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Panel 1 Overview of the Offsets Issue Moderator: Charles Wessner, Program Director, National Research Council The first panel was convened by Dr. Wessner who, as the organizer of the workshop, expressed his thanks to the speakers who had come long distances, and to the many who had changed busy schedules in order to participate in the conference. He added that on this panel he looked forward to hearing from senior representatives of the industry as well as from respected analysts of the aerospace industry about the challenges of global competition. The U.S. Aircraft Industry in a Global Market Robert Trice Vice President, International Business Development, Lockheed Martin Corp. Mr. Trice opened his remarks by emphasizing the importance of Gene Sperling's comment about understanding the hand we have been dealt. The current situation facing the aerospace industry was determined by two factors about ten years ago: record government budget deficits and the collapse of the Berlin Wall. The result of these two factors has been a dramatic reduction in defense spending.2 Out of a $7.3 trillion economy, the United States now spends $46 billion on defense procurement—about $10 billion less than is spent on tobacco. Indeed, defense has become a niche market, with more spent on snack foods in the United States than is spent on the entire NASA budget. Since 1989, total spending for defense has declined about 30 percent. But spending in the procurement account has dropped 72 percent. For the aerospace industry, that represents a slowdown greater in magnitude than the Great Depression's decline of 30 percent of GNP. Lower spending means that the number of weapons systems bought by the U.S. government has also declined dramatically—threatening the sustain-ability of the industry. For example, in 1997 the U.S. government will purchase only 73 aircraft. In these conditions, it is not possible to maintain the same defense base. However, in some areas, such as combat aircraft, foreign sales have increased to make up a part of the difference, thereby enabling the industry to maintain some sustainability and some employment, though 700,000 jobs were nonetheless lost in the 1992-97 period. In these conditions, foreign sales play a crucial role in maintaining the U.S. defense industrial base. In order to compete internationally in this new environment, the U.S. industry has consolidated into three large, globally competitive companies (Boeing-McDonnell, Lockheed-Martin, and Raytheon-Hughes) and a number of "smaller" companies (e.g., Northrop Grumman) which are, of course, at $10 billion in revenues, still sizable companies in their own right. The only real competitors in the global market are the European companies which are smaller, generally less productive state-owned firms, with the exception of British Aerospace and DASA. State ownership is key. Mr. Trice stressed the importance of understanding that U.S. companies are, in effect, competing against the foreign governments which directly or indirectly own these companies. For these European companies, controlling the European domestic market is extremely important. At present, U.S. companies can rely on a highly protected core domestic market of approximately $80 billion—defense procurement and R&D combined. No other country can match that, nor do other countries spend more than 50 percent of their defense budget on procurement. On top of that, they must use those funds to feed their own weak, noncompetitive, state-con-trolled domestic companies. As a result of these realities, the overseas market for U.S. companies is much smaller and more fragmented than many may think. Arms control critics argue that the U.S. industry dominates the world market. This is true. However, while 2 The overheads that accompanied his presentation concerning U.S. defense procurement, the structure of the industry and the importance of international markets are reproduced in Appendix 2.
