deals through which American firms compete against others in global markets and an instrument through which the United States ultimately ends up supporting both U.S. companies and their current and future international competitors.

From a policy perspective, there are two big questions surrounding the use of offsets in defense trade. First, should the U.S. government attempt to unilaterally "countervail" foreign government policies (such as offset requirements) designed to improve the bargaining power of their firms against American suppliers? Or should the United States instead (or in addition) work toward a common international "rules of the game" for competition among potential suppliers of advanced military technology that might both create a ''level playing field" for competition and reduce economic pressures to sell ever more advanced technology to ever more dubious customers? Second, how can taxpayer and national interests in maximizing returns on defense technology investments be better aligned with private returns from technology transfer in situations in which the economic impact of the technology transfer may be felt well beyond the boundaries of the firm negotiating the transfer?

In this paper I first examine the current economic environment for defense industries around the world. I then characterize the "big picture" that is stimulating more intensive competition among the major defense suppliers selling the most advanced systems into international markets, and I identify the major regions competing in this global market. Next, I discuss the government policy instruments affecting this competition and analyze the particular role of offsets and offset policy as a dimension of international competition. In the final section I identify policy issues tied to the use of offsets in global defense trade.

The Current Economics of the Defense Industry

A key economic fact is that the cost structure in many key high-technology defense industries is dominated by various flavors of economies of scale—in assembling and sustaining essential design capabilities, in systems research and development (R&D), in start-up costs, in production capacity, and in learning curves. The price of entry into development and production of the most advanced weapons systems is a large fixed investment, with unit costs declining sharply as the scale of production increases.

A fundamental element of the national security policy of many nations (including most U.S. allies) is the creation and maintenance of their own independent, autonomous capabilities to produce at least some advanced weapons systems. During the 40 or so years of the Cold War, defense spending was large enough in most countries with pretensions to producing advanced weapons to enable production of these systems in sufficient volumes to at least approach affordability. With the widespread decline in national defense budgets, however, the only way in which many nations will be able to maintain a viable industry is by exporting a much larger portion of their output to overseas customers. This is

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