IMPACT OF OFFSETS IN DEFENSE-RELATED EXPORTS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP87M00539R002303720001-1
• Release Decision: RIPPUB
• Original Classification: K
• Document Page Count: 165
• Document Creation Date: December 22, 2016
• Document Release Date: December 23, 2009
• Sequence Number: 1
• Publication Date: December 13, 1985
• Content Type: MEMO

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Compt
EXECUTIVE SECRETARIAT
D/OGI/DI
cutive Secretary
17 Dec 85
Date
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EXECUTIVE OFFICE OF THE PRESIDENT
OFFICE OF MANAGEMENT AND BUDGET
WASHINGTON. O.C. 20503
DEC 13 1985
MEMORANDUM FOR: DISTRIBUTION
FROM: Alton G. Keel, Jr.
Associate Director
National Security nd
International Affairs
SUBJECT: Impact of Offsets in Defense-Related Exports
Section 309 of the Defense Production Act (DPA) Amendments of
1984 mandates an annual report on the impact of offsets in
defense-related exports on various aspects of the U.S. economy.
The Office of Management and Budget (OMB), through a staff level
interagency committee, has been coordinating the preparation of
the first report that was due in mid-October, 1985. Executive
Order 12521 sets forth the responsibilities of the various
departments and agencies.
As you may know, there was a significant delay in
transferring data collected from industry for this report from
the International Trade Commission (ITC). As a result, the
decision was made to delay submission of the report beyond the
statutory date by approximately two months. The interagency
committee has now completed the penultimate draft of the first
report. This version includes an executive summary, which should
be of special interest to senior reviewers.
Concerning legislative strategy for fiscal year 1987, OMB
believes that the Administration position should be that Section
309 of the OPA Amendments should not be reenacted with the rest
of the DPA. The argument would be that the present report
demonstrates that offsets are not a significant problem and
therefore future reports would be of little value. Such a
position would obviate the need to collect data from industry
during calendar year 1986. If Congress is determined to
continue the reporting requirement next fall, a new data
collection effort would be impractical in time for the second
annual report.
The purpose of this memorandum is to secure policy level
views on the committee product that is attached and the 1986
legislative strategy described above. Written comments must
reach OMB by COB on December 20, 1985, as the report will be sent
to the Congress during the following week.
Attachments
/... ep~?
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DISTRIBUTION
Interagency Comment/Clearance
Honorable Kenneth L. Adelman
Director, Arms Control and
Disarmament Agency
Honorable Julius W. Becton
Director, Federal Emergency
Management Agency
Honorable William Casey
Director, Central Intelligence
Agency
Honorable Fred C. Ikle
Under Secretary of Defense for
Policy
Honorable Thomas Moore
Member, Council of Economic
Advisers
Honorable David C. Mulford
Assistant Secretary of Treasury
for International Affairs
Honorable John M. Poindexter
Assistant to the President for
National Security Affairs
Honorable William Schneider, Jr.
Under Secretary of State for
Security Assitance, Science
and Technology
Honorable Bruce Smart
Under Secretary of Commerce for
International Trade
Honorable Dennis E. Whitfield
Under Secretary of Labor
Honorable Clayton Yeutter
United States Trade
Representative
Internal OMB Comment/Clearance
John H. Carley
General Counsel
Kathryn M. Eickhoff
Associate Director for Economic
Policy
Wendy L. Gramm
Administrator for Information and
Regulatory Affairs
Bryce L. Harlow
Associate Director for Legislative
Affairs
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DRAFT
DEC 111985
Honorable Thomas P. O'Neill, Jr.
Speaker of the House of Representatives
Washington, D.C. 20515
Dear Mr. Speaker:
I am pleased to submit the first annual report on the impact. of offsets in
defense-related exports as required by Section 309 of the Defense Production Act
Amendments of 1984. It consists of assessments of the impact of offsets in
defense-related exports on the defense preparedness, industrial competitiveness,
employment, and international trade position of the United States and provides
other information as required by the statute.
This report was prepared by an interagency committee. As anticipated by
the Conference Report accompanying the bill, the Office of Management and Budget
(OMB) coordinated the work of this group. The President delegated the reporting
responsibility under this section to the Director, Office of Management and
Budget in Executive Order 12521.
This report is based, in part, on data submitted by 139 United States
companies whose cooperation is greatly appreciated. The International Trade
Commission collected this information on behalf of the interagency committee.
The core assessments are primarily the work of the Departments of Defense,
Commerce, and Labor, as shown in the Table of Contents. These departments and
nine other Executive Branch agencies collaborated on the remainder of the text.
Sincerely yours,
James C. Miller III
Director
IDENTICAL LETTER SENT TO PRESIDENT OF THE SENATE
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DRAFT
DEC 111985
IMPACT OF OFFSETS IN DEFENSE-RELATED EXPORTS
December 1985
This report is published pursuant to Section 309 of the Defense Production Act
Amendments of 1984 (P.L. 98-265). Inquiries and requests for additional copies
should be addressed to Mr. Antonio Chavez of the Office of Management and Budget
at [phone]. Copies of the questionnaire used for the survey are also
available upon request. Questions about sections of Part II may also be
directed to the appropriate Department as listed in the Table of Contents.
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Table of Contents
Page
List of Tables ....................................................... iii
List of Charts ....................................................... vi
Executive Summary .................................................... vii
Part I - Introduction to the Report .................................. 1
A. The Legislation ............................................. 1
B. Executive Branch Process .................................... 2
C. Definitions ................................................. 4
D. A Short History ............................................. 6
E. United States Policy ........................................ 8
F. Foreign Policy Context ...................................... 12
G. Economic Setting ............................................ 14
H. The Market .................................................. 19
Part II - Assessments of the Impact of Offsets ....................... 21
A. Defense Preparedness (Department of Defense) ................ 22
B. Industrial Competitiveness (Department of Commerce) ......... 37
C. Employment (Department of Labor) ............................ 58
D. International Trade ......................................... 103
Part III - Other Information About Offsets 112
A. Types, Terms, and Magnitude ................................. 112
B. Bilateral and Multilateral Negotiations ..................... 127
C. Memoranda of Understanding .................................. 132
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List of Tables
Page
I.G.1
Free World Export Trade, 1975-1984 .........................
17
I.G.2
Average Annual Value of Defense-Related Offsets Relative to
High-Technology Exports and Productions ....................
18
I.G.2
Average Annual Value of Defense-Related Offsets Relative to
Exports and Production of Engines and Turbines and Aerospace
Industries .................................................
18
II.A.1
Capital Expenditures .......................................
24
II.A.2
1983 Aerospace Capacity Utilization by Functional Area .....
30
II.A.3
FY 1984 Defense-Related Trade Balance Summary ..............
33
II.A.4
Overseas Distribution of Defense Subcontracts ..............
35
II.B.1
Reason for Engaging in Offsets .............................
38
II.B.2
Role of the Foreign Government in Offset Contracts .........
41
II.B.3
Parties to the Specified Agreements ........................
41
II.B.4
Total U.S. and Aerospace Balance of Trade,
Calendar Years 1973-1984 ...................................
47
II.B.5
Total Aerospace Industry Military Export Sales and Offset
Obligations by Standard Industrial Classification ..........
51
II.B.6
U.S. Military Aerospace Trade ..............................
53
II.C.1
Direct Employment Impact of Military Sales and Offsets:
Based on Responses by Prime Contractors Holding Contracts
with Offset Obligations Greater Than $2 Million
(Imprecise Responses Interpreted as Total Employment Effect)
66
II.C.2
Direct Employment Impact of Military Sales and Offsets:
Based on Responses by Prime Contractors Holding Contracts
with Offset Obligations Greater Than $2 Million
(Imprecise Responses Interpreted as Employment per Year) ...
67
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Page
II.C.3
Military Sales Implementations for'Contracts with Offset
Obligations Greater Than $2 Million: All Survey Respondents
69
II.C.4
Military Sales Implementations for Contracts which Gave
Numerical Labor Impact Estimates ...........:...............
70
II.C.5
Offset Implementations Based on Actual Implementations for
Contracts with Offset Obligations of Greater Than $2 Million
73
II.C.6
Offset Implementations Based on Actual Implementations for
Contracts Which Gave Numerical Labor Impact Estimates ......
75
II.C.7
Dollar Value of Military Sales Obligations, by Year and
Industry: All Respondents .................................
77
II.C.8
Estimated Military Sales Implementation Values, by Year and
Industry ...................................................
78
II.C.9
Employment Effects of Military Sales by Industry:
All Respondents ............................................
80
II.C.1O
Direct Employment from Military Sales Implementations for
Contracts which Gave Numerical Labor Impact Estimates ......
82
II.C.11
Estimated Offset Implementations by Type: Exports, Imports,
and Domestic Production ....................................
84
?II.C.12A
Direct Employment Effects of Offsets by Type: Exports,
Imports, and Domestic Production ...........................
87
II.C.12B
Total Employment Effects of Offsets by Type: Exports,
Imports, and Domestic Production ...........................
89
II.C.13A
Estimated Range of Total Employment Effects of Sales and
Offsets, 1980-1984 Inclusive ...............................
91
II.C.13B
Net Total Employment Effect of Military Sales and Offsets,
1980-84 ....................................................
92
II.C.14
Annual Average Monthly Employment in Industries Effected by
Military Sales and Offsets, 1980-1984 ......................
96
II.C.15
Industries Grouped into Miscellaneous Category by Type of
Transaction'................ ................................
100
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Page:
I.D.1
Direction of Trade ........................................
106
II.D.2
Impact of Offsets on Trade -- Upper-Bound Estimates
(Model I) .................................................
108
II.D.3
Changes in Import Volume of All Other (Non-Offset Related)
Commodities ................................................
109
11.0.4
Impact of Offsets on Trade -- Upper-Bound Estimates
(Model II) .................................................
110
III.A.1
Arms Exports ............................................... ?
113
III.A.2
Total Sales of Companies Responding to the Questionnaire ...
113
III.A.3
Total Sales of Companies Reporting Offset Obligations ......
114
III.A.4
Sales Value by Year .........
