```
Industrial Base: Assessing the Risk of DOD's Foreign Dependence (Letter
Report, 04/01/94, GAO/NSIAD-94-104).

Congress has raised concerns that the Pentagon has not established
criteria for determining acceptable levels of dependence on foreign
sources.  In response, this report proposes a framework for evaluating
the national security risk of buying military goods and technology from
foreign sources.  GAO answers the following four questions: What basic
factors determine the national security risks of buying from foreign
sources? How can these factors be measured and evaluated? Is appropriate
data for assessing foreign sourcing being collected? What are some U.S.
policy options for dealing with the risks of buying goods and technology
from foreign sources?

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

 REPORTNUM:  NSIAD-94-104
     TITLE:  Industrial Base: Assessing the Risk of DOD's Foreign 
             Dependence
      DATE:  04/01/94
   SUBJECT:  Information analysis operations
             Data collection operations
             Foreign corporations
             Cost effectiveness analysis
             Strategic materials
             Defense industry
             Defense procurement
             Risk management
             Military materiel
             Military inventories
IDENTIFIER:  Defense Key Technologies List
             Commanders in Chief Critical Items List
             
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Cover
================================================================ COVER

Report to the Chairman, Subcommittee on Defense Technology,
Acquisition, and Industrial Base, Committee on Armed Services, U.S. 
Senate

April 1994

INDUSTRIAL BASE - ASSESSING THE
RISK OF DOD'S FOREIGN DEPENDENCE

GAO/NSIAD-94-104

Industrial Base

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

  DARPA - Defense Advanced Research Projects Agency
  DOD - Department of Defense
  HHI - Herfindahl Hirschman Index
  IDA - Institute for Defense Analysis
  NDU - National Defense University
  SEMATECH - Semiconductor Manufacturing Technology
  TASC - The Analytic Science Corporation

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

B-256339

April 1, 1994

The Honorable Jeff Bingaman
Chairman, Subcommittee on Defense Technology,
 Acquisition, and Industrial Base
Committee on Armed Services
United States Senate

Dear Mr.  Chairman: 

Concerned that the Department of Defense (DOD) had not established
criteria for determining acceptable levels of dependence on foreign
sources, you asked us to propose a framework for evaluating the
national security risk of purchasing military products and
technologies from foreign sources.  In response to your request, we
addressed four questions: 

  What basic factors determine the national security risks of buying
     from foreign sources? 

  How can these factors be measured and evaluated? 

  Is appropriate data for assessing foreign sourcing being collected? 

  What are some U.S.  policy options for dealing with the risks of
     buying goods and technologies from foreign sources? 

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

Analyzing the implications of buying goods from foreign sources
requires determining what is a domestic versus a foreign source. 
Traditionally, DOD has defined a domestic or foreign source in terms
of where the production facilities are located.\1 Some analysts have
suggested broadening the definition of what constitutes a foreign
source to consider (1) firm ownership and control and (2) other
factors, such as location of research and development activities.\2
Although DOD generally does not know the extent of foreign sourcing
of defense goods, case studies of several weapon systems indicate
varying degrees of foreign sourcing exist at different levels, or
tiers, of the defense industrial base.  The tiers range from
suppliers of simple components and raw materials to the manufacturers
of complete weapon systems.  (See app.  I for a fuller description of
the defense industrial base.)

There can be advantages of using foreign sources:  manufacturers seek
out suppliers based on factors other than location, such as cost,
quality, performance, and delivery time.  In addition, buying from
foreign suppliers can entail political and military advantages. 
Despite these advantages, the increased use of foreign suppliers can,
in some instances, create a risk or vulnerability for the United
States.\3 For example, a high degree of risk would exist if the
United States were to become so dependent on a foreign source that
its ability to produce a weapon system deemed critical to national
security and/or secure the most advanced technology for the
development of a critical future weapon system were to become
compromised. 

We interviewed a variety of experts and also convened a panel of
authorities from industry, academia, and the government to discuss
risks of foreign dependencies.  (See app.  II.) In addition, we
reviewed several studies that develop various approaches to assessing
the risk of foreign sourcing.  (See apps.  III thru VI.)

--------------------
\1 Foreign sourcing, as defined by a National Defense University
report, is the use of sources of supply, manufacturing capacity, or
technology that are located outside the United States or Canada.  See
U.S.  Industrial Base Dependence/Vulnerability, a 1987 report of the
Mobilization Concept Development Center of the National Defense
University. 

\2 The 1992 amendments to the Defense Production Act require DOD to
consider, among other factors, the location of research and
development activity in determining whether firms located in the
United States qualify as domestic sources. 

\3 In a previous report, Industrial Base:  Significance of DOD's
Foreign Dependence (GAO/NSIAD-91-93, Jan.  10, 1991), we referred to
foreign dependence as a foreign source for which there is no
immediately available alternative.  In this report, we focus on the
risk associated with foreign sourcing; foreign dependence is one key
determinant of foreign sourcing risk. 

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

Assessing whether U.S.  dependence on a foreign source for a
particular military item entails substantial national security risk
requires answering two questions.  First, how critical is the item to
various national security needs--for example, engaging in a
short-term conflict, if necessary, or continuing development of some
technological capability?  And second, how great is the likelihood
that the United States will not have access to the item or technology
when needed? 

The risk of buying defense goods from foreign sources can vary
significantly according to the time frame being considered.  The
short-term risk of foreign sourcing is interrupted or delayed access
to items critical to engaging in conflicts.  Over a longer time
frame, the concern is that the United States will not have access to
the technologies, including equipment, needed to meet new or existing
threats to national security. 

To narrow the set of DOD purchases and militarily relevant
technologies to a group most likely to entail unacceptable risk, a
measure or screen can be used.  Screening for criticality to the
defense mission is a natural first step in identifying potential
risks, although it does require adequately reliable indicators of
criticality.  Measures of supplier concentration--the number and
relative market shares of supplying firms--have also been proposed as
vulnerability screens. 

Experts we consulted agreed that the data on defense suppliers
necessary to assess the risk of foreign dependence is not being
collected, particularly at the lower tiers of the defense industrial
base.  The consensus among these experts was that the costs of
selective data collection on critical items would not be prohibitive,
particularly compared with the price of major DOD acquisitions or the
potential consequences of the lack of military preparedness. 

Where substantial foreign dependency risks are identified, policy
options range from those designed to reduce the national security
risks of supply disruptions or lost access--such as stockpiling--to
those geared toward encouraging or establishing new sources of
supply.  Because the nature of vulnerabilities varies, optimal
policies vary also.  Experts we consulted pointed out the long-term
importance to the U.S.  technology base and to national security of
the overall economic and business environment in sustaining
innovative domestic industries. 

   RISK ASSESSMENT CONSIDERS
   CRITICALITY AND RISK OF LOST
   ACCESS
------------------------------------------------------------ Letter :3

The risk of buying defense goods from foreign sources depends on a
number of factors related to, among other things, supplier location,
political alliances, military function, and substitute availability. 
The risk determinants fall into two categories:  criticality of items
and the likelihood of loss of access.  More specifically, how
critical is the item to various national security objectives, such as
engaging in short-term conflicts, if necessary, or continuing
development of certain technological capabilities?  And how great is
the likelihood that the United States will not have access to the
item or technology when needed? 

Table 1 shows a number of risk factors we identified from existing
studies and interviews with experts.  Some apply to evaluating the
risks of procuring defense goods from any domestic or foreign
supplier or suppliers, and others apply only to assessments of
foreign sourcing.  The factors are listed in four categories; the
first one relates primarily to criticality and the next three relate
primarily to lost access. 

                           Table 1
           
                         Risk Factors

Criticality
------------------------------------------------------------
--The importance of the item or technology to the specific
weapon system and the overall defense mission.

--Stockpiling potential, the ability to stockpile adequate
amounts of a product (given obsolescence concerns).

--Technical substitution possibilities--the existence of
feasible technical substitutes or the ability to develop
them in an acceptable time frame.

--Linkages to other goods, industries, or technologies in
terms of industrial or technological spillovers from
domestic production that could affect the nation's ability
to compete in other important areas.

--In the case of technologically sophisticated goods, the
degree to which the technology is considered mature as
opposed to fast moving.

Disruption of supply from foreign sources

--Distance from source, in terms of required shipping time.

--Location of engineering and manufacturing facilities, if
different from assembly and shipping facilities.

--Transportation exposure.

--Risk of natural disturbances interrupting supply.

--Political stability of supplying country or region,
including political and diplomatic ties to the United
States.

--Country economic stability in terms of foreign debt,
exchange rate control, labor strife, or other factors.

--Trade stability--potential for the supplier's own supply
from another country to be interrupted.

--Country's internal business environment, such as the
nature of the regulatory environment.

--Supplying firm's economic stability.

Availability of alternative supply sources

--Supply concentration--the extent to which a few sources
worldwide control the production of goods or distribution of
technology.

--Dual-use options, or potential availability of the same or
similar good from a commercial supplier.

--Scale effects on U.S. industry--the potential negative
impact of decreased purchases from U.S. firms.

--The potential for a U.S. industry to be reconstituted if
lost.

