Defense Trade:

Issues Concerning the Use of Offsets in International Defense Sales

GAO-04-954T: Published: Jul 8, 2004. Publicly Released: Jul 8, 2004.

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Katherine V. Schinasi
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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, GAO conducted a number of reviews and issued multiple reports. Because of GAO's work in this area, Congress asked us to provide our observations on offset issues. Specifically, GAO is providing 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.

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. 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.

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