117
III.A.5
Value of Sales and Average Periods of Implementation by
Country, 1980-1984 .........................................
118
III.A.6
Value of Offset Obligations and Average Periods of
Implementation by Country, for Sale Years 1980-1984 ........
119
III.A.7
Value of Offsets Implemented by Country, 1980-1984 .........
120
III.A.8
Value of Offset Obligations by SIC and Year
121
III.A.9
Value and Percent of Offset Obligations by Type and Year ...
124
III.A.10
Value and Percent of Offset Obligations Implemented by
Type and Year ..............................................
125
III.A.11
Value of Offset Obligations by Method of Enforcement and
Industry ...................................................
126
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List of Charts
Page
I.G.1
U.S. Merchandise Trade Balance, 1967-84 ....................
15
I.G.2
Export Share, U.S. Share of World Manufacturing Exports ....
16
II.A.1
Profit/Sales ...............................................
26
II.A.2
Profit/Assets ..............................................
28
II.B.1
Aerospace Industry Segment Sales
45
II.B.2
Total Aerospace Industry Sales .............................
46
II.B.3
Export Quantity of Military Aircraft .......................
48
II.B.4
Export Value of Military Aircraft ..........................
49
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DRAFT
DEC 111985
Executive Summary
This report on the impact of offsets in defense-related exports was prepared in
response to the requirement in Section 309 of the Defense Production Act
Amendments of 1984 (P.L. 98-265). Section 309 states:
"Not later than 18 months after the date of the enactment of the Defense
Production Act Amendments of 1984, and annually thereafter, the President
shall submit . . . a report on the impact of offsets on the defense
preparedness, industrial competitiveness, employment, and trade of the
United States. Such report also shall include a discussion of bilateral
and multilateral negotiations on offsets in international procurement and
provide information on the types, terms, and magnitude of the offsets."
The effort to prepare an appropriate response to Section 309 began almost
immediately after the DPA Amendments of 1984 were approved. After discussions
within the Interagency Group on International Economic Policy, a separate staff
level committee, chaired by OMB, was formed. This approach was anticipated by
the Conference Report:
"Since there is no clear lead agency in the Executive Branch on the subject
of offsets, it is anticipated that the Office of Management and Budget will
coordinate the efforts of the Executive Branch . . . in producing such
reports."
Members of the working group represent the Departments of State, Treasury,
.Defense, Commerce, and Labor; the Federal Emergency Management Agency (FEMA);
the Arms Control and Disarmament Agency (ACDA); the Central Intelligence Agency
(CIA); the United States Trade Representative (USTR); and the National Security
Council (NSC) staff. They meet under the unofficial title of Coordinating
Committee on DPA 309 Reports. The Council of Economic Advisers (CEA) assisted
by reviewing the draft report.
The following definition of offsets was adopted for this report.
"Offsets include a range of industrial and commercial compensation
practices required as a condition of purchase of military-related exports
(i.e., either Foreign Military Sales (FMS) or commercial sales of defense
articles and defense services, as defined by the Arms Export Control Act
(AECA) and the International Traffic in Arms Regulations (ITAR)."
The various types of offsets are: coproduction, licensed production,
subcontractor production, overseas investment, technology transfer, and
countertrade (which includes barter, counter-purchase, or buy-back). Offsets in
defense-related exports are frequently divided into direct and indirect classes.
Direct offsets are contractual arrangements that involve goods and services
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addressed in the sales agreement for military exports. Included among direct
offsets are coproduction, licensed production, subcontractor production,
overseas investment, and technology transfer. Indirect offsets are contractual
arrangements that involve goods and services unrelated to the exports referenced
in the sales agreement. Some forms of foreign investment, technology transfer,
and countertrade are included among indirect offsets.
A database for this report was developed from responses to a questionnaire sent
to U.S. industry. The list of questions, which was developed by the
Coordinating Committee on DPA 309 Reports after extensive consultation with
industry groups and formal public comment, was sent to 212 U.S. corporate
entities including subsidiaries and subcontractors. The database covers five
calendar years 1980-1984, and consists of four major elements: narrative
responses to selected questions, sales information concerning the respondents,
information on sales with offset obligations of over $2 million, and summary
information on offsets of $2 million or less. For those offset obligations
greater than $2 million, the database includes a breakdown of offset contracts
executed during the reporting period.
The database reveals some interesting facts about the types, terms, and
magnitude of offsets. For the defense-related exports covered by this database,
offsets totalled $12 billion and sales totalled $22 billion. In the period
1980-1984, about $2.4-billion, or about 20 percent, of the offset obligations
were implemented. Nearly 90 percent of the respondents to the survey stated
that offsets were a necessary condition for the sale. Most of the offset
obligations occurred in three product areas, namely aircraft, engines, and
electronics. Most of the sales and. related offset obligations were with either
.NATO countries or other countries with whom the U.S. has special defense
security arrangements. Finally, the overall magnitude of offset obligations
does not appear large in the context of either total exports by the companies
reporting or in the context of the value of total military production by these
companies.
Some U.S. foreign policy goals are traditionally pursued through arms transfer
policy. Offsets can affect the nature of the arms transfer tool. Foreign
policy objectives which are traditionally pursued with arms transfers include:
o deterring aggression by enhancing the preparedness of allies and friends;
o increasing the ability of the U.S. to project power;
o supporting interoperability with the forces of friends and allies;
o enhancing U.S. defense production capacity and efficiency; and
o strengthening collective security arrangements.
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The U.S. Government does not normally enter directly into offset agreements, and
consequently there is little immediate effect of offsets on Government
procurement.
World macroeconomic conditions make it difficult to isolate and measure the
precise impacts of offsets on U.S. trade, employment, competitiveness, and
defense preparedness. The size of defense-related offsets relative to the U.S.
economy and relative to various sectors of the economy must be taken into
consideration in any analysis of offsets. In this regard, the importance of
defense-related offsets depends upon the frame of reference. The average annual
value of defense-related offset obligations between 1980 and 1984 ($2.4 billion)
is trivial relative to U.S. GNP ($3,125 bill.ion), total U.S. exports ($217
billion), or exports of manufactured goods ($143 billion).
The workings of the international arms trade market are governed more by the
objectives and policies of purchasing and selling governments than by
traditionally defined market influences. This unique situation highlights the
difficulties associated with trying to analyze international arms trade from a
traditional "market economics" orientation. For this reason, the international
arms market may be more accurately characterized as an arena of managed trade,
than as a true market in which economic influences are the primary determinants
,of the terms a seller must offer to remain competitive.
Part II of this report consists of assessments of the effects of offsets in
defense-related exports on the defense preparedness, industrial competitiveness,
employment, and international trade position of the United States. These
assessments are based in part on data collected from U.S. corporations
.concerning offset obligations incurred during the period 1980 through 1984. The
general findings of these assessments are:
o Defense-related industries are characterized by a small number of
government buyers who exert a disproportionate influence on the
institutionalized market for defense products. Due to the "buyers'-market"
situation, producers may have no choice but to accept the offsets
requirements when demanded in order to obtain sales contracts.
Consequently, policy alternatives typically used for industries that are
closer to perfect competition may not be applicable to this case.
o Government-mandated offsets may introduce inefficiencies since the most
efficient producer may not be the one to win a given contract. Rather, the
producer who offers the best offset package may win the foreign business,
despite the producer's efficiency or the appropriateness of its weapon
system.
o Inefficiencies caused by offsets may also be passed to producer levels
below prime contractors (i.e., to subcontractors) and could result in a
multiplied effect.
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o Offsets apply two opposing forces to short-run production costs (and hence
weapon systems prices): (1) costs may be lowered by the increased size of
production runs due to increased sales (assuming economies of scale exist);
and (2) costs may be increased due to the expenses of countertrade
commodity liquidation, foreign research and development investments, and
higher foreign subcontracting prices.
o Long-run production costs are faced with opposing forces: (1) costs may be
lowered by an increased number of producers both here and abroad
(particularly in the case of rationalization, standardization, and
interoperability (RSI) goals among NATO members); and (2) costs may
increase if the amount and complexity of offsets demanded by purchasing
nations increase over time.
o Offsets can be an effective foreign policy tool for both producing and
purchasing nations. Consequently, the topic is both economically and
politically sensitive.
The specific findings resulting from the four assessments are:
Concerning the impact of offsets on U.S. defense preparedness:
o In a majority of circumstances, offsets had either positive or no impact on
the productivity of defense-related industries.
o Insofar as capacity utilization rates affect investment decisions, offsets
appear to have had very little impact.
o Available evidence suggests that the profitability, and hence the strength,
of defense-related industries has not been damaged by offsets.
o Available evidence suggests that no serious capacity problems are present.
Surge difficulties that do exist can be traced to a number of causes, but
generally not to offsets.
o Evaluation of the impact of offsets on subcontractors is difficult because
data regarding both the negative effects (business lost due to offsets) and
the positive effects (business which would have been lost had the offset
not been offered to close the deal) are generally not known to the
subcontractors.
Concerning the impact of offsets on U.S. industrial competitiveness:
o American defense base industries are often obligated to offer offsets in
order to participate in and remain competitive in the international
marketplace.
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o Offsets are a factor in the competition for international defense sales,
and are being used by foreign purchasing governments as a trade management
tool for the purposes of preservation of foreign exchange, the targeted
development of selected industrial sectors, and the enhancement of the
capability of domestic industries through technology transfer.
o Offsets are increasing foreign competition, particularly at the
subcontractor level. However, without offsets, U.S. industry faces the
prospect of losing business.
o While offset-related sales of defense systems contribute to the marginal
income of defense firms, the health of the industry depends primarily upon
U.S. Government purchases.
Concerning the impact of offsets on U.S. employment:
o The employment effects of the sales exceed by far the adverse effects of
offsets. Even when one considers the upper-bound estimates, the study
finds that the positive effects of sales exceed the adverse effects of
offsets by about 62,000 job opportunities.
o The effects of both sales and offsets are felt principally in the aerospace
and avionics industries, industries that are fairly healthy by most
standards.
o The above-named industries aside, the effects of offsets while widespread
are small relative to total employment in any individual industry. This
conclusion holds notwithstanding the fact that the study included under
adverse effects offset arrangements that cannot realistically reduce
domestic production and employment.
