oversight

Defense Trade: Report and Recommendations of the Defense Offsets Commission Still Pending

Published by the Government Accountability Office on 2003-05-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

             United States General Accounting Office

GAO          Report to Congressional Committees




May 2003
             DEFENSE TRADE

             Report and
             Recommendations of
             the Defense Offsets
             Commission Still
             Pending




GAO-03-649
                                                May 2003


                                                DEFENSE TRADE

                                                Report and Recommendations of the
Highlights of GAO-03-649, a report to           Defense Offsets Commission Still
Congressional Committees
                                                Pending



Export sales of defense-related                 In February 2001, the National Commission on the Use of Offsets in Defense
products often include “offsets”—               Trade issued an interim report, Status Report of the Presidential
industrial and commercial benefits,             Commission on Offsets in International Trade. However, the Commission’s
such as technology transfer, which              final report and recommendations are still pending—a year and a half after
U.S. companies provide to foreign               its mandated reporting date. The last Commission meeting was held on
governments as incentives or
conditions for purchasing military
                                                December 4, 2000, and no further activity is apparent. The 2001 change in
goods and services.                             presidential administrations resulted in vacancies in the five executive
                                                branch positions on the Commission, which have yet to be filled.
Over the past decade, offsets have
increased and in 1998, they totaled             The interim report describes the extent and nature of defense-related offsets
about $3 billion per year. In                   in both defense and commercial trade. For example:
December 2000, GAO reported that
countries are becoming                          •   The cost to U.S. exporters of implementing defense offset transactions is
increasingly sophisticated in their                 a fraction of the transactions’ value.
use of offsets to achieve regional
                                                •   The extent of defense offsets relative to defense exports has remained
industrial and employment goals.
                                                    stable over time; however, offset demands may have grown qualitatively.
In 1999, Congress established a                 •   Most defense offset transactions are with developed nations and are
National Commission to report on                    associated with the export of aerospace products.
the extent and nature of offsets in             •   Because U.S. policy considers offsets “market distorting,” it places no
international defense trade by                      international restrictions on defense offsets and leaves responsibility for
October 2001. The Director of the                   their negotiation and implementation with U.S. exporters.
Office of Management and Budget
(OMB) was designated chair of the               The report also describes the effect that defense offsets transactions and
Commission. Congress also                       agreements may have on the U.S. defense supplier base. For example, the
required the President to report,
within 90 days after the                        Commission reported that while offsets may facilitate defense export sales—
Commission’s final report, on the               which can help maintain the economic viability of certain U.S. firms—offsets
feasibility and desirability of                 can also supplant a significant amount of work and jobs that would go to
seeking a multilateral treaty with              U.S. firms if export sales occurred without offsets. The Commission also
international trading partners on               reported that U.S. technology transfers through offsets often improved
standards for use of defense                    foreign firms’ competitiveness but rarely resulted in technology transfer
offsets.                                        back to the United States. And while it found that technology transferred
                                                through offsets did not appear to create a security risk beyond that posed by
GAO’s report responds to the                    other transfers by U.S. firms, it cautioned that offsets could exacerbate any
congressional mandate for GAO to                existing weaknesses in U.S. export control processes.
monitor and periodically report on
the President’s progress in reaching
a multilateral treaty.                          While the National Commission’s report remains pending and the President
                                                has not decided on a defense offsets multilateral treaty, Congress required
                                                GAO to monitor and periodically report to it on the progress in reaching a
                                                multilateral treaty. The Commission on the Future of the United States
                                                Aerospace Industry called for the pursuit of a multilateral solution to curtail
                                                offset demands in defense trade. It suggested that reactivating the National
www.gao.gov/cgi-bin/getrpt?GAO-03-649.
                                                Commission may be the best alternative for developing recommendations on
                                                negotiating a multilateral agreement.
To view the full product, including the scope
and methodology, click on the link above.
For more information, contact Katherine V.
                                                In commenting on a draft of this report, OMB officials provided technical
Schinasi at (202) 512-4841 or                   comments, which were incorporated as appropriate.
schinasik@gao.gov.
Contents


Letter                                                                                               1
           Results in Brief                                                                          2
           Background                                                                                3
           Commission’s Findings on Extent and Nature of Defense-Related
             Offsets                                                                                 4
           Status of the Commission’s Work                                                           5
           Conclusions                                                                               6
           Agency Comments                                                                           6
           Scope and Methodology                                                                     6


Table
           Table 1: Commission’s Potential Policy Recommendations, with
                    Advantages and Disadvantages                                                     5




