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Hong Kong's Reversion to China: Effective Monitoring Critical to Assess U.S. Nonproliferation Risks (Letter Report, 05/22/97, GAO/NSIAD-97-149).

Pursuant to a congressional request, GAO reviewed whether U.S. export
control policy toward Hong Kong will adequately protect U.S. national
security and nonproliferation interests after Hong Kong's reversion to
China, focusing on: (1) the potential risks and consequences of
continuing to export sensitive technologies to the territory after
reversion, given China's past proliferation behavior; (2) how U.S.
export controls are currently applied to Hong Kong as compared with
China; (3) planned U.S. export control policy toward Hong Kong after
reversion; and (4) possible safeguards and monitoring efforts to protect
U.S. nonproliferation interests.

GAO noted that: (1) U.S. export control policy toward Hong Kong is less
restrictive than that applied to China, based on Hong Kong's ability to
protect sensitive technologies as well as concerns over China's
proliferation activities; (2) the U.S. government allows Hong Kong
greater and easier access to sensitive dual-use technologies; many items
may be exported to Hong Kong without prior Commerce Department review
and, even when prior approval is necessary, licenses are readily
granted; (3) thus, exporters may export items such as titanium alloys,
certain types of machine tools, and high-performance computers to Hong
Kong without obtaining an export license; (4) in contrast, the export
control rules applied to China are more stringent: more categories of
exports require licenses, and the U.S. government has refused to export
certain items owing to concerns over proposed end users and end uses;
(5) in about 30 instances over the past 3 years, items that the United
States has refused to export to China could have been exported to Hong
Kong without prior U.S. government review or approval; (6) the U.S.
government does not plan to change its export control policy toward Hong
Kong after it reverts to China unless there is evidence that the Hong
Kong authorities are unable to continue to operate an effective export
control system; (7) as a result, Hong Kong will continue to have easier
access to sensitive technology that is more tightly controlled for
China; (8) major reasons for this decision include: (a) the Hong Kong
Policy Act, which calls for continued separate treatment of Hong Kong in
export controls so long as it is able to protect U.S. technology and
equipment; (b) the U.S. government's overall commitment to supporting
Hong Kong's continued autonomy; and (c) Hong Kong's record in
maintaining an effective export control system; (9) given the decision
to continue current U.S. policy toward Hong Kong, monitoring various
indicators of Hong Kong's continued autonomy in export controls becomes
critical to assessing the risk to U.S. nonproliferation interests; (10)
this may not be an easy task, given the changes that could occur in Hong
Kong and the difficulties in gauging Chinese intentions and behavior;
(11) key indicators to watch would be changes in the composition and
volume of U.S. exports of controlled items to Hong Kong, which could
signal efforts by China to obtain sensitive technology such as optical *

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-97-149
     TITLE:  Hong Kong's Reversion to China: Effective Monitoring 
             Critical to Assess U.S. Nonproliferation Risks
      DATE:  05/22/97
   SUBJECT:  Export regulation
             Nuclear weapons
             Exporting
             Foreign trade agreements
             Foreign trade policies
             International economic relations
             Foreign governments
             Dual-use technologies
             Nuclear proliferation
             Licenses
IDENTIFIER:  China
             Hong Kong
             United Kingdom
             Australia
             Japan
             Customs Service Automated Export System
             
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Cover
================================================================ COVER


Report to Congressional Requesters

May 1997

HONG KONG'S REVERSION TO CHINA -
EFFECTIVE MONITORING CRITICAL TO
ASSESS U.S.  NONPROLIFERATION
RISKS

GAO/NSIAD-97-149

Hong Kong's Reversion to China

(711213)


Abbreviations
=============================================================== ABBREV

  AES - Automated Export System
  COCOM - Coordinating Committee for Multilateral Export Controls
  MTOPS - millions of theoretical operations per second
  PLC - pre-license check
  PSV - post-shipment verification
  SED - shipper's export declaration

Letter
=============================================================== LETTER


B-275463

May 22, 1997

The Honorable Floyd D.  Spence
Chairman, Committee on National Security
House of Representatives

The Honorable Benjamin A.  Gilman
Chairman, Committee on International Relations
House of Representatives

Hong Kong will revert to Chinese sovereignty on July 1, 1997, after
over a century of rule by the United Kingdom.  As the reversion date
approaches, increasing attention has focused on how the territory
will fare under China and how U.S.  economic and security interests
could be affected.  U.S.  economic presence in the territory is
substantial, and Hong Kong's fate has significant implications for
broader U.S.-China relations. 

You asked us to focus on one key issue--whether U.S.  export control
policy toward Hong Kong will adequately protect U.S.  national
security and nonproliferation interests after Hong Kong's reversion
to China.  You raised concerns about the potential risks and
consequences of continuing to export sensitive technologies to the
territory after reversion, given China's past proliferation behavior. 
This report outlines (1) how U.S.  export controls are currently
applied to Hong Kong as compared with China, (2) planned U.S.  export
control policy toward Hong Kong after reversion, and (3) possible
safeguards and monitoring efforts to protect U.S.  nonproliferation
interests. 


   BACKGROUND
------------------------------------------------------------ Letter :1

The People's Republic of China and the United Kingdom agreed to the
terms of Hong Kong's reversion in their 1984 Joint Declaration.  The
declaration calls for Hong Kong to become a Special Administrative
Region of China that will "enjoy a high degree of autonomy" except in
the conduct of defense and foreign affairs.  Under the "one country,
two systems" formulation, Hong Kong will remain a separate customs
territory and retain its status as a free port.  Hong Kong's status
is to remain unchanged for 50 years.  China's National People's
Congress subsequently enacted the "Basic Law of the Hong Kong Special
Administrative Region of the People's Republic of China" to codify in
Chinese law the status of Hong Kong and to implement the
understandings in the Joint Declaration. 

The United States-Hong Kong Policy Act of 1992 (P.L.  102-383, Oct. 
5, 1992) articulated U.S.  support for full implementation of the
Sino-British Joint Declaration.  The act called upon the U.S. 
government to continue to treat Hong Kong as a separate territory
with respect to economic and trade matters and to support Hong Kong's
continued access to sensitive technologies so long as such
technologies are protected.  Furthermore, the act directed that U.S. 
laws continue to apply to Hong Kong on or after
July 1, 1997, in the same manner as before that date.  Nevertheless,
under the act, if the President determines that Hong Kong is not
sufficiently autonomous to justify different treatment from China
under a particular law, he may change the way in which that law is
applied to Hong Kong.  Finally, the act required the Secretary of
State to provide Congress with periodic reports on conditions in Hong
Kong, including any significant problems in cooperation between Hong
Kong and the United States on export controls.\1

The U.S.  government controls exports of dual-use items (items
primarily for civilian use but that also have potential military
applications) and munitions items (defense articles and services)
with the goal of protecting U.S.  national security and
nonproliferation interests.  The Commerce Department is responsible
for administering controls over dual-use items, which are grouped
into categories such as "telecommunications software" and "lasers and
optical equipment." Pursuant to the Export Administration
Regulations, items are controlled for various reasons, including
national security; missile technology; and nuclear, chemical, and
biological weapons proliferation concerns.  High-performance
computers are also controlled.  Generally, exporters must apply to
the Commerce Department for a license to export controlled items.  In
reviewing license applications, Commerce--in consultation with the
Departments of State, Defense, and Energy and the Arms Control and
Disarmament Agency, which are authorized to review these
applications--assesses the risk the items could pose to U.S. 
national security and nonproliferation interests and approves or
disapproves exports accordingly.  In some cases, depending on the
item involved and the country of destination, an exporter may not be
required to obtain prior Commerce approval to export the items.  The
State Department has jurisdiction over munitions items and reviews
license applications, in consultation with the Department of Defense
and other agencies, for the export of all such items.  License
applications are reviewed for consistency with U.S.  foreign policy
goals, including nonproliferation, among others. 


--------------------
\1 A bill (H.R.  750), passed by the House of Representatives on
March 11, 1997, incorporates additional reporting requirements,
including any "failure to enforce United States export control laws
or export license requirements" and any "unauthorized diversions from
Hong Kong of high technology exports from the United States to Hong
Kong."


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

U.S.  export control policy toward Hong Kong is less restrictive than
that applied to China, based on Hong Kong's ability to protect
sensitive technologies as well as concerns over China's proliferation
activities.  The U.S.  government allows Hong Kong greater and easier
access to sensitive dual-use technologies; many items may be exported
to Hong Kong without prior Commerce Department review and, even when
prior approval is necessary, licenses are readily granted.  Thus,
exporters may export items such as titanium alloys, certain types of
machine tools, and high-performance computers to Hong Kong without
obtaining an export license.  In contrast, the export control rules
applied to China are more stringent:  more categories of exports
require licenses, and the U.S.  government has refused to export
certain items owing to concerns over proposed end users and end uses. 
In about 30 instances over the past
3 years, items that the United States has refused to export to China
could have been exported to Hong Kong without prior U.S.  government
review or approval. 