Concerning the impact of offsets on the U.S. trade position:
o The effects of military trade on the U.S. economy as a whole are likely to
be.close to zero, because any imbalances in such trade are likely to be
counterbalanced by capital flows that effect both interest rates and
exchange rates, thereby generating changes in domestic production and flows
of goods and services.
o Under partial equilibrium analysis, the effect of sales and offsets is a
net positive effect on the U.S. trade position in each of the five years
covered by the DPA 309 survey.
o Under general equilibrium analysis, the U.S. trade balance is unaffected by
defense-related offsets.
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DRAFT
r-r1 i ?' r
I. INTRODUCTION TO THE REPORT
Part I consists of a brief review of the legislation and a description of the
Executive Branch process leading to this report, a list of definitions, a short
history of the phenomenon and the Government's interest in it, an explanation of
current United States policy, and a discussion of the foreign policy context and
economic setting surrounding the issue. These sections provide the background
for the analyses and other data required by the statute and the Conference
Report accompanying the bill presented in Parts II and III.
A. The Legislation
Section 309 of the Defense Production Act (DPA) Amendments of 1984 (P.L. 98-265)
approved April 17, 1984, reads:
"Not later than 18 months after the date of the enactment of the Defense
Production Act Amendments of 1984, and annually thereafter, the President
shall submit ... a report on the impact of offsets on the defense
preparedness, industrial competitiveness, employment, and trade of the
United States. Such report also shall include a discussion of bilateral
and multilateral negotiations on offsets in international procurement and
provide information on the types, terms, and magnitude of the offsets."
The Conference Report on the DPA Amendments of 1984 (House Report 98-651) dated
April 5, 1984, adds an additional requirement:
"The conferees intend that information provided on the types, terms, and
magnitude of the offsets in each report shall include the number of
relevant offset agreements required by contracts, the total dollar amount
of value of offsets required by such contracts, a breakdown of offsets by
category of defense material or defense services involved in such
contracts, and a breakdown of such offsets by recipient countries.
"In addition, each report shall contain a summary of relevant Memoranda of
Understanding between the United States and foreign countries which provide
the official framework within which foreign offset commitments incurred'in
private sales can be fulfilled. Copies of actual Memoranda of
Understanding involving such offsets shall be made available to the House
and Senate Banking Committees upon request, after each report has been
submitted by the President."
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2
Since Section 309 was approved on April 17, 1984, two hearings have been
conducted by the Subcommittee on Economic Stabilization of the House Committee
on Banking, Finance, and Urban Affairs. The first, on. May 22, 1984, included
testimony by officials from the Office of the U.S. Trade Representative (USTR),
the Department of Treasury, and the Department of Commerce. A second hearing on
July 24, 1985, involved witnesses from the Departments of Defense and Commerce
and the private sector. In addition, the Subcommittee on Oversight and
Investigations of the House Committee on Energy and Commerce conducted a hearing
on October 10, 1985, on offsets associated with foreign aircraft sales which
included testimony by the International Trade Commission (ITC), the General
Accounting Office (GAO), and the Departments of Commerce, Labor, and Defense.
.B. Executive Branch Process
The effort to prepare an appropriate response to Section 309 began almost
immediately after the DPA Amendments of 1984 were approved. After discussions
within the Interagency Group on International Economic Policy, a separate staff
level committee, chaired by OMB, was formed. This approach was anticipated by
the Conference Report:
"Since there is no clear lead agency in the Executive Branch on the subject
of offsets, it is anticipated that the Office of Management and Budget will
coordinate the efforts of the Executive'Branch ... in producing such
reports."
Members of the working group represent the Departments of State, Treasury,
Defense, Commerce, and Labor, the Federal Emergency Management Agency (FEMA),
the Arms Control and Disarmament Agency (ACDA), the Central Intelligence Agency
(CIA), the USTR, and the National Security Council (NSC) staffs. They meet
under the unofficial title of Coordinating Committee on DPA 309 Reports.
In addition to designing the report format and assigning writing
responsibilities, the Coordinating Committee decided that a mandatory survey of
U.S. corporations was necessary for the development of a database on offsets in
defense-related exports. Consequently, the Coordinating Committee developed the
data collection instrument, arranged for the questionnaire. to be sent to
industry by the ITC, and devised a scheme for processing the data that was
sensitive to the business confidentiality of this information. The Coordinating
Committee also undertook extensive discussions with individuals and groups
representing the:
o Aerospace Industries Association (AIA).
o American League for Exports and Security Assistance (ALESA).
o Defense Industry Offset Association (DIOA).
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o Defense Policy Advisory Committee on Trade (DPACT).
o Department of Commerce Industry Sector Advisory Committee on Aerospace
(ISAC #1).
o Steering Committee of the Labor Advisory Committee for Trade Negotiations
and Trade Policy (LSAC).
o Electronics Industry Association (EIA).
In addition, two status report briefings were given to the staff of the House
Subcommittee that initiated the legislation. As a group, the Coordinating
Committee did not participate in the negotiations with other governments on the
subject of offsets, which are summarized in Part III of this report. However,
some committee members were involved in these discussions as representatives of
their departments and agencies.
After operating informally for over a year, relationships among the various
agencies were formalized by Executive Order 12521 of June 24, 1985:
"The functions conferred upon the President by Section 309 of the Defense
Production Act, as amended, with respect to the preparation and submission
of reports to Congress concerning offsets shall be performed by the
Director of the Office of Management and Budget '(OMB). The Director may
further delegate to the heads of executive departments and agencies
responsibility for preparing and submitting for his review particular
sections of such reports. The heads of executive departments and agencies
shall, to the extent provided by law, provide the Director with such
information as may be necessary for the effective performance of these
functions."
Since the ITC was conducting a study very similar in terms of data requirements
to the DPA 309 report, the decision was made in November 1984 to combine the
data collection efforts in the interest of reducing the Government's demands on
the private sector. In accordance with this agreement, the ITC was designated
as the ".central collection agency" for offset data by OMB's Office of
Information and Regulatory Affairs, using its authority under the Paperwork
Reduction Act. This assignment was reiterated in Executive Order 12521:
"In order to ensure that information gathered pursuant to this authority
shall be subject to appropriate confidentiality protections, the
International Trade Commission, which previously has been designated a
"central collection agency" in gathering this information under 44 U.S.C.
3509, is authorized, pursuant to Section 705 of the Defense Production-Act,
as amended, to collect the information required for compilation of the
database to be used in the preparation of the first such report to
.Congress."
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Notice of a proposed combined questionnaire was published in the Federal
Register on December 4, 1984. After taking into account extensive comments by
industry groups, a final questionnaire was mailed to U.S. companies on
February 11, 1985, with responses due by the end of March. On April 12, 1985,
OMB provided ITC with a computer format for tabulating the data for transmission
to OMB. The purpose was to develop a database for use by those members of the
Coordinating Committee charged with producing sections of this report.
At this juncture, a dispute developed as to the type of data ITC was to furnish
OMB under the November arrangement. After lengthy negotiations, this issue was
resolved after a formal demand was sent to the ITC on June 13, 1985.
Consequently, on July 22, 1985, the ITC forwarded the agreed elements of the
database in the specified format.
On October 3, 1985, the decision was made to delay submission of this first
report beyond the statutory date. This action resulted primarily from the time
lapse between receipt of the data from industry and its release by the ITC.
Most of the analysis and writing for this report was accomplished in
August-November, 1985. During December, the draft of this first report was
reviewed and approved by senior Administration officials. The Coordinating
Committee will be meeting soon to develop an approach to the next annual report
which is due in October 1986.
C. Definitions
Since the offset phenomenon is a relatively new subject, there has been little
research or literature and no agreed definitions on the topic. This difficulty
was clearly outlined by Stephanie G. Neuman of Columbia University in an essay
sponsored by ACDA which appeared in 1985 edition of World Military Expenditures
and Arms Transfers. -
"Essentially, offsets in arms trade are arrangements which use some method
of reducing the amount of currency needed to buy a military item or some
means of creating revenue to help pay for it. ...Offsets often involve a
reverse trade flow, under which the buyer's cost for a military purchase is
at least partially compensated by the seller's acceptance of the buyer's
products in return. The literature on such trade arrangements uses
'offset,' 'barter,' 'buy-back,' 'counterpurchase,' 'countertrade,' and
'compensation,' among other terms, often interchangeably, to the confusion
and consternation of those who wish to understand the process."
In consultation with industry, the following definitions were developed for this
report:
o Offsets -- A range of industrial and commercial compensation practices
required as a condition of purchase of military related exports, i.e.,
either Foreign Military Sales (FMS) or commercial sales of defense articles
and defense services, as defined by the Arms Export Control Act (AECA) and
the International Traffic in Arms Regulations (ITAR). The various types of
offsets are defined as follows:
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Coproduction -- Overseas production based upon
government-to-government agreement that permits a foreign government
or producers to acquire the technical information to manufacture all
or part of a U.S.-origin defense article. It includes
government-to-government licensed production. It excludes licensed
production based upon direct commercial arrangements by U.S.
manufacturers.
Licensed production -- Overseas production of a U.S.-origin defense
article based upon transfer of technical information under direct
commercial arrangements between a U.S. manufacturer and a foreign
government or producer.
Subcontractor production -- Overseas production of a part or component
of a U.S.-origin defense article. The subcontract does not
necessarily involve license of technical information and is usually a
direct commercial arrangement between the U.S. manufacturer and a
foreign producer.
Overseas investment -- Investment arising from the offset agreement,
taking the form of capital invested to establish or expand a
subsidiary or joint venture in the foreign country.
Technology transfer -- Transfer of technology that occurs as a result
of an offset agreement and that may take the form of: research and
development conducted abroad; technical assistance provided to the
subsidiary or joint venture of overseas investment; or other
activities under direct commercial arrangement between the U.S.
manufacturer and a foreign entity.
Countertrade -- In addition to the types of offsets defined above,
various types of commercial countertrade arrangements may be required.
