ATTACHED IS THE SANITIZED VERSION OF THE JEC TRANSCRIPT FOR 21 NOVEMBER 1984 ON CHINA

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP87M01152R000400520010-5
• Release Decision: RIPPUB
• Original Classification: K
• Document Page Count: 30
• Document Creation Date: December 22, 2016
• Document Release Date: November 20, 2009
• Sequence Number: 10
• Publication Date: August 26, 1985
• Content Type: LETTER

Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MO1152R000400520010-5
OLL 85 1300/1
.'Record Copy
'l CENTRAL INTELLIGENCE AGENCY
Office of Legislative Liaison
.W.,olTelephone: 351-6136 26 Aug 85
TO: Joint Economic Committee
United States Congress
Attn: Richard Kaufman
Attached is the sanitized version of the
JEC transcript for 21 November 1984 on China.
STAT~
Liaison Division
According to
been:,seen' by ADDI.
(23 Aug 85
OBSOLETE
FORM 1533 P
REVIOUS
3-79 EDITIONS.
his branch chief, the document'has STAT
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MO1152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
Senator Proxmire. Now let's get into the Chinese, if you'd
like to present your presentation there.
Mr. Gates. All right, sir.
Much of what has happened economically in China over the
past year-and-a-half reflects the successes and failures of
Beijing's massive experiment with economic reform. The
.experiment, which has been underway since 1978, has touched
virtually every sector of the economy. Under what China calls
its "contract responsibility system," farmers now have effective
control, but not ownership, of most of the acreage in China.
Peasants determine, to a large degree, what and how much they
produce.
Enterprises that formerly remitted all but a small share of
their profits to the state now retain a much larger share.
Moreover, for the first time in over 20 years, individual
entrepreneurs have been allowed to set up small businesses, such
as restaurants, barber shops, and clothing stands, and actually
to employ small numbers of workers.
Economic performance in 1983-1984, particularly in
agriculture, looks quite impressive, statistically. Agricultural
output jumped sharply as a result of both the contract
responsibility system and the better-than-ever weather
conditions. Grain output reached a record 387 million tons in
1983, and may top 405 million tons this year. Cotton production
jumped 25 percent last year, to a record 4-1/2 million tons. And
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
another rise, perhaps as much as 10 or 15 percent, may be in the
offing this year.
The energy sector provided Chinese policymakers with what
was perhaps their most pleasant economic surprise of 1983-1984,
as primary energy output rose at about a 6-percent clip, the
fastest pace in five years.
Oil production rose to 106 million tons in 1983, enabling
China to export 15 million tons of crude, and output should hit a
new record of 114 million tons by the end of this year.
Coal output topped 700 million tons last year, and probably
will reach 760 million this year.
China's international financial picture also improved
steadily over the past 18 months. International reserves now
stand at more than $20 billion, the tenth largest worldwide, and
China will run a fourth consecutive large trade surplus in
1984. Beijing has borrowed very little over the past two years,
and much of what it acquired came in the form of government-
subsidized loans or money from international financial
institutions at low interest rates. As a result, less than 6
percent of export earnings are required to service China's
foreign debt.
The military has been asked to sacrifice somewhat for the
time being in order to help revive China's economy. Chinese
budget statistics show defense outlays as a share of government
spending falling moderately, from 17-1/2 percent in 1979, during
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
the border war with Vietnam, to 15.3 percent in 1982, and 13.7
percent last year.
Although data for 1984 are still unavailable, we believe the
military expenditure figure remained at 13-14 percent of
government spending.
The PRC figures probably understate total defense spending,
but we believe they accurately reflect the recent trends. The
military has so far accepted the need for sacrifice, with the
.understanding that as the economy improves the armed forces will
be appropriately rewarded.
The statistics on industrial performance also appear quite
respectable. Industrial production rose at an annual rate of
about 11 percent over the past 18 months.
Senator Proxmire. Can I interrupt to ask: You have just
read that military expenditures may have slipped below 15 percent
of government spending by now.
Mr. Gates. Yes, sir.