Adequacy of surge capabilities

--The ability to acquire additional units of a good from an
existing supplier during a crisis.

--The timely availability of additional units of a good from
other suppliers during a crisis.
------------------------------------------------------------
Assessing the risk associated with buying defense goods from foreign
sources requires weighing the impact of various factors, both
individually and together.  For example, if location or political
conditions affect the reliability of a supplier, the availability of
other suppliers or feasible substitutes will be important in
determining whether the risk to national security is too great.\4

--------------------
\4 How much weight an individual factor carries in a risk assessment
is beyond the scope of this report.  This task falls to DOD and
involves considering the relevant characteristics of military
procurement and strategy.  In fact, changes in the nature of threats
to national security may cause the importance of particular factors
to shift over time. 

      RISK ASSESSMENTS DEPEND ON
      THE TIME FRAME BEING
      CONSIDERED
---------------------------------------------------------- Letter :3.1

The risks of using foreign sources for defense goods, and the ability
to identify and possibly mitigate them can be significantly different
when viewed from a short-term perspective versus a long-term one. 
The consensus of the panel members and studies we reviewed is that,
for the short term, details about the specific scenarios that could
threaten U.S.  security, such as the location, nature, and length of
potential conflicts, are not necessary for assessing the risks of
foreign sourcing.  However, as the time frame expands, uncertainty
grows in terms of (1) the nature of threats to U.S.  national
security and the foreign vulnerability concern and (2) how foreign
dependence will affect the U.S.  ability to develop and maintain
technologically sophisticated military items. 

         THE SHORT-TERM RISK OF
         FOREIGN SOURCING
-------------------------------------------------------- Letter :3.1.1

In the short term, a period of time spanning several years into the
future, foreign sourcing could lead to lack of access to critical
items during a crisis.  Given the current world order and the
"come-as-you-are" war philosophy,\5 this concern focuses on how the
United States would be affected if it could not obtain critical items
to fight a relatively short war, particularly one where DOD lacked a
long preparatory period and had low inventories of such items. 

The critical items that would need to be obtained during a short
conflict are primarily expendable items.  Expendables include a broad
range of items that can be used up during military activity and are
less durable than end items.  Examples include fuel, ammunition, and
large items such as the tactical missiles, as well as items that
support the troops (food supplies and medicines).  Also included are
spare parts that come from offshore. 

Expendable items and spare parts are required for actual combat
activities and support of production surge capabilities before,
during, and after a conflict.  For example, in the Desert Shield
period, there was an attempt to significantly increase the production
of expendable items and it became recognized that there was a
considerable dependency on foreign parts for this increase. 

The probability of acquiring additional major end items, such as
aircraft or tanks, during or in anticipation of a short-term conflict
is quite low.  Experts we consulted said the United States will
confront threats with existing equipment, particularly in the case of
large, complex end items.  The question of having enough tanks in the
short term, for example, then becomes a question of overall planning
rather than risk of supply disruption during conflict. 

--------------------
\5 The come-as-you-are philosophy deemphasizes concerns related to
surge and mobilization capabilities and emphasizes the need to have
on hand, or within ready access, supplies adequate for engaging in
likely conflicts. 

         THE MEDIUM-TERM RISK OF
         FOREIGN SOURCING
-------------------------------------------------------- Letter :3.1.2

Beyond the short term, there is an issue of whether foreign sourcing
could impair the ability of the United States to acquire large,
complex end items.  Experts we consulted maintained that in light of
current threats, the national security risk of disruptions in the
production of large items due to foreign sourcing is minimal. 
However, if a new large threat to national security were to emerge,
the extent to which domestic manufacturing equipment, technology, and
expertise has been lost could impact on the ability to produce
certain items. 

         THE LONG-TERM RISK OF
         FOREIGN SOURCING
-------------------------------------------------------- Letter :3.1.3

Over a longer time frame, the potential risk of procuring defense
items from foreign sources includes not having access to advanced
technologies.  As the time frame expands, fundamental elements in
assessing the risk of using foreign sources become increasingly
harder to predict:  the potential enemy, the nature of the war, the
weapons to be used, and the relevant technologies. 

Experts we consulted expressed concern that the United States, by not
maintaining domestic capabilities in some technologies, will lose the
technological leadership that has undergirded its military strategy
for several decades.  Concern over technology dependence can be
segmented into risk (1) from lags in availability and loss of control
inherent in depending on another country for the supply of certain
technologically sophisticated items and (2) of losing domestic
research and development capabilities in technologies that could be
militarily important in the future, although some are not now
identified as such. 

In addition to general determinants such as military criticality and
the existence of alternative suppliers, risks of using foreign
sources for leading-edge and emerging technologies depend on several
factors.  These include how fast the technology is evolving, since
delayed access to a rapidly advancing technology can bear greater
military consequences than delayed access to a slow-moving one; the
increased likelihood of a foreign-supplied technology being available
to potential enemies; and the nature of the working relationships
between the supplying foreign firm and either DOD or defense
suppliers. 

Several experts we consulted maintained that the greatest future
technology risk concerns technologies that may have military uses 20
or
40 years from now.  Over such a long time, there is significant
uncertainty regarding political alliances and threats to the United
States, as well as what technologies will have military importance. 
Some technologies are likely to be radically different from those now
identified as having military importance, according to one panelist. 

In addition, some experts we consulted mentioned that generic
technologies--that is, technologies with wide applicability in the
economy--are areas where the United States might have a long-term
national security interest in maintaining an active presence.  The
technologies mentioned include electronics, compact energy sources,
nanotechnologies (the art of making extremely small items), software,
and manufacturing technology.  Several panelists maintained that
access to the most advanced technology worldwide does not require the
United States to be a leader in every technology, but rather
sufficiently strong in key areas to have some leverage with other
countries. 

The extent to which technologies have both defense and commercial
applications could increase DOD's ability to turn to domestic
commercial sources if foreign sources became unreliable or
inadequate.  Several experts we consulted stressed the importance of
manufacturing technologies as well as product technologies to
national security.  Manufacturing capabilities, such as flexible
manufacturing techniques and computer-integrated manufacturing, and
logistics systems may facilitate both more efficient production and
conversion from commercial to military production when necessary. 

      A SCREENING MEASURE CAN BE
      USEFUL FOR ASSESSING RISK
---------------------------------------------------------- Letter :3.2

A screening measure can help narrow the universe of foreign-supplied
products and technologies to those most likely to entail unacceptable
risk.  The studies we reviewed proposed different types of screening
based on one or more specific vulnerability factors, such as military
criticality and the concentration of supply sources.  Three studies\6
narrow the items to be examined based on such factors as mission
criticality, location and number of suppliers, and time required to
gear up domestic supply. 

  One of these studies advocated a two-stage process to identify
     potential problem areas, with the first stage involving the
     assessment just described and the second stage involving the
     calculation of measures of supplier concentration. 

  Another study\7 did not advocate screening based on
     criticality/access factors, but instead proposed using a measure
     of supplier concentration to narrow the products warranting
     further analysis. 

--------------------
\6 Dependence of the U.S.  Defense Systems on Foreign Technologies
(Dec.  1990), Institute for Defense Analysis (IDA); Foreign
Vulnerability of Critical Industries (Mar.  1990), The Analytic
Sciences Corporation (TASC); and U.S.  Industrial Base
Dependence/Vulnerability (Nov.  1987), the National Defense
University. 

\7 The Globalization of America's Defense Industries:  Managing the
Threat of Foreign Dependence, by Theodore Moran (International
Security, Summer 1990). 

         CRITICALITY AS A SCREEN
-------------------------------------------------------- Letter :3.2.1

A reasonable first step in identifying the vulnerability associated
with an item is to examine how critical it is to the overall defense
mission; this helps to eliminate from further consideration items and
technologies that are marginally important.  Criticality-based
screening does, however, require reliable indicators, but some
experts question whether such indicators exist. 

One existing DOD list cited by some experts as a useful starting
place for identifying short-term critical items and technologies is
the Commanders' in Chief Critical Items List, composed of critical
weapon systems and components identified for the Joint Chiefs of
Staff by field commanders.  For identifying technologies with
critical defense applications, existing sources are the Defense Key
Technologies List and lists from the military services, which are
constructed with input from the military, industry, interested
federal agencies, and academia.  Examples of technologies currently
on the list include computer technology, propulsion/energy
conversion, and design automation.  For identifying future
technologies with potential military applications, one panelist
suggested considering technologies identified by the Advanced
Research Projects Agency. 

Using such lists to identify critical items and technologies can
increase the objectivity of the screening process.  However, critics
have argued that (1) the technologies listed are too broad and
therefore of limited usefulness and (2) domestic defense
manufacturers can effectively lobby to have various products
included. 

         SUPPLY CONCENTRATION AS A
         SCREEN
-------------------------------------------------------- Letter :3.2.2

Two of the studies we reviewed advocated placing considerable weight
on concentration measures--measures of the number and relative market
shares of supplying firms--in identifying potential foreign supply
vulnerabilities.  One study proposed using the Herfindahl-Hirschman
Index (HHI) to measure the worldwide supply concentration of items,
both overall for firms and with firm market shares grouped by country
of origin.\8 Another study proposed a "4/4/50 rule," whereby if four
foreign firms or nations control more than 50 percent of an
international market, then that market is considered "vulnerable" and
should be monitored.  (The study's author has pointed out that the
4/4/50 rule could be adapted for expression as a threshold HHI
value.)

