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VI. Overall Effects of U.S. Export Controls on U.S.- Headquartered Firms' Foreign Operations The U.S. export controls apply to a very large portion of U.S. export trade and foreign sales--estimated to be about $78 billion in 1985. (See Figure 13.) These were transactions needing a validated license, either an Individual Validated License (IVL) or a bulk license. This figure understates the total value of transactions covered by the system because, for example, it does not include the value of downstream distributor sales, nor does it include sales of foreign firms using U.S. parts and components and/or technology which would be included under the scope of the system (resale and reexport). This estimate for the level of U.S. foreign sales covered by the licensing system already has built into it several competitive effects resulting from U.S. export controls. In other words, if the U.S. controls and procedures were identical to those utilized by other COCOM countries, U.S. foreign sales would be higher.67 67If U.S. controls and procedures were in alignment with other COCOM countries, the portion of U.S. trade covered by controls would decline. Overall U.S. foreign sales would increase for the reasons provided in the text. -70-

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First, the evidence is that U.S. firms have basically given up trying to trade with the Bloc countries. Whereas other COCOM countries in 1984 exported $16 billion of manufactures to the Soviet Union and Bloc destinations, U.S. exports were well under $1 billion.68 A crude way to assess the potential scale of foregone sales to Bloc countries is to assume that the other COCOM nations' total exports to the Bloc represent the total market available. If U.S. firms could capture the same share of that potential market that they do of total world manufactures trade (roughly 20 percent), then this would suggest foregone U.S. sales to the Bloc countries of around $3 to $4 billion.69 . A second effect present in the trade data is due to the competitive effects caused by the West-West trade. That is, the U.S. control system operates with a number of unilateral restraints and other administrative restraints which are tighter than, or slower to function than the 68Part of the large difference between U.S. and EC trade with Bloc countries are the traditional advantages EC firms have due to long-standing business relationships and simple geography. 69Increasing Bloc trade was not identified as a major concern by the firms interviewed for this study with the exception of the machine tool industry. Almost all firms indicated a great deal of concern over West-West trade. -71-

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control systems found in other COCOM countries. This competitive effect results from an amalgamation of a number of factors related to how the licensing system operates. Estimating this overall effect is difficult. In Appendix B of this report, a case study of analytic instruments is presented which provides some indication of the possible magnitude of the West-West competitive effect. The evidence for this one sector is that changes in U.S. controls influenced the level of export trade between 7 to 12 percent in the short run. Again, a crude, but illustrative way to gauge the degree of influence of controls on trade, is to apply that same range (7 to 12 percent) to the estimated $30 billion of U.S. foreign sales which were transacted under an IVY in 19~5. This would indicate that $2 to $3 billion of foreign sales would be affected in the short run by similar changes in licensing policy. This does not cover another roughly $50 billion in foreign sales which were transacted under bulk license. A different set of factors influences trade flowing under bulk licenses so extrapolation from the IVL experience is not appropriate. None of these estimates of the competitive effects of controls touches on other key competitive considerations. -72-

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For example, the U.S. high technology industries, in part, build their competitive advantage around superior technology embodied in their products. Clearly, a heavy flow of research and development (R&D) activity must precede this commercial phase. No estimates are made looking at this aspect of competitiveness where U.S. export control regulations may be influencing the effectiveness and efficiency of U.S. industrial R&D. Beyond the influences over trade flows there are direct administrative costs associated with compliance. From the survey of U.S. firms who utilize validated licenses, it was estimated that in 1986 the direct administrative costs were about $0.5 billion.70 Larger firms evidently do not view the direct costs of compliance as a major difficulty, but smaller firms can find them influencing whether they attempt to export items requiring validated licenses and the type of validated license they use. The export control process does not fall evenly across all manufacturing sectors and therefore not all U.S. firms are affected by it. The bulk of the process with respect 70This covers only narrowly defined compliance costs. -73-

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to manufactures falls on five categories: electronic systems, instrumentation, aerospace, machine tools, and electronic components. An estimated 2,000 to 3,000 U.S. firms, mainly from these five industrial categories, are actively applying for validated licenses each year.71 Traditionally, high technology is one of the sectors in international trade that the United States has had a comparative advantage. Whereas all U.S. traded goods face the same general macroeconomic set of conditions, whether positive or negative with respect to trade, the effects of export controls is a competitive burden that falls fairly narrowly on this one category. Some of the sources of the competitive burden imposed by the license system on U.S. high technology firms include: the way the licensing process functions and its complexity; 71While the system is relatively focused in terms of number of firms and their major area of business on the U.S. side, there are a substantial number of foreign entities--over 100,000--who are affected by U.S. compliance procedures. -74-