The U.S.  government does not plan to change its export control
policy toward Hong Kong after it reverts to China unless there is
evidence that the Hong Kong authorities are unable to continue to
operate an effective export control system.  As a result, Hong Kong
will continue to have easier access to sensitive technology that is
more tightly controlled for China.  Major reasons for this decision
include (1) the Hong Kong Policy Act, which calls for continued
separate treatment of Hong Kong in export controls so long as it is
able to protect U.S.  technology and equipment, (2) the U.S. 
government's overall commitment to supporting Hong Kong's continued
autonomy, and (3) Hong Kong's record in maintaining an effective
export control system. 

Given the decision to continue current U.S.  policy toward Hong Kong,
monitoring various indicators of Hong Kong's continued autonomy in
export controls becomes critical to assessing the risk to U.S. 
nonproliferation interests.  This may not be an easy task, given the
changes that could occur in Hong Kong and the difficulties in gauging
Chinese intentions and behavior.  Key indicators to watch would be
changes in the composition and volume of U.S.  exports of controlled
items to Hong Kong, which could signal efforts by China to obtain
sensitive technology such as optical sensors that it has previously
been denied.  The U.S.  government has begun a process to develop a
baseline of export data against which to measure such changes but may
have difficulty in doing so because of data limitations.  Also, the
U.S.  government intends to monitor all aspects of Hong Kong's export
control system as a basis for assessing changes that might occur and
has established an interagency group to do so. 


   CURRENT U.S.  POLICY AND
   PRACTICE TOWARD HONG KONG AND
   CHINA DIFFER SIGNIFICANTLY
------------------------------------------------------------ Letter :3

The United States applies different licensing policies and standards
to Hong Kong and China because of Hong Kong's ability to maintain an
effective export control system--as evidenced by its adherence to the
standards of various multilateral export control regimes--and
concerns over China's proliferation and military activities.  As a
result, Hong Kong receives preferential licensing treatment--for many
categories of dual-use items, exporters do not need to submit license
applications to obtain prior U.S.  government approval.  Further,
approval is generally granted even when a license is required.  In
contrast, dual-use exports to China receive greater scrutiny, and
more than 170 license applications were denied over the past 3 years. 
Lastly, Hong Kong generally is eligible to obtain munitions items,
while current sanctions generally preclude issuing licenses to China
for munitions items without a presidential waiver. 


      POLICY BASIS FOR
      PREFERENTIAL TREATMENT
---------------------------------------------------------- Letter :3.1

The United States extended preferential licensing treatment to Hong
Kong in 1992 as a result of Hong Kong's designation as a Coordinating
Committee for Multilateral Export Controls (COCOM)\2 "cooperating
country"--meaning that Hong Kong had established an export control
system containing the necessary elements of effective control.  Hong
Kong then became eligible for treatment equivalent to that accorded
COCOM members such as Australia and Japan. 

Hong Kong currently adheres voluntarily to the prevailing standards
of all the multilateral export control regimes.  It obtains regime
control lists and incorporates them into its own regulations, thereby
agreeing to control the same items that regime members control.  In
return, Hong Kong obtains specific privileges--preferential licensing
treatment and information sharing.  Because Hong Kong is not a state,
it cannot be a member of these regimes, but Hong Kong government
representatives have participated in regime plenary sessions as part
of the British delegation.  Hong Kong has agreed to adhere to the
standards of the following regimes: 

  Australia Group, focused on chemical and biological weapons
     proliferation;

  Missile Technology Control Regime, targeting missile proliferation;

  Nuclear Suppliers Group, addressing dual-use nuclear items; and

  Wassenaar Arrangement, focused on conventional arms and dual-use
     items. 

In contrast, China, although a signatory to the Nuclear
Nonproliferation Treaty, is not a member of any of these regimes.  It
unilaterally has declared its adherence only to the provisions of the
1987 Missile Technology Control Regime.\3 Moreover, U.S.  policy
restricts the export or reexport of dual-use items that would make a
significant contribution to the military potential of countries such
as China that would prove detrimental to U.S.  national security. 


--------------------
\2 COCOM was created in 1949 by the United States and its allies to
coordinate controls over exports to the Soviet Union and other
communist countries.  COCOM was dissolved in March 1994 and has been
succeeded by the 1996 Wassenaar Arrangement on Export Controls for
Conventional Arms and Dual-Use Goods and Technologies. 

\3 China has not agreed to adhere to any of the subsequent changes to
the regime's control lists and guidance. 


      DIFFERENT U.S.  LICENSING
      TREATMENT FOR HONG KONG AND
      CHINA
---------------------------------------------------------- Letter :3.2

The United States has extended more favorable licensing treatment to
Hong Kong in two basic ways.  First, exporters may export various
dual-use items to Hong Kong without obtaining a license--this is true
for a range of items controlled for national security reasons,
certain high-performance computers, and some items controlled for
chemical and biological reasons.  China's eligibility for such
"license free" treatment is more restricted, in recognition of the
greater risk that exports of controlled items could pose.  Second, in
cases where items do require a license for export to Hong Kong,
licenses typically have been granted, whereas licenses for China have
in some cases been denied. 


         DIFFERENCES IN
         ELIGIBILITY FOR EXPORTS
         WITHOUT A LICENSE
-------------------------------------------------------- Letter :3.2.1

Hong Kong is eligible to receive, without a license, items in 72 of
154 categories of dual-use items controlled for national security
reasons.\4 For 36 of the 72 categories, the U.S.  government has
determined that no review is necessary prior to export, under the
designation "no license required." In these cases, exporters do not
have to obtain licenses to export the items.  Hong Kong is also
eligible for several types of license exceptions for items in 34
other categories.\5 Eligibility for license exceptions is based
essentially on the item, the country of ultimate destination, and the
end use and end user.  If the exporter determines that the conditions
for a license exception have been met, the item may be exported
without a license.  The remaining 2 categories (of the 72) include
some items that require a license and some that do not. 

In contrast, China is not entitled to obtain any national security
items on a no-license-required basis.  Moreover, China is eligible
for only one type of license exception.  This "civil end use"
exception authorizes exports and reexports of national
security-controlled items only to civil end users for civil end uses;
exports to military end users or to known military uses still require
a license. 

Differences also exist in how computer exports to Hong Kong and China
are controlled.  Both are eligible for license exceptions, but the
Export Administration Regulations place the two under different
country groups called "computer tiers." Hong Kong's classification
under "tier 2" makes it eligible to receive--without a
license--computers with a composite theoretical performance of up to
10,000 millions of theoretical operations per second (MTOPS).\6 In
contrast, China's classification under "tier 3"\7 requires companies
to obtain an export license when the computers (1) are intended for a
military end user or an end user involved in proliferation activities
and have a composite theoretical performance of over 2,000 MTOPS or
(2) are intended for a civilian end user and have a composite
theoretical performance of over 7,000 MTOPS.  In addition, the
license exception prohibits exports to any country in tier 3 for
military, nuclear, chemical, biological, or missile end users and end
uses.  Retransfers to military and defined proliferation end users
and end uses in otherwise eligible countries are also strictly
prohibited without prior authorization.  Computers exported under a
license exception are not required to have a computer safeguards plan
restricting use and access. 

A specific case illustrates the practical application of these
different standards.  In December 1996, a U.S.  exporter shipped a
high-performance computer with a performance level of about 8,800
MTOPs to a Hong Kong university.  Because Hong Kong is under tier 2
standards, and because the computer's performance level was under
10,000 MTOPS, the exporter was able to ship it without a license and
without a safeguards plan to guard against improper use.\8 However,
this computer's performance level would preclude it from export to
China without a license, even to civilian users or for civilian uses. 

Hong Kong is treated differently from China in one other area: 
technology and equipment controlled for biological and chemical
proliferation reasons in six categories.  The U.S.  government does
not require licenses for exports of such items to Hong Kong because
it is not a country of concern for chemical and biological weapons
proliferation.  China, however, must obtain licenses for exports of
items in these categories. 


--------------------
\4 The remaining 82 categories either (1) require a license for
export to Hong Kong for national security reasons or other reasons
such as nonproliferation concerns or (2) do not require a license for
exports to Hong Kong of some items for national security reasons but
do require a license for other items for other reasons. 

\5 For example, one of these license exceptions covers exports of
certain technology and software. 