The use of concentration measures in screening for foreign supply
vulnerabilities is based on the belief that the less concentrated the
supply for an item is, the lower the risk of losing access to supply. 
More countries mean more alternative sources of supply and, according
to proponents of supplier concentration measures, the less
concentrated the supply, the less able foreign firms are to collude
to restrict the supply. 

Proponents of these concentration measures maintain they are
relatively straightforward, quantifiable, and resistant to spurious
claims of vulnerability.  Others, however, have questioned whether
markets for defense goods can be defined so that concentration
measures are both meaningful and obtainable. 

Two experts pointed out that for the short term, DOD requirements are
often very specific and almost every market will contain a very small
number of potential suppliers; thus, concentration measures will not
eliminate many items from further evaluation.  Also, obtaining
information on potential foreign suppliers is especially difficult,
according to experts.  This limitation may be particularly applicable
to technologies, limiting the value of concentration screens for the
longer term. 

--------------------
\8 HHI for an industry is calculated by summing the squares of the
percentage market shares of individual firms in a particular market. 
This concentration measure emphasizes the role of the largest firms;
the number of very small firms has little impact on measured
concentration. 

   RISK ASSESSMENTS WILL REQUIRE
   SOME DATA COLLECTION
------------------------------------------------------------ Letter :4

Assessing the risks of using foreign sources requires information on
current and alternative supply sources for critical items that is not
now readily available to DOD.  Despite DOD's current efforts to
determine the extent of foreign sourcing,\9 existing databases on
defense suppliers are, for the most part, narrow, uncoordinated, and
minimally funded.  Further, most current databases concentrate on DOD
prime contractors.  Many specific characteristics of firms comprising
the defense technology and industrial base are not readily known,
particularly at the lower tiers.  These characteristics include the
firm's location, ownership, products manufactured, production
capacity, suppliers, technologies developed, market share, and
financial conditions. 

For identifying foreign sourcing vulnerabilities, basic information
on direct and indirect suppliers to DOD could be systematically
collected and maintained either for all DOD purchases or selectively
for critical items and technologies.  Data on foreign sourcing is
part of the overall data on the defense industrial base that is
needed for various assessments, such as evaluating whether certain
sole-source domestic suppliers pose potential reliability problems. 

Information on some risk factors, such as the existence and location
of alternative suppliers and the feasibility of substitute items,
would likely require additional collection and analysis and could be
done only for those items and technologies critical to national
security.  Some analysts have proposed using nationally collected
production and trade data to determine the extent of foreign presence
in defense-relevant markets.  However, although such data may be
useful as one crude indicator in assessing risk, its value is limited
primarily because it is too aggregated, since defense product markets
are often very specific and can involve rapidly changing technology
and specialized equipment. 

Just as the potential risks of foreign sourcing vary with the time
horizon considered, the complexity of the data requirements for
evaluating those risks is greater for longer term assessments than
for shorter term ones.  Over the long term, for example, not only are
existing and potential suppliers unknown, but also the nature of the
products and technologies that will be of greatest importance to DOD,
the types of conflicts, and the identity of adversaries and allies. 

Given the uncertainty surrounding the long-term risks of foreign
sourcing, a task of the defense planner is to monitor the sources of
defense-critical technologies worldwide.\10 Information of special
interest includes (1) existing and potential sources of
technologically sophisticated products for systems in various stages
of development and (2) the nature and location of research and
development with military relevance.  Some of these data could be
obtained by (1) surveying engineers, the technical literature, and
U.S.  government organizations in other countries and (2) capturing
the results of U.S.  participation in international research
projects. 

While collecting, maintaining, and analyzing information on foreign
supply of defense goods can be costly, the general consensus among
our expert panel was that if the screening is properly done, these
costs would not be prohibitive, particularly compared with the price
of major DOD acquisitions, or, even more importantly, with the
possible consequences of the lack of military preparedness. 

--------------------
\9 For example, at the request of the Navy, the Department of
Commerce examined sources of supply for three Navy systems, tracing
sources to the raw materials level.  The Commerce study found that
the proportion of domestic suppliers is high at the subassembly tier
but low at the basic component and raw material tiers of the defense
industrial base.  Also, a contractor is doing data collection
projects for the Army and the Air Force that focus on critical parts
of major weapon systems.  In addition, DOD is now collecting
information on production capacity from existing contractor databases
on manufacturing, purchasing, and engineering capabilities. 

\10 For additional information on selected U.S.  organizations that
monitor foreign technology information, see Foreign Technology: 
Collection and Dissemination of Japanese Information Can Be Improved
(GAO/NSIAD-93-251, Sept.  30, 1993). 

   OBSERVATIONS AND POLICY OPTIONS
------------------------------------------------------------ Letter :5

Given declining real defense budgets, an increasingly interdependent
global economy, and the loss of American preeminence in certain key
sectors, an expectation of self- sufficiency or total domestic
production capability across all industries does not appear to be
realistic or desirable.  However, understanding the instances in
which foreign sourcing of defense goods may entail unacceptable
national security risks is important and deserves more attention. 

It is important to differentiate between (1) understanding the
potential risks of foreign sourcing and (2) implementing policies to
reduce them.  A careful assessment of such risks may reveal only a
limited number of cases when government intervention is called for. 

We identified several key elements of an assessment of foreign
sourcing risk.  They include consideration of criticality of items or
technologies to the defense mission and the likelihood of loss of
access.  Screening based on some measure of criticality is an
important part of assessments.  Although the studies we reviewed and
the ideas presented by experts we consulted are valuable
contributions to understanding how to assess risk, we found no
framework that we could identify as fully developed or completely
refined. 

In many cases, the data needed to implement suggested aspects of a
vulnerability assessment are not readily available to DOD.  Experts
generally believe that additional data collection efforts would be
cost-effective considering the cost of weapon systems or the
potential consequences of military unpreparedness.\11

Where substantial foreign dependency risks are identified, policy
options range from those designed to reduce the national security
risk of supply disruptions or lost access to those geared toward
encouraging or establishing new sources of supply.  One expert noted
that the likely effectiveness of measures designed to decrease
foreign sourcing risks might be greatest for the short term.  The
further into the future lies the risk, the more uncertain is the
nature of the risk, and the greater the possibility that one might
misidentify the required technology, the type of conflict, or the
identity of adversaries or allies. 

Stockpiling is one option to minimize national security risks.\12 If
short-term access could be ensured through stockpiling, then lack of
domestic or adequately reliable foreign sources might not entail
unacceptable vulnerability.  Some experts question the feasibility of
stockpiling items because of (1) the rapid obsolescence or physical
depreciation of many items and (2) the expense of stockpiling. 
However, one of our panelists emphasized that the costs of
maintaining a carefully monitored inventory of certain items, such as
those needed to produce precision-guided munitions during a conflict,
could be a fraction of the overall production costs.  To prevent
useless inventory buildup that we have reported on a number of
occasions, stockpiling requires careful monitoring.\13

Several types of policies are designed to favor or encourage
additional sources of domestic supply.\14 The Defense Production
Act,\15 for example, authorizes the use of various financial
incentives to expand domestic production capacity or supply,
particularly for items with a limited commercial demand.  It also
provides for the development of new manufacturing processes and
technologies.  In addition, under section 232 of the Trade Expansion
Act, U.S.  firms can petition the government to restrict foreign
imports in cases where the erosion of domestic capacity is alleged to
harm national security.  Other measures are directed at potential
risks associated with foreign ownership of domestically located
firms.  For example, the Committee on Foreign Investment in the
United States and the security classification system can be used to
limit foreign investment in U.S.  defense-related firms, although the
Committee has raised concerns on only a few occasions. 

Expanding DOD's reliance on domestically available commercial
alternatives is another way to expand the supplier base in some
instances.  Other options for creating domestic capacity include
directly subsidizing industry or establishing government-owned
production facilities.  Currently, these activities are receiving
very little government support. 

For long-term concerns regarding the domestic technology base, policy
options include direct government funding or other types of
encouragement of domestic capability.  Research and development
consortia, for example, both private and government-supported, have
been tried over the past several years with varying success.  Our
panelists emphasized the importance of the Advanced Research Project
Agency's efforts in dual-use technology as well as funding joint
industry-government projects, such as the U.S.  semiconductor
consortium (SEMATECH).  Our expert panel also pointed out the
long-term importance to the technology base of a thriving commercial
technology sector and emphasized the role of the overall economic and
business environment in sustaining innovative domestic industries. 

Our analysis suggests that assessing the risks of foreign dependence
requires an effective system of data collection and analysis.  Such
an effort might begin with a multi-tier assessment of risks for a
critical class of expendables, a category where our analysis suggests
that an evaluation is important, feasible, and likely to be
cost-effective.  Through such an assessment, DOD can significantly
further its understanding of the broader issues of foreign dependence
risks. 

