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D Estimate of Direct Economic Costs Associated with U.S. National Security Controls WILLIAM F. FINAN Quick, Finan & Associates The following is a report submitted to the Panel on the Impact of National Security Controls on International Technology Transfer of the Committee on Science, Engineering, and Public Policy of the National Academy complex. The principal investigator was Dr. William F. Finan of Quick, Finan & Associates, Suite 340, 1020 19th Street, N.W., Washington, DC 20036. The material in this study is a follow-on to the Quick, Finan report "Analysis of the Effects of U.S. National Security Controls on U.S. Headquartered Industrial Firms," which was submitted to the panel on August 15, 1986. This report draws heavily on the data and analyses presented in that earlier submission, which hereafter will be cited as "Analysis of the Effects of Export Controls" (either vol. I or vol. II). INTRODUCTION The purpose of this report is to estimate the aggregate economic cost imposed by U.S. national security export controls on U.S. firms and on the U.S. economy. It is based on the best information available regarding U.S. export controls and the scope of economic activity covered by those controls. Much of the information used for this estimate was developed to support the efforts of the above-named panel to understand the operation and effects of the U.S. export licensing system. (Obviously, additional information would have permitted the development of a more refined estimate covering all elements of the system.) For several reasons, the 254

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 255 cost estimate is believed to have a downward bias: (1) a conscious effort was made to err toward the conservative side and therefore keep the estimate at the lower end of the possible range; (2) as discussed later, only a portion of the possible economic costs was tabulated; and (3) the estimate attempts to capture only short-run costs and does not reflect longer-term costs. These issues will be discussed in more detail in the report. The competitive position of U.S. firms in international markets is a function of many factors, only one of which is U.S. export controls. The effects of controls on competitiveness cannot be completely isolated from the effects of other factors such as price (including exchange rates), product quality, and before-and-after sales assistance and service. Al- though some of these other factors exchange rates, for example cut across all export sectors, the effects of export controls vary by industry sector. Our earlier report indicated that a limited set of U.S. industries incur the greatest economic cost. The categories we identified as bearing most of the competitive costs associated with U.S. export controls include communications equipment, aircraft and parts, computers/office equipment, scientific instruments, electronic components, and machine tools. These industry categories accounted for about 70 percent of the total U.S. high-technology exports in 1985 and in the same year about 30 percent of total U.S. foreign sales of manufactured products (which includes U.S. exports and products manufactured abroad by U.S. firms). It is estimated that these categories account for about 85 percent of U.S. licensed exports of manufactured goods. In principal, as we discussed in our earlier report, U.S. export controls would, under ideal circumstances, have very little if any relatives com- petitive effect on U.S. firms. This would be the case if U.S. controls and procedures were identical to those of other countries that subscribe to the multilateral international coordinating committee (CoCom). But in fact U.S. controls and procedures differ; the differences arise from the greater reach of U.S. controls, the greater stringency with which foreign sales are regulated, the extraterritorial application of U. S. controls, and the greater complexity of U.S. procedures. When combined, these differences mean that U.S. firms bear competitive as well as administrative costs in complying with U.S. export controls. Estimating in full the international competitive effects of U.S. export controls is difficult because the ways in which those effects manifest themselves are numerous and diffused. For example, measurable com- petitive effects vary depending on country of destination and type of control; that is, the export control system creates a large number of possible economic effects for the different combinations of destination, type of license, and type of economic cost being evaluated.

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256 APPENDIX D TABLE D-1 Export Control Economic Cost Analysis Factors Covered Examples of Factors Not Covered 1. Direct administrative compliance cost 2. Lost sales for U.S. manufacturing operations in 1985, both for West-West and for West-East trade Lost employment (due to lost export sales item 2 above) Direct research and development (R&D) impact (due to overall lost foreign sales) 5. Lost profits (due to overall lost foreign sales) 6. Lost revenues due to denial of licenses 1. Indirect administrative costs 2. Lost sales for nonmanufactures Sales of products manufactured by a foreign firm incorporating components or technology of U.S. origin Sales lost due to U.S. nuclear or foreign policy controls (see Figure D-3) 3. Indirect R&D impact (for example, technical data restraints, controls on foreign scientists in U.S. industrial labs, etc.) . Indirect employment consequences due to items 1, 2, or 3 5. Uncertainties created by variability of . . license processing 6. Discouragement effect for small businesses in VVest-West trade due to complexity of license procedures (i.e., they forego attempting to export) 7. Long-term influence of U.S. controls on U.S.-foreign customer relations (qualitative evidence is that U.S. firms in some cases are the least preferred of suppliers if all else is equal or nearly equal) 8. Warehousing and other costs incurred when available products must await a license Table D-1 summarizes the type of economic costs for which estimates were developed as part of preparing an overall economic cost estimate for the U.S. export control process. The costs included in the overall cost estimate tend to be fairly direct and short term in nature. The table also lists a number of economic costs that are not covered in the overall cost estimate. The general reasons for excluding from the aggregate calcula- tion of costs the items listed in column 2 of the table were as follows: (1) lack of data, (2) lack of a defined analytical procedure to frame the estimation procedure, or (3) a judgment that the effects were likely to be second-order in nature. To repeat, the cost estimate we present covers only a subset of the potential economic costs namely, short-term, direct revenue losses and associated employment loss. The remainder of this report is divided into three sections and an annex. In the first section the coverage of U.S. export controls is reviewed in terms of value of foreign sales for 1985. Foreign sales include sales by U.S. affiliates abroad as well as direct U.S. exports to unaffiliated purchasers.

