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United States General Accounting Office:

GAO:

Testimony:

Before the Committee on Armed Services, House of Representatives:

For Release on Delivery Expected at 9:00 a.m. EDT Thursday, July 8, 
2004:

Defense Trade:

Issues Concerning the Use of Offsets in International Defense Sales:

Statement of Katherine V. Schinasi:

Managing Director, Acquisition and Sourcing Management:

GAO-04-954T: 

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss issues surrounding the use of 
defense offsets on the basis of our work going back almost 15 years.

Views on defense offsets range from beliefs that they are both positive 
and an unavoidable part of doing business overseas to beliefs that they 
negatively affect the U.S. industrial base. Defense offsets are often 
viewed as the key to foreign sales and thus increased business on the 
prime contractor level. They can also result in reduced unit costs to 
the U.S. military because of the increased size of production runs. 
However, the use of a foreign supplier by a U.S. prime contractor as a 
result of an offset may lead to decreased business opportunities for 
U.S. suppliers. Additionally, U.S. prime contractors may develop long-
term relationships with foreign suppliers, which may lead to the 
transfer of capability from the U.S. defense industrial base.

As a result of congressional concerns about emerging trends in defense 
offsets, we have conducted a number of reviews and issued multiple 
reports. Because of our work in this area, you asked us to provide our 
observations on offset issues. Specifically, we are providing our 
observations on (1) what constitutes offsets and how they are used in 
defense trade, (2) how that use has changed over time, and (3) the 
quality and extent of information concerning offsets that is currently 
available.

Results in Brief:

Defense offsets are the full range of industrial and commercial 
benefits that firms provide to foreign governments as inducements or 
conditions for the purchase of military goods and services. They 
include, for example, coproduction arrangements and subcontracting, 
technology transfers, in-country procurements, marketing and financial 
assistance, and joint ventures. Foreign governments use offsets as a 
means of reducing the financial impact of their purchases, obtaining 
valuable technology and manufacturing know-how, supporting domestic 
employment, creating or expanding their defense industries, and making 
the use of their national funds for foreign purchases more politically 
palatable.

Over the almost 15-year period we have studied defense offsets, 
countries buying U.S. defense items have become increasingly 
sophisticated in their offset demands. These demands have included 
requiring offsets prior to contract award and increasing the offset 
value as a percentage of contract value. These demands are often based 
on developmental goals of the purchasing country and have steadily 
increased in value so that today these demands often equal and may 
exceed 100 percent of the value of the transaction. It should be noted 
however, that purchasing countries often use multipliers as a means of 
encouraging companies to engage in certain activities to fulfill offset 
obligations.[Footnote 1] While the use of such multipliers can lessen 
the dollar effect of offset demands as a percentage of the related 
sale, their use underscores the sophistication of countries using 
offsets as part of an industrial policy. The Department of Defense's 
(DOD) current emphasis on engaging in joint development programs can be 
viewed as an avenue for an even more sophisticated offset. The 
expenditure of public funds by one country to support a another 
country's weapon system development program will be offset by access to 
developing technology that the first country could not have 
individually afforded and subsequently the opportunity to take part in 
producing the system and the jobs that production will create.

The current information available on offsets does not provide an 
adequate basis for evaluating offset practices. Defense exports 
involving offsets are small relative to the U.S. economy as a whole. As 
a result, it is difficult to measure effects using national aggregated 
data. The lack of reliable data on the impact of offsets on the U.S. 
economy has been a concern for many years, and Congress has on numerous 
occasions required federal agencies to take steps to define and address 
offset issues. Most recently, in 1999, Congress established a national 
commission to report on the extent and nature of offsets in defense 
trade. Currently, the Department of Commerce reports to Congress on an 
annual basis on offset agreements, as well as activities that U.S. 
companies engage in to fulfill offset obligations. The Departments of 
Defense and State include limited offset information when notifying 
Congress of large sales of defense items to foreign countries. However, 
no direct linkage has been made between the information collected on 
these sales and associated offset agreements and any impact on the U.S. 
economy.

Historically, the U.S. government has maintained a "hands off" policy 
toward defense offsets, viewing them as part of the transaction between 
the contracting parties. Since offsets are one of the many factors 
contributing to the globalization of the U.S. industrial base, studying 
offset transactions could provide insights into what is occurring in 
the industrial base and whether these transactions need to be 
considered on a policy level by the U.S. government.

Offsets Are an Integral but Unregulated Part of International Defense 
Trade Relationships:

Offsets are an unregulated part of defense export sales. U.S. 
contractors consider offsets an unavoidable cost of doing business 
overseas. These officials have indicated that if they did not offer 
offsets, export sales would be reduced and the positive effects of 
those exports on the U.S. economy and defense industrial base would be 
lost. These positive effects include both employment in the U.S. 
defense industry and orders for larger production runs of U.S. weapon 
systems, thus reducing unit costs to the U.S. military. They have also 
noted that many offset deals create new and profitable business 
opportunities for themselves and other U.S. businesses. Critics charge 
that negative aspects of offset transactions limit or negate the 
economic and industrial benefits claimed to be associated with defense 
export sales.