\6 Composite theoretical performance is a measure used to estimate
the maximum possible performance of a computer as measured in
millions of theoretical operations per second. 

\7 Tier 3 includes certain nuclear weapons states and other countries
of proliferation concern, such as China, Russia, India, Pakistan, and
Israel. 

\8 According to a representative of the computer manufacturer, a
safeguards plan will be implemented if the U.S.  government approves
a license for a planned upgrade to the computer to go beyond 10,000
MTOPS. 


         DIFFERENCES IN LICENSE
         REVIEW WHEN LICENSES ARE
         REQUIRED
-------------------------------------------------------- Letter :3.2.2

Other items--for example, those controlled for nuclear
nonproliferation and missile technology reasons--require licenses for
export to both Hong Kong and China.  The difference lies in how
license applications are reviewed--Hong Kong is viewed more favorably
than China in deciding whether to approve a license, according to
Commerce officials.  When reviewing license applications, Commerce
officials said they consider the risk of diversion, whether the
destination country has a nuclear or missile program, whether it
belongs or adheres to control regimes, the strength of the country's
own export controls, and the stated end use and end user.  The
standards for approval to Hong Kong are different than for China, in
part because Hong Kong does not have a known or suspected nuclear
weapons or missile development program.  According to Commerce
officials, the most likely reason an item would be denied to Hong
Kong is if Commerce believed there was a risk of diversion based on
the end user or other information. 

Data on license applications for dual-use exports to Hong Kong and
China illustrate the differences in licensing review.  From fiscal
years 1994 through 1996, the Commerce Department approved 431 license
applications for Hong Kong valued at $870 million and denied none; an
additional 71 license applications were returned without action
(meaning that the exporter failed to provide sufficient information
or withdrew the application, or Commerce determined that the item did
not require a license).  During the same period, Commerce approved
2,146 licenses for China (valued at $2.8 billion); denied 176; and
returned 640.  Figure 1 shows the relative proportions of these
licenses approved, denied, and returned without action for Hong Kong
and China. 

   Figure 1:  Licensing Decisions
   for Hong Kong and China, Fiscal
   Years 1994-96

   (See figure in printed
   edition.)

Source:  Department of Commerce. 

Further, the U.S.  government has denied license applications for
controlled items to China that it has approved for export to Hong
Kong.  We identified four cases where the U.S.  government refused to
approve items for export to China that exactly matched the
descriptions of items it approved for export to Hong Kong, including
oscilloscopes of specified standards.  The actual number of items
denied for export to China that were approved for export to Hong Kong
during fiscal years 1994 through 1996 could be much greater--our
search of data from Commerce's data base identified 14 categories
that included items denied for China but approved for Hong Kong.\9

In response to our request, Commerce also identified 29 cases where
items denied for export to China would not even have required a
license for export to Hong Kong, as shown in table 1.  Commerce
Department officials noted that the Department denied many of these
applications because of concerns over end users. 



                                Table 1
                
                 Applications Denied for China That Did
                  Not Require a License for Hong Kong,
                          Fiscal Years 1994-96

                                                             Number of
Category                                                    applicatio
number      Description                                      ns denied
----------  ----------------------------------------------  ----------
1A003       Manufactures of nonfluorinated polymeric                 1
             substances controlled under another category
             (1C008.a), in film, sheet, tape, or ribbon
             form
1C002       Metal alloys, metal alloy powder, or alloyed             1
             materials
3A001       Electronic devices and components                        3
3A002       General purpose electronic equipment                    13
3B01\a      Equipment for the manufacture or testing of              2
             semiconductor devices or materials
3C001       Hetero-epitaxial materials consisting of a               1
             "substrate" with stacked epitaxially grown
             multiple layers
3C004       Hydrides of phosphorus, arsenic, or antimony,            1
             purity better than 99.99 percent
4A003       Digital computers, "electronic assemblies,"              2
             and related equipment and specially designed
             components
6A005       Lasers, components, and optical equipment                3
6C002       Optical sensors                                          2
======================================================================
Total                                                               29
----------------------------------------------------------------------
\a This was the category and description in use at the time the
licenses were denied; the category has since been divided into eight
separate categories. 

Source:  Department of Commerce. 


--------------------
\9 Our methodology--identifying matches based on exact item
descriptions in Commerce's data base--was constrained by variations
in how data are entered into the data base and therefore did not
allow us to identify other matches that could be determined only
through additional technical review. 


         DIFFERENCES IN TREATMENT
         OF MUNITIONS ITEMS
-------------------------------------------------------- Letter :3.2.3

Another difference in U.S.  treatment of exports to Hong Kong and
China concerns access to munitions items.  Hong Kong is eligible to
obtain export licenses for munitions items, which are reviewed by the
Department of State on a case-by-case basis.  China, however, is
generally not eligible to obtain munitions items because of sanctions
the United States imposed in response to the June 1989 massacre at
Tiananmen Square.  The sanctions include suspension of (1) all
exports of munitions items to China, except for items for inclusion
in civil products not intended for the Chinese military or security
forces\10 and (2) licenses for the export of any U.S.-manufactured
satellites for launch on launch vehicles owned by China.  The
President can waive either of these suspensions.\11

During the period 1994-96, the U.S.  government licensed munitions
exports to Hong Kong valued at about $307.4 million.  Encryption
machines and equipment comprised over half of this amount, ahead of
other major categories including manufacturing and technical
assistance agreements, computer memory, and helicopters.  In the same
period, the United States licensed munitions exports to China valued
at about $284 million.  Satellites and satellite equipment, licensed
under sanctions waivers, made up over three quarters of the total,
followed by such categories as encryption machines and equipment and
software. 


--------------------
\10 The Tiananmen Square sanctions (P.L.  101-246) provide that
munitions licenses may be issued for "systems and components designed
specifically for inclusion in civil products and controlled as
defense articles only for purposes of export to a controlled country,
unless the President determines that the intended recipient of such
items is the military or security forces of the People's Republic of
China."

\11 In fact, the President has on occasion waived sanctions to allow
exports of munitions items, mainly in support of satellite projects
to be owned or operated by other countries or by multinational
telecommunications corporations. 


   U.S.  POLICY FOR TREATMENT OF
   HONG KONG AFTER REVERSION
------------------------------------------------------------ Letter :4

The U.S.  government intends to accord Hong Kong the same export
control treatment after reversion as it does now, so long as its
export control system remains effective.  This policy derives from
the U.S.  government's overall commitment to support Hong Kong's
future autonomy in economic and trade matters and is articulated in
the Hong Kong Policy Act. 

Other countries--specifically Australia and Japan--plan to continue
their current practice of requiring licenses for exports of all
controlled items to both Hong Kong and China.  The United Kingdom's
policy parallels that of the United States--the United Kingdom treats
Hong Kong and China differently for export control purposes and has
no current plans to change that policy after reversion. 


      BASIS FOR MAINTAINING
      EXISTING EXPORT CONTROL
      POLICY
---------------------------------------------------------- Letter :4.1

The Hong Kong Policy Act allows the United States to continue to
maintain separate export control requirements for Hong Kong and China
after reversion.  The act stipulates that the United States should
continue to treat Hong Kong as a separate territory in economic and
trade matters.  The act also specifically calls on the U.S. 
government to "continue to support access by Hong Kong to sensitive
technologies .  .  .  for so long as the United States is satisfied
that such technologies are protected from improper use or export."

State Department officials stated that the Hong Kong Policy Act
signals U.S.  support for the agreement between China and the United
Kingdom to preserve Hong Kong's autonomy.  State officials noted
that, in the absence of any evidence that Hong Kong's export control
system is not working effectively, the State Department would not
support a preemptive decision to modify existing U.S.  export control
policy.  To do so could risk becoming a "self-fulfilling prophecy"
that would result in less autonomy for Hong Kong.  State Department
officials also said that the U.S.  government is committed to support
Hong Kong's separate export control regime and to work closely with
the Hong Kong government to achieve that end. 


      EFFECTIVENESS OF HONG KONG'S
      EXPORT CONTROL SYSTEM IS KEY
      TO MAINTAINING STATUS QUO
---------------------------------------------------------- Letter :4.2

Hong Kong's ability to maintain its own effective export control
system is key to meeting the guideline in the Hong Kong Policy Act
that U.S.  sensitive technologies be "protected from improper use or
export." Hong Kong government officials have said that Hong Kong is
committed to adopting the highest international standards for its
strategic trade control system and views the control of strategic
trade as both an obligation and an opportunity.  In their view, Hong
Kong needs to ensure that it is not used as a conduit for diversion
of sensitive technology while maintaining an effective control system
that facilitates Hong Kong's access to technology and in turn its
continued economic growth and competitive edge. 