           Abbreviation

           OMB               Office of Management and Budget




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           Page i                                                         GAO-03-649 Defense Trade
United States General Accounting Office
Washington, DC 20548




                                   May 30, 2003

                                   The Honorable Richard G. Lugar
                                   Chairman
                                   The Honorable Joseph R. Biden, Jr.
                                   Ranking Minority Member
                                   Committee on Foreign Relations
                                   United States Senate

                                   The Honorable Henry J. Hyde
                                   Chairman
                                   The Honorable Tom Lantos
                                   Ranking Minority Member
                                   Committee on International Relations
                                   House of Representatives

                                   Export sales of defense-related products often include “offsets”—
                                   industrial and commercial benefits, such as technology transfer, which
                                   U.S. companies provide to foreign governments as incentives or conditions
                                   for purchasing military goods and services. They include, for example,
                                   coproduction arrangements and subcontracting, technology transfers, in-
                                   country procurements, marketing and financial assistance, and joint
                                   ventures. In December 2000, we reported that countries are becoming
                                   increasingly sophisticated in their use of offsets to achieve regional
                                   industrial and employment goals.1 Since 1993, when the Department of
                                   Commerce began collecting data on these transactions, defense offsets
                                   have increased. In 1998, defense offsets totaled approximately $3 billion.
                                   The increasing use of offsets in defense trade has generated congressional
                                   concern because offsets can distort the price of defense contracts and
                                   undermine competitiveness.

                                   In an effort to identify current offset practices, the impacts of offsets on
                                   the U.S. economy, and their role in increasing dependence on foreign
                                   sources for defense goods, in 1999, Congress established a Commission2 to
                                   report to it on the extent and nature of offsets in international defense


                                   1
                                    U.S. General Accounting Office, Defense Trade: Observations on Issues Concerning
                                   Offsets, GAO-01-278T (Washington, D.C.: Dec. 15, 2000).
                                   2
                                    Defense Offsets Disclosure Act of 1999, Public Law 106-133, section 1247.



                                   Page 1                                                         GAO-03-649 Defense Trade
                   trade. Congress also required the President to review and report, within
                   90 days after the Commission’s final report to Congress, the feasibility and
                   desirability of seeking a multilateral treaty on standards for use of offsets
                   in defense trade. Congress further required us to monitor and periodically
                   report to it on the progress in reaching a multilateral treaty.


                   A final report and recommendations from the National Commission on the
Results in Brief   Use of Offsets in Defense Trade are still pending, although under the
                   Defense Offsets Disclosure Act of 1999 the report was required to be
                   issued by October 2001. However, the 2001 change in presidential
                   administrations resulted in vacancies in the five executive branch
                   positions on the Commission, which have yet to be filled. The
                   Commission’s interim report—Status Report of the Presidential
                   Commission on Offsets in International Trade, issued February 2001—
                   describes the extent and impact of offsets in both defense and commercial
                   trade.3 The report also describes the effect of defense offset transactions
                   and agreements entered into by U.S. firms over a 6-year period. For
                   example, the Commission reported that while industry estimates and other
                   evidence indicate that offsets facilitate exports, they also supplant a
                   significant amount of work and jobs that would go to U.S. firms if export
                   sales occurred without offsets. The Commission also reported that in a
                   number of cases, U.S. technology transfers improved foreign firms’
                   competitiveness but rarely resulted in technology transfer back to the
                   United States.

                   The interim report includes potential policy recommendations that,
                   according to the Commission, require additional deliberation of the
                   possible advantages and disadvantages of each. However, the Commission
                   has not met since December 4, 2000. Since the President’s report on the
                   feasibility and desirability of a multilateral offsets treaty is not required
                   until 90 days after the Commission’s final report is submitted to Congress,
                   the President has not reported. Subsequent to the Commission’s last
                   meeting, another commission, set up to evaluate the health of the
                   aerospace industry, recommended that the United States pursue a
                   multilateral solution to curtail offset demands. That commission also
                   suggested that reactivating the National Commission on the Use of Offsets



                   3
                    To address the use of offsets in commercial trade, the President established the
                   Presidential Council on the Use of Offsets in Commercial Trade. Membership of the
                   Council was identical to the Commission.




                   Page 2                                                       GAO-03-649 Defense Trade
                 in Defense Trade may be the best alternative for developing policy
                 recommendations on this issue.

                 In commenting on a draft of this report, the Office of Management and
                 Budget officials provided technical comments, which were incorporated
                 as appropriate.


