Western aircraft makers see huge market potential in China and are trading jobs and technology for a piece of the action. Now, the Chinese are upping the ante.
The mountains that surround Xian Aircraft Co. are clouded with a grayish coal smoke that hangs over the Wei River valley. When people cough, say Westerners who have been there, they often spit up black phlegm.
Industrialization has gripped this remote central Asian region. And because the products built here include airplanes and giant aircraft components, advancement and prosperity also cling to the valley air.
The flow of Western capital has turned the Shaanxi province and its biggest city, Xian, into China's leading aerospace manufacturing center. It is here - 540 miles inland from the Yellow Sea, 5,400 miles from Seattle - where the interests of China and The Boeing Co. intertwine.
This is where their strategies for the 21st century are playing out, where China's rise to economic power vies with America's efforts to control the flight paths of the global economy.
It is in this remote valley, frozen in time but gripped by the future power of technology, where the Western aerospace giants bloody each other in a mad scramble to capture the dominant share of the world's next mother lode of airplane sales.
This is where Boeing, through a little-known practice called "offsets," is transferring to China and other nations aircraft production work that might have been done in Washington state and Kansas. The nations require such investment as a condition for buying Boeing's planes.
Boeing quietly accelerated its production in China recently to counter several setbacks and protect its dominant share of the Chinese aircraft market.
The transfer of production to China comes at a politically sensitive time between the two countries. Congress is about to consider renewal of China's most-favored-nation trading status and both countries are engaged in a potential trade war over China's failure to enforce a software piracy agreement.
The political disputes already cost Boeing a $1.5 billion order that went to rival Airbus Industrie, company officials contend. China continues to delay an additional $4 billion order for Boeing jets. Chinese authorities declined to discuss the issues raised in this story.
All three Western aircraft builders - Boeing, McDonnell Douglas and Europe's Airbus - have concluded they must meet Chinese offset requirements to ensure their future. But critics see the export of Western aircraft production and technology to places like the Shaanxi Valley as a threat to the long-term interests of U.S. workers, their communities and even the companies themselves.
Boeing officials say they must enter these offset agreements or they will lose the business to their rivals. Aerospace companies have long acceded to offsets in military and weapons sales, but only recently have been faced with countries that demand offsets in commercial aircraft sales.
Boeing's chief international strategist, Lawerence Clarkson, said the company's strategy is "to do what it takes to remain the preferred supplier" for China, the world's fastest growing market. The price has been giving up some production work and technology to maintain access to the Chinese market.
Aircraft manufacturers stampede to please Chinese
Xian Aircraft is the nerve center of China's ambitious plans to develop a competitive commercial aircraft industry.
It is nurtured by Chinese government demands that Boeing and other aerospace companies share their wealth - or face the stark prospect of losing sales in a period of rapid expansion. Analysts project China's airplane market is worth $140 billion over the next 20 years, about 10 percent of overall world sales.
To tap into the wealth, Boeing and the other Western aerospace companies are falling over themselves to give the Chinese much of what they want.
Until recently, the Chinese have treated Boeing well.
China has purchased 252 Boeing airplanes since 1972. Between 1993 and 1995, one of every 10 Boeing planes went to a Chinese airline. Boeing officials say China's business during the recent slump saved 10,000 jobs in the Puget Sound region that otherwise would have been eliminated.
China's recent buying spree was merely a prelude to the next 20 years, during which the Chinese expect to buy 1,500 commercial jetliners, Boeing officials say.
Airbus and McDonnell Douglas have redoubled their efforts to cut into Boeing's 70 percent share of the Chinese market. All three companies have set up divisions in Beijing, and all have showered the Chinese with money, supplier contracts, aviation technology and jobs.
Boeing invested $100 million to improve China's flight safety. Airbus put up $50 million to build a state-of-the-art flight simulator center, and McDonnell Douglas agreed to co-produce airplanes in Shanghai.
Such outlays raise alarm bells among some U.S. policy-makers, elected officials and union leaders. They fear this stampede to please the Chinese hurts U.S. employment, erodes U.S. dominance in aerospace manufacturing and could threaten national security.
What is happening in China has focused attention on the practice of offsets, which recent government reports have concluded are on the rise. They come in two forms:
-- A direct offset allows the purchaser to receive work or technology directly related to the sale, typically by producing a piece of the aircraft or components under license.