In 1992 the United States and other former COCOM members designated
Hong Kong a "cooperating country" with an export control system
possessing the necessary elements of an effective licensing and
enforcement system.  Among other things, these elements included
establishing a legal basis for controls, providing licensing review
and screening, using pre- and post-license checks, undertaking
enforcement efforts, and engaging in international cooperation.  U.S. 
government officials told us Hong Kong continues to have a strong
control system; that system is characterized by the following: 

Legal basis for controls.  The Hong Kong Import and Export Ordinance
and the accompanying Import and Export Regulations form the legal
basis for the import and export of strategic commodities.  All
imports, exports, transshipments, and certain more sensitive
in-transit shipments of controlled items must be licensed.  The Hong
Kong government believes that the requirement for both import and
export licenses has provided a double-checking mechanism on the
inflow and outflow of all strategic commodities.  Even if goods are
imported for subsequent reexport or transshipment, both import and
export licenses are required.  The ordinance also provides the Hong
Kong Director-General of Trade with the authority to approve licenses
and the Commissioner of Customs and Excise with the authority to
carry out enforcement activities. 

License review.  License applications for strategic items are subject
to various reviews, including item classification to determine
whether the items are controlled, for what reason, and their
technical capabilities.  Licenses also go through risk assessments to
determine whether (1) there is any risk of diversion, (2) the
technical capabilities of the items are suitable for the declared end
use, and (3) the end use is acceptable and believed to be genuine. 
License applications may also be subject to further review by an
interagency group, which examines more difficult cases and can impose
conditions for approval of licenses.  To assist in screening license
applications, the Hong Kong Trade Department maintains a data base
that has the capability to track the issuance of import and export
licenses and those licenses referred to Customs for consignment and
disposal checks.  The data base can also track the licensing
histories of companies on the Hong Kong government "watchlist" of
target companies. 

License checks.  Hong Kong Customs and Trade Departments conduct
consignment checks for exports and disposal checks for imports that
are to remain in Hong Kong.  Consignment checks are carried out to
ensure that reexports are legitimate and properly authorized. 
Disposal checks are conducted to ensure that the goods imported will
be used locally as declared and no diversion has occurred. 

Enforcement.  According to U.S.  Customs officials in Hong Kong, the
Hong Kong authorities have demonstrated excellent cooperation with
the United States on export enforcement activities, including sharing
of information and cooperation on investigations, searches, and
seizures of suspected illegal shipments.  In 1996, for example, Hong
Kong Customs, acting on information from U.S.  Customs, intercepted a
Chinese vessel and seized an unlicensed in-transit shipment of a
rocket fuel chemical, ammonium perchlorate, which is a controlled
item.  The shipment was reportedly exported from North Korea via Hong
Kong for shipment to the Pakistan Space and Upper Atmosphere Research
Commission. 

International cooperation.  Hong Kong adheres voluntarily to the
current standards of all the nonproliferation regimes and reviews its
strategic control list regularly to reflect the most updated lists
agreed to by these regimes. 

The Hong Kong government has also been taking several steps to
improve its export control system, including the following: 

Arranging for technical advisors from other countries.  The Hong Kong
government has sought the temporary assignment of export control
advisors from its major trading partners to assist in license
reviews.  A U.S.  Commerce Department official is presently in Hong
Kong working with the Trade Department on a 6-month detail.  The
advisor has provided technical guidance on licensing issues,
classification of items, and U.S.  export controls.  The Hong Kong
government has had discussions with Australia and Japan about the
possibility of either country providing the next advisor. 

Fostering Hong Kong's relationships with multilateral regimes.  The
Hong Kong government intends to continue to update its control lists
to make sure they conform to the lists maintained by the multilateral
control regimes.  Because the Hong Kong government will no longer be
able to participate directly in the various regimes as it has in the
past, Hong Kong has been working with the United States, the United
Kingdom, Australia, and Japan on arrangements that would keep Hong
Kong informed of the latest developments in these regimes.  The
intent is for individual countries to take the lead in informing Hong
Kong about the activities of a particular regime--for example,
Australia would take the lead in advising Hong Kong of changes in
Australia Group control lists.  Hong Kong government officials also
believe that it is critical for Hong Kong to continue to receive
intelligence and information such as country notifications of license
denials.  On a bilateral basis, Hong Kong has been discussing with
the United States and other countries how to obtain such information. 

Establishing contacts with worldwide networks of technical experts. 
The Hong Kong government has also sought to establish a network of
professional and technical experts worldwide.  Additionally, the Hong
Kong government has also shared experiences and views with other
countries in the region, such as at the January 1997 Asian Export
Control Seminar in Tokyo. 

Upgrading data capability.  Hong Kong's Trade Department is upgrading
its computer system to allow it to generate information reports with
detailed breakdowns by country and product type for both import and
export licenses. 

Considering brokering legislation.  The Hong Kong government has also
been considering the enactment of laws against brokerage of illegal
weapon deals.  The proposed brokering legislation would allow
prosecution of trade middlemen who make deals for controlled items
even if the items never actually enter Hong Kong itself.  U.S. 
export control officials would like to see legislation enacted before
reversion. 


      EXPORT CONTROL POLICIES OF
      OTHER GOVERNMENTS
---------------------------------------------------------- Letter :4.3

Australia and Japan, two of Hong Kong's other major trading partners,
plan to continue their current policy and practice of reviewing all
dual-use exports to both Hong Kong and China.  According to
Australian and Japanese officials, neither country currently permits
exports of controlled items to Hong Kong without a license, and the
two countries plan to continue this practice after Hong Kong's
reversion.  For example, under Japan's export control system all
items are controlled to all destinations, and Japan does not export
controlled items to Hong Kong without a license.  According to
Japanese officials, exports of controlled items for China receive
greater scrutiny during the review process. 

According to British officials, current British export control
policies and restrictions affecting Hong Kong and China are similar
to U.S.  policies.  Thus, items that require a license for export to
China may not require a license for export to Hong Kong.  According
to a representative of the British embassy in Washington, D.C., as of
April 1997 the British government had no plans to change this policy
after Hong Kong's reversion. 


   MONITORING CRITICAL TO ASSESS
   RISKS, BUT DATA TO TRACK
   EXPORTS COULD BE LIMITED
------------------------------------------------------------ Letter :5

As noted previously, the U.S.  government is committed to continuing
its existing export control policy toward Hong Kong, consistent with
the provisions of the Hong Kong Policy Act, as one means of
demonstrating support for Hong Kong's autonomy.  Nonetheless,
uncertainty remains over China's intentions toward Hong Kong and,
therefore, the level of risk the United States may be incurring in
continuing to export sensitive technologies to Hong Kong. 
Consequently, monitoring controlled exports to Hong Kong after the
transition--as well as assessing other indicators--becomes critical
to detecting any heightened risks to U.S.  national security and
nonproliferation interests.  However, the U.S.  government has not
identified the full range of sensitive items that have been exported
to Hong Kong.  Without accurate data, the U.S.  government will be
unable to construct baselines against which to measure changes in
exports. 


      UNCERTAINTIES AND POTENTIAL
      RISKS
---------------------------------------------------------- Letter :5.1

Various factors contribute to a level of uncertainty in assessing
potential risks to U.S.  nonproliferation interests once Hong Kong
reverts to China.  These include the nature of China's commitment to
an autonomous Hong Kong export control system, China's overall
nonproliferation credentials, and varying judgments over the nature
and severity of the current risk of Chinese diversions of U.S. 
technology from Hong Kong.  If the integrity of Hong Kong's export
control system cannot be maintained, the consequences could be (1) a
greater opportunity for China to obtain U.S.-controlled technology
and (2) increased attempts by China and others to use Hong Kong to
circumvent international controls on technology transfer. 


         CHINA'S REPORTED
         PERSPECTIVE ON HONG
         KONG'S EXPORT CONTROL
         SYSTEM
-------------------------------------------------------- Letter :5.1.1

China has taken no formal, public position on the issue of whether
Hong Kong can maintain a separate export control system.  The Hong
Kong government interprets export controls to be a trade matter (thus
falling under the provisions of the Basic Law and the Joint
Declaration providing for Hong Kong's autonomy in economic and trade
matters) but has not sought Chinese agreement for that
interpretation.  Nonetheless, Hong Kong officials point to informal
statements by two Chinese government officials indicating that China
will not challenge Hong Kong's autonomy in this area.  Hong Kong
officials also note that, more importantly, China has not ruled that
Hong Kong's Import and Export Ordinance--the basic statute governing
export controls--is in violation of the Basic Law.  They consider
this significant in view of the recent determination, by the Standing
Committee of China's National People's Congress, that various other
Hong Kong laws do contravene the Basic Law.  (Under article 160 of
the Basic Law, China effectively has the right to amend or repeal
Hong Kong laws that are later found to be inconsistent with the Basic
Law.  Article 158 of the Basic Law gives the Standing Committee the
power to interpret the Basic Law.)