--------------------
\11 Recently, DOD requested the services and the Defense Logistics
Agency to provide information on current practices that are used for
selecting those products and services that are procured only from
domestic sources.  This is one effort to establish DOD policy and
criteria for identifying and maintaining critical domestic industrial
capabilities. 

\12 Stockpiling can be considered both in terms of an option for
reducing national security risks of dependence on foreign sources and
a determinant of that risk.  If a critical item can be adequately
stockpiled at low cost, for example, a full analysis of foreign
sourcing risk might not be necessary. 

\13 See Defense Inventory:  DOD Needs to Continue Efforts to Improve
Its Requirements Determination and Ordering Processes
(GAO/T-NSIAD-92-16, Mar.  11, 1992). 

\14 One panelist commented that extensive sources of supply that
ultimately drive companies out of business are also a concern. 

\15 See Defense Production Act:  Foreign Involvement and Materials
Qualification in the Title III Program (GAO/NSIAD-74, Mar.  19,
1994). 

   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :6

In developing this report, we

  analyzed published materials on the subject;

  selected four studies that provided frameworks for assessing the
     risks of foreign sourcing (the studies were developed by (1) The
     Analytic Science Corporation (TASC), (2) Institute for Defense
     Analysis (IDA), (3) National Defense University, and (4)
     Professor Theodore Moran of Georgetown University);

  interviewed experts and convened a panel of authorities from
     industry, academia, and the government; and

  analyzed the results of the panel discussion and submitted a list
     of key themes of the panel and a questionnaire to additional
     experts to obtain their views on the panel results. 

In addition, we (1) analyzed other reports that addressed the issue
of foreign dependence, such as the Department of Commerce report on
three Navy weapon systems and (2) requested that Commerce provide
additional information regarding lower tiers of production. 

We performed our review intermittently from November 1991 to February
1994 in accordance with generally accepted government auditing
standards.  Although we did not obtain written agency comments on
this report, we discussed the report's contents with DOD officials
and have included their views where appropriate. 

---------------------------------------------------------- Letter :6.1

We are sending copies of this report to the Chairmen, Senate and
House Committees on Armed Services.  We will also make copies
available to others upon request. 

Please contact me at (202) 512-4587 if you or your staff have any
questions concerning this report.  Major contributors to this report
are listed in appendix VII. 

Sincerely yours,

David E.  Cooper
Director, Acquisition Policy,
 Technology, and Competitiveness Issues

TIERS OF THE DEFENSE INDUSTRIAL
BASE
=========================================================== Appendix I

                                                    Key
                                                    activity
      Name of                            Product    at each
Tier  product   Product definition       examples   level
----  --------  -----------------------  ---------  --------
I     System    The end product          Ship,      Assembli
                                         aircraft,  ng
                                         tank,      system
                                         missile

II    Subsyste  A subassembly of the     Engine,    Assembli
      m         end product; a major     bilge,     ng
                subdivision of the end   air-       subsyste
                product                  condition  m
                                         ing unit,
                                         gun,
                                         avionics

III   Componen  A fundamental            Carbureto  Assembli
      t         constituent of a         r, pump,   ng
                subsystem or an end      heat       componen
                product; a number of     exchanger  t
                elements joined          , audio-
                together to perform a    frequency
                specific function and    amplifier
                capable of disassembly

IV    Element   A fundamental            Screw,     Making
                constituent of a         gear,      element
                component or a           rotor,
                subsystem; one piece or  front
                a number of pieces       wheel
                joined together that     bearing
                are not normally         frame
                subject to disassembly
                without destruction

V     Material  The basic ingredient     Fuel,      Refining
                (material) from which    oil,       and/or
                an element is produced   wire,      forming
                                         casting    material

VI    Raw       The mined (or            Ore        Extracti
      material  untransformed) material  mineral,   ng raw
                                         crude oil  material
------------------------------------------------------------

BIOGRAPHICAL SKETCHES OF PANEL
MEMBERS
========================================================== Appendix II

This appendix contains biographical sketches of the experts from
industry, academia, and government that were on the panel we convened
and/or were interviewed to discuss the elements of an analytic
framework for assessing the risks of foreign dependencies.  An
asterisk (*) by the name indicates participation as a panelist. 

ROBERT COSTELLO

Dr.  Costello works as a consultant to public and private
organizations.  He held a wide variety of executive positions in a
27-year career with General Motors Corporation, including Executive
Director of Purchasing; Director of Materials Management; and various
program and research management positions for missile systems,
armored vehicles, and technology transfer.  Dr.  Costello served as
Under Secretary of Defense (Acquisition) in previous administrations. 
He has also been associated with the Hudson Institute, where he
developed innovative concepts to enhance the U.S.  industrial base
and to improve its economic performance. 

CRAIG FIELDS

Dr.  Fields is President and Chief Executive Officer of
Microelectronics and Computer Technology Corporation.  In this
position, he has operating responsibility for research programs,
planning, and human resources.  During a 14-year tenure, Dr.  Fields
served in several positions within the Defense Advanced Research
Projects Agency, including the Agency's Director. 

JACQUES GANSLER*

Dr.  Gansler is a Senior Vice President and Director of The Analytic
Science Corporation.  Dr.  Gansler has served as Deputy Assistant
Secretary of Defense (Material Acquisition) and has held research and
engineering management positions with several major corporations. 
Dr.  Gansler is also a visiting scholar at Harvard University. 

ALFRED HANSEN*

General Hansen is Vice President of Airlift Programs for Lockheed
Aeronautical Systems Company.  General Hansen retired from the U.S. 
Air Force in 1989.  During his last assignment, he served as
Commander of the Air Force Logistics Command at Wright Patterson Air
Force Base.  General Hansen was responsible for developing and
implementing the first total quality management program in the Air
Force.  General Hansen joined Lockheed in 1990 to become Vice
President for Total Quality Management and Support Operations. 

ERLAND HEGINBOTHAM*

Mr.  Heginbotham works as a consultant for various public and private
organizations.  Mr.  Heginbotham is a former Director of the U.S. 
Commercial Service, Department of Commerce.  He has served as Deputy
Assistant Secretary of State for Economic and Commercial Affairs,
East Asia Bureau, and he has worked as the Director of the Office of
Industry, U.S.  Trade Commission. 

ROBERT INMAN

Admiral Inman serves on various public and private boards and
committees.  He has served as the Director of Naval Intelligence,
Director of the National Security Agency, Deputy Director of the
Central Intelligence Agency, and Chairman and Chief Executive Officer
of Microelectronics and Computing Corporation.  He was also the
President and Chief Executive Officer of Westmark Systems, Inc. 

MARTIN LIBICKI*

Dr.  Libicki is a Senior Fellow at the National Defense University. 
He has served as a transport analyst for the Department of
Transportation.  He has also worked as an economist for the
Department of the Interior and GAO.  Dr.  Libicki also has served as
Director of the Naval Industrial Mobilization Program. 

ROBERT MARSH

General Marsh serves as a director and consultant for Thiokol
Corporation.  He retired from the U.S.  Air Force in 1984 as
Commander of the Air Force Systems Command.  General Marsh has worked
as a member of the board of directors at several major corporations. 
He retired as Chairman of the Board of Thiokol in 1991. 

THEODORE MORAN*

Dr.  Moran is a Senior Advisor on the Policy Planning Staff,
Department of State.  He has also been a professor at Georgetown
University, School of Foreign Service, and Director of the Landegger
Program in International Business Diplomacy.  He has held teaching
positions at several other major institutions, including the Johns
Hopkins University and served at the Brookings Institute. 

WILLIAM NISKANEN*

Dr.  Niskanen is Chairman of the CATO Institute.  He has served in
the government as an Assistant Director, Office of Management and
Budget, and as a member of the Council of Economic Advisers.  He has
also been employed as an economist for several major corporations,
including the Ford Motor Company, where he held the position of Chief
Economist. 

JACK NUNN*

Mr.  Nunn works as a Senior Associate at the U.S.  Office of
Technology Assessment.  He has served in the military as a Special
Forces Advisor and as a U.S.  Army Foreign Area Officer.  He held
several positions in the private sector in research and engineering
management.  He returned to government as a Senior Fellow and Acting
Director of the Mobilization Concepts Development Center, National
Defense University, and professor of Resource Strategy, Industrial
College of the Armed Forces. 

WILLIAM PERRY

Dr.  Perry is now Secretary of Defense and was the Deputy Secretary
of Defense.  He has previously served as Chairman and Chief Executive
Officer of Technology, Strategies and Alliances Corporation.  He has
extensive government-related experience, holding positions as Under
Secretary of Defense for Research and Engineering, Director of the
Acquisition Task Force for the Packard Commission, and as a member of
the Defense Science Board.  Dr.  Perry was also Chairman and Chief
Executive Officer of H&Q Technology Partners. 

ALAN PLATT*

Dr.  Platt is a consultant on issues involving international security
affairs.  Dr.  Platt has held a number of defense-related
assignments, including Chief, Arms Transfer Division, U.S.  Arms
Control and Disarmament Agency, and senior staff member of the RAND
Corporation. 