Senator Proxmire. Can you give us a percentage of GNP?
Mr. We haven't done the same kind of costing things STAT
that our colleagues covering the Soviet Union have done. But we
do have a GNP figure worked out in dollars, and I could sit down
and crank a rough estimate out for you. The hesitations that the
Soviet analysts have in doing this kind of thing are even more
amplified in our group.
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
Senator Proxmire. Can you give us a ballpark figure? Would
this be 10 percent of GNP, or 12, or eight?
Mr. I will provide that information for the record. STAT
Senator Proxmire. All right.
(INFORMATION TO BE FURNISHED.)
RESPONSES TO QUESTIONS FROM PROXMIRE HEARINGS
CHINA SECTION
STAT
PAGE 81
THE DEFENSE BURDEN
Beijing claims that it spent 17.7 billion yuan (about $9
billion) on defense in 1983. We calculate that China's GNP for
that year was about $275 billion which yields a defense burden of
only about 3.3 percent. CIA's military experts believe that the
Chinese figure for military spending may understate actual
expenditure levels by as much as 50 percent. Assuming this to be
the case, the actual defense burden is probably closer to 7
percent of China's GNP.
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
Mr. Gates. An equally impressive performance has been
achieved in their production of such consumer items as
refrigerators, washing machines, fans, and TVs. Beijing has
experienced some inflation, but at manageable levels of 5 to 8
percent.
In short, we estimate that China's real GNP grew about 8
percent last year, and even sharper growth of 9 to 11 percent can
be expected this year.
Despite the impressive statistics, Chinese leaders have
become increasingly dissatisfied with the industrial sector.
When reforms were first introduced in 1978, it was not industrial
growth that the government was interested in. In fact, Beijing
said it would willingly sacrifice short-run growth if, through
reform, it could make its enterprises more efficient.
In this area, China has failed. Its domestic enterprises
continue to be among the world's most inefficient, using, by some
estimates, up to 3-1/2 times more energy to produce a unit of
output than the average less-developed country firm.
At the same time, energy shortages presently idle 20 percent
of China's industrial capacity. Raw material consumption is also
high, and has shown almost no sign of coming down.
The state calls for reductions in per-unit consumption of
raw materials, have been answered instead by increases. Then,
too, the quality of China's output remains very low. And labor
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
and capital productivity have failed to improve under initial
reform efforts.
Finally, when China released its grip on the industrial
decisionmaking process, it also gave up some of the control it
once had over macroeconomic activity. In the wake of that move,
China has been forced to accept five consecutive budget deficits
totalling more than 55 billion yuan, about $25 billion.
Runaway local investment drained both capital and raw
materials away from high priority infrastructure projects, and
mounting price pressures showed up in budding black markets,
speculative activity, and rising free market prices. For a
while, the problems associated with the early reforms threatened
to overshadow the agricultural gains. In the 1981 to 1983
period, China's Communist Party strenuously debated the question
of reform. The argument revolved around whether to move rapidly
ahead with new reform measures or to cut back on market-
orientated practices in favor of tighter controls and more
reliance on comprehensive state plans.
Earlier this year, however, Party advocates of reform moved
into a predominant position. As a result, the drive to
restructure the economy has accelerated.
At the same time, the emphasis has shifted away from
agriculture, where the results have been good, to industry, where
little real progress has been made. By late June, Chinese
economists publicly were calling for experiments with such
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
market-oriented practices as.forcing state banks to compete
against each other, allowing enterprises to issue stock and
bonds, and were even advocating reform of the price system. Such
proposals would have been labeled heretical five years ago.
In early October, the state council issued provisional
regulations on improving the planning system -- a detailed
document calling for, among other things, a major overhaul of
China's complex planning bureaucracy. The meeting of the Third
Plenary Session of the 12 Central Committee on the 20th of
October firmly committed the Party to economic reform.
The Plenum approved a document on the reform of economic
structure that reiterated all the elements of earlier reform
efforts, and went further than any previous document on important
questions such as price reform. In essence, the Party committed
itself to a comprehensive restructuring of its economic
apparatus, that, if fully implemented, will permit free market
regulation in China to a much greater degree than elsewhere in
the socialist world, with the possible exception of Hungary.