Questions remain about Hong Kong's ability to maintain an independent
export control system after reversion.  A 1997 classified study on
Hong Kong's export control system prepared by the U.S.  interagency
group charged with monitoring Hong Kong's export controls noted that
one of the biggest questions the United States faces is whether the
Hong Kong government would continue to assert that its autonomy in
economic matters gives it the authority to block shipments from Hong
Kong to Chinese government-linked entities. 


         CHINESE PROLIFERATION
         BEHAVIOR
-------------------------------------------------------- Letter :5.1.2

China's overall proliferation record is cause for concern, thereby
contributing to the uncertainty of future Chinese government behavior
toward Hong Kong.  The U.S.  government has on numerous occasions
taken issue with Chinese proliferation activities, including

  missile technology violations for which the United States issued
     two sanctions,\12

  violations of the Nuclear Nonproliferation Treaty and the
     Biological Weapons Convention,

  transfers of chemical weapons-related technology to the Middle
     East,

  sales of conventional arms such as antiship cruise missiles to
     Iran, and

  a diversion of controlled machine tools in China.\13


--------------------
\12 See our report, Export Controls:  Some Controls Over
Missile-Related Technology Exports to China Are Weak
(GAO/NSIAD-95-82, Apr.  17, 1995). 

\13 We reported on the diversion of machine tools shipped to three
locations in China in Export Controls:  Sensitive Machine Tool
Exports To China (GAO/NSIAD-97-4, Nov.  19, 1996). 


         CONCERNS OVER DIVERSIONS
         FROM HONG KONG
-------------------------------------------------------- Letter :5.1.3

Various U.S.  government analyses have raised concerns about the
actual and potential risk of diversion of sensitive technologies
through Hong Kong.  These concerns center on China's use of Hong Kong
to obtain sensitive technology illicitly and as a means to ship
controlled technologies to other countries, as well as Hong Kong's
general use as a transshipment point by third countries.  The key
question is to what extent the risks will increase after reversion. 
Some U.S.  officials are concerned that diversions will increase,
given China's sovereignty over Hong Kong.  Hong Kong officials
maintain that China's desire to see Hong Kong continue to succeed
economically will restrain such activity. 

Some evidence exists of Chinese efforts to obtain controlled
technology illicitly from Hong Kong.  For example, following a U.S. 
seizure of 12 image intensifier tubes (a type of optical sensor),
Hong Kong Customs determined that an additional 81 tubes had been
shipped to Hong Kong and then diverted to China.\14 Chinese "front
companies" in Hong Kong have been identified with efforts to acquire
controlled technologies for illicit export to countries of
proliferation concern, according to U.S.  and Hong Kong government
officials.  Hong Kong officials said that their government has some
Chinese companies on its watchlist that it suspects of diverting
controlled technologies from China through Hong Kong. 

U.S.  officials also have emphasized the significance of Hong Kong as
a transshipment point where the large quantities of goods that
transit the territory afford an opportunity for illegal diversions to
other parts of the world.  The transshipment system is used by
proliferators as a means to circumvent the export controls of
countries that are members of nonproliferation regimes.  Hong Kong
and U.S.  Customs officials identified several cases of attempts to
divert controlled technologies through Hong Kong involving North
Korea, Pakistan, Iran, Singapore, and others that occurred between
1993 and 1996.  For example, in June 1994 a party in Singapore
arranged to ship a coder and decoder system into Hong Kong for
diversion to North Korea.  Hong Kong Customs authorities intercepted
and seized the system at the airport. 

The actual harm to U.S.  national security interests of technology
diversions depends in part on the technology involved and its utility
to China's military modernization efforts.  Controlled dual-use
technologies--including those eligible for "license-free" export to
Hong Kong--have military applications that China might find
attractive for its military modernization efforts.  The Department of
Defense has identified 21 key technological areas crucial for
developing future weapons systems, including high-performance
computing, composite materials, and biotechnology and flexible
manufacturing.  China is currently placing an emphasis on research
and development related to many of these areas.  The Commerce
Department, in reviewing license applications, is also required to
watch for items destined for China that would make a direct and
significant contribution to developments in electronic and
antisubmarine warfare, intelligence gathering, power projection, air
superiority, and nuclear weapons and their delivery systems. 
Appendix I illustrates, for selected dual-use technologies available
to Hong Kong on a license-free basis, their potential military
usefulness for China's military modernization efforts. 

In addition to the technologies addressed previously,
high-performance computers have specific national security
applications in nuclear weapons programs, cryptology, conventional
weapons programs, and military operations, according to a 1995 study
cosponsored by the Commerce and Defense Departments.  For example,
the design and development of advanced conventional weapons represent
a significant area for computing, as does direct support of military
operations.  The availability of high-performance computers to
countries of national security concern could upgrade their military
capabilities, which in turn could adversely affect U.S.  military
operations. 

The implementation of the tier 3 standards for the export of
high-performance computers, as described earlier, is particularly
troublesome for China.  China remains an authoritarian, centrally
controlled government whose economy is dominated by state-owned
enterprises and whose military is heavily involved in commercial
activities.  As such, the distinction between a civilian end user
(that can obtain a computer of up to 7,000 MTOPS without a license)
and a military end user (limited to computers of up to 2,000 MTOPS
without a license) becomes blurred. 


--------------------
\14 According to U.S.  Customs Service records, this case resulted in
convictions and fines for parties in Hong Kong and incarceration for
individuals in the United States in late 1993. 


      MONITORING CRITICAL, BUT
      DIFFICULTIES MAY EXIST IN
      ABILITY TO TRACK NONLICENSED
      ITEMS
---------------------------------------------------------- Letter :5.2

U.S.  officials agree that monitoring Hong Kong's autonomy in the
conduct of export controls is necessary, given the potential risks
involved and the U.S.  policy commitment to ensure that exports of
sensitive technology to Hong Kong are adequately protected.  U.S. 
and British government officials have suggested several means to
monitor the continued autonomy of Hong Kong's export control system
and to detect any evidence of China's involvement in the operations
of Hong Kong's export control regime. 

One such indicator would be changes in patterns of U.S.-controlled
dual-use exports to Hong Kong, which could signal that China is
attempting to acquire high technology items through Hong Kong. 
However, the U.S.  government may have difficulty in effectively
monitoring items that will continue to be exported to Hong Kong
without a license.  The only existing U.S.  government sources of
information on such exports are data that exporters provide using a
shipper's export declaration (SED) or through automated filing
systems--the methods the Customs Service and the U.S.  Bureau of the
Census routinely use to collect data on all U.S.  exports of a
certain value.\15 Exporters are currently required to cite the
category code that permits them to export an item on a
no-license-required or license-exception basis.\16 Regulations
require exporters to maintain, for 5 years, records of transactions
involving exports under any license or license exception and to
provide such records to the Commerce Department upon request. 
Failure to comply with reporting and recordkeeping requirements is
subject to sanctions and penalties as described in the regulations. 
A monthly-updated data base of export data is provided to Commerce
staff to assist in enforcement efforts. 

A January 1997 Census Bureau report found serious problems with the
accuracy of some of the data on SEDs.  The report noted that 50
percent of SEDs (which in turn represent about 35 percent of all
reported exports) were in some way incomplete or inaccurate; Census
has also reported that 25 percent of all export transactions contain
errors that need correction.  Because the Census report did not
specifically assess the accuracy of the data field used to capture
Commerce's controlled item categories and license exceptions, there
is no way to determine whether these data suffer from similar rates
of error.  Customs is instituting a new system to replace SEDs--the
online Automated Export System (AES)--that is intended to
significantly improve data accuracy.\17 However, AES is not mandatory
and uncertainty remains over the number of companies that may
participate voluntarily. 

In the meantime, Commerce enforcement staff must rely on the existing
data.  No efforts have been made to systematically test the accuracy
of the data on exports to Hong Kong.  Moreover, no attempt has been
made to construct a baseline against which to measure any changes in
the types and volumes of items exported to the territory. 

Tracking U.S.  licensed items to Hong Kong and China also could serve
as an important indicator of any shifts in exports of sensitive
technology.  Data are readily available to establish baselines
against which to measure changes after reversion, and the U.S. 
government has begun to assemble the basic data to track U.S. 
licensed exports to Hong Kong and China.  Specific indicators to
monitor could include (1) particular categories of items showing
increased exports for Hong Kong and decreased exports for China and
(2) license denials for China and any changes in corresponding
categories of exports to Hong Kong.  Figure 2 illustrates one type of
baseline--the top 10 categories for Hong Kong for fiscal years 1994
through 1996, compared to the same categories for China. 

