Conversion of Defence Industry and Central-Local Relationship in China: Problems and Prospects

Deba R. Mohanty,Research Assistants,IDSA



Conversion of defence industry as a novel concept started taking shape during the late 1960s and early 1970s in order to streamline the existing defence capability as well as transforming the defence industry into a major player in the overall economic development by a few western advanced states. Since then, considerable attention has been paid to understand the implications of this process. Seymour Melman and Lloyd J. Dumas have defined defence conversion as a permanent programme consisting of "political, economic, and technical measures for assuring the orderly transformation of labour, machinery, and other economic resources now being used for military purposes to alternative civilian uses."1 In popular usage, conversion is described as turning 'swords into ploughshares'.

In 1979, the Chinese leadership initiated a major defence industry conversion programme. This, according to official Chinese sources, involves an economic strategy of military integration that brings military-industrial technologies, facilities, and skilled labour into the purview of overall reforms. This strategy aims "gradually to reform and convert the past unified military product system into an integrated military-civilian national defence scientific research and military-industrial production system."2 The Chinese version of conversion does not fit into a generally accepted definition because for the former, the process is reversible and has always provided for using research technologies and sales from the civilian sector to support the defence industry. Nor does conversion in China aim at minimum defence.3 China's defence industry continues to produce and export growing numbers of weapons systems. Also, the budget of the People's Liberation Army (PLA) has risen substantially since 1989, partly to modernise its arsenal.

China has now had nearly two decades of conversion experience. It has yielded some impressive economic results. To a significant degree, military resources have been used for civilian production. For example, in 1990-91, it was officially claimed that over 65 per cent of the output value of the defence industry is in civilian products, and that in certain sectors, such as electronics, the civilian share of the total military production is nearly 100 per cent.4 A great diversity of new and spin-off products of varying technological intensity has been developed because of conversion. It has also promoted economic development in the special economic zones, including products for domestic consumption and export, and retraining of demobilised officers and soldiers. Notwithstanding the impressive results that conversion has brought about, it has been limited by structural problems common to most state-run industries, including low labour productivity, idle plant capacity, weaknesses in management and marketing, and the political obstacles of closing down inefficient industries. Nevertheless, conversion in China has made significant headway and deserves scrutiny and study.

During recent years, the conversion process has been facing a new hindrance. Though this may not strictly be called "new", as this problem has been there since the founding of the People's Republic, it has added a new dimension to conversion in China. The defence industry in China is organised along vertical lines, with commands stretching from the central departments in Beijing directly to the localities where subordinate enterprises are located. The chain of command often bypasses local governments. This has created enough confusion in the overall conversion process that brings into focus the role of defence industry in central-local relationship in China. The relationship has attracted attention of scholars especially since 1990.5 What changes have been made in the defence industry? Why were these changes needed? How have the changes influenced the central-local relationship? What implications will these changes bring? These are some of the queries that this paper addresses. In this research endeavor, an attempt is made to examine and evaluate China's conversion of defence industry since 1979, stressing its relationship to economic development planning. Specific attention is paid to the central-local relationship and its impact on the defence industry.

Reform of the Defence Industry System

The defence industry involves research, development, design, test, and manufacture of weapons used by ground, naval, air, and strategic forces. In China, the defence industry has been under strict military control since its inception. At that time, since the late 1950s, there was a need to accelerate the development of atomic weapons and relevant strategic forces. Thus, expansion of the defence industry and establishment of several industrial departments covering space, aerospace, shipbuilding, nuclear, electronics and ordnance industries were seen as an essential part to strengthen defence capabilities. These units were exclusively defence-oriented and did not engage in civilian production.

In the 1960s, the Chinese leadership initiated "Third Front" construction.6 This was a purposive, large scale, centrally directed programme carried out in response to a perceived external threat coming especially from the United States from the south-east, and the Soviet Union from the north. This programme was responsible for moving a large portion of the defence industries into the strategically important Chinese interior. It was estimated that between 1966 and 1975, when Third Front construction was at its height, China poured over 200 billion yuan into the plan. In contrast, an estimated 275 billion yuan was budgeted for non-defence industrial development.7 The build-up of the defence industry brought rapid industrialisation to the interior. However, it also led to the development of a dual economy in the interior regions. The Third Front enterprises were purely defence oriented. Their end-products could not meet local needs. Advanced military technologies could not be transferred to local enterprises or modified for civilian use. The vertical command structure and the strict state planning system precluded any local input. And, there was no economic interaction between the centrally controlled defence enterprises and local factories.