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ECONOMIC COSTS OF U.S. NATIONA f SECURITY CONTROLS 257 The next section examines how security benefits related to export controls vary with the level of criticality a measure of the degree of military importances of the technology or item being exported. The security benefits from controls are assumed to be greatest for exports of high-criticality items. We also indicate how competitive costs may be related to the level of criticality of a particular technology or product. The competitive costs of U.S. export controls are shown to be mostly concentrated in the low- and medium-criticality technologies3 in goods shipped to countries that participate in a system of controls on exports to Warsaw Pact nations. When the distribution of benefits is combined with the distribution of competitive costs, the conclusion emerges that the economic costs of U.S. export controls are greatest for exports of items of low and medium levels of criticality, while U.S. controls on these items contribute least to avoiding diversion. Finally, the third section summarizes the estimates for the aggregate economic costs as identified in the preceding table. These estimates relate primarily to lost direct export revenues, even though the foreign affiliates of U.S. firms also experience additional lost revenues beyond those estimated.4 The report concludes with an annex explaining the method of calculation of the economic cost estimates. SCOPE OF U.S. FOREIGN SALES COVERED BY VALIDATED LICENSING The scope of U.S. economic activity covered by U.S. export controls can be best understood through the use of a simple framework. (Only trade in manufactured products is examined.) Looking first just at U.S. exports, total U.S. export trade of manufactured products can be divided into two categories as shown in Figure D-1: trade covered by export controls (requiring a validated license) and trade that is not covered (self-licensed).5 The horizontal lines of Figure D-1 divide total export trade by category of destination. The three regional groupings identified are those of most relevance to the issue of licensed trade: the Eastern bloc countries and the People's Republic of China (PRC), the non-CoCom "Western" nations, and the CoCom countries. But the possible scope of economic activity influenced by the U.S. licensing system is broader than just U.S. exports; it also covers some of the sales of U.S. foreign affiliates (see Figure D-21. The economic cost analysis presented in this paper is based on this broader definition where it is appropriate for use in calculating a cost for the U.S. economy. It should be noted, however, that even this broader definition does not indicate the full scope of possible economic activity influenced by the U.S. licensing system because U.S. controls also reach some of the sales

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258 APPENDIX D Destination West-East* Non CoCom Western countries I r ! ! CoCom countries I Trade under I Trade requiring self-licenset I validatedlicense Total U.S. export trade *West-East refers to trade with bloc countries and the PRO. Thor example, the general destination license (GDEST). FIGURE D-1 Schematic of coverage of the U.S. export control system of non-U.S. firms. The sales of foreign-owned enterprises including unaffiliated distributors, sales operations, foreign manufacturers, and so on also can be affected in certain circumstances.6 This report attempts to estimate only those economic impacts directly related to U.S. enter- prises; it does not reach into this last area (i.e., sales of foreign-owned enterprises) because of the limitations of available information (and not because of a belief that the effects on foreign operations are inconsequen- tial). An estimated $80 billion of U.S. foreign sales were covered by U.S. export controls in 1985 a value that is at the low end of the range as explained in the annex entitled "Calculation of Economic Costs." It is likely that broadening the scope to include foreign firms would increase severalfold the figure for the economic activity influenced by U.S. controls. Returning, then, to U.S. foreign sales as the basis for measurement, the activity needs to be allocated among the various destinations and license types. But for purposes of evaluating the economic effect of U.S. export controls, the basic framework outlined in Figures D-1 and D-2 is too simple. Further subdivisions by destination and type of license are necessary because the economic effects vary across these subcategories. Moving to Figure D-3, trade under validated licensing is divided into major categories according to type of export control (i.e., national security, foreign policy, nuclear/other). The economic cost estimate developed in this report covers only those costs associated with self-licensed trade and with national security controls (the shaded areas of Figure D-31.7

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 259 The geographic divisions have been further broken down. The Eastern- bloc category is divided into the People's Republic of China and all other bloc countries, including the Soviet Union. This differentiation is needed because of the more liberal licensing policy for trade to the PRC relative to that for the Soviet Union and the other bloc countnes. Similarly, Canada is separated from other CoCom countries because the United States does not require validated licensing of most exports for use or consumption in Canada, although changes in U.S. reexport license procedures could have a direct effect on U.S.-Canadian trade. Finally, 15 Western countries are treated differently in the license review process than are other non-CoCom Western destinations (following a presidential directive authorizing Defense Department review of certain applications from these countnes). This necessitates establishing a separate category for these nations. The segment of trade covered by national security controls also must be split into subcategories to reflect the fact that the types of validated licenses used for national security purposes have differential effects on business activity. This breakdown, however, is kept somewhat simplified by showing only two validated license categones: bulk licenses (pnncipally the distribution license) and individual validated licenses (IVLs). In our earlier report to the panel, the total value of U.S. foreign sales to Western destinations under some form of validated license was estimated Destination West-East* Non CoCom r Western countries I CoCom countries 1 Trade/sales under self-licenset . Fir ~ 1 ! ! ! 1 1 1 Direct ~ Through export ~ foreign I I affiliate ! i I 1 1 1 1 1 1 Direct I Through I export I foreign I I affiliate TradeJsales under validated license *West-East refers to trade with bloc countries and the PRO. Thor example, the general destination license (GDEST). FIGURE D-2 Expanded scope of U.S. economic activity covered by U.S. export control system.