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the U.S. industry does have 55 percent of the global arms transfer market, the world market is down 50 percent and the U.S. market is down about 25 percent. The industry is doing well in terms of market share but overall the industry is still in a tough position. It is an industry that has seen a 70 percent decline in its market. It is now emerging from a massive restructuring in a stronger financial position, with a backlog of orders, and sharpened productivity. However, it is an industry that has lost its sense of humor. Competition is fierce. Staying internationally competitive is where offsets come in. Offsets, such as financing, are an important tool in maintaining overseas business: 100 percent of nothing is not nearly as good as a high percentage of a large number. Moreover, each $1 billion in sales equals 24,000 person years of employment. The reality facing the industry is of permanently lower defense and space budgets and increased competition. The U.S. industry has gone through its consolidation. Europe has not, and the task will be harder with the recently elected governments. In military sales, Europeans are erecting trade barriers; the U.S. already has them. Thus, one of the issues the workshop should address is how to deal with these competitive conditions. Another key issue to address is how the industry protects its design and technology base. While observing that some are concerned that the industry will give away its technological crown jewels, Mr. Trice implied that he considers this unlikely, but nonetheless urged that this issue be fully discussed. In conclusion, Mr. Trice underscored that the U.S. aerospace industry must still compete internationally on the basis of affordability. The U.S. industry is already noncompetitive in some respects. For example, bribes are still tax-deductible in some parts of Europe, something U.S. firms cannot offer. And state-owned firms sometimes can propose economically nonviable projects. U.S. firms cannot. The bottom line is that U.S. companies have to be able to make a return or they will get out of the business. Origins, Definitions, and Consequences of Offsets David Mowery Professor of Business and Public Policy, University of California at Berkeley Tasked with helping to define the issues, Dr. Mowery began with a focus on the definitions of offsets before assessing the trends and the complexities of analyzing the impacts of offsets on employment, technology transfer, and the defense industrial base. Referring to the background paper made available at the meeting,3 Mowery noted that it defines offsets as mandates for technology transfer or incorporation of local production, or a variety of other performance requirements typically requested by the purchasing government. Like the issue itself, these definitions are very complex. Mowery pointed out that the distinction between direct and indirect offsets is especially important in assessing the impacts, since indirect offsets are typically not integrated into the product. In addition, the definition becomes more complex when the question is broadened to the commercial sector. In the commercial sector, government mandates become much more difficult to assess and even to discern than in the military sector. With respect to the origin of offsets, Mowery stated that much of the international collaboration on the commercial side can be traced to the U.S. policy of licensed production and coproduction in Western Europe and Japan on the military side in the 1950s and 1960s. The purpose of that policy was to promote the purchase of U.S. weapons systems and foster the reconstruction efforts of our allies. The result was, over time, an evolution to increased pressure by foreign governments focusing on specific economic and technology goals, including continued support for the reconstructed defense industrial base. Thus, he suggested there is an interaction between military and commercial sectors in the creation of a workforce and industrial base structure, rather than a direct technology transfer between the two sectors. On the civil side, the emergence of offsets can be traced more to the 1970s, rather than the 1950s and 1960s as is the case on the military side and reflects the changing competitive environment of the industry. Government mandates play a role. But other factors, such as the need to share risk and seek financial support, combined with the growing technological capabilities of foreign suppliers, were also important. In addition, there were increased incentives by the prime contractors to support entry of new suppliers in order to strengthen the supplier base and create additional competition. Reflecting the interest in this topic, Mowery pointed out that trends in the industry have been documented by a series of studies over the past ten years. These studies show a difference of opinion on the impacts of offsets, highlighting the complexity of the issue and the difficulty of analysis. The most recent study by the Commerce Department states that the use of offsets is becoming increasingly important in the Pacific Rim but is not growing generally as a percentage of military export sales. The study also shows that indirect offsets are growing, especially those involving non-aerospace products. This creates even more difficulty in analyzing the employment impact of offsets, since tracing the 3 See Appendix 1.