SIDNEY WINTER*

Dr.  Winter is a Professor of Management at the Wharton School,
University of Pennsylvania.  He has also served as Chief Economist of
GAO.  He has previously served on the faculties of several
universities, including the University of California, Berkley; the
University of Michigan; and Yale University.  Dr.  Winter was a staff
member of the RAND Corporation and the Council of Economic Advisers. 

THE ANALYTIC SCIENCE CORPORATION: 
FOREIGN VULNERABILITY OF CRITICAL
INDUSTRIES
========================================================= Appendix III

   Figure III.1:  TASC Framework
   for Assessing Risk of Foreign
   Sourcing

   (See figure in printed
   edition.)

Figure III.1 illustrates the framework used to assess the risks of
buying Department of Defense (DOD) goods from foreign sources. 

      OBJECTIVES OF THE STUDY
----------------------------------------------------- Appendix III:0.1

  Develop methodology for assessing vulnerability. 

Identify and test objective measures of vulnerability. 

Determine extent of threat to national security. 

Establish priorities for government action. 

  Develop foreign dependency action plans. 

Provide industry and governmentwide options. 

  Add to the current knowledge of foreign dependencies. 

Perform case studies of three process technologies. 

Conduct thorough survey of literature. 

      SUMMARY OF APPROACH
----------------------------------------------------- Appendix III:0.2

This study (1) proposes measures to distinguish between foreign
dependencies that pose little or no threat to national security and
those that could have critical impacts on national security, (2)
suggests actions that DOD could take to identify evidence on the
scope and nature of foreign dependence, and (3) identifies actions
that DOD could take to avoid foreign dependence problems. 

      DEFINITIONS
----------------------------------------------------- Appendix III:0.3

         FOREIGN SOURCING
--------------------------------------------------- Appendix III:0.3.1

Even though foreign sourcing is not specifically defined in the
study, it is defined in a separate report prepared by The Analytic
Science Corportation (TASC) as the purchase of goods, services, or
technologies from sources outside the United States or Canada.  The
authors state that foreign sourcing is pervasive and part of DOD's
normal way of doing business and an important way of obtaining the
highest quality goods and services for DOD.  It may or may not lead
to a condition of foreign dependence or vulnerability that requires
monitoring or action by DOD. 

         FOREIGN DEPENDENCY
--------------------------------------------------- Appendix III:0.3.2

A situation where goods and services are purchased from a foreign
source of supply with no adequate alternative source or substitute
within the United States or Canada. 

         FOREIGN VULNERABILITY
--------------------------------------------------- Appendix III:0.3.3

A situation where a foreign dependency exists and national security
could be threatened by a disruption in supply.  In many cases, a few
firms in foreign countries can control access to state-of-the-art
parts, components, processes, and technologies. 

      INITIAL SCREENING
----------------------------------------------------- Appendix III:0.4

The initial screening process suggested by TASC begins with a
qualitative analysis of an item's criticality to national security
based on a number of considerations derived from several sources. 
One set of criteria used in the report was developed for the Under
Secretary of Defense for Acquisition's report, Bolstering Defense
Industrial Competitiveness.  Other factors of criticality considered
appeared in the 1983 study by K.  Myers, "U.S.  Vulnerability to
Non-Fuel Mineral Supply Problems." A final criticality listing
considered in the report came from the Defense Manufacturing Board's
Task Force on Critical Industries.  Specific factors contributing to
criticality of an industry or technology include its essentiality;
its ability to be reconstituted once lost; the ease with which the
know-how embodied in an industry can be defused; the rate of
technological change and research and development expenditures;
linkages between one industry and another; spillover effects in which
the loss of one capability would damage or lead to the loss of
others; and industry structure, which permits or precludes the entry
of alternative suppliers.  Additional criticality factors considered
included geographical location, various types of reliability (e.g.,
political, financial condition, and diversity of sources), and the
ability to stockpile and substitute items.  Applying these
criticality criteria, TASC selected three process technology areas as
case studies:  the industrial controller, electronic test equipment,
and numerically controlled machine tool industries. 

      DEPENDENCE/VULNERABILITY
      ASSESSMENT
----------------------------------------------------- Appendix III:0.5

Once criticality has been established, the authors of the TASC report
perform a quantitative assessment of vulnerability based on the
Herfindahl-Hirschman Index (HHI), a measure of the number of firms
and distribution of market shares among them in a well-defined
market.  As used by TASC, the index serves as an indicator for the
potential for effective collusive activity on the part of foreign
nations to deny the United States access to products and services. 
The HHI for an industry is calculated by summing the squares of the
market shares of individual firms in a particular market.  Squaring
market shares emphasizes the relative power of firms in a market.  In
this study, an HHI of 1,000 or less is considered indicative that a
market is relatively secure and that the likelihood of disruption
through collusive action is low.  An HHI of 1,800 or more (with no
prominent U.S.  or Canadian producers) indicates a vulnerable market,
since high concentration gives strong market power to current
suppliers and restricts the potential access by new suppliers. 
Results for HHIs between 1,000 and 1,800 are inconclusive. 

According to TASC, HHI was a key element of the study because (1) HHI
is a flexible, simple-to-apply, and appropriate tool for assessing
foreign dependencies and vulnerabilities; (2) its wide use by the
Department of Justice and Federal Trade Commission in anti-trust
cases attests to HHI's acceptance as a practical analytical tool; and
(3) although similar but simpler measures have also been applied to
assess foreign dependencies, these cannot match the robustness of
HHI; additional work must be done to verify its accuracy and to
identify appropriate threshold values. 

After defining the boundaries of the industry by identifying
competing products and close substitutes, the next step in the
quantitative portion of the analysis involves a "static" assessment
based on three different measures calculated using HHI and different
groupings of market share.  The first measure is a "geographical
index," calculated by grouping market shares by nation of origin. 
This index measures U.S.  vulnerability to the denial of critical
parts by individual foreign nations.  Second, a "foreign dependence"
index is calculated by grouping international producers' shares of
the U.S.  market by nation and excluding the U.S.  share of the
domestic market from the calculation.  This index measures the extent
of U.S.  dependence on foreign nations, highlighting instances where
U.S.  reliance is concentrated in only a few foreign nations for its
supply of a particular material or technology.  Finally, an "entry
barrier index" is derived from international firms' (U.S.  and
foreign) international market shares.  This index measures the extent
to which production of a commodity is concentrated in only a few
firms worldwide.  The last step in the quantitative portion of the
analysis involves capturing the dynamics of market share by measuring
the rate and direction of change in HHI in order to identify trends
that may lead to greater or lesser vulnerability in the future.  For
example, changes in shares of total industry research and development
spending may be a leading indicator of future changes for product
market share. 

Finally, the TASC approach identifies government actions for markets
found to be vulnerable according to results established in the
qualitative and quantitative analyses.  Table III.  1 shows the
categories of action. 

                         Table III.1
           
              Categories of Possible Government
                  Actions Identified by TASC

Highest priority policy treatment
------------------------------------------------------------
HHI > 1800 and 5-year change in market share is not
negative
or
1000 
+100

Second priority policy treatment

1000  0
but  1800 and 5-year change in market share is negative

Low priority policy treatment

1000 equipment (not only current
     product dependencies) should be a high priority.  These have the
     strongest impact on future U.S.  capabilities. 

  "Buy American" restrictions are not especially useful to resolve
     most important dependencies because they

do not apply to lower tiers of the industrial base;

are difficult to apply to critical areas, such as advanced processes
and technologies;

may be counterproductive by subsidizing the losers; and

provide few incentives to attain world-class status or promote
long-term viability. 

  Creative strategy must be developed for selected critical sectors,
     with a focus on advanced technologies and production equipment. 

      SUGGESTED REVISIONS AND
      COMMENTS BY AUTHORS
----------------------------------------------------- Appendix III:0.9

According to the authors, it has become increasingly apparent that
the government is focusing its limited resources on simply
identifying dependencies; it must determine which vulnerabilities are
more serious and then take action to alleviate them.  The purpose of
the study was to identify and apply a methodology that DOD could use
to measure and compare situations where there are perceived
vulnerabilities.  HHI showed itself to be a useful tool for gaining
insight into why a vulnerability exists and how severe it may be. 
However, this study involved only the initial application of the
method, and more extensive development and testing are required
before it can be widely applied by DOD (as it is now with the Justice
Department and the Federal Trade Commission).  Particular areas of
research include guidelines for appropriately defining the market (a
key element in anti-trust cases as well), the identification of
appropriate threshold values for foreign vulnerability applications,
and the definition of a more limited group of criticality factors
that can be used in the qualitative assessment.  To avoid potential
confusion with other anti-trust measurements, the authors also
suggest naming the resulting analytic measure the Foreign
Vulnerability Index. 

INSTITUTE FOR DEFENSE ANALYSIS: 
DEPENDENCE OF U.S.  SYSTEMS ON
FOREIGN TECHNOLOGIES
========================================================== Appendix IV

   Figure IV.1:  IDA Framework for
   Assessing Risk of Foreign
   Sourcing

   (See figure in printed
   edition.)

Figure IV.1 illustrates the framework used by the Institute for
Defense Analysis (IDA) to assess the risks of buying DOD goods from
foreign sources. 