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260 . 1 1 1 I ~ ~ 1 I .~: 0 = ~ o ! F : Ha: =~ = ~ s~ o -= 0 o e e Hi: ~ m a = = 1 = .~ a 0 ~ T . I C ~ . o ~ ~ o o ~ 1 o c o oo .E a: ~ . o o o o .g s e o o o O ~ O > a O ~O 1 ~ = . O 8 ~ ~ o o o

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 261 to be $78 billion in 1985. An additional $2 to $3 billion is estimated to have been shipped to the bloc (including the USSR) and the PRC under license. Figure D-4 shows the estimated allocation of licensed foreign sales of U.S. firms by level of criticality and destination for 1985. Total Canadian foreign sales related to the U.S. export license system are shown only for reference. An estimated 97 percent of U.S. validated license sales are made to Western destinations. Or, looked at in terms of level of military criticality, an estimated 94 percent of licensed trade falls below the high-criticality threshold (i.e., the items are eligible for shipment under a distribution license). RELATIONSHIP OF BENEFITS AND COSTS TO LEVEL OF CRITICALITY This section examines the relationship between several key factors that ultimately influence the distribution of costs and benefits associated with U.S. export controls. Figure D-5 illustrates how the value of costs and benefits varies with the degree or level of military criticality of an item. This figure summarizes a crucial point regarding the likely distribution of competitive costs and security benefits: As the level of "military" criticality increases, competitive costs fall, 8 while the security benefits of controls increase. To explain this conclusion, several essential concepts useful to characterizing the export control process must first be defined. We start by examining the relationship of security benefits from controls to the level of military criticality. Export controls are intended to enhance Western security by denying, or at least delaying, the transfer of militarily useful products and technol- ogy to the Soviet Union and other proscribed destinations. The security benefits of export controls for a particular technology or product vary directly with the potential damage to national security that a loss of that technology or product would cause; that is, the higher the degree of military usefulness of a particular product or technology, the greater the security benefit of denying its transfer to proscribed destinations. Critical- ity is the term used to reflect the degree of military usefulness, which in turn is reflected in the degree of classification by CoCom and U.S. authorities. Therefore, a higher degree of criticality indicates a greater need for control because of the greater extent of national security risk. Diversion risk (from the U.S. perspective) is defined to be a function of the quality of controls in the destination country and the degree of access to non-U.S. sources of comparable products or technology.9 Higher diversion risk is associated with the absence of adequate controls in a destination country. U.S. unilateral control measures can reduce the diversion risk of an export to such a country only to the extent that a

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262 _ _ ~ V o 1 ~ 1 o. c~i ~ tD ~ U. O |N . {D U) U' e, - :, _ .~.O =._ _ ~ ~) J _ ~_ __ ~ ei ~ o j- e ._ ~0 U. ~ ~n j V 1 ~, ~ V 1 1 _ ,~, 1 I. C ~C v l l ~ 1 ~. ~ ~ ~ m. ~ ~ c 1 1 1 E .^ - ., ~ ~ ._ I~oo . {D j ~ - ~n e ._ ~ ~ 0 0 ~ ~n j - o C 0 ~n.o e? 1 1' ' o - e ._ - ~n C] _% U. o ._ - - ._ oo - o ._ c ._ Ct ;^ _. - Cd ._ .C _~ ~n _~ .__ ._>` C~ e~ .=Cd +~ tn0 ._ C] 11 ~n C~ ~n c ._ in o~;~o O' 0~1 4, Co I C 0 0o C) a~ U) ~: C) - o o ._ .c u, . . u,

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 263 Value of Benefits or Costs Relative to Level of Criticality Cost of Compliance / \ to U.S. ~ / Business / \ \ K ,, ~ I Security Benefit ~ of Export Controls 1 +Low/Medium Criticality Increasing Level of Criticality -- ~ High .1 Criticality I FIGURE D-S Distribution of benefits and costs of export controls relative to level of criticality. comparable product is not available to the destination country without U.S. export controls. Thus, either adequate indigenous export controls or greater U.S. controllability is associated with a lower degree of diversion risk. It also can be postulated that, as the level of criticality increases, the degree of foreign access to an equivalent non-U.S. technology or product tends to decline.~ This implies that U.S. controllability increases with the level of criticality. Given the relationships between controllability and other factors, we conclude that as the level of criticality rises the security benefits associ- ated with U.S. export controls increase. To conclude, security benefits are not uniformly distributed across all levels of criticality but rather are concentrated in the region of highly critical technology and/or products. The relationship between the economic costs associated with export control compliance and level of criticality can now be examined. As established from a sample of license applications, a substantial proportion of the items covered by the export licensing system are low-criticality items-that is, comparatively low-technology items. Any technology edge one might expect a U.S. firm to have relative to its foreign competitors is less likely to exist for this low-end category. In addition, as non-U.S. sources for these items increase, the more likely it becomes that U.S. export controls will drive foreign customers away from U.S. sources. The result is that the cost borne by U.S. firms of lost sales associated with export control compliance is greatest for those items with the lowest degree of military criticality. A qualitative assessment (based on interviews and analysis) performed in the earlier study indicates how the extent of the economic impact of controls varies across the different destinations and levels of technology.