A contract may include one or more of the following mechanisms:
-- Barter -- A one-time transaction only, bound under a single
contract that specifies the exchange of selected goods or
services for another of equivalent value.
-- Counter-purchase -- An agreement by the initial exporter to buy
(or to find buyer for) a specific value of goods (often stated
as a percentage of the value of the original export) from the
original importer during a specified time period.
-- Compensation (or buy-back) -- An agreement by the original
exporter to accept as full or partial repayment products derived
from the original exported product.
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6,
Countertrade may also arise, indirectly, through other mechanisms such as
blocked currency, which is a foreign government action that prohibits hard
currency payments to foreign companies.
Offsets in defense-related exports are frequently divided into direct and
indirect classes.
o Direct offsets -- Contractual arrangements that involve goods and services
addressed in the sales agreement for military exports. Included among
direct offsets are coproduction, licensed production, subcontractor
production, overseas investment, and technology transfer.
o Indirect offsets -- Contractual arrangements that involve goods and
services unrelated to the exports referenced in the sales agreement. Some
forms of foreign investment, technology transfer, and countertrade are
included among indirect offsets.
D. A Short History -
Although the concepts which underlie offset agreements are as old as barter
itself, actual production of U.S. weapon systems in foreign countries began in
Europe and Japan in the 1950's. Coproduction of U.S. equipment began with-the-
T-33 aircraft in Japan in the 1950's and the F-86 aircraft later in that decade.
In the years that followed, an increasing number of significant coproduction
programs were undertaken within the North Atlantic Treaty Organization (NATO) as
well as with Japan, Korea, and Taiwan. The largest program, the purchase of the
F-16 by Norway, Denmark, Belgium, and the Netherlands for $2.8 billion (in 1975
dollars), involved these countries in the production of 10 percent of the value
of the initial U.S. Air Force purchase of 650 aircraft, 15 percent of the value
of all third country F-16 purchases from the United States, and 40 percent of
the value of their own purchases from the U.S. Buyers were guaranteed that
these offsets would total a minimum offset level of 58 percent of their initial
purchase, and the U.S. Government was committed to seek a 100 percent offset by
using third country sales of aircraft and other offset work of comparable
technology.
These sales benefitted both the United States and the purchasing nations through
increased exports of U.S. systems, enhanced standardization, second-source
establishment, modernization of allied forces, and strengthened U.S. ties to the
buyer countries. The net effects of offsets were less clear; to the extent that
they helped promote the sale of U.S. systems in competition with foreign
weapons, they may have had a positive impact. But early offset arrangements
uncovered some drawbacks, such as the difficulty purchasing nations faced in
establishing and maintaining efficient production lines for coproduction
contracts. Weapon systems were often tailored to U.S. operational requirements
and perhaps biased toward the use of domestic technology.
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Such drawbacks led the European nations to require other types of offsets from
the United States in addition to the coproduction of systems as compensation for
the economic problems associated with weapon procurement. Research and
development investment, technology transfer, foreign subcontracting, and
indirect offsets were alternative methods of obtaining these additional offsets.
More recently, codevelopment projects have allowed European nations and the
United States to define system requirements jointly and perform system
engineering while arranging for production in both the U.S. and Europe.
In 1975, the U.S. and Swiss governments signed a Memorandum of Understanding
(MOU) guaranteeing 30 percent combined government and industry offsets on
Switzerland's purchase of 72 F-5 aircraft for $400 million. Due to a Swiss
decision to limit participation in large-scale coproduction of the F-5,
additional offsets beyond coproduction were demanded. Strong pressure to
fulfill the goals of this program by the Swiss and difficulties experienced by
the U.S. Government in administering the project led to the most important U.S.
policy decision on offsets in defense-related exports. The Department of
Defense (DOD) decided not to obligate the U.S. Government to satisfy offset
commitments or those for compensatory coproduction following the Swiss F-5 deal.
Since 1978, the responsibility for negotiating and satisfying offset commitments
has rested solely on the commercial firms making the sales. Mil.i.tary.sal..es `
agreements negotiated in the last ten years have typically served U.S. security
interests. However, the number of offset obligations agreed to during this
period has become a cause of concern. Recently, the form of weapon procurement
agreements has changed as programs involving varying degrees of European
participation with the U.S. in weapon systems development have been started and
..the use of licensed production and codevelopment has increased.
In 1982, the AIA and the EIA, at the suggestion of the Treasury Department
staff, conducted a survey of their members' experiences in dealing with offset
requirements. The results, published in May 1983, showed that for the period
1975 to June 30, 1981, 143 contracts involving offset commitments were reported.
The total value of the contracts was $15.2 billion, and the total value of
associated offset commitments was $9.55 billion. The greatest percentage of
both totals represented sales of military aircraft. The largest recipient was
Canada. The average period for implementation of offset commitments was seven
and one-half years.
That survey, which was similar in purpose to the present report, was useful in
suggesting a rough magnitude for offset commitments, the sectors and countries
in which offsets were most frequently required, the relative frequency of use of
the various forms of offsets, the role of the U.S. Government in offset
transactions, and some industry views. It was, however, a small sample survey
to which response was entirely voluntary. It did not request dates on which
offset commitments were made, which might have permitted some conclusions about
trends. Nor did it include questions dealing with the effects of offsets on
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employment, subcontractors, or technology flows, since it. was felt such issues
would be too difficult to address in a voluntary survey and would have
discouraged response.
Three other Government reports played a major role in raising the degree of
consciousness about the subject of offsets in defense-related exports. These
are an Analysis of Recent Trends in U.S. Countertrade (Report on Investigation
No. 3397-125), published in march 1982 by the ITC; t e Report of the Department
ofvDeferise Task Group on International Coproduction/Industrial Participation
Agreements, published in August 1983; and Report NSIAD-84-102 of April 13,
1984, entitled Trade Offsets in Foreign Military Sales.
On October 25, 1985, the ITC released Assessment of the Effects of Barter and
Countertrade Transactions on U.S. Industries (Report on Investigation No.
332-185) which was prepared in part from responses to the same questionnaire
sent to industry in connection with this report. The ITC report, which covers a
broader range of activities and uses a different set of definitions from this
analysis, was produced in response to the ITC's own motion of June 11, 1984.
There are some minor differences in interpretation of the defense-related offset
data between the ITC paper and this report which are discussed in Part III.
E. United States Policy
The most important statement of U.S. policy on offsets in defense-related
exports is a memorandum from then Deputy Secretary of Defense Charles Duncan on
May 4, 1978. This memorandum noted the increased frequency of offset
arrangements, designated management responsibility for evaluating and monitoring
such agreements within the Department of Defense, and established the following
basic "...policy with respect to compensatory coproduction and offset agreements
with other nations....":
"Because of the inherent difficulties in negotiating and implementing
compensatory coproduction and offset agreements and the economic
inefficiencies they often entail,-DOD shall not normally enter into such
agreements. An exception will be made only when there is no feasible
alternative to ensure the successful completion of transactions considered
to be of significant importance to United States national security
interests (e.g., rationalization of mutual defense arrangements)."
The same document specifies that when compensatory agreements are necessary,
they should:
o be as broad as possible to obtain maximum credit for U.S. purchases of
defense goods and services.
o avoid offset targets whether stated in percentage or money terms.
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o be used to reduce administrative barriers to defense trade by all parties.
o encourage equal competition between U.S. and foreign firms concerning
bidding on contracts.
o specify that the burden of fulfilling any commitment rests with the U.S.
firms directly benefiting from the sale.
Section 42(b) of the AECA prescribes that appropriated funds may not be -used to
finance coproductioh or licensed production of any defense article of U.S.
origin outside the United States unless the Secretary of State notifies the
Congress in advance of the effects of the proposed transaction on employment and
production within the United States. The Defense Security Assistance Agency
(DSAA) has established additional guidelines concerning the use of appropriated
funds in connection with offset agreements. A significant portion of any item
which is sold through a Foreign Military Sales (FMS) credit (loan or grant)
program must be of U.S. origin unless otherwise approved by DSAA on the basis of
carefully prescribed circumstances.
The most recent iteration of the Guidelines for FMS Loan Financing of Direct
Commercial Contracts, issued on October 9, 1985, contains the following with
respect to offsets:
"Loan financing is discouraged for purchases containing offset provisions
as a condition for securing the purchase. Offset provisions are agreements
by the seller to make investments or procurements in a country other than
the U.S., either concurrent with or subsequent to the purchase for which
financing is being requested. No FMS loan funds will be authorized or
disbursed to pay for mandatory direct offsets. Mandatory direct offsets
are procurements of a foreign-made component required by the foreign
government as a condition of sale, for incorporation or installation in a
U.S.-produced end item being sold. While FMS loan funds will not be
authorized for foreign-produced content resulting from mandatory direct
offsets, such funding can be authorized for the U.S. content."
There are two classes of exceptions to the policies on offsets outlined above.
The first concerns offset agreements already in force at the time the 1978
Duncan Memorandum was promulgated. U.S. Government guarantees were sometimes
involved in these agreements, and those guarantees continued to be honored after
Government policy changed. The most notable programs in this category were the
Swiss purchase of the F-5, the F-16 coproduction program with our NATO allies,
and the Australian program which involved the purchase of ships and other
defense equipment. Of these, the Australian program has been the largest and
the most complex. Under a commitment made in 1972, DOD recognized an obligation
to provide up to 25 percent offsets through the Australian Industrial
Participation for all Australian defense purchases from the United States.
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The second class of exceptions involves an outright waiver of the rules, and
this has happened in only one case. The FMS credit guidelines pertinent to
Israel, a separate document effective August 8, 1985, includes the following
paragraph.
"There is an exception for Israel to direct offsets related to its
commercial purchases. Direct offsets are procurements of an Israeli-made
component required by the GOI as a condition of sale for incorporation or
installation in a U.S.-produced item being sold. In all instances the item
must be over 51 percent U.S. content, with final assembly in the United
States. FMS credit funds normally cannot be used under subcontracts for
operations and maintenance services, overhaul, translation services,
warranties, training, storage, testing, and other services of this nature."
