Where Industry and Security Intersect
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I appreciate the opportunity to participate once again in a conference on the ever-controversial topic of offsets in defense trade. There is a very diverse audience here -- some in favor of offsets, some opposed; industry, governments from around the world, academics, and the media.
Last year in my presentation, I talked about how relevant U.S. agencies were beginning to work together to develop a strategy for the future reduction or elimination of offsets in defense trade. It may surprise some of you to hear that, since that time, we have made considerable progress within the U.S. government on this issue. There is now an interagency task force on offsets. The task force has met with several foreign government representatives. We have also seen the passage of new legislation. More on these and other developments later.
First, let me provide some background on my interest in this issue. The Bureau of Export Administration (BXA) has a long history of involvement in defense industrial base issues, including offsets because our mission includes protecting that base. Apart from our export licensing and regulation activities, BXA is involved in a number of programs designed to maintain and enhance the competitiveness of the U.S. defense-manufacturing infrastructure. We regularly conduct assessments of key technologies and industrial sectors and provide the results to the Department of Defense and industry associations. We also assist communities in federal base closures and reuse and match technology needs of small- and medium-sized businesses with the extensive resources of the federal laboratories.
In 1992, my organization was given the responsibility of preparing annual reports to Congress on the effects of offsets in defense trade on U.S. industry. To date, we have published four reports, the most recent of which was released last December. These reports are based largely on data collected from U.S. prime contractors, supplemented with data gathered from other surveys and outside research. BXA coordinates this process with the Departments of Defense, Labor, State, and Treasury, and the Office of the U.S. Trade Representative. Let me share some of the report’s data with you.
It includes information on new offset agreements and offset transactions occurring between 1993 and 1997. According to the data that we have collected, new offset agreements between the U.S. and all foreign countries totaled $19 billion over that period and were associated with $35 billion in export contracts. This is about 54 percent of the value of the export contracts. The high point over that period came in 1995, when the value of new offset agreements reached over $6 billion and the average offset percentage was 81.5 percent. As with any of the data that I will present, you should bear in mind that offsets run in cycles, much like the defense purchases they are associated with. Many factors come into play, including the level of competition for the contract as well as the item being purchased.
From 1993 to 1997, European countries accounted for 70 percent of the value of new offset agreements with U.S. companies, with offsets averaging 88 percent of the contract value. As with total offsets, the European offset percentage peaked in 1995 with average offsets of [an astounding] 104 percent. Both the United Kingdom and the Netherlands are receiving average offsets of 100 percent or more of the export contract value. Based on our discussions with U.S. prime contractors, we expect the 88 percent average to increase in the future unless agreements are reached curtailing it.
As you know, an offset of 100 percent does not always mean that the selling company will award contracts to firms in the purchasing country that total 100 percent of the amount of the sale. There are a number of reasons why the amount of business placed in the purchasing country can be less than the stated value of the offset arrangement, including the use of multipliers, technology transfer, and training performed by U.S. firms. However, this flexibility in fulfilling offsets seems to be less prevalent in Europe than in the rest of the world.
We also measure offset transactions, which are activities -- co-production, technology transfer or counter trade -- carried out by U.S. companies to fulfill agreements entered into the same year or earlier. The total value of offset transactions rose over the five-year period, from $1.8 billion in 1993 to $2.7 billion in 1997. About 37 percent of the $12 billion in transactions that took place between 1993 and 1997 were direct offsets, 59 percent indirect, and 4 percent unspecified. Yearly averages for direct offsets ranged from 31.8 percent in 1994 to 40.1 percent in 1996; they ended the period down slightly, at 38.3 percent. Indirect offsets peaked at 60.9 percent in 1993, falling to a low of 57 percent in 1996. They rose again in 1997 to 57.1 percent. However, trend analyses can distort the actual picture of offset activity. The key offset numbers are driven by Europe, where most of the offsets continue to rise. Our discussions with the U.S. prime contractors all indicate that percentages are going up across the board in Europe.
Approximately 75 percent of the transactions were from subcontracting activity, purchases, or technology transfer arrangements with our allies. Half of the $12 billion fell into the transportation equipment industry category, specifically in aircraft and related parts. With our data showing such specific impacts on the industrial base, it is difficult to argue that offsets are a minor factor in international trade.
U.S. Government policy, developed during the Bush Administration, directs that the U.S. Government will not encourage or enter into any such agreements itself, nor will it finance such arrangements. From a purely economic standpoint, offsets are inefficient; they introduce a new element into the purchase decision unrelated to the price or quality of the products, which can distort market economies. The decision whether to engage in offsets, and the responsibility for negotiating and implementing offset arrangements, resides with the companies involved. To
the extent that offset arrangements are reached, U.S. companies will fulfill them -- and be the best partners in doing so.
I’d like to share with you some of the insights we have gained from conducting our studies over the years. Some in industry may not believe it, but we do know that offsets are a current reality of the international defense marketplace. Most countries that purchase modern weapon systems require offsets, whether they call them that or something else (such as industrial participation, industrial regional benefits or industrial cooperation). Regardless of the label, U.S. prime contractors often offer a highly-competitive offset package along with their sales proposals. Also, U.S. companies have an outstanding worldwide reputation for fulfilling offset obligations. So, it is important for purchasing nations to evaluate not only what offsets are being offered but also the past performance of companies in fulfilling their offset obligations.