While offsets take many forms, direct offsets generally involve 
technology transfer, coproduction tied to a weapon sale, and 
subcontracting for defense-related products, whereas indirect offsets 
encompass almost any economic activity not related to the defense sale. 
Offsets may result in the development of long-term supplier 
relationships. On the one hand, the U.S. prime contractor might have 
found a less costly supplier; on the other hand, U.S. subcontractors 
may find reduced business opportunities, resulting in the loss of 
capability in the U.S. industrial base. U.S. companies also may find 
that they have contributed to the development of a future competitor. 
We found that in one instance, a U.S. subcontractor stated that it was 
required by a prime contractor to grant a licensing agreement to a 
foreign company to produce a subsystem. The foreign company 
subsequently developed a similar subsystem to compete against the U.S. 
subcontractor. Offset-related technology transfer may also affect 
national security. Currently, little is known about the effect of 
offsets on increasing the foreign content in U.S. weapon systems 
because information linking offsets to foreign content is not 
collected. We have reported on the details of offset transactions in 
several reports, most recently in our report Defense Trade: U.S. 
Contractors Employ Diverse Activities To Meet Offset Obligations (GAO/
NSIAD-99-35, Dec. 18, 1998). That report and others are summarized in 
appendixes to my statement today.

Offset Demands Have Changed Over Time:

Over the period that we have been reporting on issues associated with 
offsets, countries buying U.S. defense items have been increasing their 
demands for offsets. Countries that prior to the 1990s did not require 
offsets now require them as a matter of routine policy. In at least one 
case this policy had been established in law. In some cases, purchasing 
countries require preapproval of offset projects to ensure that they 
accomplish their development goals as well as provide the stated 
economic benefit. We have also found that the nature of the offset 
demanded varies according to the objectives of the purchasing 
government and, to an extent, the level of economic development.

Countries are also increasingly sophisticated in their management of 
offsets to achieve specific regional industrial and employment goals. 
For example, one country requires that companies distribute offset 
projects across its various regions. Some countries establish time 
frames within which an offset must be performed and include penalty 
clauses for nonperformance within those time frames. An offset activity 
that is considered valuable or very desirable-the introduction of a new 
industry or technology transfer-will be encouraged through the use of 
multipliers. Further, many countries will permit companies to "bank" 
offset credits to be used to fulfill offset obligations associated with 
future sales of defense goods in that country. These countries are 
managing the timing and location of the economic activity prior to 
committing to purchase a specific defense article. According to one 
U.S. company official, companies have traded offset credits through 
industry associations and individual contacts, and one country has 
established a company to facilitate offset deals.

DOD's current emphasis on partnering with allied countries in 
development programs has opened a new avenue for offset activity. In 
previous offset agreements, the purpose of an offset was to encourage 
the purchase of foreign defense goods by balancing the expenditure of 
public funds with a perceived economic benefit. In joint development 
programs, the balance can be achieved through the promise of access to 
technology that individually the partnering countries could not have 
afforded to develop and the opportunity to win part of the production 
work and the jobs that it will create. This model is most apparent in 
the Joint Strike Fighter (JSF) program. The JSF program has established 
a model in which countries become partners at specified contribution 
levels. While there are financial benefits connected with the 
contribution--for example, the waiver of nonrecurring aircraft costs--
the primary benefit will be access to advanced technology and an 
advanced tactical aircraft that they could not afford to develop on 
their own.

However, as we pointed out in our work on JSF program, this type of 
offset comes with its own unique set of concerns.[Footnote 2] 
International participants have significant expectations regarding 
industrial return on the basis of their contributions. Because the 
prime contractor, Lockheed Martin, bears the major responsibility for 
managing partner industrial expectations, it will need to balance its 
ability to meet program milestones against meeting these expectations, 
which could be key to securing future sales of the JSF for the company. 
The need to offset partner contributions through industrial return has 
been highlighted in several recent news reports on actions being taken 
by Lockheed Martin and its major commercial partners to ensure that the 
partner countries share in the work being generated.

Data Not Available to Evaluate the Need for an Offsets Policy:

Based on our work on defense industrial base issues we have concluded 
that DOD needs to improve its knowledge of the supplier base at the 
lower tiers to enable it to better understand who its suppliers are and 
what vulnerabilities may exist. Congress has on numerous occasions 
attempted to gain increased knowledge about offsets issues and has 
urged the executive branch to take steps to mitigate the adverse 
effects of offsets. (See app. 1.) We believe that there is a 
relationship between offsets and DOD's supplier base. To properly 
manage its supplier base and ensure that U.S. technology is protected, 
DOD needs to understand the uses and effects of offsets.