                 Foreign governments often seek defense offsets to reduce the financial
Background       impact of their purchases, obtain valuable technology and manufacturing
                 know-how, enhance domestic employment, create or expand their defense
                 industries, and make the use of their national funds for foreign purchases
                 more politically palatable. However, Congress has expressed concern
                 about the use of offsets in defense trade because they can undermine
                 fairness and competitiveness and distort the price of contracts. Offsets are
                 frequently negotiated in connection with the purchase of U.S. aerospace
                 systems, such as military or commercial aircraft, and sometimes in
                 connection with the purchase of U.S. goods and services in other high-tech
                 industries, such as power generation or telecommunications.

                 The Defense Offsets Disclosure Act of 19994 established, as the sense of
                 Congress, the need to

             •   pursue efforts to address trade fairness by establishing reasonable,
                 business-friendly standards for the use of offsets in international trade
                 between the Unites States and its trading partners and competitors;
             •   require the Secretary of Defense, the Secretary of State, the Secretary of
                 Commerce, and the United States Trade Representative, or their
                 designees, to discuss with industrialized nations the need for reasonable
                 standards to govern the role of offsets in international trade;
             •   enter into discussions regarding the establishment of multilateral
                 standards for the use of offsets in international defense trade through the
                 appropriate multilateral forum; and
             •   include in those discussions the distortions produced by other benefits
                 and subsidies provided by various countries, such as export financing.

                 The act also established a National Commission on the Use of Offsets in
                 Defense Trade, requiring the President, with the concurrence of
                 congressional leaders, to appoint 11 members to the Commission. The act



                 4
                     Defense Offsets Disclosure Act of 1999, Public Law 106-133, section 1244.




                 Page 3                                                           GAO-03-649 Defense Trade
                         required the Commission to submit a report to Congress addressing all
                         aspects of the use of offsets in international defense trade within a year of
                         its establishment. It also specified that the Commission include 5 members
                         from the executive branch, 3 from industry, 1 from labor, and 2 members
                         from academia. In October 2000, the President appointed the 11 members.
                         The act designated the Office of Management and Budget (OMB) member
                         as the chair of the Commission. 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.


                         The Commission released its interim report in February 2001. The report
Commission’s             described the following extent and nature of defense-related offsets.
Findings on Extent
                     •   The cost to U.S. exporters of implementing defense offset transactions is a
and Nature of            fraction of the transaction value.
Defense-Related      •   The extent of defense offset agreements relative to defense exports has
                         remained stable over time; however, offset demands may have grown
Offsets                  qualitatively.
                     •   Most defense offset transactions are with developed nations.
                     •   Most defense offsets are associated with the export of aerospace products.
                     •   The most common types of defense offset transactions are
                         counterpurchases, subcontracts, and technology transfers.
                     •   There are no international restrictions on defense offsets. U.S. policy
                         considers offsets “market distorting” and leaves responsibility for their
                         negotiation and implementation with U.S. exporters.

                         The Commission also found the following on the impacts of defense
                         offsets:

                     •   Offsets have a direct effect on U.S. jobs by facilitating exports, but they
                         also supplant a significant amount of work and jobs that would go to U.S.
                         firms if export sales occurred without offsets.
                     •   In some cases, offsets hurt the U.S. defense supplier base by transferring
                         work to foreign firms, but the erosion has yet to show up in overall trade
                         statistics.
                     •   At the same time, defense export sales may be important to the economic
                         viability of aerospace firms and may provide an incentive for their
                         development of new defense products and technologies.
                     •   In a number of cases, U.S. technology transfers improved foreign firms’
                         competitiveness but rarely resulted in technology transfer back to the
                         United States.



                         Page 4                                               GAO-03-649 Defense Trade
                                                             •       Technology transferred to foreign firms through offsets does not appear to
                                                                     pose a special security risk above and beyond that posed by other
                                                                     technology transfers by U.S. firms.
                                                             •       However, recent examples show that U.S. export control processes are not
                                                                     flawless in preventing the transfer of sensitive technology abroad and that
                                                                     offsets could exacerbate any leakages.


                                                                     The Commission’s interim report outlines areas for future Commission
Status of the                                                        study and several potential recommendations. However, the Commission
Commission’s Work                                                    has yet to determine whether these potential policy recommendations are
                                                                     feasible or desirable.