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264 APPENDIX D TABLE D-2 Qualitative Assessment of the Degree of Economic Impact by Level of Criticality and by Destination Degree of Impact Destination Low 2.8 Bloc 1.0 Medium 4.4 PRC 1.6 High 1.0 15 Western countries 3.8 Other Western nations 3.9 CoCom countries 3.1 NOTE: The table excludes self-license and Canadian trade categories. Degree of Impact (Figure D-6 illustrates these variations; the darker the shading, the greater the degree of economic impact.) Western destination, low- and medium- criticality items are the most affected. 12 Table D-2 summarizes the qualitative assessment by weighting the impact estimates, using data shown in Figure D-4, for each combination of destination and level of criticality. The purpose of the table is to summarize where the economic costs associated with U.S. controls are estimated to be the greatest. The numbers simply indicate relative orders of magnitude. Weights from Figure D-4 were applied to the qualitative scale shown in Figure D-6 and averaged, either for columns (i.e., by level of criticality) or for rows (i.e., by destina- tion). On a scale of 0 to 5, 0 indicates no effect and 5 indicates the greatest effect. This qualitative assessment suggests that economic costs are greatest for West-West trade on low- and medium-technology products. ESTIMATE OF ECONOMIC COSTS ASSOCIATED WITH U.S. EXPORT CONTROLS A reasonable estimate of the direct, short-run economic costs to the U.S. economy associated with U.S. export controls was on the order of $9.3 billon in 1985. This is a very conservative estimate because it does not cover all aspects of economic costs and it only applies to a subset of the potential scope of business activity influenced by U.S. export controls. (Table D-3 details the major components of this figure.) Asso- ciated just with lost U.S. exports was a reduction in U.S. employment of 188,000 jobs. If we were to calculate the overall impact on the aggregate U.S. economy of the value of lost export sales and the reduced R&D effort, the associated loss for the U.S. 1985 GNP would be $17.1 billion.~3 In evaluating the economic cost estimates presented in Table D-3, it is useful to keep in mind both the framework developed earlier in this report (see the section entitled "Scope of U.S. Foreign Sales Covered By Validated

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 267 basis to extrapolate the likely impact across all segments of licensed U. S. manufactured exports. We chose this approach for several reasons. First, the estimate is based on empirical rather than anecdotal evidence. It is the only estimate we are aware of that has been developed from actual trade data. It is useful to note that the size of the effects is consistent with the general anecdotal evidence, conclusions of knowledgeable experts interviewed in the course of preparing this report, and information developed in a survey of U. S. firms prepared for the panel. A second reason for using the analytic instruments estimate is that there is no clear reason to believe that the analytic instruments case is extreme or unique. It must be recognized that the effects of U.S. export controls that is, lower overall U.S. foreign sales are built into the level of current U.S. exports. Therefore, it is difficult to extract from general U.S. trade data and other data currently available to the panel measures of the extent of the impact of controls. The analytic instruments case, on the other hand, permitted us to make an empirical appraisal of the degree to which the unilateral elements of the U.S. export control process influence the level of U.S. exports in the affected sectors. (The reader should keep in mind that it is only the degree of "unilateralness" of the U.S. system that affects U.S. firms' competi- tiveness.) As indicated in the introduction to this report, we believe further data would permit a more accurate assessment. Therefore, the estimate is developed to indicate a reasonable order of magnitude. Obviously, further efforts could refine it and allow a greater degree of precision. But it should be recognized that the limits of available data were reached in preparing this estimate. Tables A-1 and A-2 present data from a sampled of 1,600 IVLs, which permit calculation of the distribution of U.S. IVLs by value and number for the level of criticality and destination. The distribution of trade under bulk licenses (predominantly the distribution license) was assumed to follow the same distribution with respect to level of criticality. This assumption results in 34 percent of the value of bulk license trade being classified as medium criticality (i.e., above AEN but within the distribu- tion license level),~5 and the balance as low criticality (i.e., below the AEN level). (Because many firms using bulk licenses reported they do not take the trouble to reclassify their low-technology items below the AEN level out of the licensing system, this assumption probably overstates the average level of technology supplied under bulk licenses.) Using the distribution of trade by destination for each level of technol- ogy (see Table A-2), the 1985 foreign sales for each level of criticality (see Figure D-4) were distributed across the different destinations. Table A-3 shows the base trade data on U.S. foreign sales by destination. The foreign sales data were taken from a U.S. Department of Commerce 1982