      OBJECTIVES OF THE STUDY
------------------------------------------------------ Appendix IV:0.1

The objectives of the study were to (1) identify the extent and
nature and quantify the importance of U.S.  defense systems'
dependence on critical foreign technologies and (2) assess the
significance for defense capabilities that these dependencies affect. 

      APPROACH
------------------------------------------------------ Appendix IV:0.2

The Defense Advanced Research Projects Agency (DARPA), now called The
Advanced Research Project Agency, requested IDA to study selected
defense systems to determine and quantify the extent of their
dependence on foreign technology.  Four defense systems chosen by IDA
were (1) cockpit displays, (2) aircraft radar, (3) air-to-air
missiles, and (4) heavy combat vehicle engines.  IDA teams
interviewed and collected data from system program offices, prime
contractors, subcontractors, and other relevant sources for each of
the four systems.  On the basis of their analysis of the data
collected, the study teams were to (1) determine technology areas in
which U.S.  defense systems depend on foreign sources and (2) provide
factual and, where possible, quantitative measures of foreign
dependence for the systems reviewed. 

      DEFINITIONS
------------------------------------------------------ Appendix IV:0.3

         FOREIGN SOURCING
---------------------------------------------------- Appendix IV:0.3.1

The project team used a broad definition that included sources of
supply using foreign-owned facilities located outside the United
States and Canada, U.S.-owned facilities outside the United States
and Canada, or foreign-owned facilities located in the United States
and Canada.  The study team applied this term without any prejudgment
that it automatically connoted dependence or vulnerability, any more
than domestic sourcing does. 

         FOREIGN DEPENDENCE
---------------------------------------------------- Appendix IV:0.3.2

Foreign dependence was considered context-specific in that a key
consideration was the ability of the United States to obtain
alternative supplier(s) when necessary. 

         FOREIGN VULNERABILITY
---------------------------------------------------- Appendix IV:0.3.3

Foreign vulnerability was considered a function of dependence; of
political, military, and economic relations with source countries;
and of such factors as proximity, technology options, and
alternatives for responding to possible supply disruptions.  Like
dependence, vulnerability was considered highly context specific and
distinguishing between them was considered a matter of judgment.  In
general, the study team tended to consider that a condition of
dependence raising questions of vulnerability existed if items for a
system being studied were provided by only two or three foreign
sources; concentration of suppliers in a single country was taken as
further reinforcement of a condition of dependence to the point that
it raised strong possibilities of vulnerability. 

      INITIAL SCREENING
------------------------------------------------------ Appendix IV:0.4

Because of severe time limits on conducting the study, the study team
used a Delphi technique\1 to select critical weapon systems for
review, relying on several convocations of experts to discuss
alternatives within the context of selection criteria.  The DARPA
selection criteria stressed systems that would (1) be representative
of critical technology areas, (2) cover technology currently used in
important defense systems and expected to have significant roles in
the future, and (3) include systems procured by different armed
services.  The project team efforts resulted in selecting systems
that would

  be multigenerational, involving at least one major upgrade to
     permit examination of any trends in foreign sourcing in the
     system over time;

  include current technologies by choosing systems with a recent
     upgrade entering into low rate initial production or into final
     stages of prototyping as recently as possible, to include the
     latest fielded technologies;

  involve minimal overlapping or duplication with other selected
     systems, but include a multiplicity and diversity of
     technologies that could be considered; and

  include some dual-use technologies, anticipating that defense
     systems will be influenced by technologies developed initially
     for civilian applications. 

DARPA further influenced the system selection process by requiring
IDA to provide both quantitative and qualitative responses to
vulnerability issues.  Finally, the availability of data also
influenced the selection of defense systems reviewed. 

--------------------
\1 The Delphi technique is an attempt to elicit expert opinion in a
systematic manner, usually involving iterative questionnaires
administered to individual experts with feedback of results
accompanying each iteration of the questionnaire. 

      FURTHER ASSESSMENT OF THE
      EXTENT OF RISK
------------------------------------------------------ Appendix IV:0.5

Instead of attempting to formulate and apply a general definition of
vulnerability, the study emphasized the facts, circumstances, and
reasons involved in current sourcing decisions, as well as the
alternatives for responding to possible supply disruptions.  A
listing of 26 vulnerability factors was developed for application to
specific contexts or scenarios.  This listing included (1) three
location factors, (2) four political-military factors, (3) four
economic-commercial factors, (4) seven supply and technology factors,
and (5) eight procurement and program factors. 

      DATA REQUIREMENTS
------------------------------------------------------ Appendix IV:0.6

The study found no defense database useful in identifying foreign
sourcing in the four systems studied.  In practice, determining the
extent of technology from foreign sources meant that the four system
teams had to follow an elaborate data collection process down several
tiers in the procurement chain.  The study teams visited system
program offices, prime contractors, subcontractors, and other related
sources to obtain information related to the following: 

  Known instances of foreign sourcing of procurement and/or
     technology and contract terms. 

  Identification of foreign parts, equipment, or processes used by
     prime contractors. 

  Reasons foreign sourcing was used. 

  Importance of foreign-sourced items, processes, or equipment to the
     system. 

  Difficulties system production would encounter if foreign sourcing
     were interrupted. 

  Costs, obstacles, and delays that would be encountered in
     developing alternative domestic sources. 

  Military standards that affect the system. 

The study concluded that the lack of systems to track the sourcing of
parts and components makes it prohibitively difficult and costly to
determine the extent, let alone the significance, of defense system
sourcing of foreign technologies on a broad scale. 

      FREQUENCY OF RISK ASSESSMENT
------------------------------------------------------ Appendix IV:0.7

There was no mention in the study of how often a risk assessment of
systems should be done.  However, according to the Project Director,
due to the complexity of weapon systems and the ambiguity of
potential military contingencies, it would not be practical to try to
develop a generic analytical framework for assessing the national
security risk of foreign dependence.  In IDA's experience, by the
time a system is fielded, its technology is usually out of date, and
therefore, a system approach is not the best technique for assessing
dependence on advanced technologies.  Instead, the Project Director
believes that resources for assessing national security risk should
be directed toward examining the development of future weapon systems
rather than currently fielded weapon systems. 

      SUGGESTED REVISIONS AND
      COMMENTS
------------------------------------------------------ Appendix IV:0.8

As discussed in the previous section, the Project Director urged
DARPA to allow the IDA team to use a technology-based approach rather
than a system-based assessment.  The team recommended that DARPA
permit it to select a series of technologies known or expected to be
important in defense applications or to use a combined approach
studying several systems and several technologies.  It was the IDA's
team opinion that a technology focus would permit more of an
anticipatory look at dependence.  Emerging technologies often involve
extraordinary degrees of dependence and vulnerability because the
first country to develop and apply a technology can establish an
exclusive position more easily than countries with maturing
technologies where they must compete with other technology holders
for market advantage.  In the study, an analysis of high-definition
flat panel displays was used to represent an emerging technology. 

The Project Director of the IDA study stated that for practical
purposes, it would be wise to focus attention on a few technologies
that would be at the core of any vulnerability analysis due to their
dominance in the makeup of critical weapon systems.  He specifically
mentioned electronic components, as being an important area for
consideration in a vulnerability analysis because they make up about
60 percent of the cost of advanced weapon systems.  The Project
Director also cited semiconductor manufacturing equipment, machine
tools, and process control. 

Since DARPA did not specify a context or scenario or want IDA to
propose any, the Project Director emphasized that in conducting the
analysis, consideration of vulnerability factors gives an opportunity
to make judgments based on circumstances applicable to a myriad of
possible scenarios. 

Regarding the information necessary to focus the U.S.  government's
attention on technologies, the Project Director said that there was a
need to constantly monitor technology developments.  He stated that
applying a much simplified version of Project Socrates would be
useful.\2

--------------------
\2 Project Socrates was a Defense Intelligence Agency program
(1984-90) designed to enable officials to (1) limit the flow of
technology to potential adversaries, (2) identify strong market areas
for U.S.  businesses, and (3) identify emerging technologies with the
best opportunities for U.S.  investment. 

      STUDY CONCLUSIONS
------------------------------------------------------ Appendix IV:0.9

On the basis of the four systems studied, the IDA team reached the
following conclusions: 

  The most significant concentrations of foreign technology sourcing
     were in microelectronics, certain types of production equipment,
     advanced and specialty materials, and high-resolution flat panel
     displays. 

  Foreign sourcing of technology exhibited an increasing trend in
     microelectronics, machine tools, lithography equipment, and
     high-resolution systems. 

  There was no imminent vulnerability from foreign denial or delay of
     technology in the systems studied under the procurement
     conditions prevailing during the study. 

  Heavy dependence existed on a few highly concentrated foreign
     sources in four mature technologies. 

The IDA report found that an assessment of fielded systems more
easily provides hindsight into the supply state of aging technologies
than foresight on trends in advanced technologies. 

NATIONAL DEFENSE UNIVERSITY:  U.S. 
INDUSTRIAL BASE
DEPENDENCE/VULNERABILITY
=========================================================== Appendix V

   Figure V.1:  NDU Framework for
   Assessing Risk of Foreign
   Sourcing

   (See figure in printed
   edition.)