   Figure 2:  Highest Categories
   of Licensed Exports to Hong
   Kong Compared With China,
   Fiscal Years 1994-96

   (See figure in printed
   edition.)

Note:  Numbers for the categories listed are 9A004, 5A002, 9E003,
3A001, 4A003, 7A003, 9A003, 1C350, 7A101, and 7E003, respectively. 

\a Commerce licensed no items in these categories for China. 

Source:  Department of Commerce. 

Similarly, figure 3 shows the top 10 categories of controlled items
for China as compared with Hong Kong, which highlights the categories
of items that may be exported to Hong Kong without a license. 

   Figure 3:  Highest Categories
   of Licensed Exports to China
   Compared With Hong Kong, Fiscal
   Years 1994-96

   (See figure in printed
   edition.)

Note 1:  This list excludes licenses associated with categories 3B01
(semiconductor manufacturing equipment; total licenses valued at
about $110.9 million), 1B50 (vacuum or controlled environment
furnaces; total licenses valued at about $17.4 million), and 1B70
(chemical weapons production equipment; total licenses valued at
about $25 million) because Commerce replaced these with multiple new
categories and we were unable to allocate license data among them. 

Note 2:  Numbers for the categories listed are 4A003, 9A004, 4E002,
5A001, 5A002, 1C350, 2B001, 0A95, 6A001, and 5A101, respectively. 

\a Most items in these categories required no prior U.S.  government
review before export to Hong Kong. 

\b Commerce licensed no items in this category for Hong Kong. 

Source:  Department of Commerce. 

Changes in export trends may not, by themselves, represent evidence
of attempts to acquire technology illicitly.  Increases in certain
high-technology exports to Hong Kong could be due, for example, to
the Hong Kong government's encouragement of technology-driven
economic growth.  Thus, changes in any baseline would signal the need
for further analysis and checking. 

Another means to monitor Hong Kong's continued autonomy in export
controls involves pre-license checks (PLC) to determine the
legitimacy of proposed end users and post-shipment verifications
(PSV) to verify shipments after licenses have been granted.  Defense
and Commerce Department officials have suggested that these checks
could be increased to test the Hong Kong government's continued
willingness to provide transparency and to obtain more information on
the status of particular exports.  The Hong Kong government has
stated that it will continue to cooperate with the U.S.  government
in the conduct of PLCs and PSVs. 

The U.S.  government has had much greater success in conducting PLCs
in Hong Kong than in China.  The Hong Kong government supports PLCs,
while the Chinese government limits them, as evidenced by the numbers
of such checks that have been canceled.  Data are readily available
on PLCs and PSVs to provide a baseline against which to measure
changes in Hong Kong's autonomy, as shown in table 2. 



                                Table 2
                
                 Comparison of Number of PLCs for Hong
                  Kong and China, Fiscal Years 1994-96


PLCs                              Number   Percent    Number   Percent
------------------------------  --------  --------  --------  --------
Completed                             23      74.2        25      22.7
Canceled                               8      25.8        85      77.3
======================================================================
Total                                 31       100       110       100
----------------------------------------------------------------------
Source:  Department of Commerce. 

The ability to conduct PSVs after reversion will also provide a
useful indicator of the continued autonomy of Hong Kong's export
control system.  Currently, Hong Kong allows the United States to
perform post-shipment verifications of deliveries of U.S.  exports,
but China does not.  During the past 2 years, the U.S.  government
conducted a total of 35 PSVs in Hong Kong but none in China. 

U.S., British, and Hong Kong government officials also suggested
other potential indicators of changes in Hong Kong's autonomy: 

SED reviews.  Commerce Department officials conduct on-site reviews
of selected SEDs at U.S.  ports prior to the export of goods.  The
officials review numerous transactions before selecting a smaller
target group for closer scrutiny.  Commerce also conducts a
systematic review at headquarters of SEDs after shipments have
occurred.  Commerce officials advised us that the number of such
reviews could be increased or refocused more directly on Hong Kong
exports. 

Changes in government personnel.  Shifts in key positions beyond
those resulting from normal staff rotation could signal a diminished
commitment to export controls.  However, U.S.  Consulate General
officials indicated that identifying and assessing changes that were
unusual would be judgmental. 

Problems in liaisons with Hong Kong representatives.  Changes in the
Hong Kong government's responsiveness to information on illicit
shipments through the territory, for example, could be an adverse
signal.  While instances of reduced Hong Kong cooperation could be
empirically determined, attributing such problems to changes in Hong
Kong's autonomy would require analysis and judgment, according to
U.S.  government officials. 

Prosecutions of criminal cases.  A decline in numbers of Hong Kong
government prosecutions for export control violations might presage a
change in Hong Kong's autonomy.  Data to construct a baseline would
be readily available. 

Passage of new export control legislation.  "Brokering" legislation
was introduced in the Hong Kong Legislative Council in April that
would allow the prosecution of middlemen making illegal deals
involving controlled items that may not even enter Hong Kong. 
Enactment of this law would be a good indicator of the Hong Kong
government's continued commitment to a strong export control system. 

The U.S.  government interagency working group established to
coordinate policy on Hong Kong completed a classified study in
January 1997 that designated benchmarks for monitoring whether
changes have occurred that affect the autonomy of Hong Kong's export
control system.  According to State and Commerce officials, lead
agencies will collect data on the various benchmarks and meet
periodically to review the data and make assessments. 

U.S.  government officials recognize that monitoring the
effectiveness of Hong Kong's export control system and detecting
diversions will be a challenge.  The Consulate General in Hong Kong
is tasked with monitoring a wide array of issues and staff are spread
thin, according to Consulate and other U.S.  government officials. 
Consulate officials also believe that individuals operating outside
direct Chinese government control will be very difficult to detect
and, even with continued Hong Kong cooperation, the U.S.  government
will not be able to detect everything. 

As provided by the Hong Kong Policy Act, should the President
determine that Hong Kong is not sufficiently autonomous to justify
different treatment from China under the export control laws, he may
change the way in which these laws are applied to Hong Kong.  The
State Department's Deputy Assistant Secretary for Export Controls has
stated that the United States would not prejudge the situation in
advance of monitoring efforts.  She declined to identify specific
changes that might trigger either a presidential determination under
the act or a change in U.S.  export control procedures for Hong Kong. 
She further commented that a whole series of areas will be monitored
and any one change might be sufficient if it seriously affected the
autonomy of Hong Kong.  Alternatively, a number of smaller changes in
a variety of areas might add up to a significant loss in
effectiveness.  According to Defense Department officials, there are
many variables to consider in reaching such a decision, and the
decision itself will be subjective.  They noted that it might be
difficult to assess whether Hong Kong's autonomy had been reduced if
a series of minor events occurred. 


--------------------
\15 Exporters are required to file documentation for shipments by
mail valued at more than $500 and for shipments by means other than
mail valued at more than $2,500; exporters must file for all
shipments requiring an export license regardless of value. 

\16 With one exception:  the current Export Administration
Regulations do not require exporters to record category information
when the item falls under the license exception for technology and
software exports. 

\17 We are currently reviewing Customs' implementation of AES,
including the extent to which AES will improve U.S.  export data. 


   RECOMMENDATIONS
------------------------------------------------------------ Letter :6

We recommend that the Secretary of Commerce establish appropriate
baselines to monitor trends in controlled items exported to Hong Kong
and China after Hong Kong's reversion to Chinese sovereignty.  To
accomplish this, we further recommend that the Secretary of Commerce,
working with the Commissioner of the Customs Service, systematically
assess data already filed by exporters, particularly information on
license exceptions and controlled item category numbers, to determine
whether the data are sufficiently complete and accurate to monitor
trends in exports of nonlicensed controlled items to Hong Kong.  If
the export data cannot be relied upon for monitoring purposes, the
Secretary of Commerce, in consultation with the Commissioner of
Customs, should assess the causes for the problems and initiate
corrective actions. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :7

The Departments of Commerce, State, and Defense, the U.S.  Customs
Service, and the Hong Kong government provided written comments on a
draft of this report.  The Departments of Commerce, State, and
Defense agreed with the information and analyses in the report. 
Commerce also agreed with our recommendation to develop appropriate
baselines to monitor accurately the potential risk to U.S.  national
security interests and stated that it is working with other agencies
to develop such baselines. 

