How Far Can China’s Defense Technology Reforms Go?

“We will improve the system and layout of science, technology, and industries related to national defense and step up capacity building in these areas,” Chinese leader Xi Jinping stressed in his report to the Chinese Communist Party (CCP)’s 20th National Congress on October 16. Soon after that, on October 25, the State Administration for Science, Technology, and Industry for National Defense (SASTIND) held a cadres conference, in which its director, Zhang Kejian, reiterated Xi’s remarks regarding Chinese defense technology and demanded that his subordinates fulfill Xi’s vital instructions. It is clear that defense technology reform remains a priority for the CCP, and China will keep pushing this forward to make the PLA a “world-class military.”

However, China has already been pushing for reform at the core of China’s defense industry – its defense science and technology institutes (军工科研院所) – to very limited results. As long as the causes of this stagnation persist, efforts to reform China’s defense technology sector are unlikely to succeed in the near future.

The Nature of China’s Defense S&T Institutes

Although China’s technology R&D system includes government research units, universities, and corporate research departments, defense science and technology (S&T) institutes are the most crucial source for 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 companies on weapons and equipment. They, rather than their parent companies or universities, are the main force for developing China’s defense technology.

For instance, Beijing Aerospace Automatic Control Institute of China Aerospace Science and Technology Corporation, founded in 1958, has been responsible for research on China’s missile control systems for decades, participating in the R&D of the notable “Two Bombs, One Satellite” program and many types of Dongfeng missiles. In another example, the 701st institute of China State Shipbuilding Corporation has been in charge of warship design since its establishment in 1961, and took part in constructing China’s first aircraft carrier, Liaoning. Undoubtedly, defense S&T institutes are the core of China’s military capability.

Nevertheless, even though these institutes are crucial for China, problems have existed for a long time. Beijing must solve these issues through a genuine system overhaul to boost its defense technology research capacity.

Defense Research Institutes: Problems and Related Reform Efforts

Similar to their parent companies, China’s defense S&T institutes have suffered from inefficiency and a lack of incentives for innovation. Based on the socialist system, they have been designated “public institutions (事业单位),” meaning that their property, finance, and personnel are controlled by the Chinese government. In particular, institutes’ funding and salary are appropriated by the government, and their research outcomes cannot be sold commercially without official authorization. The implication is that both the institute and individual researchers are short of the flexibility needed for innovation.

As public institutions, defense S&T institutes are plagued by complicated bureaucratic processes and low profitability, causing inefficiency and a lack of motivation for innovation. Since the economic reform era began in the 1980s, many manufacturing units of defense companies, which are responsible for civilian products, have been listed in the stock market, but defense S&T institutes with sensitive technologies have remained public institutions.

Xi started the reform of core defense S&T institutes five years ago, seeking to transform them from public institutions into enterprises. In 2017, SASTIND issued the “Implementation Opinions on the Transformation of Defense S&T Institutes into Enterprises,” declaring the first wave of reform impacting 41 institutes. In 2018, eight state and party departments jointly issued the “Reply on the Implementation Plan for the Transformation of the Institute on Automation of China South Industries Group,” representing the formal commencement of the reform. Some Chinese industry analysts proclaimed that this reform would be carried out in a speedy fashion.

The purpose of the reform was to let these defense S&D institutes be responsible for their own profits or losses, boosting their efficiency and motivation for innovation as well as relieving the government’s financial burden. The reform included four aspects: assets, accounting, funding, and staff benefits.

First, the assets of the institutes belong to the Ministry of Finance, not the institutes or their parent companies. Aside for part of the assets that would be transferred to the corporatized institutes, under the reform effort the government would liquidate and transfer the assets to other governmental units, or sell them and return the profit to the state treasury.

Second, a public institution has different accounting rules compared to enterprises. Generally speaking, the rules for enterprises are much stricter than for public institutions, meaning that the corporatized institutes would need to be more discreet about financial management than in previous times. On the other hand, they would also have more flexibility in accounting due to greater control over their remaining assets.

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

Fourth, the salary and pensions of a public institution are entirely paid by the government. After the reform, the newly corporatized institutes would be responsible for their staff’s salary and welfare benefits, while the staff would also to contribute part of the pension payments. Nevertheless, researchers would be able to receive additional profits through equity distribution and technology commercialization.

These changes would overall decrease governmental control and burdens while increasing the freedom and flexibility of the corporatized institutes, conducive to China’s defense technology innovation.

Nonetheless, the reform has yet to make any noticeable progress so far. After announcing the first list of 41 institutes to be transformed in 2017, the Chinese government has not announced reforms regarding the remaining 40 institutes. The stalled reform process for institutes on the first list was reported in 2019. On August 3 of the year, a piece of news posted on the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) website showed that only the Institute on Automation of China South Industries Group had completed the reform, indicating that this critical project of China’s defense technology reform supported by Xi still has not succeeded after a five-year effort.

Policy Implications

The personnel arrangements at the 20th Party Congress indicate that Xi should be able to dictate China’s policy direction. This implies that no political force could object to the defense technology reform. That means that two factors might be the cause of the stalled reform effort.

First, China’s economic slowdown would lead to decreased motivation for reform. The reform envisioned allowing the corporatized institutes to accept market investment and technology-related profits, while stopping their reliance on government funding. However, China’s economic slowdown is so evident that these institutes might worry about not being able to draw enough investment and profit from the market, which could lead to default, even bankruptcy. Hence, this situation would hamper their enthusiasm for reform and lead to their reluctance to corporatize, indirectly affecting the reform progress of the defense S&T institutes.

More crucially, Xi’s enhancement of the CCP’s leadership of everything could damage the atmosphere for innovation. Xi has micromanaged almost every policy with frequent party and administrative instructions. Furthermore, he has organized anti-corruption and anti-trust campaigns to make sure his policy would be followed through. For example, Alibaba – a private company that became a model for innovation because it had less government support and guidance than major state-owned enterprises but still became a leading technology company – was forcefully targeted by the Chinese government on antitrust grounds. Although the Chinese government might have certain policy goals in mind, the end result is that all innovation must follow the CCP’s lead, and any project not directly in line with the government’s expectations will be contained. This is very detrimental to the defense S&T institutes’ reform.

Because reform of the defense S&T institutes involves various issues, many problems need inter-department coordination, and their consequences could be profound. For instance, the reform of the Institute on Automation of China South Industries Group – the only institute to successfully complete the process thus far – required the approval of eight party and government departments. To avoid punishments, the institutes and related officials might not take the initiative to solve the deadlock themselves before Xi steps in and gives further policy instructions, causing reform to stagnate.

Due to the gloomy prospects for reform posed by China’s economic slowdown and Xi’s prolonged reign, the factors hindering the reform effort will persist, meaning that the transformation of defense S&T institutes is unlikely to succeed soon.

Undoubtedly, China keeps investing lots of resources in defense technology and will improve its weapons and equipment, but the prospects for China’s defense technology development are not promising. Although China’s missiles, warplanes, and AI have made significant progress recently, most of that progress was, in fact, in catching up with the Western countries’ technology, not in genuine innovation. To foster innovation, China needs to reform its current system, of which defense S&T institutes are a critical part. Nevertheless, China’s declining economy and the severe political environment might impede the reform effort.

With U.S. technology containment and the slow progress of China’s defense S&T reform, it will be hard for China to access foreign advanced technology and boost native technology innovation. Consequently, China’s potential for defense technology R&D is still limited, and the outcomes might not meet expectations.