Evaluating offsets and identifying their effects on industrial sectors 
or the U.S. economy as a whole is difficult. Although we have 
identified instances of the impact of offsets on individual companies, 
we have not quantified the impact of offsets on the overall U.S. 
economy or on subsectors of the U.S. industry. First, according to 
officials from large defense firms and an association representing U.S. 
suppliers, obtaining reliable information on the impact of offsets is 
difficult because company officials are generally not aware that a 
particular offset arrangement caused them to lose or gain business. As 
a result, it is difficult to isolate the effects of offsets from the 
numerous other factors affecting specific industry sectors. 
Additionally, technology is transferred overseas for reasons other than 
to fulfill an offset obligation. In some instances, alliances such as 
joint ventures may be formed to gain access to the European market 
without being the result of offsets. Likewise, European companies may 
gain access to U.S. technology as they gain access to the U.S. market 
through acquisitions of small and medium-sized U.S. defense companies. 
Second, defense exports involving offsets are small relative to the 
U.S. economy as a whole, making it difficult to measure any effects 
using national aggregated data.

The lack of reliable data on the impact of offsets on the U.S. economy 
has been a concern for many years, prompting Congress to enact 
legislation requiring three federal agencies (the Departments of 
Commerce, Defense, and State) to collect data on offsets. The Defense 
Production Act of 1950 as amended[Footnote 3] requires the President to 
report annually to Congress on the impact of offsets on U.S. defense 
preparedness, industrial competitiveness, employment, and trade. 
Commerce prepares the report, and requires companies to annually report 
(1) offset agreements entered into during the previous year that are 
valued at more than $5 million and are associated with the sales of 
defense articles or services and (2) completed offset transactions 
being used to meet existing offset commitments that have a credit value 
of at least $250,000. The required information includes the name of the 
country purchasing the defense item or service for which the offset is 
required, the credit value of the offset, the actual dollar value of 
the offset, and a description of the type of offset.

The Departments of Defense and State report to Congress on offset 
information pertaining to individual sales of defense items. The Arms 
Export Control Act, as amended,[Footnote 4] requires the President to 
notify Congress of any agreements to sell defense articles or services 
over a certain amount. The President delegated this reporting function 
to the Secretary of Defense for foreign military sales agreements and 
to the Secretary of State for commercial sales of defense items that 
require an export license. Beginning in 1994,[Footnote 5] the law was 
amended to require that the congressional notification contain a 
statement of whether or not an offset agreement was associated with the 
sale and a description of it. This requirement applies to both 
government-to-government and commercial sales of defense articles.

Congress also legislated that the President develop an offset policy 
and negotiate with foreign countries to mitigate the adverse effect of 
offsets. The National Defense Authorization Act for Fiscal Year 1989 
directed the President to establish a comprehensive offset policy 
addressing (1) technology transfer, (2) the application of offset 
arrangements, and (3) the effects of offset arrangements on specific 
subsectors of the U.S. industrial base. It also directed that the 
policy address preventing or ameliorating any serious adverse effects 
on such subsectors.[Footnote 6] In 1990 the President issued a policy 
statement recognizing that certain offsets are economically inefficient 
and market distorting but reaffirms the U.S. government's traditional 
policy of noninvolvement in offset arrangements.[Footnote 7] The policy 
statement did not address technology transfer or the effects of offsets 
on specific subsectors.

In 1992 the Defense Production Act Amendments of 1992 directed the 
Secretary of Defense to lead an interagency team to consult with 
foreign nations on limiting the adverse effects of offsets.[Footnote 8] 
According to Defense Department officials, the interagency team began 
to meet in 1999. As of September 1, 2000, the interagency committee had 
met with representatives of the governments of Canada, France, Great 
Britain, and the Netherlands and had sent letters to other nations that 
had memorandums of understanding with the U.S. government requesting 
meetings to discuss offsets. The committee had also begun to consult 
with industry.

In 1999 Congress passed the Defense Offsets Disclosure Act of 1999, 
which expressed the sense of Congress that (1) the executive branch 
should try to establish reasonable, business-friendly standards for the 
use of offsets with foreign counterparts for use in international 
business transactions and that (2) the U.S. government should raise 
offset issues in discussions with other industrialized nations and 
should enter into discussions through multilateral forums to establish 
standards for the use of offsets in international defense 
trade.[Footnote 9] That act also established the National Commission on 
the Use of Offsets in Defense Trade. As we reported in May of last 
year, the Commission's final report and recommendations are still 
pending. An interim report was published in February 2001, based on the 
last Commission meeting held in December 2000. Since the change of 
administrations in 2001, the President has not appointed new executive 
branch members. Consequently, the Commission has ceased activity and 
has not issued its final report.

CONCLUSIONS:

Offsets are an element in international defense trade, the nature and 
importance of which have changed over time. Despite the many 
congressional attempts to force the development of information that 
would enable an accurate evaluation of the role--both positive and 
negative--played by offsets, this information has not been developed. 
The same would appear true for the many times Congress has urged action 
to address the perceived adverse effects of offsets. The last action--
establishing the National Commission on Offsets in Defense Trade--
appeared to be a culmination of many prior efforts. However, because of 
circumstances the Commission never achieved its purpose. The Committee 
may want to consider reinvigorating that process and combining it with 
a specific direction to the executive branch to enter into multilateral 
talks, particularly with our closest allies, to discuss how offsets may 
result in market distortions and to determine whether steps can be 
taken to mitigate the adverse effects while protecting the interests of 
all involved.

