By Phil Stewart

WASHINGTON (Reuters) - A research arm of the U.S. intelligence community just wrapped up a competition to see who could develop the best facial recognition technology. The challenge: identify as many passengers as possible walking on an aircraft boarding ramp.

Of all the entries, it was a Chinese start-up company called Yitu Tech that walked away with the $25,000 prize this month, the highest of three cash awards.

The competition was one of many examples cited in a report by a U.S.-based think tank about how China's military might leverage its country's rapid advances in artificial intelligence to modernize its armed forces and, potentially, seek advantages against the United States.

"China is no longer in a position of technological inferiority relative to the United States but rather has become a true peer (competitor) that may have the capability to overtake the United States in AI," said the report, written by Elsa Kania at the Center for a New American Security (CNAS) and due to be released on Tuesday.

Future U.S.-China competition in AI, Kania wrote, "could alter future economic and military balances of power."

Alphabet Inc's Executive Chairman Eric Schmidt, who heads a Pentagon advisory board, delivered a similar warning about China's potential at a recent gathering in Washington.

Schmidt noted that China's national plan for the future of artificial intelligence, announced in July, calls for catching up to the United States in the coming years and eventually becoming the world's primary AI innovation center.

"I'm assuming that our lead will continue over the next five years, and that China will catch up extremely quickly. So, in five years we'll kind of be at the same level, possibly," Schmidt said told the conference, which was also hosted by CNAS.

An unreleased Pentagon document, viewed by Reuters, warned earlier this year that Chinese firms were skirting U.S. oversight and gaining access to sensitive U.S. AI technology with potential military applications by buying stakes in U.S. firms.

In response, a bipartisan group of lawmakers in the U.S. Senate and House of Representatives this month introduced bills to toughen U.S. foreign investment rules.

The CNAS report noted the Chinese acquisitions and said Beijing faces hurdles to forging a domestic AI industry to rival the United States, including recruiting top talent.

Schmidt, however, expressed confidence in China's ability.

"If you have any kind of ... concern that, somehow their system and educational system is not going to produce the kind of people that I'm talking about, you're wrong," he said.

BATTLEFIELD 'SINGULARITY'

Artificial intelligence, which promises to revolutionize transportation with the advent of self-driving cars and bring major advances to medicine, is also expected to have military applications that could alter the battlefield.

Some machine learning technology is already being applied to a Pentagon project that aims to have computers help sift through drone footage, reducing the work for human analysts.

China's People's Liberation Army is also investing in a range of AI-related projects and PLA research institutes are partnering with the Chinese defense industry, the report said, citing publicly available documents.

"The PLA anticipates that the advent of AI could fundamentally change the character of warfare," the report said.

Kania acknowledged that much of her research was speculative, given the early stages of AI development and policies surrounding it in China and elsewhere.

Still, she said some PLA thinkers anticipate the approach of a "singularity" on the battlefield, where humans can no longer keep pace with the speed and tempo of machine-led decisions during combat, the report said.

The report quoted PLA Lieutenant General Liu Guozhi, the director of the Central Military Commission's Science and Technology Commission, warning "(we) must ... seize the opportunity to change paradigms."

Although Pentagon policy currently calls for a human role in offensive actions carried out by machines, it was unclear whether China's People's Liberation Army would adopt such a policy, the report said.

"The PLA may leverage AI in unique and perhaps unexpected ways, likely less constrained by the legal and ethical concerns prominent in U.S. thinking," Kania wrote.

(Reporting by Phil Stewart; Additional reporting by Cate Cadell in Beijing; Editing by Lisa Shumaker)