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268 ~PENDIX D TABLE A-1 Distribution of License Sample By Destination and Level of Technology fin thousands of dollars and (number of licenses)] Level of Criticality DestinationAENMARC~DL>DL Bloc1,540810384a3,744 (28)(9)(3)(8) PRC4,64110,3202754,667b (39)(43)(10)(13) 15 Western countries11,43011,44016,20028,140 (90)(110)(54)(42) Other Western nations35,09135,10031,50431,150 (159)(130)(82)(50) CoCom countries314,72062,08821,97151,490 (280)(199)(173)(95) TOTAL367,422119,758C70,334c119,191 PERCENTAGE OF54.317.710.417.6 TOTAL VALUE aUsed overall average. bUsed non->DL average. CMedium category is the sum of MARC and ~DL columns. SOURCE: Based on the sample of individual validated licenses. See Appendix E, "Analysis of the Erects of Export Controls," vol. II. benchmark survey on U.S. foreign operations. The allocations presented in these tables, especially for the 15-Western-countries and other-Western- nations destination categories, could only be estimated because published Department of Commerce data were not disaggregated sufficiently by individual country destination to permit an exact allocation. However, it is believed that the relative magnitudes are reasonable. TABLE A-2 Column Proportions for the Distribution of Licenses by Destination for Level of Technology Destination AEN MARC ~DL >DL Bloc 0.4 0.7 0.5 3.1 PRC 1.3 8.6 0.4 3.9 15 Western countries 3.1 9.6 23.0 23.6 Other Western nations 9.6 29.3 44.8 26.1 CoCom countries 85.7 51.8 31.2 43.2 TOTALa 100.0 100.0 100.0 100.0 aDue to rounding, totals may not equal exactly 100.0 percent. SOURCE: Table A-1.

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 269 TABLE A-3 Estimated Distribution of U.S. Foreign Sales in 1982 (in billions of dollars) Other Trans Other Electr~cal portation Computing Equip- Equip- Equip- Instru Equipment ment ment ment meets Destination aa b a b a b a b TOTAL Canada 2.5 0.1 1.3 0.6 3.5 0.9 1.0 1.4 1.1 0.2 12.6 Other 17.0 0.5 10.1 0.7 12.2 3.4 1.4 4.8 10.0 0.7 60.8 CoCom countries Other 1.7 0.5 0.1 1.9 9.6 5.6 0.1 5.3 1.3 1.0 27.1 Western nations 15 Western 1.0 0.1 0.5 0.2 1.7 0.7 0.5 1.2 0.3 0.1 6.3 countries TOTAL 22.2 1.2 12.0 3.4 27.0 10.6 3.0 12.7 12.7 2.0 106.8 a Sales by U.S. foreign affiliates. b Direct export sales to unaffiliated parties. NOTE: For some geographic groupings and/or product groupings, Bureau of Economic Analysis (BEA) data were not available. Therefore, an estimate was made for these groups consistent with overall BEA data. The distribution is believed to be a reasonable represen- tation of the pattern of U.S. foreign sales by destination for the major product categories associated with use of a U.S. validated license. The 1982 values were uniformly inflated by a factor of 1.21 to yield 1985 values. The factor accounts for inflation and real growth in the 1982-1985 time frame. The 1982 value was rounded to $107 billion, and the 1985 value was rounded to $130 billion. SOURCE: Calculated from data in U.S. Department of Commerce, Bureau of Economic Analysis (BEA), U.S. Direct Investment Abroad: 1982 Benchmark Survey Data (Washing- ton, D.C.: GPO, 1985); and a special BEA tabulation of 1982 export data using the benchmark survey data. The estimated 1982 U.S. export value was $42.5 billion for five industrial categories whose export trade was covered by validated licens- ing (see Table A-41. This was adjusted to a 1985 value of $51 billion. (The 1982 value was inflated by a factor of 1.21 to yield the 1985 value. The factor accounts for inflation and real growth in the 1982-1985 time frame.) Data developed from a survey of U.S. distribution license holders suggest that the five industrial categories represented about 84 percent of total U.S. licensed export trade in 1985, which is estimated to be about $62 billion. The $11 billion difference is accounted for in trade under validated licensing spread across a large number of U.S. manufacturers' export categories. To prepare the cost estimate, this trade was assumed to

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270 APPENDIX D TABLE A-4 Estimated Allocation of U.S. Foreign Sales Between U.S. Direct Exports and Foreign Affiliates in 1982a (in billions of dollars) Total Foreign Exports to Exports to Total Destination Shiest AffiliatesC Nonaffiliates Exports Canada 12.6 3.6 3.0 6.6 Other CoCom countries 60.8 4.5 10.6 15.1 Other Western nations 27.1 3.6 14.3 17.9 15 Western countries 6.3 0.6 2.3 2.9 TOTAL 106.8 12.3 30.2 42.5 aAdjusted to a 1985 basis, the total estimate increases from $42.5 billion to $51 billion. bTotal foreign sales figures include both exports to affiliates and exports to nonaffiliated. CExports to affiliates (column b) cannot be deducted from total foreign sales (column a) to estimate sales originating from foreign affiliates because U.S. content is measured at a different point in the process. Total exports = exports to affiliates + exports to nonaffiliated. SOURCE: Estimated from data in Tables III.G.4 and III.G.9, U.S. Department of Commerce, Bureau of Economic Analysis, U.S. Direct Investment Abroad: 1982 Bench- mark Survey Data (Washington, D.C.: GPO, 1985); and from the allocation developed above in Table A-1. go to the four destination groups (Canada, other CoCom countries, other Western nations, and the 15 Western countries) in the same proportion as the five high-tech categories. This total value of $62 billion was divided between IVL-covered trade and bulk license trade (predominantly export trade under distribution licenses) and self-licensed trade (i.e., under general license GDEST). A 1985 IVL coverage of $36 billion was used; this figure includes trade with the PRC and bloc countries, which represented approximately 8 percent of the total or about $3 billion. A 1985 bulk license coverage of $26 billion for exports was used.~7 (See Table 9, "Analysis of the Effects of Export Controls," vol. I, for an estimate of service and project license coverage.) The level of lost sales associated with U.S. exports in 1985 to Western destinations was estimated as follows. The fraction of U.S. exports under IVLs to nonbloc and PRC destinations (33/59) was applied to the total 1985 export trade for each major destination (15 Western countries, CoCom countries, and so forth) to get the 1985 value of IVL exports to each destination. For the other-CoCom-countries category, a direct estimate of the degree of lost sales had been made for one segment of U.S. manufactured exports, analytic instruments. (See Appendix B.1, "Analysis of the Effects of Export Controls," vol. II.) The range of impact of U.S. controls on analytic instruments exports was from 7 to 12 percent. The analytic instruments case, in which U.S. interpretation of essentially