Mr. Chairman, this concludes my statement. I would be happy to respond 
to any questions that you or members of the Committee may have.

This statement is based on the results of our work on offsets (see app. 
2) and related issues (see app. 3) from our reports issued from April 
1990 through May 2004, and therefore agency comments were not 
requested. All of the reviews were done according to generally accepted 
government auditing standards.

Contacts and Acknowledgments:

For future questions regarding this testimony, please contact Katherine 
Schinasi, (202) 512-4841. Individuals making key contributions to this 
testimony include Thomas Denomme, Paula Haurilesko, and Lillian 
Slodkowski.

Selected Legislation Concerning Offsets:

1984:

Statute:  Defense Production Act Amendments of 1984 (Pub. L. 98-265); 
Information gathering: Requires the President to submit an annual 
report on the impact of offsets on the defense preparedness, industrial 
competitiveness, employment, and trade of the United States.

1986: 

Statute:  Defense Production Act Amendments of 1986 (Pub. L. 99-441); 
Information gathering: Requires the President's annual report be a 
"detailed" study that includes (1) summaries of interagency studies on 
the effects of offsets, (2) the long-and short-term effects of offsets, 
and (3) the direct and indirect effects on lower-tier defense 
subcontractors and non-defense industry sectors.

1988: 

Statute:  National Defense Authorization Act, Fiscal Year 1989 (Pub. L. 
100-456); 
Information gathering: Requires firms entering into a defense contract 
subject to an offset arrangement exceeding $50 million to notify the 
Secretary of Defense of the proposed sale; 
Actions to mitigate adverse effects: 
(1) Requires the President to establish a comprehensive offset policy 
that addresses the effect of offsets on specific subsectors of the 
industrial base and how to prevent or ameliorate any serious adverse 
effects on those subsectors; 
(2) Directed the President to enter into negotiations with foreign 
countries to limit the adverse effect of offsets on the defense 
industrial base. Requires the President to report to Congress every 
year for four years (1989-92) on the status of negotiations; 
(3) Required a report by March 15, 1990, discussing actions the United 
States could take in reaction to offsets, such as requiring an offset 
or other equivalent advantage when buying goods from a country that 
requires U.S. firms to offer offsets.

1989: 

Statute:  National Defense Authorization Act for Fiscal Years 1990 and 
1991 (Pub. L. 101-189); 
Actions to mitigate adverse effects: Directed the President to "make 
every effort" to achieve an agreement that would limit the adverse 
effects of offsets during negotiations of memoranda of understanding 
between the United States and other countries.

1992: 

Statute:  Defense Production Act Amendments of 1992 (Pub. L. 102-558); 
Information gathering: (1) Designated the Secretary of Commerce to 
prepare the annual report on offsets, and required the report to 
address the cumulative effect of offset agreements on domestic defense 
productive capability, especially the lower-tier subcontractors or 
suppliers, and the effect on the defense technology base of technology 
transfers that occur to fulfill offset agreements; (2) Required 
companies to notify Commerce Department officials when entering into a 
contract that is subject to an offset agreement exceeding $5 million in 
value; 
Actions to mitigate adverse effects: Required the President to 
(1) designate the Secretary of Defense to lead an interagency team to 
consult with foreign nations on limiting the adverse effects of 
offsets in defense procurement and 
(2) report annually on the results of the consultations.

1994: 

Statute:  Foreign Relations Authorization Act, Fiscal Years 1994 and 
1995 (Pub. L. 103-236); 
Information gathering: Amended sections 36(b) and (c) of the Arms 
Export Control Act to require that notifications to Congress of 
impending sales of defense goods indicate whether any offset agreement 
is proposed in connection with the sale and required a description of 
the offset agreement proposed.

1999: 

Statute:  Defense Offsets Disclosure Act of 1999 (Pub. L. 106-113, App. 
G); 
Information gathering: Established a National Commission on the Use of 
Offsets in Defense Trade. Required a report within 12 months on (1) 
the collateral impact of offsets on industry sectors unrelated to the 
item sold, (2) the role of offsets with respect to U.S. competitiveness 
in international trade, and (3) the impact on national security of 
technology transferred to fulfill offset obligations; 
Actions to mitigate adverse effects: 
(1) Directed the United States government to enter into discussions 
through multilateral forums to establish standards for the use of 
offsets in international defense trade; 
(2) Required the National Commission on the Use of Offsets in Defense 
Trade to submit an analysis of proposals for unilateral, bilateral, or 
multilateral measures to reduce the detrimental effect of offsets and 
to identify the appropriate agencies to monitor the use of offsets.

2003: 

Statute:  Department of Defense Appropriations Act, 2004 (Pub. L. 
108-87); 
Information gathering: Requires the Secretary of Defense to report to 
Congress by March 1, 2005, on the effect of offset arrangements on 
specific subsectors of the U.S. industrial base; what actions have 
been taken to prevent or mitigate any serious adverse effects, and the 
extent to which offsets and other arrangements have provided for 
technology transfer that would significantly and adversely affect the 
national technology and industrial base. 