Figure V.1 illustrates the framework used by the National Defense
University (NDU) to assess the risks of buying DOD goods from foreign
sources. 

      OBJECTIVES
------------------------------------------------------- Appendix V:0.1

In 1986, the Under Secretary of Defense (Policy), in his role as
Chairman of the Department of Defense Mobilization and Deployment
Steering Group, tasked the Mobilization Concepts Development Center
to examine the potential national security problems of (1) the
reported growing dependence of the U.S.  defense industry on foreign
sources for a wide range of manufactured goods and (2) the potential
dependence on foreign sources for advanced technology.  The Center
was directed to conduct a two-phase study.  In phase I, it was to
survey recently completed and ongoing studies of foreign dependency
and assess the conclusions of the studies.  In phase II, it was to
identify and evaluate actions that might be taken to mitigate U.S. 
national security vulnerabilities resulting from a cutoff of foreign
sources.  Ultimately, phase II focused on (1) defining the nature of
the vulnerability problem, (2) developing a framework for identifying
and assessing the degree of foreign vulnerability, and (3) suggesting
methods for dealing with identified vulnerabilities. 

      SUMMARY OF APPROACH
------------------------------------------------------- Appendix V:0.2

The phase I survey of the literature concluded that there were
extensive studies of cases that revealed foreign dependence, but
these dependencies were mostly limited to a single weapon system, a
group of similar systems, or a single industrial sector.  It further
concluded that this ad hoc approach to studying foreign dependence
had limited use in determining where to make additional efforts to
identify critical foreign vulnerabilities or when to spend federal
funds to address these vulnerabilities. 

Phase II defined foreign sources, foreign dependence, and foreign
vulnerability and examined ways to develop priorities for weapon
systems and components to be analyzed.  DOD priorities were
considered together with other analyses that sought to determine the
aggregate potential use of a system by analyzing a range of national
security contingencies.  Phase II also included an analysis of three
case studies of foreign dependence.  Each case examined a particular
aspect of the issue.  The first case examined foreign dependence as
it relates to the capability to surge the production of
precision-guided munitions and the risk of an unanticipated cutoff in
supplies.  The second case examined the effects of foreign dependence
in a general mobilization and discussed the risks of insufficient
capacity for materials (including energy and minerals).  The third
case examined the effects of foreign dependence and technological
vulnerabilities by focusing on the potential consequences of losing
the U.S.  technological edge in the production of integrated
circuits. 

The study provided a methodology for placing priorities on areas
needing further study and for evaluating where potential
vulnerabilities exist in systems selected for further study.  The
approach emphasizes the importance of subjective judgment about
factors such as probabilities of conflict and probabilities of
disruption, but makes these considerations explicit so that they can
be discussed. 

      DEFINITIONS
------------------------------------------------------- Appendix V:0.3

         FOREIGN SOURCE
----------------------------------------------------- Appendix V:0.3.1

Any source of supply, manufacture, or technology outside the United
States or Canada. 

         FOREIGN DEPENDENCY
----------------------------------------------------- Appendix V:0.3.2

Any source of supply, manufacture, or technology outside the United
States or Canada for which there is no immediately available
alternative source in the United States or Canada. 

         FOREIGN VULNERABILITY
----------------------------------------------------- Appendix V:0.3.3

Any source of supply, manufacture, or technology outside the United
States or Canada for which there is no immediately available source
and whose lack of reliability and substitutability jeopardizes
national security by potentially precluding the production, or
significantly reducing the capability of a critical weapon system. 

The study considers three categories of vulnerabilities:  surge
capability, mobilization capabilities, and the technology base. 
Surge vulnerability exists when a foreign dependency has a high
probability of preventing the rapid increase of production within a
given time frame, thus causing fielded systems to be less effective
than required, and thereby jeopardizing the planned mission. 

Mobilization vulnerability exists if there is a high probability that
the production of key weapon systems and supporting systems or a
range of systems will be prevented or slowed, thus jeopardizing the
capability of the United States to support its actual or potential
wartime objectives. 

Technology base vulnerability exists when there is a high probability
that the United States will not have sufficient access to essential
technology and that this lack of access will prevent the United
States from developing and producing weapon systems critical for
maintaining deterrence or winning a war.  The concern in this kind of
vulnerability is not time dependent, but is focused on the inability
to retain a technological edge over potential enemies. 

      INITIAL SCREENING
------------------------------------------------------- Appendix V:0.4

The evaluation framework requires criteria to assist in both the
selection of key systems and the priority ranking of systems selected
for further analysis.  The following selection criteria were
considered: 

1.  Degree to which the system is considered critical to success in a
contingency and the importance of the contingency for which the
system is required.  Is the system critical in the most important
scenario or in many contingencies?  This criterion provides insight
into the relative importance of the system to the overall U.S. 
national security mission. 

2.  Production requirements of the system:  numbers, time criticality
of production, and sophistication.  A system may be judged critical
to performing a mission but have small wartime production
requirements.  (Strategic nuclear weapons, for example, have
relatively small surge or mobilization requirements.) Further, while
peacetime manufacturing dependencies are unlikely to be
vulnerabilities, peacetime technology dependencies could be.  While
this criterion addresses surge and mobilization, it does not address
the technology base issue, where the focus is on the sophistication
of the weapon system and the availability of the technology for it. 

3.  Location and number of sources of supply and likelihood of supply
disruption.  A single source of supply is of particular concern. 
Sources in some geographical areas are less secure than others. 
Disruption may occur through either direct attack, sea lines of
communication interdiction, political decisions, or general
instabilities.  The number of sources is important even when these
sources are in the United States.  Multiple sources abroad might be
highly useful for overall survivability and proximity to the conflict
in some contingencies. 

4.  Effect of the identified dependency on the specified or
envisioned weapon systems or other items/technologies.  How and to
what degree does the dependency slow or preclude the United States
from fielding a particular system? 

5.  Reversibility of identified dependency.  To what degree is it
reversible?  This criterion ties in with the criticality of time: 
How soon and in what quantities are the weapon systems needed? 

In determining the criticality of systems, this approach considers
deterrence to nuclear war as the most important U.S.  mission, and
thus, strategic nuclear weapons and systems remain the most important
class of systems in the U.S.  arsenal. 

      RANGE OF CONTINGENCIES
------------------------------------------------------- Appendix V:0.5

Since the United States was faced with the need to prepare for a
number of contingencies and required a range of forces, the study
examined several types of contingencies, rather than concentrating on
a single scenario.  The study argued that any framework for assessing
foreign dependencies and potential vulnerabilities must include a
range of contingencies that can be analyzed in sufficient detail to
determine U.S.  and allied force requirements, their corresponding
material requirements, and their production requirements.  Specific
contingencies were considered in the study, including, for example, a
global conventional conflict with the Soviet Union and the U.S. 
support of an allied conflict. 

The study indicated that once a manageable group of selected systems
has been identified, they can be examined in detail for potential
foreign vulnerability in the areas of surge, mobilization, and
technology base.  A single system might be vulnerable in all three
areas, or several systems might share the same vulnerability in areas
such as key subcomponents, manufactured tools, or procedures. 

According to the NDU study, the first level of analysis is the end
product.  Does the United States buy the entire end item from abroad? 
The second level of analysis is the purchase of subcomponents such as
integrated circuits.  The third level of analysis is an examination
of the mobilization production requirements for the system, to
understand whether current internal mobilization constraints might in
reality be foreign dependency related or whether foreign sourcing may
remove these constraints. 

Identifying a foreign dependency is a necessary but not sufficient
condition for vulnerability.  Only in the first two cases must there
be a potential for disruption; in the case of technological
dependence, there may be costs even without disruptions.  Such
disruptions are a function of military action, political decisions,
general instabilities (e.g., labor strife or local revolution), and
natural disaster.  Considering relative probabilities of the types of
disruption from a particular geographic source of supply during
selected security contingencies is a way of thinking about the
potential for disruption.  This is determined by the number and
location of sources of supply. 

A final consideration is that the effectiveness of any particular
disruption is a function of both its duration and its thoroughness. 
This analysis involves considering the opponent's capability to
enforce the disruption and the U.S.  ability to overcome it. 

The study briefly comments on the threat of a technology cutoff.  It
states that access to foreign technology is an asset as well as a
potential problem and that there is no clear evidence that the United
States will not continue to have access to foreign technology,
although that access might not be as rapid as desired. 

      DATA/UPDATING REQUIREMENTS
------------------------------------------------------- Appendix V:0.6

The study concluded that the required data might be relatively
limited, based on the small number of actual vulnerabilities that
might be identified. 

      STUDY CONCLUSIONS
------------------------------------------------------- Appendix V:0.7

Based on the three case studies of foreign dependence, the authors
concluded the following: 

  Foreign vulnerabilities exist but are a small subset of all foreign
     sources.  Once identified, actions can be taken to manage the
     risks. 

  Ensuring availability for conflicts with low probability but high
     risks, is very expensive, but there are some policy options,
     such as stockpiles, that entail reasonable costs. 

  The vulnerabilities associated with the security of the U.S. 
     technology base exist across the spectrum of possible conflicts. 