Why is the Party now prepared to make such a massive assault
on its urban economic problems?
First, the waste and inefficiency that characterized the
industrial sector has reached intolerable proportions. Heavy
industrial sector warehouses now store more than $10 billion in
unusable machinery, while Chinese factories continue to produce
mostly 1950 and 1960 vintage equipment. Chinese mills continue
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
to produce large quantities of low quality steel but most
industries complain of major shortages.
Then,, too, the weakness of the urban economy began impacting
on the agricultural sector. A huge surplus of grain is presently
accumulating in the countryside because the urban commercial
system is incapable of transporting it to points of need. At the
same time, consumer goods are not reaching the countryside in
quantities sufficient to meet rural demands.
Beijing also chose to move now because it believes it is
well positioned economically to survive the problems that will
inevitably arise from the planned overhaul. Agriculture, foreign
trade, and energy are all performing well above expectations.
Finally, and perhaps most importantly, the reform wing of
the Party is eager to push ahead while the 80-year-old Deng
Xiaoping is still active and at the peak of his power.
Because this accelerated drive at industrial reform is in
its infancy, assessing its chance for success is difficult. We
can say, however, that implementation will be very tough. Major
economic problems will begin surfacing immediately as price
adjustments work their way through the system.
Bureaucratic infighting is bound to increase as power is
redistributed. Some Party and state officials can be expected to
resist the entire program, since they would tend to lose power if
the reforms succeed.
Price reform is unquestionably both the most essential and
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
the most troublesome element of the reforms. The Chinese economy
is shortage-driven, and even rumors of price adjustment can spark
panic-buying and bank runs. Many Chinese citizens remember the
dislocations caused by hyperinflation in the late 1940s. They
react rapidly and sometimes irrationally to announcements of
upward price adjustments.
Beijing has also had a difficult task in determining what to
do with the nearly 20 percent of state-run enterprises that are
now losing money. Factory close-downs on such a large scale
would mean unacceptable unemployment problems and industrial
readjustments. But to permit continued operation encourages
inefficiency.
Financial problems also will continue to plague Beijing.
While China has many of the fiscal and monetary tools it needs to
control the macroeconomy, it has little practical experience in
their use. Given the difficulties that even industrial economies
have in using these tools effectively, Beijing will probably be
very tempted at the first sign of major problems to resort to
what it knows best -- direct control.
Finally, political opposition will continue to threaten the
reform program, and it is the most difficult factor to measure.
The mounting economic problems will provide ammunition to
Party and state bureaucracies that are already resisting
change. Nevertheless, we are cautiously optimistic that Beijing
gradually will get a good percentage of the reforms into the
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
pipeline, and that the new program will achieve a measure of
success.
We are struck, for example, by the straightforward,
nonideological approach contained in the Plenum document.
Chinese leaders are keenly aware of both the economic and
political obstacles they face. By allowing five years to get the
program into place, Beijing is calculating realistically the
tremendous problems it will face in implementation.
Beijing's willingness to launch a frontal assault on
irrational prices also bodes well for success. Western and
Chinese economists alike have long viewed the irrational price
system as a major stumbling block to urban reform, but until this
year, Party bureaucrats viewed the potential danger of price
reform as too high to warrant any major experiment.
It appears now, however, that these planners realize that
piecemeal reforms in the absence of rational prices may be worse
than no reforms at all. In addition, by letting individuals set
up service-related businesses and handle commerical functions,
Beijing has unleashed forces that could markedly increase the
speed at which economic transactions take place. A more smoothly
functioning economy is a likely outgrowth of such policies.
On the whole, then, we believe that the industrial reform
program China has devised is workable and will accelerate
economic gains, albeit at a slower pace than occurred following
the early agricultural reforms. Some inflation is to be
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
expected, though we do not believe Beijing will experience wildly
spiraling prices. For this to occur, the government would have
to be willing to sustain increases in consumer demand by printing
money, something this fiscally conservative government is
unwilling to do. In fact, we are more concerned that Beijing's
fear of inflation will cause it to overreact to initial price
changes by cutting back price reforms. Such a move could stall
the entire reform program.