The U.S.  Customs Service observed that it has controls in place to
monitor "licensable" shipments destined for all countries, including
Hong Kong.  Customs specifically cited its periodic inspections to
identify controlled items lacking proper Commerce or State licenses,
its reviews of ship manifests to detect suspect shipments, and its
Automated Export System to track manifests and SEDs for shipments
destined for Hong Kong.  Our primary concern, however, is that the
U.S.  government will have difficulty in tracking items that are
eligible for export to Hong Kong without a license--a concern that
Customs did not specifically address in its comments.  Furthermore,
less than 1 percent of all U.S.  exports are actually inspected,
according to Customs officials, and the results of the Census
Bureau's 1997 study suggest that there are considerable inaccuracies
in SEDs.  This, in turn could adversely affect Customs' ability to
inspect nonlicensed export shipments to Hong Kong.  Moreover, to
date, AES is being used in only a very limited capacity, and
questions remain about the numbers of exporters that will choose to
use this system. 

Commerce noted that it will be difficult to gather sufficient data on
exports of items to Hong Kong that do not require a license, and
that, given our findings on SED data accuracy, the Department has
reservations about overly relying on such data in the short term. 
Commerce pointed out that, in addition to data on nonlicensed
exports, the U.S.  government has other corollary information that
will serve as important indicators of the risk to U.S.  interests,
including monitoring of such areas as Hong Kong's cooperation with
PLCs and PSVs, prosecutions, seizure rates, and changes in
enforcement and export licensing personnel. 

In its comments, the Hong Kong government emphasized its commitment
to an effective export control system, backed up by comprehensive and
up-to-date legislation, stringent licensing requirements, rigorous
enforcement, and international support.  In the Hong Kong
government's view, Hong Kong's "clear autonomy" in the area of export
controls, in accordance with provisions of the Basic Law, provides a
solid basis for the U.S.  government's policy of treating Hong Kong
separately from China in the continued export of sensitive
technologies. 

The Hong Kong government does not believe there should be any
questions about Hong Kong's ability to maintain an independent
control system after reversion, noting the strong constitutional,
legal, and practical foundation on which its system is built.  The
Hong Kong government also stressed the need for Hong Kong's trading
partners to continue their present liberal export control policies
toward Hong Kong and warned against restrictive actions that run the
risk of undermining Hong Kong's system to the detriment of Hong
Kong's development and the broader cause of global nonproliferation. 
Further, the Hong Kong government saw no need for the U.S. 
government to institute specific baselines to monitor Hong Kong's
controls, given the transparency of Hong Kong's system, and cautioned
against instituting actions based on "unilateral statistics." The
Hong Kong government also commented on other specific potential
monitoring indicators. 

As we have noted, the effectiveness of Hong Kong's current export
control system was a key factor in the U.S.  government's decision to
continue existing export control policy toward Hong Kong after its
reversion to China.  The central issues are how well that system can
be preserved after reversion and how well the U.S.  government will
be able to detect any changes that signal a weakening of the system. 
Various factors--including China's overall proliferation record and
evidence of Chinese efforts to obtain controlled technology illicitly
from Hong Kong--raise questions about the level of increased risk
that the United States may be incurring in continuing to export
sensitive technologies to Hong Kong after reversion.  We therefore
believe the U.S.  government should monitor exports of sensitive U.S. 
technologies to both Hong Kong and China to ensure that such
technologies continue to be protected as called for in the Hong Kong
Policy Act. 

Comments from the Departments of Commerce, State, and Defense, the
U.S.  Customs Service, and the Hong Kong government are presented in
appendixes II, III, IV, V, and VI, respectively.  The State and
Defense Departments also provided technical comments and these have
been incorporated in the report as appropriate. 


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :8

To determine how U.S.  export control policies and procedures are
currently applied to Hong Kong as compared with China, we reviewed
U.S.  export control regulations governing licensing of dual-use and
munitions items.  We analyzed these regulations to identify which
dual-use categories allow items to be exported to Hong Kong without
licenses or prior government review, but not to China.  We discussed
our analysis and application of U.S.  export control policy and
regulations with officials of the Departments of State,
Defense--especially the Defense Technology Security
Administration--and Commerce and the U.S.  Arms Control and
Disarmament Agency.  To identify and compare historical patterns of
U.S.  exports of controlled items to Hong Kong and China, we obtained
data from the Commerce Department's licensing data base to determine
which license applications were approved, denied, and returned
without action for both Hong Kong and China during fiscal years 1994
through 1996.  We also analyzed license applications for exports to
China that were denied to determine whether the items on these
applications could have been exported to Hong Kong without a license. 
We prepared a preliminary list of such cases and had the Commerce
Department validate this list.  To determine if any items denied for
China were actually licensed for Hong Kong, we searched data from
Commerce's data base to identify matches in item descriptions.  As
these matches were done on a text field from two separate files of
item descriptions, only an exact match of the text language in each
field would identify the "same" items.  However, using the criterion
of an exact match does not indicate the extent of identified items,
given that identical items may be described differently in the data
base.  Therefore, the actual number of items that were denied for
China but exported to Hong Kong could be much greater than our
methodology allowed us to identify.  We did not independently verify
the accuracy of the data base from which we obtained data for use in
our analyses. 

We obtained information from the Defense Intelligence Agency on the
military and proliferation significance of dual-use categories of
items that do not require licenses for export to Hong Kong.  We also
obtained a list of authorized U.S.  munitions exports to Hong Kong
and China from the State Department's Office of Defense Trade
Controls. 

Assessing differences in application of export controls toward Hong
Kong and China also required us to obtain and review documents, such
as papers presented at two nonproliferation conferences held in
Washington, D.C., and Tokyo, Japan, which showed regime policies,
restrictions, and obligations for Hong Kong, China, and the United
States.  We interviewed officials from several U.S.  government
agencies, including the State Department's Bureau of
Political-Military Affairs, the Commerce Department's Bureau of
Export Administration, the U.S.  Customs Service, intelligence
agencies, the Office of the Secretary of Defense and Defense
Technology Security Administration, and the U.S.  Consulate General
in Hong Kong, for their analyses and views. 

To determine U.S.  export control policy toward Hong Kong after
reversion and the rationale for the policy, we reviewed the
provisions of the United States-Hong Kong Policy Act of 1992 and
statements and testimony of State Department officials on the act and
on U.S.  policy.  In addition, we reviewed over 60 State Department
cables concerning Hong Kong, nonproliferation, and the reversion and
two studies prepared by an interagency working group on these issues. 
We also reviewed laws, regulations, investigative case files, and
data base information concerning Hong Kong's export control and
enforcement system obtained from both the U.S.  government and the
Hong Kong government's Trade and Industry Branch, Trade Department,
and Customs and Excise Department to gain an understanding of the
operation of Hong Kong's export control system.  To obtain
assessments of the effectiveness of Hong Kong's system and the nature
of cooperation with U.S.  authorities, we interviewed U.S.  officials
in Hong Kong and Washington, D.C.  Additionally, we reviewed
documents and discussed with Hong Kong officials current and planned
actions to preserve and improve Hong Kong's current system.  To learn
how other key governments plan to treat Hong Kong after reversion and
what impact these plans might have on U.S.  policy, we interviewed
officials of the United Kingdom and Japan and cabled the government
of Australia with specific questions.  Information on foreign laws in
this report does not reflect our independent legal analysis but is
based on interviews and secondary sources. 

To assess the risks to U.S.  nonproliferation interests posed by
reversion, and the need for U.S.  safeguards and monitoring efforts
to protect such interests, we interviewed U.S., British, and Hong
Kong officials in Hong Kong and Washington, D.C.  Specifically, we
discussed the officials' views on continued Hong Kong autonomy after
reversion and the risks of (1) China's diverting U.S.  technology
from Hong Kong and (2) China or other parties using Hong Kong as a
conduit for illicit high-technology transfers.  We also reviewed
interagency studies, cables, and memorandums on Hong Kong and export
controls.  Furthermore, we discussed with officials of the State,
Commerce, and Defense Departments, the Customs Service, and the
Census Bureau, current and planned U.S.  capabilities to provide data
to assist in monitoring changes in Hong Kong's autonomy, export
patterns, and export control effectiveness.  In addition, we reviewed
a 1997 Census Bureau report that discussed existing and planned data
bases for export information. 

We conducted our review between September 1996 and April 1997 in
accordance with generally accepted government auditing standards. 


---------------------------------------------------------- Letter :8.1

As agreed with you, we plan no further distribution of this report
until
10 days from the date of the report, unless you publicly announce its
contents earlier.  At that time we will send copies of the report to
the Secretaries of State, Defense, and Commerce; the Commissioner of
Customs; representatives of the Hong Kong government; and other
appropriate congressional committees.  We will also make copies
available to others on request. 