For the last several years, Israel has sought to require offsets in commercial
contracts with American companies supplying goods and services that are financed
by FMS credit appropriations. Prior to 1984, this Israeli policy was largely
ignored by the United States Government as the dollar value was of minimal
significance. As dollar value rose and U.S. Government cognizance of the
problem increased, the need for a policy was recognized.
Consequently, for fiscal year 1984, Israel was allowed to take "directed -
offsets" on up to 15 percent of the total value of Israeli purchases of items on
a commercial basis. This decision gave the Israelis over $225 million worth of
offset business. For 1985, Israel was allowed to take a lesser amount in
offsets, this time expressed as a specific dollar ceiling of $200 million rather
than a percentage of purchases. The Administration plans to reduce this program
again for fiscal year 1986 and a further reduction for fiscal year 1987, after
which it will be terminated.
In the unique Israeli program, the term "directed offsets" means those
activities that are termed Subcontractor Production in this report except for
those items which are of Israeli origin, and are financed by grants from the FMS
credit appropriation. Excluded from these limitations are offset requirements
negotiated between Israel and U.S. corporations that are not financed by the
U.S. Government.
On July 29, 1983, the USTR-chaired Trade Policy Staff Committee (TPSC)
established a formal set of policy guidelines on Countertrade and Barter which,
like offsets, condition the completion of an import transaction on a separate
purchase or exchange of goods from the importing country. While explicitly not
applicable to military sales offsets, these guidelines are applicable to
civilian countertrade related to government-mandated defense-related offsets
which are not directly contributing to U.S. national security goals.
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"U.S. Government policy toward the private sector
i. The U.S. Government generally views countertrade, including barter, as
contrary to an open, free trading system and, in the long run, not in the
interest of the U.S. business community. However, as a matter of policy,
the U.S. Government will not oppose U.S. companies' participation in
countertrade arrangements unless such action could have a negative impact
on national security.
ii. Since U.S. businesses must compete in an environment in which they are
voluntarily or involuntarily confronted with countertrade, U.S. Government
agencies may provide advisory and market intelligence services. However,
U.S. Government officials should not promote the use of countertrade,
including barter, and they should advise U.S. businesses that countertraded
goods are subject to U.S. trade laws including quotas. This information
should be provided to U.S. businesses by our embassies overseas, by
Department of Commerce district offices, and by U.S. Government officials
in Washington.
iii. When dealing with foreign government officials and foreign
businessmen, U.S. Government officials will draw upon the guidance set in
this section with regard to barter and countertrade, especially when these
practices are mandated by governments.
iv. The U.S. Government will advise U.S. companies that countertraded
goods imported into and sold in the United States are subject to U.S. trade
laws. These statutes include Sections 201 and 406 of the Trade Act of
1974, providing import relief from injurious or disruptive imports as well
as the antidumping and countervailing duty statutes.
V, The U.S. Government will continue to review financing for projects
containing countertrade/barter on a case-by-case basis, taking account of
the distortions caused by these practices.
U.S. Government policy towards foreign governments
i. The U.S. Government should continue to oppose Government-mandated
countertrade.
ii. The TPSC subcommittee on antidumping and countervail should examine
U.S. trade laws to ensure that they adequately cover countertraded goods.
Most of these goods are disposed of in third country markets at present,
but trade patterns may change in the future resulting in an influx of
countertraded goods into the U.S.
iii. The U.S. Government should exercise caution in the use of its barter
authority, reserving it for those situations which offer advantages not
offered by conventional market operations.
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iv. In the context of the trade debt link, the U.S. Government should
explore what measures the IMF might take to discourage countertrade, and
the U.S. Government should lend its support to these efforts.
v. The U.S. representative to GATT should consider raising the question
of countertrade imposed by governments in the CG-18 and pursue the
possibility of a working group on this subject in the GATT."
There is another special situation where the U.S. Government has established a
policy concerning offsets in defense-related export trade. On June 14, 1985,
the Administration proposed legislation establishing a new type of international
procurement arrangement called a NATO Cooperative Project. This bill included a
change to the AECA prohibiting offset demands on contracts pursuant to this new
procurement scheme unless specified in the government-to-government agreement
that establishes the cooperative project. The provision became law on August 8,
1985, and become effective on October 1, 1985. Section 27(c)(3), AECA, now
contains this limitation:
"Such agreements shall provide that no requirements for work sharing or
other industrial or commercial compensation in connection with such
agreement shall be imposed by a participant that is not in accordance with
such agreement."
Although the number of potential offsets that will be prohibited by this section
is estimated to be very small, the fact that the potential problem was
recognized and that there was a concrete Government response is evidence of
.increased sensitivity to the offset issue..
F. Foreign Policy Context
Some U.S. foreign policy goals are traditionally pursued through arms transfer
policy. Offsets can affect the nature of the arms transfer tool. Foreign
policy objectives which are traditionally pursued with arms transfers include:
o Deter aggression by enhancing the preparedness of allies and friends --
Offsets are intended to enhance the preparedness of allies by supporting
rationalization, standardization, and interoperability (RSI) but do not
alter significantly the extent to which this foreign policy goal is
advanced through arms transfers. Increased preparedness will take place
regardless of extraneous industrial or financial conditions in the
transaction if countries continue to invest in defense preparedness.
However, in a broader sense, inefficient offsets can have the effect of
reducing the total resources available for enhancing preparedness.
o Increase the ability of the U.S. to project power -- Power projection
capabilities are enhanced through arms transfers when such transfers are
agreed to in whole or in part as consideration for the granting of basing
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or access rights for U.S. forces on foreign soil. Offset arrangements are
not primary factors with regard to this objective. On a secondary level,
however, to the extent that acceptance of offsets is a condition without
which the transfer cannot take place, (and without which advantages
external to the sale itself, such a base or access rights would not be
granted), offsets can have a bearing on U.S. power projection capabilities.
o Support interoperability with the forces of friends and allies -- The
primary effect of offsets is negligible. To the extent that acceptance of
offsets is a condition of sale, and that in the absence of a U.S. sale the
customer would acquire equipment from another supplier which would not be
interoperable with U.S. equipment, offsets can have a positive effect.
.o Enhance U.S. defense production capacity and efficiency -- To the extent
that offsets involve the transfer of production to foreign customers that
would otherwise have taken place in the U.S., American production capacity
and efficiency probably are reduced. If the sale would not have occurred
without the inclusion of offset arrangements, then offsets support this
objective in that they allow some U.S. defense production/export to take
place.
o Strengthen collective security arrangements -- Offsets can enhance
collective security arrangements by making purchasing governments better
able to defend such arrangements on grounds other than security alone. Our
NATO partner's concern about the essentially one-way flow of defense trade
has given rise to the concept of the two-way street. To the extent that
offsets lead to increased defense production in other NATO countries, they
have the same effect as U.S. purchases of foreign manufactured defense
goods. However, many offsets are taking the form of trade or investment in
non-defense goods, making the contribution of offsets to the improvement of
the defense trade balance problematic. In any case, foreign government
leaders are better able to assert that the Alliance is truly mutually
beneficial.
Offsets can alter the nature of arms transfers. Offsets can introduce
rigidities and increased costs into the procurement process because they may
prevent the supplier from obtaining needed commodities from the most
cost-effective sources. They can cause a diversion of resources which may
enhance military capability at the expense of efficient resource use. Viewed in
political terms, offsets can be seen as a response to the concerns of allies
over the arms trade imbalance.
Information on current foreign government policies pertaining to offsets in.
defense-related exports was gathered by a Department of Commerce survey of 26
U.S. Foreign Commercial Service Posts during the first four months of 1985. The
responses suggest several trends in foreign government policies:
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o Military offsets have increasingly become a central factor in awarding
military contracts by foreign governments.
o The range and magnitude of offsets. demanded by foreign governments has
increased significantly in the last five years.
o The nature of military offsets demanded has increasingly tended toward
arrangements which include targeted technology transfer (direct and
indirect) and production/management know-how.
o Offset requirements also take the form of technical assistance to
non-military industries selected for growth and development.
o Foreign governments have begun to codify official policies and procedures
concerning offsets in military trade.
G. Economic Setting
World macroeconomic conditions make it difficult to isolate and measure the
precise impacts of offsets on U.S. trade, employment, competitiveness, and
defense preparedness. "Global Competition," The Report of the President's
Commission on Industrial Com etitiveness,-lanuary-..1 , found -tat urtng the
last eca e, the U.S. has become increasingly dependent on its competitiveness
in international markets, for its continued economic growth and high standard of
living. Approximately 20 percent of this nation's current industrial production
is shipped to foreign markets, and almost 70 percent of goods the U.S. produces
at home compete with foreign merchandise. U.S. imports and exports have more
than doubled over the last ten years, and now U.S. international trade accounts
for nearly 14 percent of GNP.
While becoming more dependent on foreign trade, the U.S. has also experienced a
gradual but steady erosion in its ability to compete successfully in
international and domestic markets. For example, the U.S. trade deficit has
increased during the past 10 years. In 1984, U.S. merchandise imports exceeded
$340 billion, while exports were more than $220 billion. Chart I.G.1
illustrates the significant downturn in the U.S. trade balance.
Despite an increase in the size of the world market, the U.S. share of world
manufacturing exports has also declined both in terms of volume and value.
Chart I.G.2 highlights this decline over the period 1962-1982.
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CHART I.G.1
U.S. Merchandise Trade Balance, 1967-84
(billions of U.S. dollars)
1!i! it 72 74 i6 is io Li 44
Source: U.S. Department of Commerce, International Trade
Administration.
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CHART I.G.2
Export Share, U.S. Share of World Manufacturing Exports
SOURCE: Report of the President's Commission on U.S. Industrial
Competitiveness, 1984.
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DRAFT
In terms of value, the U.S. share has remained approximately 12 percent of the
market in the period 1976-1984. Similarly, the U.S. volume share of exports has
declined from 15 percent to 12 percent of the world market.