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the influence the controls have on the relationship between U.S. firms and their foreign customers; and the disadvantages the system accords smaller exporters. The Commerce Department measurements on operation of the licensing system report that it processes over 120,000 licenses annually and, on average, issues a validated license in about 25 days. For most transactions, the system is reasonably consistent. Over 80 percent of all licence applications are processed in under 40 days. But this measure does not fully reflect the way the system operates from the viewpoint of the firm. Firers see the average processing times taking closer to two months, with very large variances in processing times depending on the destination. (See Figures 11 and 12, for example.) And while the reported denial rate is quite low, 1 to 2 percent, in fact this results in part from firms negotiating their way through the system or withdrawing their applications before getting denied or avoiding applications for controversial products or destinations. These variances in processing times and variability in criteria for rejection all translate into uncertainty. —7S—

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Uncertainty increases compliance costs, both administrative and economic. Uncertainties created by the procedures also translate into barriers to entry. Large firms can cope with the costs associated with managing the license system, smaller firms have to make more extensive adjustments in their scope of their foreign operations. The simple fact is that the U.S. licensing process is extremely complex. One indication is reflected in the fact that 17 percent of the cases in a large sample of licenses were applications most of which never needed to have been made at all--the items were already eligible for export under a self-licensing provision. This indicates the difficulty firms have in interpreting the regulations. Not only is the system complex, but it casts a very broad net. It processes not only critical technology items, but also a large volume of low technology items--37 percent of the items in a sample of license applications fell within the acceptable limits of Administrative Exception Note 9 for COCOM. This category is essentially low technology that can be transferred to Bloc countries on -76-

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the authority of the individual COCOM member country with no concurrence of other COCOM-member countries. The limited discrimination the system currently makes between sensitive versus less sensitive technology is indicated by the fact that average processing times for West-West items do not vary with the level of sensitivity nor whether the item was multilaterally controlled versus unilaterally controlled for national security reasons. Because the system casts such a broad net, a wide range of items of very low sensitivity are caught in it. What this indicates is that U.S. firms are probably bearing a higher cost to comply with the system than is needed to ensure that the goals of the national security controls are being fulfilled. This low-level technology is where the U.S. has very little, if any, technical lead. It is in this less sensitive category that the controls re more likely to make a competitive difference--that is, drive a foreign customer to alternative, non-U.S. sources. These less sensitive goods are more widely available abroad and therefore foreign customers are more likely to be driven to a foreign source by the presence of U.S. controls. Of the two costs, lost sales and administrative, the evidence is -77-

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that the bulk of compliance cost occurs from a relative deterioration of competitive position in world markets. The most difficult aspect of the effects of the controls on competitiveness to evaluate empirically is their influence over U.S.-foreign customer relations. This seemingly innocuous sounding term in fact embodies the heart of the competitiveness problem. Because the U.S. controls are a net negative competitive factor,72 this means that a U.S. firm must be superior to its foreign competitor in other dimensions such as technology, price, follow-on support, etc. Customers must integrate all these factors into a decision about which supplier to rely on. Therefore, U.S. firms are very concerned about how their customers weigh these different variables. The information obtained from the questionnaire and interviews with firms indicated there is an erosion of the foreign customer base. Thirty-eight percent of the firms surveyed (the value was 50 percent for the larger firms in the sample) reported that existing customers were indicating a preference to shift to a non-U.S. sources. This suggests that U.S. firms are being challenged on price, technology, etc. by foreign 72This arises because U.S. controls and procedures are more strict and complex in administration. -78-

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firms, and that the export licensing criteria has been the decisive variable in customer decisions. That is, foreign customers are given greater weight to export controls in making their decisions about where to source from. This is not a definitive reading, but it should raise concerns about the long-run position of U.S. firms in foreign markets where U.S. export controls are present. While one limitation of the scope of this study was that it did not include field research to focus on this area, all the evidence reviewed in the course of this study was consistent on this point: the U.S. controls were more stringent than those of other COCOM countries and at the margin affect business decisions. The third competitive element we were able to document was the way the license process puts smaller fins at a relative disadvantage. They have more difficulty getting an efficient compliance program up and operating than larger firms and even then they experienced longer processing times and a greater probability of having a license application rejected. -79-

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