Source: GAO analysis.

[End of table]

GAO Reports on Defense Offsets, 1990-2003:

Defense Trade: Report and Recommendations of the Defense Offsets 
Commission Still Pending (GAO-03-649, May 30, 2003):

GAO found that the final report and recommendations of the National 
Commission on the Use of Offsets was still pending although its 
mandated reporting date was October 2001. The Commission had issued an 
interim report in February 2001 calling for additional work on the 
issues raised. However, the last Commission meeting was held December 
4, 2000, and no further activity had occurred. The 2001 change in 
presidential administrations resulted in vacancies in the five 
executive branch positions on the Commission, which were never filled.

Defense Trade: The Use of Intellectual Property Generated at Department 
of Energy's Laboratories to Satisfy Offset Requirements (GAO-01-271R, 
Jan. 8, 2001):

GAO found that the use of Department of Energy laboratories' 
intellectual property and services to satisfy defense contractors' 
offset requirements has been limited. GAO identified 14 instances from 
as early as 1995, all at one laboratory, where the laboratory's 
intellectual property and services were involved in offset projects. 
The 14 instances, valued at about $200 million, involved 4 intellectual 
property licenses and 10 service arrangements through which laboratory 
personnel performed training, workshops, and other services for various 
foreign countries. In addition to the 14 offset projects, we were 
informed by three other laboratories of other offers to use the 
laboratories' intellectual property and services of laboratory 
personnel to meet potential offset requirements. These offers did not 
result in specific projects because the weapon system sales did not 
take place.

Defense Trade: Observations on Issues Concerning Offsets (GAO-01-278T, 
Dec. 15, 2000):

GAO provided a statement for the record to the National Commission on 
the Use of Offsets that summarized its work on defense offsets. GAO 
commented that views on the effects of offsets were divided between 
those that saw them as damaging to the U.S. industrial base and those 
that believed them an unavoidable part of doing business overseas. GAO 
also pointed out that demands for offsets had increased over time and 
that data to quantify the impact of offsets were not available.

Defense Trade: Data Collection and Coordination on Offsets (GAO-01-83R, 
Oct. 26, 2000):

GAO determined that three federal agencies-the Departments of Commerce, 
Defense, and State-are required by law to report to Congress on defense 
offsets, although other federal agencies may collect related data. The 
Department of Commerce was the primary agency collecting data on 
offsets and is required to submit an annual report to Congress. GAO 
also found that federal agencies generally had not coordinated defense 
offset data collection efforts. This lack of coordination might not be 
significant because (1) the type of data being collected by each of the 
reporting agencies differs or (2) the time period for reporting to 
Congress differs. However, federal agencies were coordinating on 
reporting and some policy issues.

Defense Trade: U.S. Contractors Employ Diverse Activities to Meet 
Offset Obligations (GAO/NSIAD-99-35, Dec. 18, 1998):

GAO examined over 100 offset transactions of six major U.S. defense 
contractors to determine the types of activities in which U.S. 
contractors engage to fulfill offset obligations. GAO found that 
companies had undertaken a variety of activities to satisfy offset 
requirements, such as coproduction and subcontracting related to 
defense items, technology transfers, in-country procurements, 
marketing assistance, financial assistance, and investments or joint 
ventures. Coproduction tied to a weapon sale, subcontracting for 
defense-related products, and technology transferred were transactions 
commonly found in the arrangements reviewed. The long-term supplier 
relationships that develop through these activities might have resulted 
in reduced business opportunities for some U.S. firms. Nonetheless, the 
value of the export sale, in the transactions examined, greatly 
exceeded the amount of work placed overseas.

Military Offsets: Regulations Needed to Implement Prohibition on 
Incentive Payments (GAO/NSIAD-97-189, Aug. 12, 1997):

GAO reviewed the status of the State Department's efforts to issue 
regulations implementing the Feingold Amendment (Pub. L. 103-236, 
section 733, Apr. 30, 1994, 22 U.S.C.  2779a). The Feingold Amendment 
prohibits U.S. contractors from making incentive payments to a U.S. 
company or individual to induce or persuade the contractors to buy 
goods or services from a foreign country that has an offset agreement 
with the contractor. At the time of this report, the amendment applied 
only to the sale of defense articles or services sold under the Arms 
Export Control Act, not commercial sales.[Footnote 10] GAO also found 
that the State Department had made little progress in developing the 
needed regulations.

Military Exports: Offset Demands Continue to Grow (GAO/NSIAD-96-65, 
Apr. 12, 1996):

GAO examined the experience of 9 U.S. companies with 10 countries in 
Asia, Europe, and the Middle East in 76 offset agreements. GAO found 
that, over a 10-year period, demands for offsets in foreign military 
procurement had increased in terms of requiring more technology 
transfer, higher offset percentages, and higher local content. 
Countries that previously did not require offsets now require them as a 
matter of policy, and many countries were now focused on longer-term 
offset deals to pursue industrial policy goals. Also, the type of 
offset project required varied according to each country's industrial 
and economic development needs. For example, countries with developed 
economies encouraged offsets related to the defense or aerospace 
industries; whereas, countries with less industrialized economies 
generally pursued indirect offsets to help create profitable businesses 
and build their country's infrastructure.