Please contact me on (202) 512-4128 if you or your staff have any
questions concerning this report.  Major contributors to the report
are listed in appendix VII. 

Benjamin F.  Nelson
Director, International Relations and
 Trade Issues


SELECTED CATEGORIES OF ITEMS
REQUIRING NO COMMERCE LICENSE TO
HONG KONG:  ASSOCIATED MILITARY
UTILITY
=========================================================== Appendix I

Category
number      Description                        Military utility
----------  ---------------------------------  ---------------------------------
1A001       "Composite" structures or          Aerospace
            laminates, except for two
            subcategories of items requiring
            licenses

1B002       Systems and components specially   Small engines
            designed for producing controlled
            metal alloys, metal alloy powder
            or alloyed materials

1B003       Tools, dies, molds or fixtures,    Various structures (aerospace,
            for "superplastic forming" or      naval, ground)
            "diffusion bonding" titanium or
            aluminum or their alloys,
            specially designed for the
            manufacture of aerospace and
            aircraft equipment and engines

1C004       Uranium titanium alloys or         Shaped charges for heavy
            tungsten alloys with a "matrix"    penetrators/anti-armor materials
            based on iron, nickel or copper

1C006       Fluids and lubricating materials   Precision production and
                                               hydraulics for weapons systems
                                               operating in temperature extremes

2A001\a     Ball bearings or solid roller      Precision components
            bearings (except tapered roller
            bearings) having specified
            tolerances and standards

2A002       Other ball bearings or solid       Precision components
            roller bearings (except tapered
            roller bearings) having specified
            tolerances and other
            characteristics

2A003       Solid tapered roller bearings      Precision components
            having specified tolerances and
            standards

2A004       Gas-lubricated foil bearing        Nuclear weapons production
            manufactured for use at specified
            operating temperatures and unit
            load capacities

2B001       "Numerical control" units,         Precision production of
            "motion control boards,"           structures
            specially designed for "numerical
            control" applications on machine
            tools, machine tools, and
            specially designed components.
            (Certain items within this
            category require licenses for
            nuclear proliferation reasons.)

2B002       Non-"numerically controlled"       Precision production of
            machine tools for generating       structures
            optical quality surfaces

2B003       "Numerically controlled" or        Precision production of
            manual machine tools specially     structures
            designed for cutting, finishing,
            grinding or honing specified
            classes of bevel or parallel axis
            hardened gears, and specially
            designed components, controls and
            accessories

2B008       Assemblies, units or inserts       Precision production of
            specially designed for machine     structures
            tools, or for other controlled
            equipment

2B009       Specially designed printed         Precision production of
            circuit boards with mounted        structures
            components, or "compound rotary
            tables" or "tilting spindles,"
            etc., capable of upgrading
            equipment to controlled levels

3B001       "Stored program controlled"        Semiconductors with applicability
            equipment for epitaxial growth     to air superiority, power
                                               projection, antisubmarine
                                               warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3B002       "Stored program controlled"        Semiconductors with applicability
            equipment having specific          to air superiority, power
            characteristics designed for ion   projection, antisubmarine
            implantation                       warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3B003       "Stored program controlled"        Semiconductors with applicability
            anisotropic plasma dry etching     to air superiority, power
            equipment                          projection, antisubmarine
                                               warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3B004       "Stored program controlled"        Semiconductors with applicability
            plasma enhanced chemical vapor     to air superiority, power
            deposition equipment               projection, antisubmarine
                                               warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3B005       "Stored program controlled"        Semiconductors with applicability
            automatic loading multi-chamber    to air superiority, power
            central wafer handling systems     projection, antisubmarine
            for vacuum environments            warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3B006       "Stored program controlled"        Semiconductors with applicability
            lithography equipment              to air superiority, power
                                               projection, antisubmarine
                                               warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3B007       Masks or reticles                  Semiconductors with applicability
                                               to air superiority, power
                                               projection, antisubmarine
                                               warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3B008       "Stored program controlled" test   Semiconductors with applicability
            equipment, specially designed for  to air superiority, power
            testing semiconductor devices and  projection, antisubmarine
            unencapsulated dice                warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3C001       Hetero-epitaxial materials         Semiconductors with applicability
            consisting of a "substrate" with   to air superiority, power
            stacked epitaxially grown          projection, antisubmarine
            multiple layers                    warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

3C002       Resist materials, and              Semiconductors with applicability
            "substrates" coated with           to air superiority, power
            controlled resists                 projection, antisubmarine
                                               warfare, nuclear weapons,
                                               electronic warfare, intelligence
                                               collection

4A004       Computers, and specially designed  Computers, and specially designed
            related equipment, "electronic     related equipment as applicable
            assemblies" and components,        to air superiority, power
            including "systolic array          projection, antisubmarine
            computers," "neural computers,"    warfare, nuclear weapons,
            and "optical computers"            electronic warfare, intelligence
                                               collection

5C001       Preforms of glass or of any other  Guidance systems, secure
            material optimized for the         communications
            manufacture of controlled optical
            fibers

6A001       Acoustics, including (1) marine    Antisubmarine warfare,
            acoustic systems, equipment and    intelligence collection,
            specially designed components and  electronic warfare
            (2) correlation-velocity sonar
            log equipment designed to measure
            horizontal speed relative to the
            sea bed at distances between the
            carrier and the sea bed exceeding
            500 m

6A004       Optics, including (1) mirrors      Optics as applicable to guidance
            (reflectors); (2) components made  systems, image intensifiers/low
            from zinc selenide or zinc         light level TV
            sulphide with a specific
            wavelength transmission range;
            (3) "space-qualified" components
            for optical systems, as
            specified; (4) optical filters,
            as specified; (5) optical control
            equipment, as specified; and (6)
            "fluoride fiber" cable, as
            specified

6B004       Optics equipment for measurement   Optics as applicable to guidance
                                               systems, image intensifiers/low
                                               light level TV

6C002       Optical sensors, as specified      Guidance systems

6C004       Optics, as specified               Guidance systems

6C005       Synthetic crystalline "laser"      Laser range finders, laser
            host material in unfinished form   weapons

8A001       Submersible vehicles or surface    Antisubmarine warfare,
            vessels                            intelligence collection

8A002       Systems or equipment for           Sensor and control systems for
            submersible vehicles               submersibles as described in
                                               8A001

8B001       Water tunnels meeting certain      Design of submersibles
            specifications, designed for
            measuring acoustic fields
            generated by a hydro-flow around
            propulsion system models

9A002       Marine gas turbine engines with    Warships, submersibles (power
            specified standards and specially  projection, antisubmarine
            designed assemblies and            warfare)
            components

9A003       Specially designed assemblies and  Warships, submersibles (power
            components, incorporating any of   projection, antisubmarine
            the technologies controlled by     warfare)
            9E003.a, for gas turbine engine
            propulsion systems
--------------------------------------------------------------------------------
\a Quiet running bearings in this category are subject to State
Department licensing. 

Source:  Department of Commerce's Bureau of Export Administration and
Defense Intelligence Agency analyses. 




(See figure in printed edition.)Appendix II
COMMENTS FROM THE DEPARTMENT OF
COMMERCE
=========================================================== Appendix I



(See figure in printed edition.)




(See figure in printed edition.)Appendix III
COMMENTS FROM THE DEPARTMENT OF
STATE
=========================================================== Appendix I




(See figure in printed edition.)Appendix IV
COMMENTS FROM THE DEPARTMENT OF
DEFENSE
=========================================================== Appendix I




(See figure in printed edition.)Appendix V
COMMENTS FROM THE U.S.  CUSTOMS
SERVICE
=========================================================== Appendix I



(See figure in printed edition.)



(See figure in printed edition.)




(See figure in printed edition.)Appendix VI
COMMENTS FROM THE GOVERNMENT OF
HONG KONG
=========================================================== Appendix I



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


The following is GAO's comment on the Hong Kong government's letter
dated May 7, 1997. 

GAO COMMENT

1.We have substituted a different case (involving an attempted
diversion by a Singapore entity to North Korea) to further illustrate
efforts to use Hong Kong as a diversion point.  The Pakistan
diversion case is mentioned earlier in the report, on p.  12. 


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix VII

NATIONAL SECURITY AND
INTERNATIONAL AFFAIRS DIVISION,
WASHINGTON, D.C. 

Eugene Beye
Sharon W.  Chamberlain
Jason Fong
Hynek P.  Kalkus
Jeffrey D.  Phillips
F.  James Shafer

OFFICE OF THE GENERAL COUNSEL,
WASHINGTON, D.C. 

Richard Seldin


*** End of document. ***