Most nations view offsets as a winning proposition both politically and economically. From a political standpoint, this may be true, as offsets may help some governments justify weapon purchases to their electorate. However, from an economic perspective, this line of thinking is flawed. Simply put, offsets cost money! They increase the cost of the weapon system, and this cost ultimately must be passed on to the purchaser. These increased costs are associated with shifting component production to overseas suppliers, fees for transferring technology, or other administrative expenses. Co-production is the most costly form of offset, as it typically involves the replication of an entire production or assembly facility to produce a limited number of military items.
In reality, it is less expensive for most nations to import weapon systems than it would be to develop and produce them domestically. Few nations can afford, or have the capability, to maintain a fully integrated military industrial base. Many countries find that they must diversify into dual-use applications to expand the market for their goods. Offsets are not needed to achieve national security; they simply make the import more attractive politically to the purchasing nation. As I mentioned before, our latest report shows that 59 percent of the offsets transactions between 1993 and 1997 were indirect, having nothing to do with the weapon being purchased. Even though we saw a slight decline in indirect offsets toward the end of the period, they remained fairly stable overall and are a not-insignificant part of the transaction total.
This suggests that many countries may be making weapons purchases and/or choosing suppliers based on the offset offers instead of the security and operational requirements of their military. From a NATO perspective, this type of decision may not be in the best interest of the alliance since it places a higher burden on already dwindling defense budgets. NATO’s activities in Kosovo revealed a gap in military readiness among member nations; offsets will not close this gap. What is needed is more partnership and cooperation, both government to government and industry to industry. The focus should be on system performance upgrades and overall NATO interoperability, rather than concentrating on who offers the best offset package. This needs to be a joint effort by all of NATO as well as other key defense partners. Later this afternoon, Margaret Cahill of my bureau, will speak on alternatives to offsets in her presentation.
Where do we go from here? Clearly, not in the direction of unilateral action. Our goal has been -- and remains -- continued international consultations on offsets, both bilateral and multilateral. In the last year, we have made progress in the area of international consultations on mutually beneficial alternatives to offsets in defense trade. The Department of Defense is leading an interagency team, including the Departments of Commerce, Labor, and State, and the Office of the U.S. Trade Representative, which has been formed to initiate and pursue these consultations. During 1999, the interagency group met with representatives from the Canadian and Dutch governments to discuss reducing or eliminating offsets. Additional sessions are being planned with both governments.
Based on the willingness of these countries to enter into discussions, we recently sent a letter to all nations which have a reciprocal procurement Memorandum of Understanding with the Department of Defense requesting consultations on offsets. We are also taking steps to insure that U.S. industry is aware of these efforts.
Ultimately, we believe that agreements to reduce or eliminate offsets must be multi-lateral in nature. Therefore, we have also requested a working group on offsets with our European Union counterparts through the Transatlantic Economic Partnership; we are awaiting a formal response from the Europeans. Again, our objective is to focus attention and spur thinking on mutually-beneficial, economically-viable solutions. We’re also working to spur interest among the members of the industry-driven Trans-Atlantic Business Dialogue, a group that is running in parallel to the Transatlantic Economic Partnership.
My organization is also working with other parts of the Department of Commerce on defense offsets. Recently, we sent a cable to all U.S. Embassy Foreign Commercial Posts abroad that provided updated information for senior commercial officers regarding barter, counter trade and defense offset trade. We are working with the Posts to obtain information about current defense offset activity overseas and insure that embassy employees are aware of the U.S. position on offsets and our recent efforts to reduce or eliminate the practice.
Offsets have also recently received renewed Congressional attention. The House held a hearing on offsets in June 1999 in which the Departments of Commerce and Defense testified. That hearing led to legislation enacted late last year which will create a Presidential Commission to study offsets and make recommendations to the President on future U.S. policies regarding military offsets. The Commission will include representatives from industry, government, academia, and Congress. The legislation also calls on the President to develop a strategy for negotiating a multilateral treaty on standards for the use of offsets in international defense trade, with the goal of limiting transactions that are considered injurious to the economy of the United States.
My organization has participated in offset conferences like this one around the world, speaking to audiences of foreign governments and U.S. and foreign industry. Our message, which has been well-received, is that offsets are not the most economically sound means of improving a country’s technological capabilities, enhancing national security, or bolstering manufacturing capabilities. If a country nonetheless enters into an offset program, it should do so only after a prudent and realistic assessment.
I believe that most parties would readily reduce offsets if an acceptable alternative were available. While we have made great strides in opening communications on offsets, there will be no quick solution. We believe increased communication and cooperation are the best possible means of tackling this sensitive issue. This communication must occur company-to-company across borders as well as country-to country. Thank you.
In April of 2002 the Bureau of Export Administration (BXA) changed its name to the Bureau of Industry and Security(BIS). For historical purposes we have not changed the references to BXA in the legacy documents found in the Archived Press and Public Information.