Military Exports: Concerns Over Offsets Generated With U.S. Foreign 
Military Financing Program Funds (GAO/NSIAD-94-127, June 22, 
1994)[Footnote 11]

GAO examined offset transactions associated with weapon sales to 
countries that received grants or loans from the U.S. Foreign Military 
Financing Program. At the time of this review, four countries-Egypt, 
Greece, Israel, and Turkey-were the largest recipients of Foreign 
Military Financing Program funds. GAO found that all four countries 
were obtaining offsets in purchases funded by the Program. Thus, these 
countries benefited from the Program by (1) using U.S. funds to 
purchase weapon systems and (2) developing their industrial bases 
through offset requirements, such as technology transfer and directed 
subcontracting. At the time this report was issued, U.S. laws, 
regulations, and policies did not preclude offsets when purchasers were 
using Foreign Military Financing Program funds.[Footnote 12]

Military Exports: Implementation of Recent Offset Legislation (GAO/
NSIAD-91-13, Dec. 17, 1990):

GAO examined the implementation of the National Defense Authorization 
Act, Fiscal Year 1989 (Pub. L. 100-456), which (1) directed the 
President to establish a comprehensive offset policy and enter into 
negotiations with foreign governments about limiting the adverse 
effects of offsets and (2) required U.S. industry to notify the 
Secretary of Defense of offset arrangements exceeding $50 million. GAO 
found that the President's April 1990 policy statement on offsets did 
not specifically discuss technology transfers and the effects of 
offsets on U.S. industrial base subsectors, as required by the law. 
Additionally, the President directed that an interagency team consult-
not negotiate-with foreign nations. Finally, at the time of the report, 
the Department of Defense had not developed regulations, in accordance 
with the law, requiring U.S. industry notification.

Defense Production Act: Offsets in Military Exports and Proposed 
Amendments to the Act (GAO/NSIAD-90-164, Apr. 19, 1990):

GAO reviewed (1) the administration's 1988 report to the Congress, 
Offsets in Military Exports, and (2) proposed amendments to the Defense 
Production Act of 1950, under Senate bill 1379. GAO found that the 
results of the methodology used to prepare the defense preparedness and 
employment sections of the 1988 report were of limited value because, 
although they provided an assessment of the overall impact of offsets 
on U.S. industry, they did not identify the effect on more specific 
industry sectors critical to defense. Additionally, the use of 
differing assumptions in applying that methodology to the sections on 
defense preparedness and employment made the analyses of the two 
sections inconsistent and appeared contradictory. Regarding Senate bill 
1379 as well as the Defense Production Act itself, GAO stated the need 
to better provide for disclosing significant differing agency views in 
the annual report.[Footnote 13]

GAO Reports on Issues Related to Defense Offsets, 1994-2004:

Joint Strike Fighter Acquisition: Observations on the Supplier Base 
(GAO-04-554, May 3, 2004):

GAO reported that subcontract awards for the Joint Strike Fighter (JSF) 
had been made to 16 foreign countries. These included the eight partner 
countries and France, Germany, India, Israel, Poland, Russia, Spain, 
and Switzerland. However, the majority of subcontracts were with U.S. 
firms. The second major recipient of subcontract dollars on the JSF 
program was the United Kingdom. GAO also reported that the Buy American 
Act and the Preference for Domestic Specialty Metals clause 
implementing the Berry Amendment apply to the purchase of manufactured 
end products and that only one of the JSF prime contractors was under 
contract in the current phase of the program to deliver manufactured 
end products. GAO found that the information maintained by the JSF 
program office, while greater than required, was not sufficient to 
provide a complete picture of the supplier base.

Joint Strike Fighter Acquisition: Cooperative Program Needs Greater 
Oversight to Ensure Goals are Met (GAO-03-775, July 21, 2003)[Footnote 
14]

GAO found that the JSF program faces management challenges that are 
made more difficult because of international participation. The 
Department of Defense (DOD) expects to benefit from partners' financial 
contributions and access to foreign industrial capabilities, while 
partner countries expect to benefit from access to advanced U.S. 
technology and industrial return through contracts for their defense 
companies. Because the prime contractor bears the responsibility for 
managing partners' industrial expectations, it will be forced to 
balance its ability to meet program milestones against meeting those 
expectations, which could be the key to securing future sales of the 
JSF for the company. While steps have been taken to position the 
program for success, additional attention on the part of DOD and the 
program office could help minimize the risks associated with 
implementing the international program. DOD and the program office need 
to maintain a significant knowledge base to enable adequate oversight 
that can ensure that the program is carried out to the satisfaction of 
both the United States and the international partners.