-- An indirect offset involves barter and counter-trade deals, investment in the purchasing country or the transfer of technology unrelated to the product.
"In the 1970s, American aerospace companies were involved in such disparate activities as marketing Swiss chocolate and Danish hams" to meet foreign offset requirements, said Joel Johnson, a spokesman for the Aerospace Industries Association of America.
"Now, countries are more sophisticated," he said. "More frequently, they either want a piece of the actual product, a piece of the defense industry, or something in the manufacturing or high-tech sectors."
"How much technology is going over there?"
The federal government is required to seek offset limitations from its trading partners under a policy adopted in 1992 as part of the Defense Production Act.
But investigators with the General Accounting Office, the investigative arm of the U.S. Congress, found that while other countries are increasing their demands for offset arrangements, the U.S. government has yet to consult with foreign governments on limiting the resulting "adverse effects," as the policy requires.
Clinton administration officials recognize the dilemma. Increasing trade with fast-growing nations such as China is a public policy priority. Yet Commerce Undersecretary William Reinsch acknowledges that offsets "can shift production jobs overseas, and (have) the long-term effect of creating competitors" to U.S. industries.
While it's unclear how many U.S. jobs are lost through offsets, one factor to consider is that Boeing and the other aerospace companies treat factories such as Xian Aircraft as low-cost manufacturing outposts.
Chinese-built 737 tail sections can be found on planes for Southwest Airlines or Scandinavian Airlines System as well as China Southern.
Boeing's largest union, the International Association of Machinists and Aerospace Workers, has suggested Boeing uses China's market-access barriers to camouflage its real aim of taking advantage of China's cheap labor - a claim Boeing disputes.
"We know they have to deal with the Chinese," said George Kourpias, the Machinists' international president. "But the question is: How much production are we going to lose in the U.S. over this? And how much of the technology is going over there?"
A growing number of elected officials in Washington, D.C., share that concern. Some are considering drafting new legislation to stop the practice if aerospace companies refuse to moderate themselves.
"Offset arrangements do involve the transfer of technology and manufacturing capability," said U.S. Sen. Jeff Bingaman, D-N.M., who is a member of the Armed Services Committee and a key offsets opponent. "Over time, this does mean jobs."
China aiming to make 180-seat "Asian" jetliner
One of the symbols of global power is a thriving aerospace industry. Most analysts agree that China remains years away from becoming a credible competitor. But the country has a step-by-step plan that begins soon with the building of a 100-seat jetliner and culminates with the construction of an 180-seat "Asian" airliner in the next decade.
Boeing has blunted potential competitors by drawing them into joint production efforts. Industry analysts point to Boeing's ability to appease the Japanese, making them significant partners on the 777 and the 747, and thwarting, for the moment, Japan's goal of building a commercial jetliner.
But even Boeing's Clarkson recognizes that China presents a powerful new challenge that even large Western companies can't address on their own.
China has developed a policy that includes close government coordination among industries, the military and the government agencies, General Accounting Office investigators asserted in a 1994 report.
The policies are "characterized by strong government support, importation of technologies, a strong emphasis on applied - as opposed to theoretical or basic - research, and direct, synergistic links between the military and civilian aeronautics projects."
This poses serious problems for Boeing. It has long supported free trade and less government interference in the global economy. That's why the company pushes for China's inclusion into the World Trade Organization, which supports free-market reforms.
"The down side is if they get big enough, then they can start writing their own ticket," Clarkson said of China. "That's not a Boeing thing as much as it is a world politics thing."
Politics straining Boeing's ties with Beijing
Until recently, it was assumed Boeing had the world's richest aircraft market locked up.
After all, Boeing's relationship with the People's Republic of China dates back to 1972, the year President Nixon and Secretary of State Henry Kissinger renewed diplomatic ties with the Communist country.
The Nixon administration used the lure of Boeing 707s as one of several incentives to persuade the Chinese to form a strategic alliance with the United States that opposed the Soviet Union.
"The sale of Boeing 707s to China was politically a very important, symbolic act and personally approved by President Nixon," said former Ambassador Chas Freeman, Nixon's China interpreter. "It was the Chinese who asked about Boeing aircraft."
