Unpacking Expanding Export Controls and Military-Civil Fusion

“Military-Civil Fusion” (MCF) in China—an effort to erase barriers between the civil economy and defense sector—has made it increasingly difficult for U.S. companies and regulators to ensure advanced dual-use technologies are not transferred from commercial companies to the Chinese military. To address this concern and learn more about Chinese supply chains, the Department of Commerce recently finalized new rules, which expand the number of products that require export licenses and remove certain license exemptions. The ambiguity of the new rules leaves room for the Department of Commerce’s Bureau of Industry and Security (BIS), which administers export controls, to exercise considerable discretion. While exporters are currently experiencing short-term panic given the level of uncertainty and potential for rejection, some uncertainty should subside once patterns emerge, and exporters learn which end users are being approved and which are not. As a result, these new rules could be a helpful starting point for addressing the risks posed by exporting advanced dual-use technologies.

Q1: What are the new rules issued by the Department of Commerce?

A1: On April 28, BIS published two final rules as well as one proposed rule to amend the Export Administration Regulations (EAR). The first rule amends Rule 744 of the EAR and expands the licensing requirements for exports to “military end users” and “military end use” in China, Russia, and Venezuela. Several restrictions for these two groups existed previously in the EAR. The new rules did not change the definition of military end users, but the scope for military end use was expanded. As a part of this restriction, companies will not be granted an export license if they have “knowledge” that the product they are exporting, reexporting, or transferring, which are covered by the new rule, is to one of these two groups.

The second rule removes an exemption that allowed companies to export some dual-use products on the Commerce Control List (CCL) to the 23 countries in Country Group D:1, including China, which were typically restricted due to national security concerns so long as they were destined to “civil end-users for civil end-uses.” As a result, while these exports may still be approved, they will now require an EAR license. The third proposed rule would eliminate an exemption that allowed the reexports of certain CCL controlled products to the 23 countries referenced in the second rule so long as they were from the Wassenaar Participating States. Comments for the proposed rule are due June 29, 2020, the same day the first two rules are scheduled to go into effect.

Q2: What motivated these changes?

A2: In all three rules, BIS references the 2017 National Security Strategy (NSS) and the Export Control Reform Act of 2018 (ECRA) as background. In the 2019 National Defense Authorization Act (NDAA), which included ECRA, the Department of Commerce was instructed to produce new guidelines for export controls on emerging technologies and to conduct a series of reviews for license requirements of exports, reexports, and in-country transfers to the 23 countries under arms embargoes. These two new rules are the beginning of the Department of Commerce’s implementation of license reviews required by the ECRA. BIS issued the first guideline for emerging technologies in January for geospatial imagery software. It also plans to issue six new guidelines covering other emerging technologies this year. Both the NSS and ECRA describe the growing challenge of MCF in China as the People’s Liberation Army (PLA) continues to obtain advanced dual-use technologies from the United States despite existing export controls.

MCF consists of the eroding lines between the PLA and commercial companies in China to facilitate the military acquisition and development of technology to support China’s national security objectives alongside the development of China’s high-tech sector. The origin of MCF is often attributed to 1978 and Deng Xiaoping’s slogan: “Combine the military and civil, combine peace and war, give priority to military products, let the civil support the military.” The United States’ concerns over MCF in China have become particularly acute, following the policy’s inclusion into China’s national strategy in 2014 and the establishment of the Central Commission for Military-Civil Fusion Development in January 2017—led by President and General-Secretary Xi Jinping. In practice, one aspect of MCF policy provides the government the legal authority to force companies in China to transfer products to the PLA without the consent of the country that exported the technology, such as the United States. As a result, even if the export was to a civil end user for civil end uses, it may still end up in the hands of a military end user due to MCF. This has created significant risks when exporting sensitive technologies. While complicating license requirements for exporters, these new rules are intended to address this problem and provide additional insight into Chinese supply chains.

Q3: What was the United States exporting to the Chinese military?

A3: While the United States arms embargo prohibits exports of defense articles and defense services to China, there have been several reported cases of advanced dual-use technologies being transferred to the PLA as a part of China’s MCF strategy. In an annual report to Congress in 2019, the Department of Defense stated that since 2015, China has specifically attempted to obtain the following technologies: “radiation hardened integrated circuits, monolithic microwave integrated circuits, accelerometers, gyroscopes, naval and marine technologies, syntactic foam trade secrets, space communications, military communication jamming equipment, dynamic random access memory, aviation technologies, and anti-submarine warfare.” While not all of these technologies have been successfully acquired, some of the most recent examples have involved aviation and naval technologies, which were legally exported to commercial customers, but illegally transferred to the Chinese military.

In addition to strengthening export restrictions through the removal of license exemptions and expanding the definition of military end use, the new 744 rule significantly expands the number of products that will require EAR licenses to address this problem. The list of products that will be controlled fall into nine different categories: 1) materials, chemicals, microorganisms, and toxins; 2) materials processing; 3) electronics design, development, and production; 4) computers; 5) telecommunications and information security; 6) sensors and lasers; 7) navigation and avionics; 8) marine; and 9) propulsion systems, space vehicles, and related equipment. With new products added to the list and new rules for obtaining an export license, many companies will be making phone calls to BIS in the coming months to seek clarifications.

Q4: How will this impact U.S. exporters?

A4: The ambiguity of the new rules leaves room for BIS to exercise discretion. It is therefore important to distinguish between the uncertainty impact—the consequences of exporters not knowing how the rules will be implemented—and the rejection impact—the consequences of previously approved licenses now being rejected. Experienced exporters already have a good idea of what they need to do to make sure their exports are not going to unacceptable end users. Exporters who have not had to deal with sales to problematic entities in the past, however, are going to be faced with new challenges following the expansion of the military end use definition. It is generally true that uncertainty declines as patterns become clear. For semiconductor companies with established bulk customers, for example, they will have to decide initially whether they now need to apply for a license or not in a particular case. However, once they decide, the situation clarifies—either by BIS acting on the application if they made one confirming that they don't need to apply or taking enforcement action if they are supposed to apply and do not. Over time, the situation will become clear with respect to existing customers, and they will probably adopt new procedures for vetting new customers. The CSIS Technology Policy Program has explained how this would lead to a helpful establishment of precedents specifically for semiconductor companies. In other words—short-term panic, long-term settling into a groove.

The greater impact will occur if BIS ends up rejecting a significant number of license applications, which would not have been submitted but for the rule. There is a presumption of denial for military end users in China, but BIS decisions will probably turn more on whether or not the end user is actually "military" as defined in the rule. Companies will likely apply for a license out of an excess of caution (with exceptions—some will follow the old cliché that it's better to ask forgiveness than permission), and BIS will deny those going to entities it views as military end users but not to entities it views as benign. And there, again, as patterns develop, panic will decline. If a company gets a license approved, they can safely assume future licenses to that entity will likely be approved as well and perhaps get BIS to tell them that the particular entity is not a military end user and, therefore, no license is required. That said, there is also the chilling effect of an ambiguous rule. Some companies will choose not to apply for a license, having concluded that their customer meets the military end user definition, which would mean a sale foregone—unnecessarily if the company's judgment about the end user was wrong. There again, as word gets around, as it always does, about which end users are being approved and which are not, panic will subside.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Jack Caporal is an associate fellow with the CSIS Scholl Chair in International Business. John Hoffner is an intern with the CSIS Scholl Chair.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2020 by the Center for Strategic and International Studies. All rights reserved.

John Hoffner

Intern, Scholl Chair in International Business

Jack Caporal