Defense Trade: Contractors Engage in Varied International Alliances 
(GAO/NSIAD-00-213, Sept. 7, 2000):

GAO surveyed four large U.S. contractors, reviewed four weapon system 
programs, and studied three foreign-owned U.S. companies to determine 
(1) what types of alliances U.S. and European defense companies are 
establishing and the reasons for forming alliances; (2) why companies 
prefer certain types of alliances over others, and (3) whether U.S. 
laws, regulations, policies, and practices influence a company's 
decision to form an alliance or the type of alliance chosen. GAO found 
that U.S. and European companies created teams, joint ventures, and 
subsidiaries and sometimes merged with or acquired another company to 
access and increase their competitiveness in another country's market. 
Large U.S. companies preferred to engage in flexible alliances, such as 
teaming, whenever possible to increase company capabilities without 
forming permanent relationships, and access unique technology needed to 
meet military requirements. Companies that wanted to satisfy European 
governments' desire for greater industrial participation formed joint 
ventures in which companies shared risk, decision making, work, and 
technology. Subsidiaries were not a favored approach for U.S. companies 
because in the fragmented European market a subsidiary in one country 
had no impact on market access in another country. However, European 
acquisitions of small and medium-sized U.S. defense companies were 
common because they provided access to the U.S. market, which is the 
world's largest. The companies reviewed did not consider the U.S. legal 
and regulatory environment to be a major impediment to forming an 
alliance or to be a principal determinant of the type of alliance 
chosen.

Defense Trade: Department of Defense Savings From Export Sales are 
Difficult to Capture (GAO/NSIAD-99-191, Sept. 17, 1999):

GAO reviewed the sales of five major weapon systems-The Hellfire 
Missile, Advanced Medium Range Air-to-Air Missile (AMRAAM), High 
Mobility Multipurpose Wheeled Vehicle (HMMWV), Black Hawk Helicopter, 
and Aegis Weapon System-to determine whether DOD is maximizing the cost 
benefits of export sales. DOD saved at least $342 million on its 
purchases of the five systems because either the department or its 
contractors also exported the systems to foreign governments. However, 
the full impact of contractor direct sales on the price of weapon 
systems could not be assessed because sufficient information was not 
available. Nonetheless, DOD could have realized greater savings had it 
(1) combined purchases for foreign governments with purchases for the 
U.S. military; (2) negotiated prices for export sales without giving up 
U.S. system price reductions; (3) required the contractor to perform 
work in the most economical manner, even if offset agreements were 
affected; or (4) ensured that the export prices always included a 
proportionate share of the sustaining engineering and program 
management costs.

Defense Trade: Weaknesses Exist in DOD Foreign Subcontract Data (GAO/
NSIAD-99-8, Nov. 13, 1998):

GAO reviewed (1) DOD's reported trends on contracts performed outside 
the United States, (2) DOD's use of foreign subcontract information, 
and (3) the completeness and accuracy of how DOD collects and manages 
its data. From fiscal year 1987 through fiscal year 1997, DOD's prime 
contract awards outside the United States remained about 5.5 percent of 
total DOD contract awards. These contracts tended to be concentrated in 
countries such as Germany, Italy, Japan, South Korea, and the United 
Kingdom and in sectors such as services, fuel, and construction. DOD's 
Office of Foreign Contracting and industrial base offices each collect 
and use foreign subcontract data but do not exchange data with one 
another. Additionally, the Office of Foreign Contracting, which is 
responsible for collecting foreign subcontract information from prime 
contractors and first-tier subcontractors, had no process or procedures 
to systematically ensure that contractors were complying with the 
foreign subcontract reporting requirement. Furthermore, the office 
lacked standards and procedures for managing its database, which had 
caused numerous data entry errors that compromised the database's 
usefulness.

U.S.-Japan Fighter Aircraft: Agreement on F-2 Production (GAO/NSIAD-97-
76, Feb. 11, 1997):

This report examined issues relating to the F-2 fighter aircraft 
program-known as the FS-X program during the development phase-such as 
(1) the proportion of production work that will be done in the United 
States, (2) the status of technology transfers from Japan to the United 
States and whether these technologies are of interest to U.S. 
government and industry, and (3) the program's potential contributions 
to Japan's future aerospace industry. Under the F-2 production 
agreements, signed on July 30, 1996, U.S. industry was expected to 
receive about 40-percent workshare, based on estimated production costs 
and a constant exchange rate of 110 yen/dollar. The U.S. workshare was 
to be monitored through verifying that Japan has awarded contracts to 
U.S. companies, although the value of the contracts would not be 
tracked. Transfers of technology from Japan to the United States were 
generally in accordance with the development agreements, although U.S. 
access to some technologies has been limited because of disagreements 
over whether these technologies are derived from U.S. technical data-to 
which the United States is entitled to free and automatic access-or 
Japanese indigenous technologies-for which U.S. companies would have to 
pay a licensing fee to use. The United States conducted several 
technology visits to explore the potential benefits of F-2 technologies 
but found that some technologies were too costly to produce or not 
advanced enough to be of interest. However, officials at one company 
indicated that tooling techniques from the F-2 program were being 
applied to the Joint Advanced Strike Technology program. DOD officials 
believed that the F-2 program would significantly enhance Japan's 
systems integration capability but would not provide significant new 
capability in engine production.