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 271 multilateral controls was changed- first loosened and then tightened- allows a measurement of how differential U.S. licensing practices influ- ence U.S. exports, even within a multilateral framework. The empirical result is believed to be consistent with qualitative appraisals covered in the first report to the panel. We prepared our estimate from this base because it is the first quantitative estimator that has been made for the economic impact of controls, even though it covers only a small portion of U.S. licensed trade. It should be treated as an order-of-magnitude estimate. For the purposes of this analysis, a value of 10 percent was used as the measure of lost sales the midrange of the analytic instruments estimates. This estimate of 10 percent for lost sales due to export controls was then applied to the entire category of other-CoCom-countries trade under IVLs. To obtain lost sales estimates for the other destination categories (15 Western countries and other Western nations), the 10 percent rate of lost sales was scaled relative to the other-CoCom-countries level using the qualitative factors contained in Table D-2. (For example, other- Western-nation destinations were assessed to be affected to a greater degree; the 10 percent estimator was scaled by 1.26, the differential relative to the other-CoCom-countries category.) The overall estimate for the value of lost U.S. export sales in 1985 under the IVL was $3.8 billion. For the bulk license component of export trade, the same process was used. Bulk licenses were estimated to cover a particular fraction (26/59) of total U.S.-licensed exports. Relative to the rate of lost sales under IVLs, it was assumed that distribution license-covered trade was affected to only half the degree that IVL-covered trade was affected. This is a subjective assessment based on responses to a questionnaire that indi- cated that U.S. firms were losing some sales of bulk-licensed trade. (See "Analysis of the Effects of Export Controls," vol. I, pp. 54-56.) The overall amount of lost sales estimated for bulk-licensed exports was $1.5 billion. Finally, the impact on self-licensed exports was subjectively estimated to be one-tenth the IVL rate. The total value of U.S. foreign self-licensed sales influenced by U.S. export controls was estimated to be $62 billion. These are sales for those categories of manufactures in which some foreign sales are under validated licenses. If all U.S. self-licensed foreign sales were covered, the figure would be six times greater. This impact arises indirectly, principally due to U.S. reexport requirements and overall U.S. license policy. Again, the degree of lost sales is believed to be consistent with the firm interviews. (See Section V, "Analysis of the Effects of Export Controls," vol. I, pp. 57-69.) This segment of export trade was estimated to have lost sales of $0.6 billion. (It should be noted that, while the rate of lost sales for the non-IVL categories is subjective,

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272 APPENDIX D the base to which that rate is applied is calculated using data from the Department of Commerce and U.S. businesses.) To summarize, the overall estimate for lost sales of U.S. exports to Western destinations was calculated to be $5.9 billion ($3.8 IVL, $1.5 bulk, $0.6 self-license). (Canadian trade was excluded from the calcula- tions except in the self-license segment because U.S. reexport procedures cover even Canadian reexports.) B-2. ASSOCIATED GNP LOSS $~.8 BILLION A GNP multiplier of 2 was applied to the direct U.S. export loss to calculate the associated loss to the U.S. economy due to lower U.S. exports. This multiplier value was based on discussions with economists at several government and financial institutions who regularly calculate and apply U.S. GNP multipliers. Cal. REVENUE LOSS FOR WEST_EAST EXPORTSIB $~.4 BILLION With respect to the bloc countries and the Soviet Union, the evidence developed in our earlier report suggests that, generally, U.S. firms have given up trying to trade with the bloc countries and the Soviet Union. Whereas other CoCom countries exported approximately $16 billion of manufactures to the bloc and the Soviet Union in 1985, U.S. exports were well under $1 billion. (These figures include both licensed and self- licensed trade.) Obviously, part of this large disparity is due simply to the advantages the European Community-based firms have as a result of long-standing business relationships and simple geography. Still, if U.S. controls and procedures were more closely harmonized with those of other CoCom countries, U.S. sales would be higher. In West-West trade, most of the economic impact associated with U.S. export controls fell on license-related foreign sales; for trade with the bloc, however, our qualitative assessment suggests that the self-licensed segment was the area for which the value of lost sales was more significant. (See Table D-2 and Table A-5 for the basis of this appraisal. Note that Table D-2 excludes self-licensed trade.) This appraisal should be kept in mind in evaluating the estimate of lost U.S. sales to the bloc. Self-licensed trade with the bloc is influenced because of U.S. licensing requirements on services and support (including training) and on spare parts, and because of general U.S. licensing policy, which makes the United States less preferred as a source of supply. The value of European Community and Japanese manufactures trade to the bloc was about $16 billion in 1985. Of the total, we estimated that roughly 10 percent occurred under a validated license. (For the U.S.