TABLE I.G.1
Free World Export Trade, 1975-1984
(in billions of estimated current dollars
Total
Year Free
$ 166.8
279.9
791.2
900.8
1,023.5
1,175.4
1,492.8
1,829.4
1,804.1 _
1,655. 2
1,619.4
1,715.7
$ 27.5
43.2
107.7
115.2
121.2
143.7
181.9
220.6
233.6
212.2
200.5
217.9
SOURCE: Department of Commerce, International Trade Indicators, and
Economic Report of the President, 1984.
Using the country groupings contained in the World Development Report 1985,
published by the International Bank for Reconstruction and Development World
Bank), the database developed for this report indicates the percentage of the
value of sales going to developed countries during the 1980-1984 period to be 67
percent, while 77 percent of the value of offsets obligations were with these
countries. Offsets have been increasingly used by these countries to serve
economic and political purposes.
The size of defense-related offsets relative to the U.S. economy and relative to
various sectors of the economy must be taken into consideration in any analysis
of offsets. In this regard, the importance of defense-related offsets depends
upon the frame of reference. The average annual value of defense-related offset
obligations between 1980 and 1984 ($2.4 billion) is trivial relative to U.S. GNP
($3,125 billion), total U.S. exports ($217 billion), or exports of manufactured
goods ($143 billion).
U.S. Share
United States (in percent)
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The importance of offsets to some high-technology sectors of the economy is more
significant. The value of high-technology offset obligations under two
definitions of high-technology industries is presented in Table I.G.4 together
with exports and production in the corresponding categories. The narrow
definition used below is the Department of Commerce "DOC 1" definition which
includes drugs and medicine, computers and office machines, electrical
equipment, aerospace products, and scientific, engineering, and medical
instruments. In the narrow measure shown on Table I.G.4, offset obligations are
the amounts implemented or fulfilled during 1980-1984. The broader definition
(the Department of Commerce "Technology Intensive" definition) includes all of
the products in the narrow category plus all other transportation equipment,
machinery, and chemical products.
TABLE I.G.2
Average Annual Value of Defense-Related Offsets
Relative to High-Technology Exports and Production
($ in billions)
Narrow Measure Broad Measure
Average Offset.-Obligations ...-....... 0.48 1.33
Average U.S. Exports ................ 56.81 117.20
U.S. Production ..................... 330.21 730.25
Offsets/Exports ..................... 0.8% 1.1%
Offsets/Production .................. 0.1% 0.2%
The industries in which offsets loom largest relative to U.S. production or U.S.
exports are aircraft industries and engines and turbines. Even in these
industries, offsets are still fairly small. Offset obligations are less than
two percent of shipments and less than eight percent of exports in both
industries.
TABLE I.G.3
Average Annual Value of Defense-Related Offsets Relative to
Exports and Production of Engines and Turbines and Aerospace Industries
($ in millions)
Total
Aircraft
Engines and Turbines
Average Offset Obligations ......
790
268
Average U.S. Exports ............
15,675
3,582
U.S. Production (1982)
61,877
13,997
Offsets/Exports .................
5.0%
7.5%
Offsets/Production ..............
1.3%
1.9%
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DRAFT
Defense-related offsets are much larger relative to trade in defense goods and
services. The average annual value of defense-related offset obligations ($2.4
billion) is 19.4% of annual defense-related deliveries ($12.4 billion) in the
1980-84 period.
Offsets incorporate inefficiencies associated with the absence of a medium of
exchange, such as increased transaction costs, and the time required for
liquidation. These inefficiencies explain why those involved in an exchange of
goods usually prefer cash, as opposed to taking back goods or to giving away
part of the production such as in coproduction., Therefore, central to any
discussion of offsets in defense-related exports is an understanding of the
market and the motivations of U.S. corporate sellers and foreign government and
international organization buyers for entering into an offset agreement.
H. The Market
As might be expected, one effect of offset programs has been to expand foreign
defense industrial bases which, in turn, has increased the number of arms
exporters. Two kinds of exporters are apparent: "industrial base" nations which
manufacture weapons for export and the "subterranean market" countries which
sell used arms to other countries. Arms producers fear that the expanded number
of exporters will further increase competition in the arms market via larger and
more complex offset arrangements. Moreover, offsets mandated by foreign
governments have the potential of diverting business away from U.S.
subcontractors and of establishing new foreign competitors over the long run.
The international arms market most closely resembles an oligopsony, in the sense
.that the market is characterized by a relatively small number of purchasers.
The market also exhibits some characteristics of oligopoly,
is also characterized by a relatively small number of sellersnthat alsoemayat it
exert a disproportionate influence on the workings of the market. The buyer in
an international arms market is almost invariably a government. The seller is
either a government, or a government-regulated private sector entity.
Transactions are further complicated by the fact that some purchasing
governments also function as sellers within the same market.
Consequently, the workings of the international arms trade market are governed
more by the objectives and policies of purchasing.and selling governments than
by traditionally defined market influences. This unique situation highlights
the difficulties associated with trying to analyze international arms trade from
a traditional "market economics" orientation. For this reason, the
international arms market may be more accurately characterized as an arena of
managed trade, than as a true market in which economic influences are the
primary determinants of the terms a seller must offer to remain competitive..
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The objectives of a government making an arms purchase are far more complex than
the basic objective of procuring arms at a cost-effective price. Considerations
of the political acceptability of arms purchases from a foreign source, the
maintenance and development of domestic defense and commercial industries, and
preserving foreign exchange, are often overriding, if exogenous, considerations
in the development of weapons procurement policies of purchasing governments.
In like fashion, the export arms sale policy of the U.S. Government is
influenced by foreign policy/national security considerations which often
override economic efficiency.
Some forms of offsets (e.g., coproduction) have become a basic component of
achieving defense sales and of furthering national policy goals for both foreign
and U.S. governments. This fact has several connotations for the U.S. firms
which engage in arms sales to foreign governments which require offsets. The
selling corporation may be faced with both discretionary and non-discretionary
choices in completing a defense sale: it can elect not to offer offsets, which
may result in the loss of the sale; it can elect to offer offsets and proceed
with the bargaining, in hopes of reaching an agreement which will both meet the
requirements of the purchasing government, and serve its own interests; or, it
may be obligated to provide offsets as an integral part of a foreign
policy/national security objective.
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DRAFT
II. ASSESSMENTS OF THE IMPACT OF OFFSETS
Part II consists of assessments of the effects of offsets in defense-related
exports on the defense preparedness, industrial competitiveness, employment, and
international trade position of the United States. These sections are based in
part on data collected from U.S. corporations concerning offset obligations
incurred during the period 1980 through 1984, a summary of which appears in Part
III of this report.
The greatest barrier to analysis of defense-related offsets is the difficulty in
determining the alternatives to offsets. Unless we have some idea of how
affected industries would differ in the absence of offsets, it is difficult to
answer any question along the lines of "How much higher (or lower) would
aerospace exports (or employment, profits, etc.) be without offsets?"
The effect of defense-related offsets depends in part upon the extent to which
the offset requirements are binding. In some cases, the offset agreements might
be non-binding; they require U.S. companies to do nothing more than the U.S.
would do in the absence of an offset agreement. An example of this might be an
indirect offset agreement which requires that the U.S. import goods from the
country purchasing the defense systems that it would import from the purchasing
country or some other-country-even-'without-the-offset agreement.- Offset -''
agreements simply reallocate U.S. imports among source countries in this case.
Offset agreements may also be nonbinding or only partially binding if the
enforcement mechanism for the offset agreement is "best efforts." In.this case,
the U.S. company is under a moral obligation to try to fulfill the offset
.agreement, but is not subject to any contractual penalties should it fail to
fulfill the agreement. In other cases, offset agreements might be completely
binding; none of the goods and services purchased in the offset agreement would
have been purchased in the absence of the offset agreement.
Countries demand defense-related offsets for a variety of reasons: perceived
employment gains, changes in the industrial structure, national security,
national prestige, domestic political, etc. In any case, countries are willing
to spend more on foreign-designed defense goods in exchange for defense offsets.
Conversely, if offsets were not possible, the importing countries would be
willing to spend less on foreign-designed defense goods. This would
unambiguously lower sales of U.S.-designed defense goods in cases where
countries demand indirect offsets. The effect would be ambiguous in cases where
countries demand direct defense offsets because total spending on defense goods
would fall while the fraction of value accounted for by U.S. producers would
rise. The market share of U.S.-designed defense products falls if offsets by
U.S. firms are not possible.
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The preceding discussion assumes that countries either obtain defense-related
offset agreements from the U.S. or they reduce their foreign defense purchases.
This neglects the alternatives of producing the defense-related goods
domestically or purchasing the defense-related offset commodities from third
country suppliers willing to enter into offset agreements. Both of these
possibilities would lower the absolute level of U.S. defense exports, U.S.
global market share in defense goods, and the global market share of
U.S.-designed products.
A. Defense Preparedness (Department of Defense)
Some forms of offsets contribute to obtaining rationalization, standardization,
and interoperability of American forces with those of its allies. Cooperative
weapon production programs assist major alliance partners in creating a defense
base that enables them to share in the defense of the alliance in which all are
members.
Most offsets occur in the NATO nations, and the impact of offsets toward
achieving U.S. national objectives is felt to the largest extent within NATO.
The United States has followed a policy of maintaining the capability to produce
any weapon system it purchases overseas. Although the offset policy of
America's allies has generally been less demanding than this, the two-way flow
of trade stemming, in-part, , from offsets has-hel ped to-'build' an industrial "base
in foreign nations which is often capable of sustaining the projection of U.S.
power.
These benefits must be balanced against any potential adverse economic
-consequences of offset deals and against potential domestic industrial base
erosion arising from offsets. In the defense arena, one possible negative
effect is a loss of subcontractor work resulting from the granting of offsets
for overseas production. However, this potential loss must be weighed against
the benefits of being able to sell the weapon in the first place (which might
not have been possible without offsets) and against the alliance and other
foreign policy objectives which offsets fulfill.