If China is successful at getting its reform program into
place, there are several important implications for the United
States. In our judgment, implementation of the reforms would
both broaden and deepen China's ties with the United States and
the West.
The emphasis on technological innovation at the plant level,
foreign capital acquisition and increased joint ventures will
expand investment and trade opportunities for US and Western
business.
At the same time, however, the reforms will aggravate some
current problems in US-Chinese relations. It can be expected
that Chinese enterprises will continue to push for greater access
to Western markets, and pressure on Washington to lower trade
barriers probably will increase.
Similarly, Beijing will probably press harder on technology
transfer in response both to its needs for economic and military
modernization and the demands of its own enterprises. It is also
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
likely that China will reduce its grain imports from the West, as
its agricultural production continues to improve.
Beijing's success with economic reform could also prove to
be a tempting example for other countries struggling with central
planning. Beijing reportedly is already encouraging the North
Koreans to learn from Chinese reforms and relax their tight
control over the economy. As China's program proceeds, other
countries, including some LDCs and even a few of the East
European nations that China patterned its earlier forms after,
may consider making wider use of market-oriented programs.
Having said this, I must conclude, still, on a cautious
note. Several factors could derail China's reform program
completely. For example, the death of China's 80-year-old leader
would remove from the scene the most powerful advocate of
reform. Deng's most likely successors are also deeply committed
to reform, but in his absence, they probably would not be able to
push the program to the extent he has done.
Other problems, such as a sharp upsurge in speculation and
economic crime or several years of bad weather could, over the
longer term also tip the political scales against reform and lead
to retreat.
Senator Proxmire. I appreciate that.
Both these presentations have been extremely good. And as
Richard Kaufman just mentioned to me, this is the kind of
corrective for the feeling that there's a lot of Chinese euphoria
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
going on, that they're going to be the Adam Smith free enterprise
economy any day now. I think the note of caution is very
welcome.
In your discussion of improvements and recent successes in
Chinese agriculture, you say that improved weather and price
increases have played an important role together with market-
oriented rural reforms.
First, weren't the price increases part of the reforms, and
secondly, can you assign weights to the roles of reform and
weather in recent improved performance?
There is some question about exactly what you
include under the label of reform. The people in our shop who
have examined the agricultural sector most carefully choose to
distinguish somewhat between price adjustments, which China has
tried periodically over the past 30 years, and the recent
structural changes such as introduction of the contract
responsibility system. The latter changes we are calling
"economic reform."
Our experts believe that even if the commune system had been
left in place, and the economic structure had remained basically
as it was, increased prices would have elicited an output
response. Nevertheless, the freedom that the Chinese have given
the farmer to make production decisions and to carry out those
decisions has undoubtedly strenghtened the output response.
As to how to weight each of these factors in terms of their
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
impact on production, there is a great difference of opinion
between experts both within our office and outside.
Weatherwise, the Chinese say that 1983 was in many ways the
worst year they have had in some time. But, in terms of grain
and cotton, they had the best harvest they've ever had. So
there's some indication that weather, while it has played a role
in this, is not playing as important a role as perhaps some
people would think.
Senator Proxmire. It sounds like it might be playing a
preverse role.
In what sense?
Senator Proxmire. In other words, if they had these
bounteous crops of wheat and cotton, and they had it in spite of
bad weather, it sounds as if their reforms are more responsible
than they would be, if the weather had been the same.
I'm not sure that's the case. If the weather
had been better, they might have gotten additional gains beyond
what they achieved. What I think we can say is that the
agricultural reforms are proving capable of generating production
gains even under adverse climatic conditions.
We can start to say, sure, the weather's always been a
factor, but the price adjustments, and the introduction of the
contract responsibility system, are perhaps the major elements in
this whole expansion we've seen in ag production.