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 273 TABLE A-5 Notes on Figure D-6 of the Extent of Economic Impact Beyond Intentional Denial Destination Level of Criticality Bloc 3(a) l(b) l(b) l(b) PRC 2(f) l(c) 2(c) 10) 15 Western countries l(f) 3(d) 5(e) 10) Other Western nations l(f) 3(d) 5(e) 10) Other CoCom countries l(f) 3(g) 4(h) 10) Canada l(f) 2(g) 3(i) 10) SL LC MC HC aCODES: 0 = No effect. 1 = Secondary impact. 2 = Limited impact. 3 = Moderate impact. 4 = Significant impact. 5 = Largest impact. (a) Spare parts and training cause competitive problems; makes it difficult to support a basic level of trade. (b) Limited volume of opportunity; reexport not an issue nor is rate of denial. (c) Reexport not a problem. (d) U.S. reexport authorization and intensive level of end user screens create problems. (e) Heavy degree of U.S. screens on destination and problems with U.S. reexport authority. (f) Spillover effect (i.e., U.S. controls on some items) creates broad disincentive to rely on U.S. source. (g) If an end user wants to incorporate U.S.-licensed technology and components, more than minimal problems are created in relation to other CoCom-based sources of supply. (h) Additional screens and reexport authority. (i) Reexport authority; cannot reexport in this category without approval. (I) Little opportunity in general for foreign purchaser to go elsewhere (i.e., the U.S. technology edge offsets the U.S. red tape disadvantage). SL = Self-license. LC = Low criticality. MC = Medium criticality. HC = High criticality. firms, we estimated that nearly 20 percent of 1985 manufactures foreign sales was under license. We assumed that the other CoCom countries had only half the proportion of trade covered by license. Because this is a global average, however, it may understate the volume of trade under validated license to the bloc.) Using a 10 percent validated license figure suggests that roughly $14.4 billion of European Community and Japan manufactures trade with the bloc was self-licensed. We also assumed that total Western trade of manufactures to the bloc was the total market

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274 APPENDIX D available; any lost U.S. sales are shifted to other Western sources. If U.S. firms could capture at least half the same share of that total market as they do of total world manufactures trade (roughly 20 percent), this would suggest that the amount of lost U.S. sales to the bloc countries because of export controls was about $1.4 billion in 1985. Focusing just on the licensed segment, the estimate would be consid- erably less. Assuming that 10 percent of CoCom manufactures trade with the bloc is licensed and assuming that U.S. firms would have captured an additional 10 percent of the licensed trade, then the lost sales figure would be $0.1 billion. We used the estimate for the self-licensed segment because, as indicated earlier, the qualitative appraisal is that the eco- nomic impact falls mainly on the self-licensed segment. C-2. ASSOCIATED GNP Loss $2.8 Samoa The multiplier used for West-West export sales loss was also used here for West-East losses. D-~. R&D DIRECT SPENDING Loss $o.s BILLION We have included an estimate of lost R&D effort because the export licensing system tends to focus on the it&D-intensive sectors of the U.S. economy. The estimate simply takes the fraction of total lost foreign revenues that, on average, would be used to fund R&D. The R&D-to- sales ratio for the high-technology firms covered by the validated licens- ing system was estimated to be 9.2 percents in 1983. This ratio was used to calculate the lost R&D input associated with lower U.S. exports and an additional component due to lower overall total U.S. foreign sales. The reduction in U.S. R&D spending was estimated to be about $0.48 billion. (This represents about a 1 to 2 percent reduction in the overall level of industrial R&D spending for the five high-technology sectors covered in our estimate.) D-2. ASSOCIATED GNP Loss $~.5 s`EE'oN A multiplier of 320 was used to estimate the overall GNP loss associated with the reduction in R&D spending. This suggests that the overall loss to the U.S. economy from lower R&D spending was $1.5 billion. E-~. VALUE OF LICENSES DENIED $o.s BILLION See Table 10, "Analysis of the Effects of Export Controls," vol. I. The figure represents the actual value of licenses denied in 1985.

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 275 E-2. ASSOCIATED GNP LOSS $~.0 BILLION F. LOST PROFITS ON LOST EXPORTS $o.s BILLION Table III.D.8, "Income Statement of Affiliates, Industry of U.S. Parent by Account," from the BEA benchmark survey data (see Table A-3) shows net income for the five high-tech manufacturing affiliates to be about 6.2 percent of the value of sales. This is applied to the total value of lost export sales and foreign affiliate sales, assuming that the rate of profit in 1985 was the same and uniform for export sales and foreign affiliate sales. G. ANNUAL EMPLOYMENT Loss ~88,ooo The direct export loss associated with U.S. export controls was $7.3 billion. The annual job loss of 188,340 was based on a value of 25,800 jobs lost per $1 billion of exports lost. NOTES 1. "Relative" in this context is defined with respect to firms headquartered in other countries that subscribe to the multilateral control system (CoCom). 2. Military importance is defined by the extent of control exerted by CoCom and the United States. Based on the definitions contained in CoCom and U.S. licensing concepts, we define four basic levels of military importance. In their ascending order, they are: (1) items eligible for national discretion in exporting to the Soviet bloc (administrative exception note or AEN); (2) items eligible for national discretion and permission for reexport to the People's Republic of China ('PRC); (3) items eligible for the distribution license (ADO); and (4) items not eligible for export using a distribution license (>DL). In the last category, some items are included for reasons other than national security. 3. These categories are developed from the nomenclature outlined earlier in note 2. Low-criticality items fall within CoCom national discretion (AEN) levels; medium criticality includes all items above the AEN level but below the distribution license level. High-criticality items are those not eligible for the distribution license. 4. The impact of U.S. controls on affiliate sales cannot be dismissed as inconsequential for some U.S. multinationals, their foreign affiliates may be their only customers for U.S. exports. 5. Technically, all U.S. exports require a license. A large proportion of U.S. exports are shipped under a self-license; that is, the exporter is not required to submit a license application and receive specific prior authorization. Included in the self-license segment are exports made under the general destination license (GDEST); we also consider as self-licensed trade, for the purposes of this analysis, general licensed trade (shipped under the G-COM license). 6. This arises because the extent of the foreign firms' sales (including reexport) is affected by incorporating U.S. parts and components, and they, therefore, may avoid relying upon a U.S. source. 7. Practically speaking, this narrower definition of scope cannot always be maintained.

