Offsets in Defense Trade

Prepared by U.S. Department of Commerce.

[The following material is extracted from the seventh annual report (July 2003) on offsets in defense trade prepared pursuant to Section 309 of the Defense Production Act of 1950 (1) (DPA), as amended. This report covers offset agreements and offset transactions entered into from 1993 through 2000. Some of the footnotes and tables have been omitted from this excerpt; however, the footnote and table numbers remain the same as in the original document. The complete report is available at the following web site: http://www.bax.doc.gov/DefenseIndustrialBasePrograms/ OSIES/offsets/7thOffsetsReport.htm.]

Executive Summary

The Department of Commerce's Bureau of Industry and Security (BIS), (2) has been delegated responsibility for preparing the reports required under Section 309. This report is prepared after analyzing offset data reported to the Department of Commerce by U.S. defense firms, in compliance with regulations established under Section 309 of the DPA. To assess the impact of offsets in defense trade, the Department of Commerce obtained data from U.S. defense firms involved in defense offsets.

1993-2000 Offset Activity

Total offset activity during 1993 to 2000 can be measured by the number and value of new offset agreements entered into between U.S. defense contractors and foreign governments, and the number and value of individual offset transactions carried out in fulfillment of offset agreements during the eight-year reporting period.

Offset Agreements, 2000

U.S. defense contractors reported entering into twenty-five new offset agreements with ten different countries in 2000. The new offset agreements had a total value of $5.1 billion, and accounted for 89.7 percent of total U.S. defense export contract values ($5.7 billion). In comparison with the previous seven years, offset agreements as a percentage of total defense export contract sales were highest in 2000.

In 2000, European nations received offsets equal to 116 percent of the total export values, the highest offset percentage on record for any single year of the eight-year reporting period. For non-European nations, the offset percentage was 50 percent in 2000.

Offset Agreements, 1993-2000

U.S. companies reported entering into 345 offset agreements with thirty-two countries during the time period from 1993 to 2000. U.S. companies reported export sales of 177 different defense systems or subsystems with a total value of $48.6 billion. Offset agreements related to those export contracts were valued at $29.8 billion, or 61 percent of the export contract value. Sales of aerospace defense systems (i.e., aircraft, engines, and missiles) were valued at $42.8 billion and accounted for nearly 90 percent of the total export contracts.

On a regional basis, Europe accounted for only 47 percent of total U.S. defense export contracts, while new offset agreements with Europe accounted for more than 70 percent of total offset agreements (by value). Asia and the Middle East each accounted for 14 percent of new offset agreements, and the Americas accounted for two percent. Non-European countries accounted for approximately one-third of new offset agreements (by value) but 53 percent of the total value of defense export contracts. While the non-European nations had higher defense export contract totals, Europe had a much greater offset impact on U.S. industry because of the higher offset percentages required by European purchasers.

Offset Transactions, 2000

U.S. companies reported offset transactions with a total actual value of $1.7 billion - down eight percent from the 1999 total of $1.8 billion, and the lowest total actual transaction value reported in any of the eight years. A decrease in offset transactions in 2000 was anticipated because of a drop in defense sales and offset agreements in previous years. However, increasing levels of defense sales (and higher related offset percentages) in 2000 likely will lead to more new offset agreements and, thus, an increase in offset transactions in the future.

Offset Transactions, 1993-2000

During the reporting period, U.S. companies reported 4,425 offset transactions executed in thirty-five countries. These offset transactions were related to 227 defense systems under existing offset agreements. The actual value of the offset transactions from 1993 to 2000 was just under $18 billion.

Conclusions

The defense environment changed in the 1990s, reflecting both the general retrenchment of military expenditures and tougher offset policies and enforcement worldwide. In recent years, offsets have become more important in winning procurements and, ultimately, in access to foreign markets by U.S. companies. Offset agreements with values exceeding 100 percent of the total export contract value are occurring regularly; in fact, 100 percent seems to be the baseline.

From the U.S. perspective, Europe is clearly the central focus of offset activity, dominating both new offset agreements and the number of offset transactions with U.S. companies. Because 90 percent of offset agreements are aerospace-related, concerns about the competitiveness of U.S. aerospace prime contractors and the aerospace infrastructure have increased.