Price reforms cannot be discounted. My feeling is, the
STAT
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
price reforms have probably been at least as important as the
contract responsibility system. The Chinese continue to rejigger
prices, and they've seen just tremendous shifts in resources out
of certain products and into other agricultural. products, in very
short order, with changes in prices.
Senator Proxmire. One of the most interesting contrasts
between our country and the Soviet Union, and I presume, China,
too, although it would be interesting to get your figures on
this, is the enormous proportion of the Russian population that
is in agriculture compared to this country.
Now the figures that I had a few years ago were that this
country, less that 3 percent of our people were in agriculture,
that is, were on farms producing, working on farms as their
principal occupation, whereas, in Russia, it's closer to 30
percent, or was.
On China, I don't have any figures at all.
Could you bring me up-to-date on Russia and also tell me
what the proportion of the people in China who are involved in
food production is, that is, who are on farms?
Perhaps 20 to 25 percent, I believe, of the
labor force is now working in agriculture. It was 30 percent
back in 1960.
Senator Proxmire. So they not only had a better crop year,
but there's more productive work?
This is in the Soviet Union.
STAT
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
Senator Proxmire. That's right. We were told by the CIA a
few years ago that it was 30 percent. I remember I was so
startled by the figure, it remained with me.
I believe that figure for 30 percent refers back
to 1965 and the 1970s. They've made considerable progress in
reducing the labor force in agriculture through the late '70s,
they've made less progress since then.
Senator Proxmire. So it's about 20 to 25 percent now?
Of the labor force working in agricultrue.
Senator Proxmire. How about China?
rural economy.
80 percent of China's population is in the
STAT
STAT
STAT
Senator Proxmire. 80 percent?
80 percent. 800 million people in the STAT
countryside. Some experts estimate that as much as 70 percent--
this is the highest estimate--of this rural labor force is
surplus labor, you could pull them off the farms without hurting
production.
Senator Proxmire. What you're telling me is that you have
about 80 percent of the people in rural areas, and they've mostly
engaged in agricultrue.
Mr At one time of the year or another.
Senator Proxmire. But about 70 percent of that 80 percent,
or 56 percent of the population, to get a precise calculation, is
surplus?
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
That's the high figure, and as I say, it's a
very rough figure, but I think it gives you an order of magnitude
as to the size of the problem and to the potential if you could
put those people into productive employment. The Chinese
themselves say that by the year 2000 they hope to have this
figure down to about 30 percent. Their goal is to have 30
percent or less of the labor force engaged in agricultural
production.
Senator Proxmire. A big share of them are going to be
unemployed.
That won't take place. They're basically
unemployed now, but they continue to receive a salary and are not
unemployed in the Western sense of the word. China will not
permit a large amount of Westen style unemployment.
Senator Proxmire. Think how many people that is. That's
between 500 million amd 600 million people.
Actually the figure is not that large because
much of the rural population is too young or too old to be
employed. Nevertheless there is a tremendous amount of surplus
labor. All Beijing has to do is give many of these rural people
the sign, ie allow them to go into the city and set up barber
shops, clothing stands etcetera, and you immediately get an
influx. They're already facing problems this way. Their system
is not geared to having people move freely from point A to point
B. As a matter of fact, it's geared to preventing people from
STAT
STAT
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
moving from rural areas to urban areas. The government is trying
to make changes right now that will allow part of this labor
force, not to move to Shanghai and Beijing, but to move to small
towns that they hope will form in the middle of these green
belts.
Senator Proxmire. You mentioned the large and rising budget
deficits starting in 1977, which forced cutbacks in investment
and transportation.
What had been the trends in other areas of capital
investment and what are the causes of those budget deficits
That should be '79. I beg your pardon.
'79 was their largest deficit. In '79 and '80 STAT
they had sizable decifits. The
initial reaction to the deficits
was to cut back government spending. At the same time they
counseled their industrial sector to also cut back investment.
They achieved the cutbacks in government spending, which came
mainly out of major infrastructure projects. But in the private
sector, what we would have to call the noncontrolled sector,
there were big increases in investments.
