Defense Trade
Issues Concerning the Use of Offsets in International Defense Sales Gao ID: GAO-04-954T July 8, 2004Views 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.
GAO-04-954T, Defense Trade: Issues Concerning the Use of Offsets in International Defense Sales
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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).