That set off a series of discussions among senior State, Defense and National Security advisers over the details of such a sale. Concerns arose over the transfer of sensitive technology. The Chinese made no secret that they wanted Boeing technology.
"China wanted to break out of its isolation and faced a hostile Soviet Union," said Richard Solomon, former National Security and State Department official under Nixon and President Bush. "What the sale of Boeing (jets) did was break China out of its dependence on Soviet supply and spare parts and open the prospects of technical cooperation with the U.S."
Two weeks after Kissinger and Nixon left China, Boeing senior executive Tex Boullioun and other company officials flew to Hong Kong, and then traveled overland to Beijing.
At that time, China had no commercial flights.
Three weeks later, the Chinese agreed to buy 10 707s. Boeing was one of the first U.S. companies to sign a contract with Communist China.
"After the president went in, our complications were not great at all," recalled Boullioun, then the president of Boeing's commercial division. "They wanted our airplanes, and we established a relationship immediately."
Boeing and China tightened that relationship over the next 25 years in a mutually beneficial exchange of airplane orders for cash and technical expertise. Today, Boeing planes dominate the new fleet of Western passenger jets on Chinese flight paths.
But that relationship has been strained by the American reaction to China's threat to invade Taiwan and by China's violation of trade, software copyright and nuclear proliferation agreements.
For the first time in the relationship, political disputes have led to some serious setbacks. Politics was partly responsible for Boeing's loss of a $1.5 billion order to Airbus. Politics has contributed to the delay of more than $4 billion in passenger-jet orders. And it played a role in Boeing's loss of a contract to jointly produce a 100-seat passenger jet with China.
Analysts say that's a significant blow to Boeing, because the project helps the Western aerospace partner protect its market share. The Chinese appear to have chosen several European aerospace companies for the project with South Korea.
Boeing responds to discord by enriching Chinese contracts
With the loss of the 100-seat airplane project, the company has to change its strategy. That includes strengthening its subcontracting relationship with Xian Aircraft and other Chinese aerospace suppliers.
Xian Aircraft is about to begin producing at least 1,500 tail sections for Boeing's 737-700 - up sharply from the original agreement two years ago to build 100 tail sections.
Plus, Boeing supplier Northrop-Grumman will shift a percentage of its contract for 757 tail sections from Dallas to Chengdu Aircraft Co., southwest of Xian in the Sichuan province.
Chinese officials, in an official news agency announcement in March, hailed the contracts as the largest in the history of China's aviation industry.
Boeing officials, however, made no public mention of them. When asked, company representatives acknowledged that they're steadily expanding China's role as a supplier for the 737 and likely for the stretch version of the 747.
Boeing has very few other options. It has given the Chinese just about everything else, as senior Boeing executives are quick to point out.
"I must tell you that I am disappointed in China's most recent order for Airbus airplanes," Ronald Woodard, president of Boeing Commercial Airplane Group, told Chinese officials in a recent speech in Beijing.
Woodard then ticked off his company's generous record of service to China:
-- It lobbied for permanent most-favored-nation status for China that would end the annual controversial practice of granting China trading privileges.
-- It supported China's inclusion into the World Trade Organization, which would prohibit offsets and promote market reforms, but would also give the Chinese access to international financing for industrial development.
-- It transferred production and assembly operations to China.
-- It created internships for nearly 2,000 Chinese pilots and maintenance people in Seattle and China.
-- It invested $100 million to improve Chinese airport safety equipment.
-- It donated two 737 simulators for Chinese training of air crews.
The list now includes a planned visit in June by Boeing's board of directors to Beijing, Guangzhou and Xian.
But Woodard fears Boeing's dominant position in China is at risk. "Right now we're hanging by our fingernails," he said.
Chinese break pledge, divert technology to military use
A controversy involving Boeing competitor McDonnell Douglas' deal to sell advance military technology to the Chinese underscores some of the national security risks involved when aerospace companies swap their technology for aircraft orders.
The financially struggling U.S. airplane maker, eager to close a $1 billion deal to build 40 jets in China, agreed to sell the Chinese sensitive tooling technology. The advanced "five axis" tools are used to make components for aircraft but also for cruise missiles and nuclear warheads.
The Chinese pledged to send the machines to a nonmilitary factory in Beijing but illegally diverted them to Nanchang, a major center for Chinese missile programs.
