China's Military Grapples With Conversion

ZHANG JINRU is ``caught between two mentalities.''

Mr. Zhang and managers of hundreds of other military enterprises in China's vast military-industrial complex are under orders from the government to convert to civilian production and to turn a profit in the emerging market economy. But they are also expected to continue to support modernization of the Army and arms sales abroad.

``They are making a double shift from military to civilian and from the comfortable world of socialism to capitalism,'' says John Frankenstein, a defense conversion specialist at the University of Hong Kong business school.

Zhang's firm, Yuandong Machine-Building Company, is switching from aircraft-control systems to compressors and petrochemical pumps. But it, like other firms, is hampered by its past:

* Yuandong can only export through a military middleman and must fill loss-making military orders at fixed prices.

* The firm's technology is three decades behind that of the former Soviet Union and the West.

* Part of a massive 1960s military-industrial shift to remote inland areas out of range of foreign attack, Yuandong is headquartered in western Shaanxi Province, far from China's booming coastal markets.

* The firm is forced to maintain a virtual small town with hospital, schools, and even an antiaircraft battery. ``I don't think the president of Boeing has to support something like this,'' Zhang observes.

* Every year, the executive is forced to absorb dozens of demobilized soldiers, but is prohibited from trimming his already bloated 10,000-man work force. And even if he could lay off the unneeded one-third of his workers, Zhang admits he is afraid to do so, because China's labor scene is so volatile.

``Managers are very cautious in using this power, because they fear for their personal safety,'' says the engineer, who received management training in Singapore. ``If I sacked workers because there were no jobs, or if their work was not satisfactory, my life and that of my family would be under threat.''

Status of conversion

The country's defense sector portrays itself as successfully converting to civilian products. China claims 70 percent of military enterprises have converted, although Western analysts estimate the figure to be closer to 40 percent.

According to government figures, the more than 1,000 large- and medium-sized defense enterprises have increased civilian output by 20 percent annually since being ordered to convert 15 years ago. Civilian products such as motorcycles, sewing machines, cameras, televisions, and refrigerators are said to account for 65 percent of defense-sector production.

But the path of conversion has been confused and haphazard, according to Western analysts. Like the Communist Party itself, the military remains torn ideologically over the pace of reforms.

``In the initial stages of conversion, there was a lot of resistance, not unique to China. If you're making missiles for the motherland, it's hard to get excited about making washing machines,'' Mr. Frankenstein says. ``There is a lot of opportunity for the Army to be involved in commercial activities. But the old generals are saying, `This is diluting our strength.' There is tension between the civilian and military sides on these issues.''

Although defense production once accounted for 10 percent of China's gross national output, two-thirds of the defense industry is either barely getting by or hampered by heavy debt, Western and Chinese analysts say. The fading cold war and a rapidly changing economy have left China with hundreds of useless factories and too many defense workers.

``One of the problems of the defense sector is ... it operates in a totally protected market,'' Frankenstein says. Government reformers ``would like to see some of these guys go down for demonstration effect. But the issues of national defense and sovereignty are just too hot.''

About 60 percent of military enterprises is located in the interior provinces of Sichuan, Shaanxi, and Hubei. With the difficulty of getting consumer products to market and the inferior quality of some, many firms are floundering.

China North Industries Group (NORINCO) is one of the largest military conglomerates. Formed five years ago by the ministry that produces ordnance, the group has more than 150 enterprises, 60 overseas companies, numerous research centers, and a work force of 800,000.

But two-thirds of its enterprises lose money. NORINCO's Dongfang Machinery Factory in Xian produces fusing systems for missiles, sources say, and consumer products. Dongfang got a late start in conversion and now struggles to find its market niche. Visitors are shown a dreary display room full of motorcycles, clocks, and other unsaleable products.

With more than 12,000 employees and two-thirds of its heavily subsidized output military, Dongfang will only break even this year on revenues of about $25 million. Since new capital is virtually impossible to raise, Dongfang is desperately seeking foreign help for its conversion.

But US pressures on Beijing not to export arms and the reluctance of the United States and some other Western nations to sell high technology to China are hurting foreign fund-raising efforts. A Western financial executive says he turned down a request to help underwrite a Chinese defense-enterprise stock issue on the Hong Kong Stock Exchange because ``I didn't want to get into any kind of political hassle [in the US] on this weapons issue.''

The US imposed sanctions last August on some kinds of technology in response to China's alleged sale of missiles to Pakistan. Western analysts worry that some military industries have the economic clout to export independently of Beijing's checks, shipping through third countries or finding loopholes in international controls. But analysts say Chinese arms exports have fallen since the heavy exports of the 1980s, when, according to the Stockholm International Peace Research Institute, China earned more than $15 billion in exports to countries such as Iran, Iraq, and Pakistan.

Effort to import technology

NORINCO admits it is exporting conventional weapons, and it has joint ventures in arms production with US, British, and other Western companies. But company officials recognize that its arms trade raises suspicions and hurts subsidiary Dongfang's ability to import even some nonmilitary technology.

Dongfang was rebuffed when it tried to import Japanese technology to make refrigerator compressors, forcing the company to develop its own design. Facing obstacles in technology transfer, firms increasingly turn to Russia for technology.

Underwriting China's military modernization adds to the strain for such firms. Despite widespread cutbacks in the People's Liberation Army (PLA) - which includes Navy and Air Force - the official defense budget has climbed steadily in recent years to more than $5 billion.

In China's shifting landscape, the military's vast business empire gives it growing economic and political autonomy from the Communist Party, Western observers say. ``The Army wants economic power and to be independent from the party,'' a Western analyst says. ``The PLA has its own life aside from the political leadership, and that influence will only grow.''

Although Western analysts say profits from the still highly secretive defense enterprises are not known, they estimate revenues nearly match government defense spending. Firms are expected to turn more than one-third of their earnings over to the government, executives say.

For some independent-minded executives like Zhang, sustaining the military business is more trouble than its worth. With Yuandong's revenues poised to jump to $33 million from $22 million a year ago, Zhang resentfully watches as his meager $1 million profit from civilian production is eroded by the 50-percent deficit in defense-related production.

``This is typical about China: The civilian production is based on the hardware of old military enterprises. So it's taken for granted that profits from civilian production should have a share for the military,'' he says. ``But if this situation is not changed, the enterprises will begin refusing to take military orders.''