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impacts of these non-aerospace indirect offsets is especially difficult. With respect to the impacts of offsets on employment, Mowery stressed the difficulty of reaching definitive answers. First, he pointed out that we need to know what would have happened if the offset had not been given. Would the sale still have taken place? Second, tracing the impacts of indirect offsets is very difficult, especially given that a variety of industries are involved. Third, separating out the effect of government mandates from the broader trends in the globalization of sourcing and employment is very difficult. Government mandates are not the sole, and may not even be a prime, driver of the globalization trend. Likewise, the impacts of technology transfer are difficult to observe clearly. In part this is because defense offsets have historically involved the sales of completed weapons systems and not, historically, development arrangements where there is a more substantial technology transfer impact. Even on the civilian side, where there is greater involvement of foreign partners in the development process, it is difficult to see much substantial effect on, for example, the probability of entry by the foreign partner into the market as a prime contractor. In part, this reflects the controls placed on the technology by the prime contractors as well as the difficulty of entering the aerospace industry. Mowery also stated that it is difficult to see any obvious impacts on the industrial base from offsets. However, the anecdotal evidence and the modest amount of statistical evidence show that the impact is felt by the supplier tier, rather than the primes. In conclusion, Mowery emphasized that the impacts of offsets are dwarfed by the effect of the reduction in defense spending. Thus, in considering policy responses, it is important to recognize that the use of government-mandated offsets is only one factor affecting the industry trends and that the identifiable near-term cost to the U.S. economy appears to be small. Policy options should look at ways to reduce foreign government demands for offsets, support firm and worker adjustment, and take into account the demands by the U.S. government, such as domestic production sites or "Buying American" provisions, that are imposed on foreign suppliers of military equipment. Strategies for Success in the Commercial Aircraft Market Raymond Waldmann Vice President, International Business, The Boeing Company Describing the competition in the commercial sector, Mr. Waldmann observed that, over the last ten years, Airbus has increased its market share from 16 percent to 33 percent, while Boeing has remained at approximately 65 percent, and the market share of McDonnell Douglas has fallen from 18 percent to three percent. In addition, there was the demise of Fokker in the 100-seat aircraft market. Consequently, the large aircraft business is now a two-player game. The Russians or someone else may be competitive in the future, but they are not competitive now. To deal with the issue of offsets, the industry was able to get a trade agreement on large commercial aircraft in the 1979 Tokyo Round that banned government-mandated offsets in commercial sales. However, only 24 developed countries have signed on to that agreement, and it still does not cover most of the developing countries. Nor does it cover non-GATT members, such as China and Russia. U.S. government policy is to require all new GATT entrants to sign on to the aircraft agreement. However, many see the problem with offsets as not limited to mandatory offsets. Concerns are expressed about voluntary industrial participation agreements—which are often loosely called offsets. For Boeing, the bottom line is that 86 percent of the content of Boeing's aircraft is U.S. made, including an average figure for the engines. That percentage has not changed much over the past few years—nor is it likely to. The number may go down in the future as the company engages in additional international activities; it may go up as the company drops nonperforming foreign suppliers. Waldmann stressed that regardless of the numbers, Boeing enters into voluntary industrial participation agreements as a means of gaining market access. Boeing sees the ability to place work overseas as an important tool in competing against Airbus, a perspective he affirmed is understood by the union leadership. The questions raised by the union leadership during the recent strike concerned how much work is placed overseas and at what pace. Mr. Waldmann stressed that the company was not shifting massive amounts of union work abroad. Much of the past downturn in employment was due to decreased market demand, not a shift of work overseas. In addition, it is important to note that for every union job that went overseas, 100 others were retained because of overseas sales. According to the Commerce Department, every $1 billion in exports creates 11,000 jobs in the industry—with the multiplier for jobs in other industries, that number may be closer to 20,000 jobs—and Boeing currently exports 70 percent of its commercial jets, up from 60 percent. In closing, he observed that the commercial and military sectors are very different. Mandatory offsets are still the rule in the military sector. However, in the commercial sector it has been his experience that government requirements for offsets or other arrangements are declining.
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Ready or Not: Competing in a Global Economy William Greider National Editor, Rolling Stone Magazine Mr. Greider began by pointing out that he is a reporter, not a policy analyst or an economist, who has written a recent book on globalization. His goal in the book was to try to understand the dynamics of multinationals from a global perspective. He began with what he hoped would be provocative assertions—with a focus on the commercial sector, not the defense industry. First, offsets are a principal mechanism, but not the only mechanism for encouraging and allowing migration of the industrial base from developed countries, primarily the U.S. but also Europe and Japan, to the developing countries. From the point of view of the developing world, this may be economic justice. But, from the U.S. point of view, it raises serious national interest concerns. This process is happening not only in aerospace, but in all areas of advanced technology. The process is also contributing to the vulnerability of the global economic system by creating overcapacity—a phenomenon clearly visible in the automobile industry, but also occurring in aerospace. In addition, offsets contribute to the vulnerability of the global economy by subverting the trading system. Offsets are political business bargains, usually made with government involvement. They are not based on an economic rationale of comparative advantage. The result is an undermining of support for the trading system, because workers and communities are told that the displacements are simply caused by the economics of free trade, but then they find out that their jobs were traded away in a political deal. Boeing is a good case