Because of the Duncan Memorandum, the U.S. Government does not normally enter
directly into offset agreements, and consequently there is little immediate
effect of offsets on Government procurement. However, the general effect of
offsets occurs in two areas. First, in the short run, weapon sales which are
made possible because of participation in offset agreements tend to increase the
length of production runs and, therefore, to lower unit costs. In this regard,
a 1983 report entitled, Offset/Coproduction Requirements in Aerospace and
Electronics Trade: Report of a Survey of Industry, the Department of .t e
Treasury explained that three-fourths of survey respondents felt the sale would
have been lost if offsets had not been offered. Moreover, nearly 90 percent of
the DPA 309 database respondents felt that offsets were a necessary condition
for the sale. However, it is possible that they may introduce inefficiencies
which have the opposite effect.
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DRAFT
Second, by creating new foreign manufacturers of arms, offsets have the long-run
potential to alter procurement patterns by lowering the rate of growth and
reducing the ultimate size of the United States' industrial base.
a 1984 U.S. Air Force study, Blueprint fo r Tomorrow, indicated that 75 percent
of all foreign-sourced items used in the aerospace sector were supplied as a
result of offset requirements. It is difficult to determine the extent to which
this is due to offset deals alone, as opposed to reflecting a need to procure
items which were in short supply or were non-competitive in the U.S. before the
offset. However, the possibility also exists that if the sale requiring an
offset had not been made, U.S. productive capacity in the sector producing goods
for which offset items were substituted would have shrunk anyway due, for
example, to depressed demand.
These items will be covered in greater detail in the sections which follow.
However, it should be kept in mind that the period covered by the report was one
of large fluctuations in the business cycle as well as substantial growth in the
defense sector due to the military buildup initiated by the Reagan
Administration. The effects of business cycle swings and the buildup were much
longer than the effects of the offsets.
This section will discuss the relationship of offsets to defense-industry
productivity, investment, profitability, surge capacity, foreign source
dependency-, and defense- contractors,--A -brief- summary-of'reverstr'techrrol-ogy ?'--
transfers which may affect offsets concludes the discussion.
Relationship to Defense-related Industry Productivity
Since higher output affects productivity, offsets may have an impact on the
productivity of defense-related industries. This occurs because of the
relationship between longer production runs and learning curves. Over 40
percent of the prime contractor respondents to the questionnaire associated with
this report and five percent of the subcontractor respondents indicated that
sales agreements associated with offsets had a positive impact on their capacity
and utilization rates. Typical respondent statements included the following:
"The sales and offset agreements have caused more efficient utilization of
existing plant and equipment with increased production", and, "The existence of
this contract ensures the continuing economic utilization of...production
capacity." Furthermore, none of the'prime contractor respondents, and less than
one percent of the subcontractor respondents said that these sales and related
offsets agreements had a negative effect; however, nearly 50 percent of the
prime and 89 percent of the subcontractor respondents said that these agreements
had either no effect or an insignificant effect. These responses, therefore,
support a conclusion that in the majority of circumstances, offsets had either
positive or no impact on the productivity of defense-related industries.
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Relationship to Defense-related Industry Investment
Table II.A.1 was constructed from data in the Defense Financial and Investment
Review (DFAIR) published by the Department of Defense in June 1985.
TABLE II.A.1
Capital Expenditures
($ millions, adjusted for inflation)
Year
Defense-Related
Durable Goods
1975
365.3
13,937.4
1976
385.4
14,123.7
1977
500.2
17,042.8
1978
672.1
18,870.6
1979
827.3
19,854.5
1980
1,111.7
21,169.6
1981
1,239.9
22,162.4
1982
1,444.0
NA
1983
1,494.9
NA
Average Percentage- ?Inc-rease
Including data on both defense industries and durable goods industries provides
a basis for comparison. Rather than using total manufacturing industries data,
the category "durable goods" industries eliminated those industries not doing
work comparable to that performed by defense contractors in the negotiated
contract environment. The industry groups deleted were: stone, clay and glass
products; primary metals industries; lumber and wood products, furniture and
fixtures; and miscellaneous manufacturing industries. Because contracts with
the shipbuilding industry contain different financing provisions and different
pricing/profit mechanisms, they were eliminated from the category
"defense-related" industries. Furthermore, data collected for services
contracts was also deleted because it cannot be compared to data for durable
goods manufacturers. Durable goods capital expenditures data for 1982 and 1983
were not available from the Census Bureau at the time of the DFAIR report.
The data reveal that not only has capital investment increased, but it did so at
a substantially faster rate in defense-related industries than in durable goods
manufacturing. DFAIR also analyzed the degree to which firms are replacing
their assets. It found that defense contractors are replacing older equipment
at a much faster rate since 1980 than they did from 1975 through 1979.
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With regard to practical non-wartime plant and equipment capacity and
utilization rates, responses to the industry questionnaire generally indicate
that offset agreements had very little impact. Generally speaking, responses to
the questionnaire sent to industry in connection with this report indicate that
offset agreements had very little impact on their practical (non-wartime) plant
and equipment capacity and utilization rates. Almost half of the prime
contractor respondents and nearly 90 percent of the subcontractor respondents
indicated that offsets either had no impact or only an insignificant impact.
One of the prime contractor respondents and less than one percent of the
subcontractor respondents said that offsets had a negative impact. Therefore,
.insofar as capacity and utilization rates affect investment decisions, offsets
appear to have had very-little impact.
Once again, over 40 percent of the prime contractor respondents, but only five
percent of the subcontractor respondents, indicated that the sales agreements
associated with the offsets had a positive impact on their capacity and
utilization rates. Typical respondent statements included: "This sale
agreement... avoided the elimination of...production capability" and "the
existence of this contract ensures the continuing economic utilization
of...production capacity". Only about five percent of the prime contractor
respondents and less than three percent of subcontractor respondents said that
the sales agreement actually caused them to increase their investment in plant
and equipment.
Against a backdrop of generally increasing rates of growth in defense-related
industry capital investment shown in the DFAIR analysis, the DPA 309 database
supports a conclusion that sales agreements and their resulting offsets are a
-relatively insignificant factor in the investment decisions of defense-related
industries. However, profitability (to be discussed in the next section) is
another important determinant of investment. If the inferences on profitability
drawn from the DFAIR study are valid, then offsets, if necessary to make the
sale, may have had a beneficial effect on defense-related industry
profitability; and if this is indeed the case, then offsets may have had an
indirect, but positive, impact on the investment decisions of these same
industries. However, available data do not enable us to rigorously test the
degree of these relationships.
Relationship to Defense-related Industry Profitability
Chart II.A.1 was constructed from DFAIR data and compares profit/sales of
defense-related industries to that of comparable durable goods manufacturers.
For the 10-year period 1970-1979, the average returns-on-sales were fairly
close. For the recessionary period 1980-1983, however, durable goods
manufacturers experienced substantial losses, while defense-related industry
profitability declined only slightly.
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CHART II.A.1
PROFIT/SALES
78
DEFENSE-RELATED
E
R 2
C
E
---tt.
T 1
70 71
-3
72 73 74 75
81
DRAFT
26
82 83
% I
DURABLE GOODS
~v
SOURCE: Defense Financial and Investment Review, June 1985, p. V-41.
76 77
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Chart II.A.2 compares profit/assets for both groups. The 10-year average
returns are very similar; but again, during all recessionary periods but
especially for the 1980-1983 period, durable goods manufacturers experienced
significant losses while defense-related industries' return-on-assets declined
only moderately. Both figures, therefore, show that profitability of
defense-related businesses were somewhat similar to that of durable goods
manufacturers during the 1970-1979 period, but substantially better during the
1980-1983 period.
As to the question of prime versus subcontractor profits, DFAIR indicates that
profits on DOD subcontracts are slightly less than on DOD prime contract work.
We have no evidence that offsets change this relationship, nor is there evidence
that overall profit trends exhibited in the charts were substantially different
between primes and subcontractors.
DFAIR concluded that defense industries were able to maintain their
profitability primarily because of the increase in defense outlays and the
decline in inflation. Nevertheless, DFAIR also concluded that profits from
foreign military sales are even greater than they are on direct DOD sales. This
supports the view that offsets, if necessary to make the sale in the first
place, enhance defense industry profitability. Furthermore, as pointed out
earlier, the 1983 Treasury study as well as the DPA 309 summary responses
reported strong evidence that- offset-s?arerrecessary-to--successful-Ty=cl e=arariy=-=
defense deals. At the very least, therefore, available DFAIR evidence suggests
that the profitability, and hence the strength, of defense-related industries
has not been damaged by offsets.,
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CHART II.A.2
PROFIT/ASSETS
10
P
E 4
R
C 3
E
-3
-5
-6
70 71 72 73 74 75 76 77 78 79 1 80 81 82 83
YEAR
1 I
I
I
I
DURABLE GOODS
SOURCE: Defense Financial and Investment Review, June 1985, p. V-42.
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Relationship to Wartime (Surge) Capacity
Approximately 50 percent of Department of Defense purchases of manufactured
products and 70 percent of U.S. defense exports come from the aerospace sector.
Hence, close scrutiny of aerospace industry can provide an understanding of the
relationship of offsets to surge capacity.
Table II.A.2 shows the rates of capacity utilization for both prime and
subcontractors in aerospace industries. These capacity figures are based on a
3x8x5 shift workweek (three eight-hour shifts per day for a five-day week).
This type of workweek is normally used for planning high volume production
because it permits the use of the sixth day for overflow work and the seventh
day for maintenance, if required. The table presents these data in three ways:
average capacity used on a 3x8x5 workshift, the range of capacity used across
the plants surveyed, and capacity used by number of 1x8x5 workshifts worked.
As the table demonstrates, there is a great deal of excess capacity in the
aerospace industry. Although this table does not show potential problems which
may exist for specific products, capacity in the aerospace industry does not
appear to be a problem. The DPA 309 database reveals that the military sector
comprises only about one-fourth of total sales of companies reporting offset
obligations, and the military export share amounts to less than four percent of
the total .sales of- these companies.-- Offsets -are -a small --part ?of ~sobcontractor`-
production; therefore, one would expect them to have little impact on capacity
utilization.