The defence industry had a detrimental impact on the regional economy. In order to expedite weapons production, local governments had to give defence enterprises priority access to power and water supply, and provide them with housing, food and other necessities, with very little benefit in return. For the localities, this was simply another form of 'exploitation'. When the price of agricultural products began to rise, the burden on local governments increased further. Subsidising defence industry only made local governments suffer.

In the late 1970s, China began to reform the defence industry. "Defence conversion" became the most popular slogan.8 Two powerful factors were responsible for this large-scale restructuring.9 First, a change in national priorities from the prevailing policy of 'politics in command' to developing the economy. Deng Xiaoping was the chief architect of this new programme. The second factor was a change in security perceptions that led to the adoption of a pragmatic policy of maintaining status quo in the contemporary balance of power politics. Defence industry reform, thus, was seen as an obvious corollary to these developments. It was, indeed, a long-term programme that needed several well thought out steps. The first round of reform was identical to that introduced in regular state-owned enterprises. Confusing as it may sound, defence enterprises count as state enterprises despite their exclusive military role. Most regulations that govern the civilian state-owned industrial sector also apply to defence enterprises. It is to be noted here that objectives for both defence and industrial reforms were the same. Both needed a break up of the old rigid planning system, more autonomy, and promotion of economic development.

Introduction of the responsibility system allowed defence enterprises more freedom in choosing their own civilian products that they decided to manufacture. Decision-making became more free and efficient as they adopted the factory director responsibility system. Suitable changes in the legal spheres gave them independence as well as protection in transferring declassified military technologies. This made them participate in civilian economic activities. Reform in the finance sector put them in a commanding position in retaining their profits and thus, finance further development. Price reform enabled them to fix the prices of goods produced outside the national plan. Finally, foreign trade reform enabled enterprises to retain a proportion of their foreign exchange earnings, which could then be used to develop civilian production.10

Amalgamation and decentralisation took place at the central government level. Changes were made to facilitate defence conversion. In May 1982 Beijing renamed its industrial ministries in order to clarify which specific fields they were in charge of, and set up the Commission of Science, Technology, and Industry for National Defence (COSTIND), whose functions included making policy recommendations concerning conversion. In 1987, the entire defence industrial sector was placed under the State Council's jurisdiction. It had previously been under the Central Military Commission (CMC). This change was made to pave the way for establishing business connections with foreign firms and allow for better conversion to civilian production. Decentralisation was also a part of the reform programme. Beijing delegated authority over several centrally controlled defence industrial enterprises to the provinces where they were located. This move was meant to break down the artificial barriers created by the state planning system while at the same time streamlining the central industrial bureaucracy and facilitating the marketing of civilian products produced by local defence factories. It is said that all military electronics enterprises have been devolved to provincial governments.

A reorganisation of the defence industry was intensified. After several years of trials, the Beijing government began encouraging the defence industrial sector to form enterprise conglomerates in the 1990s.11 This development has chiefly served to break down the vertically organised, self-contained industrial system of the past. The authorities hope that such reorganisation—especially conglomerates that bring together technology development, industry and trade, and encourage division of labour, economies of scale, and mutual assistance—will promote overall development. Enterprise conglomerates have a fairly large degree of autonomy, and perform projects under contract to their superior units. The development and manufacture of military products, however, is still controlled by the central plan. Although these enterprise conglomerates are based in the provinces, they remain the property of their superior units, who receive the profits over the local governments.

Enterprise conglomerates are granted certain privileges. For example, the Guizhou Aviation Industrial Conglomerate, consisting of forty four closely connected units, twenty two semi-closely connected units, and more than two hundred loosely connected units, is allowed to conduct its own imports and exports and make decisions concerning external cooperation in funding and technology.12

The overall enterprise organisation of the defence industry has now been settled. At the top, there is an industrial department or reorganised general headquarters corporation directly under the State Council. In the next layer, there is the provincial-level general corporation, followed by the enterprise conglomerates, enterprises and industrial factories.13 For example, in 1993 the China General Corporation of Aeronautics Industry was set up under the State Council. The corporation has the functions of a defence industry department. Below the Beijing head office, there is the Guizhou Aeronautics Industrial Conglomerate, centered on the Guizhou General Corporation of Aeronautics Industry. At the next level is the Jiangnan Astronautics Enterprise Group, which in turn oversees the Zunyi Shengda Electric Appliance Company and other connected companies.14

