to military and commercial customers even though such items have no real military value or function.  These are only some of the questions the definition raises.  
   
    
3. The proposed regulation’s application to reexports multiplies the already significant compliance burden on U.S. firms and effectively means that exporters of components will have to determine whether their customer’s product is a military item.  The reexport provision will reinforce the perception of American firms as unreliable suppliers, as foreign customers consider the use of their product further downstream in other markets and design-out U.S. components.  It is also guaranteed to be ineffective and unwelcome by our trading partners, who have not applied similar restrictions.  
   
    
4. Finally there is foreign availability.  Of the 47 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.  BIS has not argued that these items should be controlled notwithstanding foreign availability.  What remains to be seen is what standard of evidence BIS will require before concluding that availability exists. 

These uncertainties about coverage reflect the fundamental policy debate.  The business community believes that everything that matters from a national security perspective is already controlled to China, and this regulation represents a solution in search of a problem.  And it suggests that paranoia is taking over from sound policy making. 

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 Administration thinking and the political landscape as well – a wave the anti-China crowd is cheerfully riding.