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TABLE II.A.2
1983 Aerospace Capacity Utilization by Functional Area
Large
Aircraft
Fighter/
Attack
Other
Aircraft
Propulsion
Missiles
Fabrication
*42%
40%
26.5%
57%
43%
**10-80
(25-66)
(8-50)
(31-75)
(20-66)
***1.5
1.0
1.6
1.3
Process/Paint
39%
45%
31.5%
64%
43%
(9-80)
(25-60)
(8-70)
(28-100)
(20-66)
1.5
1.0
1.2
1.3
Assembly
41%
40%
27%
51%
43%
(8-80)
(33-80)
(11-45)
(28-65)
(20-66)
1.5
1.0
1.2
1.3
Test and
40%
40%
26%
57%
70%
Check out
(22-80)
(20-75)
(11-45)
(28-65)
(40-100)
1.8
1.0
1.0
2.1
Avionics
Materials
Structures
fabrication
44.50%
53%
(4-90)
(27-81)
1.43
1.80
Process/
41.90%
33%
37%
Paint
(25-60)
(11.42)
(12-75)
1.22
1.30
1.70
Assembly
38.60%
Total
32%
(25-50)
Manufacturing
(14-70)
1.20
Functions
1.40
Test and
58.30%
41%
Check out
(40-81)
(18-70)
1.91
1.50
*
**
Average percent capacity on a 3x8x5 shift basis.
Range of percent capacity utilized on 3x8x5 shift basis.
Average number of shifts utilized on 1x8x5 basis.
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Within the aerospace industry, offsets appear to have had a limited effect on
surge capacity outside of the foreign-sourcing arena. Moreover, in the large
aircraft sector, where business has been adversely affected by the drop in
export sales resulting from financial problems of aircraft purchasers, the
suggested corrective action made by the Air Force in the 1984 study, Blueprint
for Tomorrow, was to seek innovative financing support, in both standard and
non-standard transactions, to include countertrade and offset.
When queried by the U.S. Air Force in late 1983, the materials sector of the
aerospace group was the only sector which reported that it had been noticeably
affected by offsets. This sector reported that offsets create foreign
competitors for future procurement and force overseas technology flow. The
following remedies for this situation were suggested by the same study:
o Restrict flow of technology offshore as part of coproduction.
o Improve list of restricted technologies by making it more specific.
The questionnaire sent to industry in connection with this report defined
wartime (surge) capacity as the ability of a firm to double production within 12
months. Two-thirds of the prime contractor respondents to the questionnaire
felt that offsets had either no effect or an insignificant effect on their surge
capacity. Almost 28 percent- felt 'that-offsets-?had a--tsertefltiay'-bffect"betaUse- `
they allowed sales to occur, while less than three percent felt that offsets had
a detrimental effect on their surge capacity.
Thus, although a number of factors have adversely affected the industrial base
in the aerospace sector over the last few years, and although problems with the
'industrial base can lead to surge problems, for the aerospace sector at least,
available evidence suggests that no serious capacity problems are present.
Surge difficulties that do exist can be traced to a number of causes, but
generally not to offsets.
Relationship of Offsets to Foreign Sourcing
Foreign sourced items are of concern because, depending on the source, they may
affect the ability of the U.S. to sustain weapon production in time of war.
According to Blueprint for Tomorrow, offsets are one reason that foreign-sourced
items are used in the aerospace sector. Of these items, only eleven specific
cases are sole source while the rest have some production capability located in
the United States. Furthermore, foreign sourcing seems to follow the large
offset contracts (Israel and the NATO countries are prominently featured) and
Canada, which is part of the North American (U.S. and Canada) domestic
industrial base, is a major participant.
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However, when one considers the number of parts used in modern aircraft, the
total number of foreign sourced items is very small. In addition, virtually all
of this sourcing takes place in areas such as NATO or Israel where U.S. policy
is to support a strong foreign industrial base. Similar foreign source data are
available for Amy procurements. Again, with very few exceptions, the NATO
countries are the suppliers. There is no indication of the amount of this trade
which is based on offsets.
Impact on Defense Contractors _
The 1983 Treasury report cited subcontractor production as comprising 24.9
percent of the total offsets reported in its survey. The DPA 309 database
yielded a slightly lower result -- 21.2 percent of offset obligations being
subcontractor production. There are several reasons for the importance of
subcontractor production in offsets. First, prime contractors are hesitant to
make offset agreements which will ruin their markets over the long-term.
Second, if the foreign country has the technological and production capabilities
to do the work of the prime, one would assume that the foreign country would
have built the weapon itself. As a corollary, most of the countries which
demand offsets can only accomplish production tasks of a simpler nature (e.g.,
the type of task usually associated with subcontractors).
A review of where U.S-.-defense-rei;ated?-goods -and-servrces -arp'suld demonstrates
that most of the purchasers will not be capable of the sophisticated production
techniques necessary to assume the role of a prime contractor. Note that the
buyers fall into two general categories: NATO countries and the LDCs. While
the LDCs cannot assume the role of the prime through offsets, it is obvious that
the non-U.S. NATO countries, under many conditions, could assume this role. It
is U.S. policy to encourage NATO in this endeavor, but the two-way defense trade
statistics between the United States and other NATO countries demonstrate that
the U.S. gains a good deal more in terms of trade from the relationship than
other NATO countries do from the relationship with the United States.
Concurrent with this, the United States maintains a policy of establishing
domestic production capabilities for any major weapon system it purchases
overseas. In fact, in those cases where the United States buys weapons from one
of the NATO countries whose technology and productive capability could be a
threat to our own prime contractors, the United States requires that it also be
allowed to produce the weapons. This policy is used to keep our industrial base
capable of supporting the weapons we use.
Table II.A.3 shows the U.S. balance of defense-related trade with NATO. Note
that this trade currently flows in favor of the United States by a 2.8 to 1
ratio.
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DRAFT
33
TABLE II.A.3
FY 1984 Defense-related Trade Balance Summary
(thousands of current dollars)
Country
Total
U.S.
Exports 1/
Total
U.S.
Imports 2/
From Foreign
Subcontracts
DOD
Computed
FY 84
Ratio 3/
-
Belgium
202,826
114,139
10,545
1.78
Denmark
48,053
49,281
44,189
0.98
France
68,027
47,601
11,626
1.43
FRG
402,728
307,590
47,853
1.31
Italy
104,862
65,009
10,036
1.61
Luxembourg
1,561
1,486
--
1.05
Netherlands
485,798
38,975
28,529
12.46
Norway
230,897
43,743
20,794
5.28
Portugal
27,562
1,245
22.14
Spain
101,446
24,973
892
4.06
UK
1,595,714
492,865
84,794
3.24
Total Europe
~
259,258
2.75
Canada 4/.
1,306,525
875,400
--
393,700
"'
1.49
Total Europe
Plus Canada
4,565,999
2,062,307
652,958
2.21
1/ Estimated totals of FMS and commercial exports licensed under the Arms Export
Control Act. These totals represent the dollar value of Government and
commercial sales on a delivery basis.
2/ Figures do not include subsistence, petroleum, construction, and support
services awarded in FY 84.
3/ "Total U.S. Exports" divided by "Total U.S. Imports."
4/ Data provided by the Government of Canada; the figures were adjusted to
reflect FY 1984 and converted into U.S. dollars using an exchange rate of
0.8073 for the months of October through December and an exchange rate of
0.7837 for January through September.
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A major issue in defense trade is the impact of offsets on subcontractors. The
amount of subcontractor work performed in the FY 1984 trade (II.A.6) with other
NATO countries is assumed to be primarily due to offsets for the reasons already
given. While having this amount of subcontracting done overseas has an obvious
effect on the U.S. industrial base, several points should be remembered. First,
the work done by other NATO countries is done in response to a U.S.,policy to
promote RSI. Table II.A.4 provides a wider context for this discussion of
overseas defense subcontracts. Note that of the subcontractor work done by our
NATO allies over half is done in Canada, a country that is part of the North
American (U.S. and Canada) defense industrial base.
All other countries with significant amounts of subcontract work are either in
NATO or reflect very specific foreign policy concerns.
Thus, these data show that the area of subcontracting, where one would expect
offsets to have the major impact on U.S. defense industry, has experienced
impacts in precisely the manner that one would have guessed, a priori, based
solely on a rudimentary knowledge of our policies with regard to NATO and to
Israel. These data do not support a conclusion that offsets affecting the
defense industrial base have occurred in large numbers outside of the countries
that are our major allies.
A model developed -by- the-- Department--of -Defense -firnd'tCates that, 4n ? general ,
defense business comprise only a small portion of any sector's subcontractor
activity. Offsets comprise an even smaller share. Evaluating the impact of
offsets on subcontractors is difficult because data regarding both the negative
effects (business lost due to offsets) and the positive effects (business which
would have been lost had the offset not been offered to close the deal) are
generally not known to the subcontractors themselves. In addition, a
subcontractor from one sector may lose business while a subcontractor from
another may gain -- all due to the same offset deal. In this case, the overall
effect of the offset can only be measured by knowing the severity of industrial
base degradation in the first instance compared to the enhancement of the base
in the second. This information is, at best, subjective in nature and often
inseparable from general economic conditions.
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TABLE II.A.4
Overseas Distribution of Defense Subcontracts
(Fiscal Year 1984)
Region/Category
Country
Millions of
Dollars
Percent of
Total
$ 653.207
91.41
Canada
393.700
55.09
UK
84.794
11.87
Denmark
44.189
6.18
West Germany
47.853
6.70
Netherlands
28.529
3.99
Norway
20.794
2.91
France
11.626
1.63
Italy
10.036
1.40
Belgium
10.545
1.48
Spain
0.892
0.12
Greece
0.249
0.03
OTHER OECD
29.177
4.08
Australia
14.104
1.97
Japan
8.273
-1.16
Switzerland
4.310
0.60
Sweden
2.048
0.29
Austria
0.442
0.06
NEWLY INDUSTRIALIZED
23.858
3.33
Korea
0.680
0.10
Taiwan
0.633
0.09
Israel
20.675
2.89
Hong Kong
1.022
0.14
Singapore
0.528
0.07
Mexico
0.320
0.04
DEVELOPING
8.367
1.17
Saudi Arabia
5.491
0.77
Philippines
0.225
0.03
Kuwait
0.119
0.02
El Salvador
0.101
0.01
Egypt
0.018