In addition to the above reforms, the Chinese government has offered special assistance to the defence industrial sector, particularly in the Third Front region, in facilitating conversion to civilian production. One important measure has been to relocate enterprises and factories from remote mountainous areas to urban areas in the heartland or even to the coastal provinces. The purpose of this move has been to bring these enterprises closer to their markets and improve communications with the outside world. The government has also drawn up a number of regulations to facilitate relocation. One resolution passed at the August 1984 Third Front Adjustment Work Conference called for the transfer of defence enterprises scattered in the remote areas, or areas with a problematic geographical location. At the end of 1983, the Beijing government set up an office for Third Front Adjustment and Reform under the State Council to provide systematic assistance to Third Front areas in coping with post-reform problems. The transfer of these enterprises was included in the national plan, and the cost of moving machinery and equipment as well as providing new housing for employees and schooling for their children was all to come from loans made by state banks or through self-raised funds. During the Seventh Five Year Plan (1986-90), 2 billion yuan was spent on relocating and reorganisation, out of which 800 million yuan was provided by the state in the form of direct loans. Another 600 million yuan was invested by the ministries in charge of the enterprises and the rest was provided by the enterprises themselves. This investment was spread among the 121 production enterprises and research units within the national plan. The relocation of these enterprises was expected to be completed in 1990.15

Another form of assistance offered by the government is related to the selection of civilian products. The government has encouraged defence enterprises to select products of an appropriate technological level in order to make the most of their technology and work force. However, this is not easy. In manufacturing civilian products, enterprises, particularly those involved in mechanical and electrical engineering, often need to purchase new equipments, and hence need large quantities of capital. The government has been ready to help these enterprises carry out the technological renovation necessary for conversion. To do this, the government first had to make provision for technological renovation in the national plan and then provide capital grants or loans for the said purpose.

The government has poured large amounts of investment into technological renovation. During the Seventh Five Year Plan, loans worth 4 billion yuan were granted to renovate 296 items of technology and construct 450 production lines for civilian products. During the Eighth Five Year Plan (1991-95), 6.3 billion yuan in loans was spent on the renovation of more than 400 technology items.16 A similar kind of assistance has been provided for capital construction, particularly major items included in the national plan. To ensure production efficiency, the Beijing authorities are making provisions in the national plan and providing capital to enable the provinces concerned to construct automobile production zones.

The government has also assisted military industries by helping to market their civilian products. Friction between military industrial enterprises and local governments has made it difficult for the former's products to compete in the local markets, thus hindering their development and threatening their survival. The government has adopted a number of different solutions for this problem, including gradually devolving their authority over some military industrial enterprises to local governments. Control over military electronics enterprises has been entirely devolved to the local level.

Assessing Conversion and the Central-Local Relationship

The reforms of the defence industry system have had a positive impact on central-local relationship. This has happened particularly after the Beijing government began systematically directing defence conversion in the mid-1980s. During the initial period of defence conversion prior to the mid-1980s, more tensions were created between defence industrial enterprises and localities. At that time, Beijing did not have any specific programme for implementing conversion. As a result, defence industrial enterprises, which had been no more than extensions of the central bureaucracy for more than thirty years and had no expertise in converting to civilian production, were forced to do anything they could to survive. PRC sources contain vivid descriptions of the plight of these enterprises. One writer described, "at that time, it was basically a case of doing any thing one could. Some nuclear arms factories produced soft drinks, air fields produced chicken coops, mirrors, dressing tables, etc."17 Examples such as this underline the fact that the choice of civilian products for almost all defence industrial enterprises entirely depend on short-term market demand.

This kind of short-term behaviour was a source of tension with local governments. Prior to recent reforms, the dual economy system did not allow defence industrial enterprises to get involved in local markets, but once they were permitted to do so, they soon disrupted the established market balance, producing redundant civilian products, that had long been the preserve of local small state enterprises. In brief, the localities felt threatened by defence conversion. They were particularly angered by the defence industrial enterprises' flouting Beijing's decree to produce civilian products on a similar technological level to their defence products. In order to survive, defence industrial enterprises opted for low-tech products that could easily be produced by the civilian sectors. This inevitably created tensions between localities and the defence industry.