Export Controls: Sensitive Machine Tool Exports to China (GAO/NSIAD-97-
4, Nov. 19, 1996):

In September 1994, the Department of Commerce approved an export of 
machine tools to China. The machine tools were to be used to produce 
parts for commercial aircraft that would be built in China under a 
contract with McDonnell Douglas but were subsequently diverted to a 
Chinese facility in Nanchang engaged in military production. GAO 
reviewed (1) the military and civil applications of the equipment and 
whether these military applications were important to China's military 
modernization plans and (2) the process for approving the export 
licenses and how the process addressed the risks associated with the 
export, and determined whether export control license conditions were 
violated and what the U.S. government's response was. GAO found that, 
although the equipment was not state-of-the-art, it had military and 
civil applications, and China needed machine tools to upgrade both its 
military and civil aircraft production capabilities. The Commerce 
Department had approved the export, subject to conditions to mitigate 
the risk of diversion. The movement of the machine tools to Nanchang 
violated key conditions in the Commerce export licenses. However, 
before it could be misused, the diverted equipment was relocated to a 
facility associated with the McDonnell Douglas aircraft project. 
Commerce's enforcement office did not formally investigate the export 
control violations until 6 months after the violations were first 
reported, and the Justice Department was overseeing a criminal 
investigation at the time of the report.

Asian Aeronautics: Technology Acquisition Drives Industry Development 
(GAO/NSIAD-94-140, May 4, 1994):

GAO reviewed (1) the approaches that selected Asian nations used to 
develop their aeronautics industries, (2) the level of aeronautics 
development that each country had achieved, and (3) the implications of 
this development for the U.S. aeronautics industry. China, Japan, 
Indonesia, and Taiwan appeared intent on developing their own 
aeronautics industries by acquiring technologies developed in the West 
and improving them over time. These countries were developing their 
aeronautics industries using (1) strong government support; (2) the 
importation of technologies; (3) a strong emphasis on applied research 
rather than basic research; and (4) direct, synergistic links between 
military and civil aeronautics projects. The Asian countries reviewed 
often required technology to be transferred as a condition of 
purchasing Western equipment. These transfers can occur through such 
activities as subcontracting, licensed production, and codevelopment. 
The four countries differed in the level of aeronautics development, 
with Japan being the most advanced and China the slowest to develop, 
and each could be expected to continue to develop at varying rates 
because of differences in their political and economic environments. It 
appeared unlikely that Asian aeronautics companies would compete 
directly with U.S. aircraft builders in the immediate future, but some 
industry observers believed that in the long term, cooperative 
aeronautics technology transfers to Asia could help to create a new 
competitor for the U.S. aeronautics industry.

(120367):

FOOTNOTES

[1] A multiplier is used to increase the value of an offset project 
when determining offset credit. For example, if a company helped 
facilitate a $10,000 export of a product with particular importance, 
the country could offer a multiplier of 5, thereby increasing the 
amount of offset credit to $50,000.

[2] Joint Strike Fighter Acquisition: Cooperative Program Needs Greater 
Oversight to Ensure Goals Are Met (GAO-03-775, July 21, 2003) and Joint 
Strike Fighter Acquisition: Managing Competing Pressures Is Critical to 
Achieving Program Goals (GAO-03-1012T, July 21, 2003).

[3] 50 U.S.C. App.  2099.

[4] 22 U.S.C.  2776.

[5] Pub L. 103-236.

[6] Pub. L. 100-456  825.

[7] Congress incorporated this policy statement into statute with the 
Defense Production Act Amendments of 1992, Pub. L. 102-558  123.

[8] Pub. L. 102-558  123.

[9] Pub. L. 106-113, App. G.

[10] The Defense Offsets Disclosure Act of 1999 (Pub. L. 106-113, App. 
G  1246) expanded the prohibition to include items licensed under the 
Arms Export Control Act, i.e., commercial sales.

[11] GAO also testified on this issue before the Subcommittee on 
Commerce, Consumer Protection, and Competitiveness, House Committee on 
Energy and Commerce. See Military Sales: Concerns Over Offsets 
Generated Using U.S. Foreign Military Financing Program Funds (GAO/T-
NSIAD-94-215, June 22, 1994).

[12] The Defense Federal Acquisition Regulation Supplement partially 
addressed this in 1994 when it precluded U.S. companies from recovering 
offset-related costs if the sale was financed with nonrepayable foreign 
military financing grants.

[13] Senate bill 1379 was not passed, although similar language on 
offsets was included in the Defense Production Act Amendments of 1992 
(Pub. L. 102-558).

[14] GAO also testified on this issue before the Subcommittee on 
National Security, Emerging Threats, and International Relations, House 
Committee on Government Reform. See Joint Strike Fighter Acquisition: 
Managing Competing Pressures Is Critical to Achieving Program Goals 
(GAO-03-1012T, July 21, 2003).