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276 APPENDIX D Not all the data developed in our first report to the panel could be categorized by type of export control (i.e., national security, foreign policy, nuclear nonproliferation, short-supply, and crime control). To keep this in perspective, however, in those cases in which 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 overwhelmingly reflect national security controls. See Table E.3, Data Appendices, "Analysis of the Effects of U.S. Export Controls," vol. II. It should also be noted that most U.S. businesses, and especially foreign users of U.S.-controlled products, do not realize there is a distinction among the different types of controls. Management decisions are based on the need to obtain a license and not on the underlying government rationale for requiring the license. 8. Administrative compliance costs probably increase. But, although the administrative cost per transaction is high, the total cost, which includes competitive costs, is low in relation to low-level technology items since the number of transactions is only about 15 percent of total licensed transactions. See "Analysis of the Effects of Export Controls," vol. I, pp. 57-69, for a discussion of the relationship between compliance and administrative costs and level of military criticality and destination. Firms that were interviewed indicated that compliance and administrative costs increased with the level of military criticality and with diversion risk. 9. Diversion risk could also be defined as a function of military usefulness; that is, the risk would be directly related to criticality. But here we use a different definition by defining diversion risk as a function of destination country characteristics. 10. The notion is that the higher the technical performance of the item or the greater the degree of sophistication of the technology, the more likely it is that the United States is the principal source of the technology. The reader should note that we are not claiming the United States has a monopoly on high-criticality technology. Rather, we are saying that on balance the United States is more likely to have the dominant position in this category (i.e., high-criticality items) than in the less critical categories. 11. See "Analysis of the Effects of Export Controls," vol. I, pp. 40-44. 12. The extent of the economic impact (beyond intentional denial) is a function both of the volume of trade in a particular category, the screens applied to end users, and other factors such as the necessity for U.S. reexport control authority, which may result in the avoidance of U.S. products by foreign (Western) firms. Table A-S in the annex annotates Figure D-6 with the simplified evaluations that led to the conclusions on the degree of impact for each level of technology and destination. 13. This estimate is the multiplier impact of the lost export revenues and lower R&D effort on the overall U.S. economy. Multiplier refers to the change in overall U.S. GNP associated with the decrease in U.S. exports or reduction in R&D spending. In economic parlance, it is the change in aggregate spending associated with a change in external or autonomous spending (in this case, a reduction in exports or R&D). See, for example, pp. 65-70 in Rudiger Dornbush and Stanley Fischer, Macroeconomics (New York: McGraw-Hill, 1978), for further discussion. 14. See Appendix A, "Analysis of the Effects of Export Controls," vol. II, for a discussion of the sample. The numbers simply indicate relative orders of magnitude. Weights from Figure D-4 were applied to the qualitative scale shown in Figure D-6 and averaged, either for columns (i.e., by level of criticality) or for rows (i.e., by destination). On a scale of 0-5, 0 indicates no effect and 5 equals the largest effect. 15. There cannot be any high-criticality bulk license trade because high-criticality items are defined as items not eligible for the distribution license. 16. See Stephen Merrill, "International Business Under the Distribution License," pre- pared for the panel.

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ECONOMIC COSTS OF U.S. NATIONAL SECURITY CONTROLS 277 17. This includes $22 billion for U.S. distribution license trade coverage and $4 billion for trade under other types of bulk licenses. The estimated coverage of $42 to $56 billion for bulk licenses presented in the earlier report to the panel refers to both U.S. exports and foreign sales. 18. We do not include PRC trade in the scope of West-East exports. No explicit estimate is made with respect to the U.S.-PRC trade. 19. Calculated for high-technology manufacturing industries, except chemicals and allied products, from data in Appendix Tables 4-5 and 4-7, Science Indicators: The 1985 Report (National Science Board). 20. This multiplier was taken from M. Baily and R. Lawrence, "The Need for a Permanent Tax Credit for Industrial Research and Development" (The Coalition for the Advance- ment of Industrial Technology, February 1985), pp. 61-63. 21. Source: Lester A. Davis, "Contribution of Exports to U.S. Employment," in United States Trade Performance in 1985 and Outlook, pp. 92-94.