Beijing's reforms since the mid-1980s have helped to ease these tensions, as these reforms have involved the devolution of administrative power over defence industrial enterprises to the localities where the enterprises are located. The provinces have thus been encouraged to assist in the marketing of civilian products manufactured by defence industrial enterprises. Furthermore, Beijing has requested that civilian products manufactured by them should be incorporated into the local economic plan. A 1990 pronouncement concerning the relationship among local governments, defence industrial enterprises, and the economic plan stated: "The policy of military-civilian integration ...... is not simply the concern of the departments of science, technology, and industry for national defence; it is the joint responsibility of all departments and all localities."18 Under the influence of this pronouncement, Guizhou province issued a supporting decision entitled the "Decision on the Gradual Strengthening of Military-Civilian Integration Work." This kind of arrangement has been very important for enterprises just beginning conversion. It has been very difficult for enterprises to win a share of the market when they are producing technologically advanced and distinct products. Since their products are not cost effective, they rely on administrative assistance to find markets for their products.

The central government has attached great importance to cooperation between defence industrial enterprises and local authorities particularly concerning conversion. As one Chinese source put it: "We know from experience that when local leaders pay attention to an enterprise and include its civilian products in the local economic development plan, when military industrial departments actively rely on the localities, and when important problems can be promptly discussed with the local government, military-civilian integration is more successful. At present, enthusiasm for the development of civilian products by military industrial enterprises is low in some localities; this is a structural problem and a problem of economic interests."19 Inclusion of defence industrial enterprises in local planning systems solves both these problems in one stroke.

Beijing incorporated civilian products produced by defence industrial enterprises into its plan in order to make full use of these enterprises human and technological resources as well as separate their products from the products of the local civilian enterprises. This has both eased the tensions which had arisen during the conversion before the mid-1980s and helped develop the local economy. It has also helped defence enterprises to at least maintain their existing technological levels.

Beijing has also assigned some important national construction projects to the defence enterprises, particularly those demanding high technologies. This policy, to some extent, prohibits import of major construction items and instead contracts them to domestic enterprises. Through this endeavor, two goals can be achieved: defence industrial enterprises can survive and their technological capabilities can be upgraded.

Reforms have included the formation of enterprise conglomerates. Despite the introduction of manager/director responsibility system, in each enterprise conglomerate, superior units, particularly the head offices of Beijing and provincial capital conglomerates still wield great influence over resource distribution. The superior units chalk out labour regulations, set up annual production targets and consequent profit remittance targets, appoint high level personnel and draft personnel policy, make final decisions on development of civilian products, and approve bank loans for technological transformation, while the subordinate units seek contracts from the superior units.

The powers wielded by the superior units of enterprise conglomerates have demonstrated that the old central system remains influential, despite the devolution of administrative powers to the provincial level. The head offices in Beijing and the provincial capitals decide which civilian products should be produced, while local governments and enterprises passively accept the decisions. To some extent, the central system has been transformed into enterprise conglomerates and has actually gained momentum, although it is not as rigid as before. This has serious implications for central-local relations, as enterprise conglomerates can integrate local economies into the national economy. The core enterprises contract out the manufacture of civilian product components to local enterprises, and if necessary, provide technical assistance or even a certain share of the required capital. This kind of cooperation tries to prevent central-local relations from worsening.


Economic reform since 1978 has exerted pressure on both the defence industry system and the localities. The defence industry has been faced with the task of converting excess production capacity to manufacture civilian products , while localities particularly those in the Third Front region, have suffered from the development gap between the hinterland and the coastal areas, as well as chronic problems encountered by regular state-run enterprises. Their interests converged when the centrally-directed defence industry system proceeded with a systematic programme of state-guided conversion to civilian production, and civilian enterprises in the Third Front region cooperated with the relevant defence industrial units. This kind of cooperation has had the unexpected effects of integrating local economies with the national economy and helping solve the chronic problem of central-local relations that has long been a serious concern for the central leaders.

This political economy-based integration theory still contains inconsistencies and requires further observation. When industrial conglomerates were initially formed, the localities were worried that the centre would use the conglomerates to keep the local enterprises in line with the national economy and as a consequence boost its own power. Hence, they were quite unenthusiastic about the move.

