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l I. Introduction This study focuses on one element of the work of the Panel on the Impact of National Security Controls on International Technology Transfer: the effects of the controls on the competitive effect of U.S. products in international trade. Determining the overall competitive effects of the export licensing system is difficult both because the mechanisms by which the effects manifest themselves can be diffused and because the licensing system has so many varying degrees of influence. In principal, the U.S. export control system should have very little, if any, relative competitive impact on U.S. firms. The costs of utilizing the system might discourage some firms from exporting but otherwise there should be no competitive effects. This would be the case if the U.S. controls and procedures were identical to those utilized by other countries who subscribe to the multilateral control system (COCOM). But in fact, they are not identical.7 The difference in degree of economic activity covered, the greater stringency with which trade is governed by controls, and the greater complexity of the 7Al l U. S . firms interviewed for this study that had worked with foreign licensing systems of other COCOM-member states supported this view.

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procedures by which U.S. controls are administered are all factors when combined mean that U.S. firms bear a competitive as well as an administrative cost in complying with U.S. export control regulations. In order to understand the scope of this study, a series of schematics frame the extent of U.S. firms' foreign sales covered by the U.S. control system. We start by looking just at U.S. exports. Basically, one can divide all U.S. export trade into the portion covered by export controls and the portion that is not.8 (See Figure 1.) The vertical axis of the figure breaks down total export trade by geographic region. The three regional groupings identified are those of relevance to the issue of licensed trade: the Bloc/People's Republic of China (PRC), the countries of the multilateral international Coordination Committee (COCOM), and lastly, the non-COCOM, "West" countries. This is the most basic level, but it excessively oversimplifies the framework. Further divisions are necessary because important subcategories are 8Technically, all U.S. exports require a license. A large portion of U.S. exports goes out under a self- license, i.e., the exporter is not required to get prior written approval. 2

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t left out which have very different degrees of control by -the licensing system. Moving to Figure 2, the basic distinctions of type of export control, whether national security or foreign policy or nuclear/other, are specified. Basically, this study seeks only to focus on national security controls, but practically speaking this narrower definition of scope cannot always be maintained. Not all of the data developed for this report could be broken down by type of export control (i.e., national security, foreign policy, nuclear nonproliferation, short supply, and crime control). To keep this in perspective, however, where we were able to identify licenses by national security versus other types of controls, 99 percent of the license cases were classified as national security. This indicates that the basic data is overwhelmingly reflecting national security controls. It should also be noted that most U.S. businesses do not realize there is a distinction among the different types of controls. Management decisions are based on the need to obtain a license, not on the underlying rationale for the license. -3-

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Now to begin to appreciate how difficult assessing the competitive effects can be, examine Figure 3. Here, the geographic divisions have been further differentiated because the geographic divisions identified in Figure 2 are still too aggregate from the standpoint of examining competitive impact of the licensing system. For example, the East-West category is divided into the Peoples Republic of China (PRC) and all other Bloc countries. This differentiation is needed because a very different licensing policy pertains to the PRC relative to all other Bloc countries. Similarly, Canada is separated out from other COCOM countries because the U.S. does not require a validated license for exports to Canada. Changes in U.S. license procedures should have no effect directly on U.S.- Canada trade. Lastly, the Memorandum of Understanding (MOW) West countries are treated differently in the license review process from all other non-COCOM, non-MOU West designations. This necessitates making 2 unique category for them. Column 1 of Figure 3 indicates a possible six categories of licensed trade which could be analyzed. But the picture is still not complete. The segment of trade covered by national security controls needs to be broken down further to reflect the 4

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fact that there are different types of licenses. The procedures by which these different licenses are issued and their purpose sets up differential effects as far as their influence on business activity. With this additional division, there becomes 18 possible combinations of type of license and country destination for which competitive effects could be examined. (See Figure 4.) But the possible scope of economic activity influenced by the license system is still broader than the scope indicated in Figure 4 which covers only U.S. direct exports. The U.S. licensing system covers more than just U.S. exports, it can reach to the sales of U.S. affiliates, as Figure 5 illustrates. And even this does not indicate the full extent of possible coverage because foreign enterprises, distributors, sales operation, manufacturers, etc., are affected by the U.S. system in certain circumstances. While this report attempts to extend the scope over all direct U.S. enterprise activity, it does not reach into this last area. Limitations of available information rather than any belief that effects on foreign operations are inconsequential is the reason. The scope we utilize in this study is illustrated in Figure 6 J but with the additional detail indicated in Figure 5. Reference 5