Basically, there are several reasons for the deficits.
Probably the most important is that when China adjusted prices,
they raised procurement prices, meaning the state paid the farmer
more, but continued to sell the grain to cities for exactly the
same price that they did before. Of course this led to a
tremendous subsidy.
-18-
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
Another factor was the readjustment in policy which shifted
resources away from heavy industry to light industry. Heavy
industry generated a large part of China's tax base, and when
production began to slow down, and even decline, tax revenues
fell. They had their expenditures going up at the same time
their tax revenues were tapering off.
Senator Proxmire. You indicated in your longer statement
that Chinese do not reveal much about their defense spending.
Is it roughly as difficult to know what they spend, as it is
to know what the Soviets spend? If so, doesn't that mean we know
less about the Chinese military, in view of the fact that we
place far less emphasis on gathering and assessing information
about China's defense?
Mr. Gates. I think that based on earlier
comments, we do have even greater uncertainties in the realm of
Chinese defense spending than we do for the Soviet Union. By the
same token, again, I would go back to comments I made earlier.
Even so, we have a pretty good fix on the actual military ca-
pabilities of the Chinese, in terms of the forces that they have,
the equipment that they have, their military research and
development, the programs, the new weapons systems that they're
developing, whether they're submarines or missiles, and so on.
Senator Proxmire. How about their strategic capability?
Mr. Gates. I would say that our capability there is
probably the best of all.
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
Senator Proxmire. What's that?
Mr. Gates. I would say that our ability to accurately
assess their strategic capabilities is probably the best of any
aspect of their military.
Would you like to add anything?
I think that's accurate.
As Mr. Gates said, we basically have a good feel for the
direction, for the kind of sacrifice that the military has so far
been willing to accept in the name of economic modernization.
Senator Proxmire. How does the Chinese strategic capability
compare with the United States and the Soviet Union? Factor of
10? Factor of 20? And with France and the United Kingdom?
I would say we should field that question and
bring it back. Our military experts aren't here. My own feeling
is that they're just not even in the same ballpark as the U.S. or
the USSR, especially if you're talking about strategic weapons.
Senator Proxmire. I realize that. I realize they're not in
the same ballpark as the United States and the Soviet Union, but
I just wondered what the discrepancy is. Is it on the order of,
as I say, 10? 20?
Mr. Gates. You're looking at a country where their
strategic missiles can be counted in a few 10s.
Senator Proxmire. Compared with a few thousands?
Their ships, we could add, are basically
coastal ships. They are not a blue water navy.
STAT
STAT
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MO1152R000400520010-5
Senator Proxmire. And their submarine fleet? Do they have
nuclear weapons on their submarines? How about their air
force? Does that have a nuclear capability?
Again, we should really bring the military STAT
people in to talk to you more closely on that.
Senator Proxmire. You're going to give some of that for the
record?
Mr. Gates. We'll respond.
Senator Proxmire. Let me just pursue that question I asked
a little bit earlier, just one more time. Maybe you can't give
it to me directly, but it would be very helpful if you could make
an approximation.
In a discussion of the Chinese defense sector, you indicated
that the burden of defense has been reduced somewhat. I realize
that you have no precise estimates of the proportion of GNP that
goes for defense, but can you say whether it is closer to the US
figure of 7 percent, or the Russian figure of 13 to 14 percent?
My gut feel is that it would be much closer to STAT
the U.S. figure, and when I respond, I will be more accurate.
Let me say this: there's been a lot of fat in the Chinese
military budget that's been cut out without really deleting too
much of their military capability, as small as it is.
For example, they had a tremendous capital construction
corps. That was part of their military budget. When they cut
that military budget, that corps of people was freed up and sent
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MO1152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
back to private practice. China's military capability, however,
was probably not severely hurt.
So our military people tell me that while the Chinese
military has definitely sacrificed, we should not overstate the
degree to which is has impacted on military capabilities.
The military continues to get a lot of technology. They
have gotten into the business themselves of exporting military
weapons, and this has been generating foreign exchange for
them.