     They are more difficult to resolve than those associated with
     continuous production because they affect weapon systems not yet
     in existence. 

  It is important to remember that although disruptions are possible
     due to military or political causes, allied support is likely in
     most cases.  Nevertheless, foreign sources may require action to
     hedge against the possibility of disruption. 

The study describes the purchase of military goods and services from
foreign sources as both an opportunity and a potential problem. 
Foreign purchases may provide access to products and technologies not
available in the United States.  However, these purchases may also
have the following effects:  (1) to the extent that foreign sources
are less reliable than domestic ones, continuous production flow is
jeopardized; (2) domestic capacity is reduced; and (3) the
development of domestic technology may be retarded. 

      SUGGESTED REVISIONS AND
      SUBSEQUENT COMMENTS BY
      AUTHORS
------------------------------------------------------- Appendix V:0.8

The authors pointed out that the study was conducted during a period
of concern about the military threat from the Soviet Union.  With the
demise of that threat, the contingencies might be reduced to (1)
theater conflict, (2) global conventional conflict, and (3) nuclear
conflict. 

THE GLOBALIZATION OF AMERICA'S
DEFENCE INDUSTRIES:  MANAGING THE
THREAT OF FOREIGN DEPENDENCE BY
THEODORE MORAN
========================================================== Appendix VI

Figure VI.1 illustrates the framework used by Dr.  Theodore Moran to
assess the risks of buying DOD goods from foreign sources. 

   Figure VI.1:  Moran's Framework
   for Assessing Risk of Foreign
   Sourcing

   (See figure in printed
   edition.)

      SUMMARY OF APPROACH
------------------------------------------------------ Appendix VI:0.1

In his article, entitled "The Globalization of America's Defence
Industries:  Managing the Threat of Foreign Dependence," Moran
concludes that vulnerability (risk) in the defense industrial base is
directly related to the amount of foreign control in a particular
industry or technology.  This control arises from market
concentration.  Moran defines market concentration using a 4/4/50
rule.  That is, parts, components, or technologies purchased from
four or fewer foreign countries or from four or fewer foreign
companies that supply over 50 percent of the market should be
monitored.  He incorporates this quantitative measure into a
"national strategy." The strategy comprises three key elements:  (1)
promoting cutting-edge industries, (2) preserving threatened
industries, and (3) regulating foreign acquisitions and foreign
investments.  In addition, the article addresses possible
vulnerabilities resulting from the concentration of supply among
domestic sources. 

      OBJECTIVE
------------------------------------------------------ Appendix VI:0.2

The article seeks to provide a new framework for assessing (1) the
adequacy of the defense industrial base and (2) the risk of foreign
control of the supply of defense goods and technologies. 

      DEFINITIONS
------------------------------------------------------ Appendix VI:0.3

         FOREIGN SOURCING
---------------------------------------------------- Appendix VI:0.3.1

A foreign source includes any firm or industry outside the United
States, Canada, and--with the implementation of the North American
Free Trade Act--Mexico. 

         FOREIGN DEPENDENCE
---------------------------------------------------- Appendix VI:0.3.2

Moran does not specifically define foreign dependence.  He states,
however, that foreign dependence is not a public policy issue unless
suppliers are concentrated. 

         FOREIGN VULNERABILITY
---------------------------------------------------- Appendix VI:0.3.3

Foreign vulnerability is defined according to a set of supplier
concentration rules.  Foreign vulnerability exists when either four
foreign firms or foreign countries control 50 percent or more of a
particular market.  According to the author, the 4/4/50 rule could be
adapted for expression as a threshold HHI value. 

      INITIAL SCREENING
------------------------------------------------------ Appendix VI:0.4

Moran advocates the implementation of the 4/4/50 rule for
concentration as a means of initially screening for vulnerability. 
This framework does not provide for an initial screening based on
criticality to national security. 

      FURTHER ASSESSING THE EXTENT
      OF RISK
------------------------------------------------------ Appendix VI:0.5

Moran argues that while strictly determining the concentration of
supply is the most important factor in the process, the breakout
between foreign and domestic suppliers should also be considered. 
Moran does not distinguish among various foreign sources in terms of
political reliability.  A greater extent of concentration is
acceptable if the suppliers are primarily domestic, although reliance
on a large number of foreign suppliers is preferable to reliance on a
small number of domestic suppliers. 

      POLICIES FOR ADDRESSING RISK
------------------------------------------------------ Appendix VI:0.6

1.  Promoting cutting-edge technologies.  As a first step toward
achieving a goal of protecting the defense industrial base from
foreign dependence, Moran advocates the use of government funds for
innovation.  He recommends that these resources be distributed
according to the degree of a project's usefulness to the military. 
The first priority for funding would be projects with high potential
defense payoffs and limited, or no, commercial prospects.  The lowest
priority would be those projects with a "dual use"--that is, projects
where commercial prospects are especially high.  Once appropriate
projects are funded, Moran believes that the United States should
then allow companies from allied and quasi-allied nations to
participate in the development of these high-technology programs.  He
would require, however, that all foreign firms associated with these
projects, along with any U.S.  participants, carry out any proposed
research and development at facilities in the United States. 
Furthermore, he would stipulate that subsequent production be located
either in the United States or a neutral third country. 

2.  Preserving industries threatened by foreign competition.  Moran
states that, whenever possible, trade protectionism should be
avoided.  When it becomes in the U.S.  national interest to impose
trade restrictions, he recommends the quick implementation of a
tariff.  Moran cautions that this action is warranted only when
external concentration in an industry
(as defined by the 4/4/50 rule) threatens U.S.  national security. 
Without this threat, there is no need to take actions to preserve the
continuation of a domestic industry. 

Moran is opposed to the use of quotas and voluntary restraint
agreements as a means of restricting foreign countries from U.S. 
markets.  Moran states that these measures only encourage
inefficiency in the marketplace by fixing the amounts that external
producers can supply to the domestic market, no matter how high
domestic prices rise.  Moran especially dislikes voluntary restraint
agreements, which are self-administered export limitations among
foreign producers, as he believes that their use further encourages
the oligopolistic structure of an external industry and inhibits new
entrants into the market. 

Moran opposes the implementation of a set "strategic trade policy" as
a means of combating foreign dependence by restricting imports and
promoting exports.  He argues that such a policy would eventually
encourage retaliation and potentially destroy any chance for the
development of a domestic industry.  He favors the promotion of an
alternative approach, which he calls a "push for parity" of access to
national markets.  Moran asserts that cooperation among nations would
benefit the entire marketplace and eventually lead to higher
productivity, innovation, and efficiency. 

3.  Regulating foreign acquisitions and foreign investment.  Moran
notes that foreign direct investment can be considered a penetration
of the defense industrial base and that acquisition of a U.S. 
defense company by a foreigner can represent a loss to the base. 
U.S.  policy has traditionally stressed the need for regulation of
classified materials and has recently moved further toward
restrictions by advocating industrial policies that attempt to keep
foreigners from "burrowing into" the U.S.  defense industrial base
through foreign direct investment.  Moran argues that in an era in
which technological leadership in industries of vital importance to
defense are shared more broadly than in the past, these restrictions
may no longer be appropriate.  He therefore outlines three instances
where foreign investment/acquisition may be warranted. 

  When foreign direct investment into the United States creates
     subsidiaries that seek to extend their product line into
     defense-related activities.  Moran contends that obstructing a
     foreign country's entrance into a new market would force the
     company to produce its products off shore, further minimizing
     U.S.  control over its conduct of business. 

  When a prospective foreign buyer of a U.S.  firm agrees to divest
     itself of all defense-related activities. 

  When a proposed foreign acquisition of a U.S.  firm results in the
     intention of the new owner to continue operating a business of
     direct importance to the U.S.  defense industry.  In this case,
     the 4/4/50 rule provides a useful screening device for
     determining potential vulnerability caused by the acquisition. 

Finally, Moran notes that the approach described above, by itself,
would not totally protect the United States against the prospects of
"foreign influence, foreign manipulation, and foreign control." He,
therefore, calls for the convening of an international conference to
negotiate a convention on extra-territoriality backed by a dispute
settlement mechanism to handle disagreements.  Here Moran reaffirms
his belief that international cooperation is the most efficient means
to promote both industrial progress and national security. 

      DATA REQUIREMENTS
------------------------------------------------------ Appendix VI:0.7

Moran believes that DOD should collect data on concentration from all
alternative supply sources for particular categories of products. 
Further research is needed to determine how narrowly the market
should be defined, but the subcontractor level is particularly worthy
of surveillance.  Moran states that the mechanics of collecting the
data are not a consideration in this study.  Moran mentions, however,
that several proposals for creating a database have been suggested to
DOD. 

      UPDATING REQUIREMENTS
------------------------------------------------------ Appendix VI:0.8

Updating should be done on a regular basis. 

      CONCLUSIONS
------------------------------------------------------ Appendix VI:0.9

Vulnerability in the defense industrial base is directly related to
the amount of foreign control in a particular industry or technology. 

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

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

Kevin Tansey, Assistant Director
Rosa M.  Johnson
Celia Thomas
Marilyn Mauch
Ned Nazzaro
Carolyn Blocker

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