Using data submitted by industry and data from the Bureau of the Census, BIS estimates offsets maintained 41,666 work-years annually in the U.S. defense industry between 1993 and 2000. However, the data reported by U.S. companies also show that offsets displaced 9,688 work-years annually in the lower-tier companies that are suppliers or subcontractors to large U.S. defense companies.

The U.S. aerospace trade surplus fell from its all-time high of $40 billion in 1998 to approximately $27 billion in 2000. Imports of aerospace products have increased rapidly in the last decade for a number of reasons, including offsets. Offset agreements calling for aerospace subcontracting arrangements lead to increased imports, to the extent that they result in U.S. prime contractors importing subcontracted parts and systems rather than relying on domestic sources. Aerospace-related imports have increased regardless of the state of the market and despite the fact that the United States spends more on aerospace research and development than any other nation.

In the coming year, using authorities granted under the DPA, the Department of Commerce is committed to work with U.S. industry, the Department of Defense and other agencies, and foreign governments to analyze the impact of offsets on all parties. The Department of Commerce does not encourage or regulate the use of offsets in defense trade, and recognizes that offsets are market distorting. However, we also recognize that offsets are a part of the current international defense trade environment. We will seek ways to mitigate the negative effect of offsets on competition. Our goal is to support the U.S. defense industry and to ensure a robust and vibrant industrial base at all levels.

Background

Legislation and Regulations

In 1984, the Congress enacted amendments to the DPA, which included the addition of Section 309 addressing offsets in defense trade. (3) Section 309 of the Defense Production Act (DPA) required the President to submit an annual report on the impact of offsets on the U.S. defense industrial base to the Congress's then-Committee on Banking, Finance, and Urban Affairs of the House of Representatives (4) and the Committee on Banking, Housing, and Urban Affairs of the Senate.

Initially, the Office of Management and Budget coordinated the interagency process of preparing the report for the Congress. Other agencies involved in the process included the Departments of Commerce, Defense, Labor, State, and Treasury, and the Office of the

U.S. Trade Representative

In 1992, Section 309 of the DPAwas amended, and the Secretary of Commerce was given the responsibility of preparing the report for the Congress, on the President's behalf, and was directed to function as the President's Executive Agent for carrying out responsibilities under Section 309 of the DPA. (5)

Under section 309, the Secretary of Commerce is authorized to develop and administer the regulations necessary to collect offsets data from U.S. defense exporters. The Secretary of Commerce delegated this authority to the Bureau of Industry and Security, which published its first offsets regulations in the Federal Register in 1994. (6)

The 1992 amendments to Section 309 of the DPA made other changes to the offset data collection process. The amendments lowered the offset agreement reporting threshold from $50 million to $5 million for U.S. firms entering into foreign defense sales contracts subject to offset agreements. Under the regulations, firms report all offset transactions for which they receive offset credits of $250,000 or more. Every year, U.S. companies report offset agreement and transaction data for the previous calendar year to BIS. The data elements collected each year from industry are listed in Section 701.4 of the Department's offset regulations.

The Official U.S. Government Policy

The official U.S. government policy on offsets in defense trade was developed by an interagency offset team. The policy was announced by the President in April 1990, in a statement issued by the White House Press Secretary.7 In 1992, it was set forth as a Policy of Congress as follows:

* In General

Recognizing that certain offsets for military exports are economically inefficient and market distorting, and mindful of the need to minimize the adverse effects of offsets in military exports while ensuring that the ability of United States firms to compete for military export sales is not undermined, it is the policy of the Congress that:

** No agency of the United States government shall encourage, enter directly into, or commit United States firms to any offset arrangement in connection with the sale of defense goods or services to foreign governments;

** United States government funds shall not be used to finance offsets in security assistance transactions, except in accordance with policies and procedures that were in existence on March 1, 1992;

** Nothing in this section shall prevent agencies of the United States government from fulfilling obligations incurred through international agreements entered into before March 1, 1992; and

** The decision whether to engage in offsets, and the responsibility for negotiating and implementing offset arrangements, reside with the companies involved. …

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