Senator Proxmire . The last page of your longer statement,
you have a table showing selected economic indicators in China.
You have the growth of the GNP and the gross value of industrial
output, and so forth.
Can you tell me what their GNP is?
Well, we do rough estimations of GNP on an
annual basis, and have it in the neighborhood of $300 billion.
Senator Proxmire. It used to be about the same size as
Italy's. Can you give me any countries that are about the same
GNP as China?
Not right offhand. Again, I can put that in
for you.
STAT
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
Mr. Chairman, if I may add, you're correct, in
1983 total Italian GNP in 1983 in U.S. dollars was $355 billion.
COMPARING CHINA'S GNP WITH MAJOR OECD COUNTRIES
(billion US $)
United States
3305
Japan
1156
West Germany
655
France
543*
United
Kingdom
460
Italy
350
Canada
317
China
275
Spain
156
*1982 figure.
Senator Proxmire. It's a little bigger now. Of course,
they have grown more raidly than just about any other major
country, in GNP.
I notice you have a 7.0, 5.2, 3.0, 7.4, 9.0, 10. Those are
very, very healthy growth figures.
Again, I don't think that's necessarily a good
sign. The Chinese are not necessarily pleased at that. As we
said in the paper.
Senator Proxmire. Why?
Their feeling is that what they really need is
an improvement in efficiency. They continue to produce a lot of
junk, basically, and the state continues to have a procure that
stuff at high cost. Their warehouses are full and yet their
STAT
STAT
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
factories are crying for better machinery, equipment, and steel.
So what China wanted was growth rates more in the
neighborhood of four -- well, their plans have been for anywhere
between 4 and 6 percent growth. That's what they were asking for.
Senator Proxmire. Well, that's a good helpful modification.
Your discussion of the problems of inefficiency and waste in
the industrial sector suggests recent reports of Chinese economic
success may be somewhat exaggerated. Do you agree that a big
question mark remains as to whether China will overcome its
economic problems and be able to maintain the pace of economic
reform?
That certainly is a key question. The press is
overplaying how well the Chinese have done. The Chinese
themselves have been very, very pragmatic, for probably the first
time.
Senator Proxmire. Are you talking about our press?
Our press, the Western press.
The Chinese themselves have been very, very pragmatic in
saying: "We have done well in agriculture, but in the industrial
sector, our performance has been bad." They recognize the
weaknessess. Party members, for the first time are being told to
prepare for.problems that will inevitabley arise when reforms go
into place. And to attack new problems not by labeling people as
capitalists or something else but by trying new reform.
Senator Proxmire. I think that's pretty hard to avoid. We
STAT
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
have an understandable, and, I think, a proper, bias in favor of
free enterprise. I am sure all of you would agree with that.
So when they move toward a little freedom, we say, "See how
well they're doing?" and we would like to feed on that as
evidence of how superior our system is.
It is superior. But, I think we tend to overstate it.
We should probably also say that in terms of
the free enterprise, we feel that probably about 2 percent of the
Chinese labor force, urban labor force, right now is engaged in
these kind of what you could really call free-enterprise--type of
activities: small shops, etcetera. So, the sector of the
economy that is uncontrolled is still quite small.
Senator Proxmire. You explained that very well. You point
out that the improvements have been by giving incentives to
cooperative entities which are not free, competitive
operations. And then a price modification, rather than the fact
that you have as you say, a lot of people getting into barber
shops and that kind of thing, which is fine, but it can't account
for the improvement.
An example of the problems that remain in the background,
some panic buying, you report, occurred last month in the -- and
the fact that you conclude that panic buying would be
inflationary in the short run.
Can you give us an idea of the magnitude of these problems,
whether panic buying has stopped, and inflation?.And I would also
STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
like to discuss the problem of unemployment.
The feeling we have is that there were pockets STAT
of panic buying and bank runs but the Chinese were quick to stamp
these out. They simply refused to let people pull their money
out of banks, they also came out strongly with proclamations that
no one would be allowed to change prices for a while, and when
changes were made they would be gradually with incomes being
adjusted at the same time.