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will be made back to these figures from time to time to refresh the readers' understanding of the framework of analysis. The competitive effects one can measure can vary depending on country of destination and type of control; this is depicted in Figure 6. That is, for the different combinations of destination, type of license, and type of economic activity analyzed, there are a large number of possible economic effects created by the export control system. This study will only address a limited set of these effects. Estimates of the size of economic impact developed in Chapter VI principally are prepared to illustrate how for administrative costs and for effects of reduced direct exports, the magnitude of the impacts are consequential. But these estimates do not trace through the possible economic effects of the controls on a number of other areas. For example, the controls may be decreasing the efficiency of the industrial R&D process in the U.S. Raising R&D costs would lower R&D output and have long-run competitive consequences. Likewise, the export control system may be encouraging foreign rivals to U.S. firms to engage in independent research and enter markets previously dominated by U.S. firms. These effects are not 6

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examined. Thus, the cost estimates which are presented only cover a subset of potential economic costs--namely short-term, direct costs. A concluding note on the scope of this report. The competitive position of U.S.-based firms in international markets is a function of many factors--only one of which is the U.S. export control system. The effects of the control system on competitiveness cannot be viewed completely in isolation from the effects of other factors such as exchange rates, relative productivity, product quality, etc. But while some of these other factors, exchange rates for example, cut across all export sectors, the export control system effects vary by industry sector. Our initial research indicated that it was the high technology industries that were incurring the greatest economic costs due to the U.S. export control system. We therefore focused the analysis, for the most part, on the high technology industries. Because so little empirical data has been developed on the export control process in the past, this report is organized along somewhat unusual lines. Rather than address generic issues, it reports on the various data

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sources utilized to analyze the system and concurrently addresses various competitive issues. The second chapter starts by providing an estimate of the scope of U.S. business activity influenced by the controls. This basically puts numbers in the slots of Figures ~ through 5. The next three chapters report on three different sources of information which were developed for this report. Each source provides a different view of the basic issue of how the competitive disadvantage is created by the U.S. export control system and how extensive or significant it is. Chapter ITI looks at various measures of performance of the U.S. licensing system. This chapter draws extensively on information taken from the Department of Commerce databank on export licenses. Chapter IV looks at the export control system from the viewpoint of the private sector, using information developed from the nearly 200 responses to a National Academy Questionnaire. In order to better define the complex competitive effects of the system, interviews were conducted with over 20 U.S.- headquartered firms that use the export control system. Chapter V summarizes these interviews and defines why the system can act as a barrier to exporting for some firms. -8-

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Having analyzed the operation of the system from -several different perspectives, the concluding chapter pulls the pieces together to indicate the order of magnitude of some of the associated economic costs. These estimates show that the U.S. export control system does create a significant economic cost which is uniquely borne by U.S. business. There is another inherent limitation in the research design followed in this study that the Panel should understand besides the point regarding the limited scope of the cost estimates. We predominately collected data from U.S.-headquartered operations, but some reports about possible adverse competitive effects of the controls focus on the reaction of the U.S. foreign customer base to U.S. controls. To a major degree, we only obtained qualitative appraisals of the changing customer relationships from the U.S. point of view. A final note. We are fully and solely accountable for this study, but we would be remiss not to acknowledge the excellent assistance and cooperation we received from the Department of Commerce Export Administration, the National Academy of Sciences and the following trade associations: _9_

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1 Aerospace Industri Association of America, Inc., Electronics Association, Computer Business Equipment Manufacturer's Association, Electronic Industries Association, Health Industry Manufacturers Association, National Electrical Manufacturers Association, National Machine Tool Builders Association, Robotic Industries American Association, Scientific Apparatus Makers Association and Semiconductor Equipment and Materials Institute. -10-