Table 1: Commission’s Potential Policy Recommendations, with Advantages and Disadvantages

 Potential Commission
 recommendation                                                  Possible advantages                               Possible disadvantages
 The U.S. government could seek a                                • Could diminish adverse effects on U.S.          • Would likely reduce U.S. export sales.
 multilateral agreement with its trading                           jobs, economic competitiveness, and             • May be difficult to monitor and enforce.
 partners to reduce or prohibit the use of                         national security.                              • The United States may be asked to
 offsets in defense trade.                                       • Could attract support from labor and              provide concessions, such as greater
                                                                   industry groups.                                  access to the U.S. defense procurement
                                                                                                                     market.
 The U.S. government could work                                  •    Could help reduce adverse effects of         • Some foreign governments may not be
 cooperatively with other countries to shift                          offsets on U.S. economy and national           willing to shift their offset demands.
 the type of offsets they request away                                security.                                    • A shift in the types of offsets currently
 from defense subcontracting or                                  •    Could provide foreign governments with         sought by foreign nations could alter the
 production.                                                          needed political support to import major       competitive playing field.
                                                                      U.S. defense systems.                        • Does not focus on reducing or eliminating
                                                                 •    Could be tried bilaterally as well as          defense offsets.
                                                                      multilaterally, and on a pilot basis.        • Could undermine the competitiveness of
                                                                 •    Could yield technological and economic         non-defense industries.
                                                                      benefits to U.S. exporters and other U.S.
                                                                      firms.
 The U.S government could increase                               •    Could help reduce offset demands.            •   No assurance that participating nations
 foreign firms’ involvement in the                               •    Could facilitate reciprocal technology           would reduce offset demands.
 research and development stages of                                   transfer.                                    •   Participating nations may demand work
 new defense systems to reduce their                             •    Foreign firms’ participation in subsequent       guarantees, which are similar in effect to
 governments’ subsequent demand for                                   production of the defense system—a               offsets.
 offsets.                                                             natural extension of their initial
                                                                      involvement—would result in few
                                                                      adjustment costs relative to offsets.
Source: Status Report of the Presidential Commission on Offsets in International Trade.



                                                                     According to the interim report, the Commission was to continue its
                                                                     deliberations and prepare a final report and recommendations by October
                                                                     2001. The final report is still pending. Further, according to OMB officials,
                                                                     the President has not determined the feasibility and desirability of seeking
                                                                     a multilateral treaty on standards for use of offsets in defense trade.


                                                                     Page 5                                                           GAO-03-649 Defense Trade
                  However, the issue of defense offsets has continued to raise concerns. The
                  Commission on the Future of the United States Aerospace Industry
                  recommended that the United States pursue a multilateral solution to
                  curtail offset demands and suggested that reactivating the Commission
                  may be the best alternative for developing policy recommendations on this
                  issue.


                  As a major factor in the competitiveness of a company’s offer to sell goods
Conclusions       and services, offsets are an accepted feature of defense trade. However,
                  their use has been shown to distort markets. Recognition that unilateral
                  U.S. government constraints could limit U.S. company competitiveness has
                  led Congress to establish a commission to address the use of offsets in
                  defense trade. It also led Congress to require the President to determine
                  the feasibility of a multilateral treaty on standards for the use of offsets.
                  While the Commission has taken concrete steps toward fulfilling its
                  mandate, it has not completed its work in that it has not issued a final
                  report. In addition, the President has not reported on the feasibility and
                  desirability of a multilateral treaty. However, the President’s report is not
                  due until 90 days after the Commission’s final report to Congress under the
                  Defense Offsets Disclosure Act of 1999.


                  In commenting on a draft of this report, OMB officials provided technical
Agency Comments   comments, which were incorporated as appropriate.


                  To determine the progress in reaching a multilateral treaty, we reviewed
Scope and         legislation pertaining to offsets to determine the roles and responsibilities
Methodology       of the presidential Commission. In addition, we reviewed the
                  Commission’s interim report to identify its potential recommendations to
                  the President. We also interviewed several officials from the Department
                  of Commerce, the Office of Management and Budget, and the Office of the
                  United States Trade Representative who had knowledge of the
                  Commission’s deliberations.

                  We conducted our work from January through May 2003 in accordance
                  with generally accepted government standards.


                  We are sending copies of this report to the Secretaries of Commerce,
                  Defense, and State, and the Director, Office of Management and Budget.
                  Copies will be made available to others on request. In addition, this report


                  Page 6                                               GAO-03-649 Defense Trade
           will be available at no charge on the GAO Web site at http://www.gao.gov.
           If you have questions, please contact me at (202) 512-4841. Major
           contributors to this report were Thomas J. Denomme, Gregory K. Harmon,
           John Neumann, Karen M. Sloan, Robert L. Ackley, and Marie P. Ahearn.




           Katherine V. Schinasi
           Director
           Acquisition and Sourcing Management




(120224)
           Page 7                                            GAO-03-649 Defense Trade
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