example. No one would question Boeing's market advantages. Nor is it an issue of traditional comparative advantage, since wages of Boeing workers are not a factor. But, the buyers say, give us a part of the high value-added production and the technology. And, according to several Boeing officials cited, Boeing has to go along with what the buyers want. Buyers, such as China, play hard ball with Boeing and play Boeing off against Airbus. Boeing, in turn, plays hard ball with its suppliers. Greider cited cases of a number of Boeing suppliers, including Northrop Grumman and Mitsubishi, moving Boeing work to China. He does not fault Boeing for following this strategy, saying that its management is undoubtedly doing what it believes is best in the situation. But the question must be raised as to what is wrong with this process. Though the number of jobs currently involved is not dramatic, the numbers are growing. In addition, Airbus and other foreign companies are playing the same game, so the advantage that U.S. firms once gained by moving work to China is now gone. The end goal of the Chinese is to make their own aircraft. Boeing clearly feels it needs to be a partner in this process, though it may result in an Asian Airbus—while still trying to block the Chinese from entering the market. Being part of the process may be a good strategy for now. However, at some point the wage differential between the U.S. and China will make a difference in the cost of the aircraft—and the U.S. will lose sales on the affordability criterion. Greider went on to ask what the rules of the game are. Again citing Boeing officials, he noted that offsets may be illegal under the trade rules, but they are still part of the game. They have just become less explicit. Moreover, Greider suggested that in the international trading system, enforcement of the rules is only done when it is convenient and practical. According to Boeing officials, the company did not take action against Airbus because of pressure from European customers. From this, Greider concluded that companies are caught between their foreign customers and their workers in their home countries. In such a situation, the only way out of the dilemma is through government action. An important part of that action should be a complete debate and airing of the issue. Discussion Mr. Trice stated that he agreed with the earlier statement that offsets are trade-distorting and are creating a problem of overcapacity. Companies have moved to indirect offsets in some cases because of the problem of overcapacity—there is no production left to give as an offset. Analyzing the issue, he believed, must include the cost of the implementation of the offset versus the trade distortion that occurs. He did take issue with an assumption that the U.S. industry has a monopolistic position and that taking a hard line on offsets will not result in lost sales. Sales are lost when the offset requirement is too onerous to produce an economically viable deal. The real question is whether industry or government is best able to decide how to care for industrial interests. Mr. Waldmann stated that it was true that Boeing was pressed by European customers not to pursue trade actions against Airbus. But, he pointed out, Boeing did not desist. Boeing pursued a case was pursued against the Germans on exchange rate support in 1989 and in 1990-91 pursued a general subsidies case against Airbus which led to the 1992 agreement. He also questioned Airbus's claim that it has between 20 and 40 percent U.S. content. Moreover, in light of the jobs that must be allocated among the partners in Europe for political reasons, Airbus does not
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seem to have much flexibility to work with other foreign suppliers. Professor Ted Moran from Georgetown University noted that his recent study of outward direct investment shows that companies that stay at home are less competitive, have fewer good jobs, and a less favorable distribution of "good versus bad" jobs. He suggested that it is likely that a study of offsets would have the same findings. Another member of the audience, Alan Tonelson of the U.S. Business and Industrial Council, asked whether the issue of offsets represented a massive U.S. foreign policy failure and was a demonstration of U.S. impotence. Given the U.S. defense support for Europe, Japan, and Korea and the fact that the U.S. market absorbs 40 percent of China's exports, why is the U.S. unable to wield more influence in setting the terms of trade? This is a failure of U.S. policymakers to recognize their leverage and use it to promote highly competitive U.S. workers and companies. In response, Dr. Mowery pointed out that 50 years after the Marshall Plan, we have seen the reconstruction of Europe, the economic development of the Pacific Rim, and the end of the Cold War. Those were goals set out by the developers of that policy. Thus, the problems we are facing today, while not trivial, are the result of policy success—not failure. Mr. Greider stated that, especially in light of the end of the Cold War, it is of concern that the issue of globalization has been shrugged off. But the issue will continue to come up. For example, a political battle is shaping up over the U.S. Export-Import Bank (Exim) in which exporters want to relax U.S. content rules required to qualify for a government-backed Exim loan. In his view, this proposal goes against the charter and purpose of the Exim, but makes sense to companies from a global operational perspective. He stated that we need to have a debate over what the national interest is in these situations. Such a relaxation of the content rules may be in the interest of the companies but that may not be the same as the national interest. Questions such as this will continue to be raised until there is a clear debate on the issue. Mr. Trice stated that setting aside U.S. defense purchases, 70 percent of the aerospace industry's total business is international. If international sales produce jobs, then offsets may be the price of getting into the game. He said he did not see offsets as a failure of either will or of foreign or national security policy. Nor did he see the issue as among the top ten foreign policy problems.
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