There are other problems that have impinged the relations between the defence industrial enterprises and the localities. The first is related to technical management capabilities. The local governments were forced to accept decisions made at the Beijing or provincial capital head offices without any input by local enterprises' technical and management personnel. This could have allowed core defence industrial enterprises to contract production orders to fellow enterprises within the same system, regardless of whether these enterprises were located in other provinces or not, thus hindering the process of integration. The second problem is connected with competition between the local government and the defence industrial enterprises. In order to boost economic development, local governments, taking advantage of their newly devolved power, have placed pressure on the defence industrial enterprises, demanding that they purchase components from the local enterprises. However, these enterprises' superior units have ordered them to place production orders with enterprises within their own system. This, in other words, results in a constant struggle between the central and local systems which is unhealthy for integration. The third and most important problem is the paucity of adequate funds for core enterprises. Conversion is a herculean task and it requires a huge amount of funds. In order to make the management more conscious of this, Beijing has requested enterprises to seek loans from state banks after a conversion project is approved instead of appropriating funds without restriction. It has instructed that if a conversion project is within the national plan and approved, the state banks will provide a loan of 40 per cent of the required amount, local governments will provide 30 per cent and the converted enterprises will raise the rest. This new policy has substantially increased the financial burden on the converted core enterprises and thus hindered integration. Unless these problems are addressed by the core leadership of China, the much talked about conversion programme will remain unstable and inconsistent and may inevitably lead to a major economic disruption.


1. Seymour Melman and Lloyd J. Dumas, "Planning for Economic Conversion," The Nation, April 16, 1990, p. 509.

2. Commission on Science, Technology and Industry for National Defence, Science and Technology Intelligence Agency (eds.), Shijie janshi gongye gailan (Survey of World Military Industry), (Beijing: National Defence Industry Publishing House, 1990), p. 107.

3. Mel Gurtov, "Swords into Ploughshares : China's Conversion of Military Industry to Civilian Production," The China Quarterly, no. 134, June 1993, p. 214.

4. Paolo Maggiano et al., "Arms Production," in Stockholm International Peace Research Institute (SIPRI), SIPRI Yearbook 1992: World Armaments and Disarmament (Oxford: Oxford University Press; 1992), Table 9.5, p. 375.

5. Many scholars have analysed the relationship on a macro level in order to understand why and how conflicts have come about. Some have focused more on fiscal management in examining fiscal problems between the centre and the local governments over a certain period of time. Others have even analysed the problem from a township enterprise viewpoint. For a general study, see, Chen-min Chao, "Tiaotiao vs. Kuaikuai: A Perennial Dispute between the Central and Local Governments in China, Issues and Studies, no. 8, August 1991, pp. 31-46.

6. For the history of the Third Front industrialisation, see, Barry Naughton, "The Third Front: Defence Industrialisation in the Chinese Interior," The China Quarterly, no. 115, September 1988, pp. 351-86.

7. John W. Lewis and Litai Xue, China's Strategic Sea Power: The Politics of Force Modernisation in the Nuclear Age (Stanford, California: Stanford University Press, 1994), pp. 93-94.

8. Much attention has been paid to this new development. For an analysis of China's defence industry conversion, see, Paul Humes Folta, From Swords to Ploughshares? Defense Industry Reform in the PRC (Boulder, Colorado: Westview Press, 1992).

9. Mel Gurtov, n. 3, p. 215.

10. Folta, n.8, pp. 87-109.

11. The Chinese enterprise conglomerate consists of any group of companies linked by some form of cooperation: for example, a core plant and a number of satellite plants. It does not include the western concept of the conglomerate as a collection of enterprises linked by a holding company. In other words, the Chinese have expanded the term.

12. Guizhou nianjian 1993 (Guizhou Yearbook 1993), (Guiyang: Guizhou renmin chubanshe, August 1993), p. 345.

13. Jean-Claude Berthelemy and Saadet Deger, Conversion of Military Industries to Civilian Production in China: Prospects, Problems, and Policies (OECD Development Center Report issued at the International Conference on the Conversion of China's Military industries, co-sponsored by the OECD Development Center and the China Association for the Peaceful Use of Military Industrial Technology, Beijing, June 26-27, 1995), p. 28.

14. Arthur S. Ding, "Mainland China's Defense Industry in the Context of the Central-Local Relationship," Issues and Studies, vol. 32, no. 7, July 1996, p. 8.

15. Third Line Task Force, Sichuan Provincial Academy of Social Sciences, The Adjustment of Our Country's Policy toward Third Front Industries, in Kaifa daxinan: Diqu chanye juan (Developing the Great Southwest: Regional Industries) (Beijing; Xueyuan chubanshe, September 1991), p. 507.

16. Zhongguo junzhuanmin (China's conversion) (Beijing: Zhongguo jingji chubanshe, January 1994), p. 15.

17. Ibid., p. 28.

18. Ibid., p. 5.

19. Ibid., pp. 21-22.