So I think so far the scale of this sort of thing has been
very, very small. We highlight it because the potential for
major problems is there, and every time the Chinese talk about
price reform they raise the spector of bank runs and panic
buying.
The Chinese are so sensitive to this that they react quickly
whenever problems occur. We are more concerned that they will
overreact to this sort of thing than we are that they will let
price problems get out of hand.
Senator Proxmire. You warned us about the effect of Deng's
death. You also indicated that his successors shared his view of
the reforms, or his most immediate successors. But they wouldn't
have the same force and power that he has.
Can you give us a little more specific assessment of the
prospects for the reform movement to prevail in the event of
Deng's death or removal from office in the near future?
You know, it's speculation, but I will give you STAT
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
my best feel for what could happen.
The two people next to Deng in power are Zhao Ziyang and Hu
Yaobang. Both of them are very openly pro-reform. Even the
people in the top echelons of the Party who are not strong
advocates of reform -- and we do have indications that some
important leaders are not fully on board -- are not Maoists.
They are not going to argue for a retreat all the way to the
left. There are people who would argue that free enterprise
should not be allowed to operate to the degree that reformers are
now advocating. These opponents argue for a pull back. They
contend that free enterprise should operate only at the very
fringes, and a tight central plan should regulate the bulk of the
economy.
So, whereas during the 1960's and early 1970's we had
extremes--Maoists who argued for strict Chinese Marxism opposed
to a few others like Deng who were at the other extreme--now the
band has narrowed significantly.
Even the people who advocate a retreat from reform are
really talking about a retreat to a milder kind of reform.
Although this group does not wield much power right now, if the
reforms begin to bog down, I think these leaders would resurface,
and there's definitely the capability among those people to slow
the reform process.
Having said that, the ag reforms have been widely accepted
by about 80 percent of the population, and it will be very, very
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
hard to turn those people around.
So my best guess would be that any new leadership would not
be able to undermine the program to a major degree; that, in
fact, even when we do get succession, we will continue to have
reform.
Again, that's just my guess.
Senator Proxmire. Mr. Gates, would you briefly discuss the
recent developments in Chinese-Soviet relations and the prospects
for closer ties between them?
Mr. Gates. There were some developments about a year-and-a-
half or two years ago that suggested that the two parties, for
reasons of their own, probably related to the relationship of
each to the United States, was interested in moving closer to one
another to establish a closer bilateral relationship.
.There were a number. of very small steps that were taken, and
we anticipated, or at least raised the prospect, that might
involve some longer term, significant improvement in relations.
Frankly, this just hasn't happened. There has been a slight
warming in state-to-state relations. There have been some
contacts between the two parties, some negotiations. Trade
between the two is increasing rapidly, but from a very small
base.
They are still planning on having a Soviet Deputy Prime
Minister, or Premier, if you will, visit China, a visit that was
cancelled earlier.
But on the whole, it appears that the Soviets.are totally
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
 Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5
unprepared to meeting the Chinese preconditions for a
significantly improved relationship: getting out of Afghanistan,
ending their support to the Vietnamese, and getting the
Vietnamese out of Kampuchea, getting out of Mongolia, and so
on. There's just no sign that the Soviets are prepared to
undertake any of those things, and absent that, any improvement
in relations, even'on a state-to-state basis, will be, in our
view, quite limited.
Senator Proxmire. Gentlemen, I want to thank all of you,
Mr. Gates
and commend you for
STAT
your excellent testimony and the comprehensiveness and high
quality of the papers on the Soviet Union and China.
In the interests of getting information to the public as
soon as possible, I would like you to sanitize the written papers
you gave us, so they can be released, hopefully in the next two
weeks or so.
The entire transcript will eventually be printed in
sanitized form, after we have heard from the Defense Intelligence
Agency.
Again, I want to thank you and your staff for the fine work
you're doing, and your appearance today. Thank you very much.
(Whereupon, at 12:25 p.m., the hearing was adjourned.)
Sanitized Copy Approved for Release 2009/11/20: CIA-RDP87MOl 152R000400520010-5