It is just such technology transfer that critics fear could pose a competitive threat to U.S. industry, or even a national security threat. But in a deregulated global market, it is tougher than ever to safeguard technology.
For Boeing, the basic strategy is simple, if risky.
Boeing will share current technology if it must, but will always seek to be on the leading edge of next-generation technology.
"Boeing over the years has jealously guarded its critical technologies and core competencies," Clarkson said. "While we may agree to transfer some technology, we better have something in the works that is better."
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-- Communists take over China.
-- Chinese communists troops join North Korea against U.S. in Korean War.
-- Troops crush Tibetan revolt; Dalai Lama flees to India.
-- Chinese Cultural Revolution.
-- Nixon meets Mao Tse-tung in Beijing.
-- Boeing sells 10 707s to Chinese.
-- Mao dies.
-- Deng Xiaoping launches "four modernizations" program.
-- China orders three Boeing 747s.
-- Washington and Beijing establish diplomatic relations; Deng visits U.S. and tours Boeing assembly plants in Renton and Everett.
-- The United States grants China most-favored-nation trading status.
-- Boeing establishes China office with one field-service representative.
-- China builds a replica of a Boeing 707, dubbed the Y-10, through reverse engineering. But the passenger jet had no center of gravity and was built out of steel, not aluminum. Several test flights were made, but the plane was never produced commercially.
-- China orders 34 Boeing 737s, 33 757s and 10 767s.
-- Xian Aircraft Co. signs contract with Boeing to supply machine parts for the 747.
-- Xian Aircraft signs second contract with Boeing to produce 737 forward access doors. That leads to further contracts for 747 trailing-edge ribs, 737 vertical fins and horizontal stabilizers. Boeing eventually signs supplier contracts with Shenyang Aircraft Co. to build 757 cargo doors and with Shanghai Aircraft Co. to produce 737 component parts.
-- Massacre in Tiananmen Square; Boeing forced to cancel contract to sell six Chinook CH-47 helicopters to Chinese military for an estimated $100 million.
-- China places one of the largest commercial-aircraft orders in Boeing history: 36 airplanes and 36 options for a total value of $9 billion.
-- China takes delivery of its 100th Boeing airplane.
-- Boeing trains 400 Chinese pilots and maintenance employees.
-- China's president, Jiang Zemin, comes to Seattle for the Asia Pacific Economic Cooperation meeting, where he meets with President Bill Clinton. Zemin also tours Boeing's Everett factory and visits the home of a Boeing production worker. Zemin asks Boeing Chairman Frank Shrontz to help improve flight training and airport safety in China. Boeing obliges and spends $100 million achieving that goal.
-- Boeing trains more than 800 Chinese pilots and airline maintenance employees.
-- Clinton "delinks" human rights from debate over granting most-favored-nation trading status to China.
-- Xian Aircraft Co. wins contract to produce 100 tail sections for Boeing 737-300/500.
-- China takes delivery of its 200th Boeing airplane.
-- China Southern becomes first Chinese carrier to operate Boeing 777.
-- Boeing and Harbin Aircraft Manufacturing Co. explore the possibility of co-producing a civilian version of its CH-47 Chinook helicopter in China.
-- Boeing Machinists strike the company for 69 days; transferring production work to China and other suppliers is one of the union's chief concerns.
-- Taiwan voters elect Lee Teng-hui president in March; China threatens to invade. U.S.-Sino relations deteriorate over trade, software piracy, human-rights abuses and nuclear-proliferation violations.
-- China delays an estimated $4 billion order for Boeing airplanes because of tensions in U.S.-Sino relations.
-- Xian Aircraft completes construction of new $600 million factory, signs contract with Boeing in March to build at least 1,500 737 tail sections.
-- Northop-Grumman, which builds Boeing 757 tail sections, announces in March it will subcontract a percentage of the work to Chengdu Aircraft Manufacturing Co.
-- Boeing officials in April say they appear to have lost the contract to build a 100-seat airliner with the Chinese and South Koreans. The Chinese appear to have chosen the Europeans as their Western partner.
-- Boeing announces in April that it plans to hire 8,200 employees (6,700 locally), mostly production workers, to meet growing demand for new airplanes fueled largely by the rapid expansion of air traffic in China and Asia.
-- To date, Boeing has sold 252 airplanes to China and employs more than 100 company employees throughout the country.