IV
ANNEXES



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--> IV ANNEXES

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--> Defense Industry Offset Association Position on Offset Issues Gordon Healey Defense Industry Offset Association BACKGROUND The Defense Industry Offset Association (DIOA) is an organization of offset professionals from across the U.S. defense and aerospace industry. Its 65 member companies represent virtually 100 percent of the defense/aerospace prime contractors in the United States. Membership requirements specify that a member company be a U.S. corporation engaged in the defense business and that it have undertaken at least one offset obligation as a prime contractor to a foreign customer. The purposes of the DIOA are to: educate its members about the practice of offsets and related business functions such as countertrade, joint venture formation, international finance, and transactional analysis; provide a forum and a means for its members to network with one another; and address business and policy issues affecting the practice of international offsets. It is under this third objective that the DIOA sets forth the following position statement addressing issues raised about offsets.1 1   The positions expressed below are those of the Defense Industry Offset Association (DIOA) as a professional organization and do not necessarily reflect the individual opinions of each of its constituent members. Gordon Healey, of Bell Helicopter, is serving as president of DIOA.

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--> Issue: Voluntary Versus Mandatory Offsets Industry Experience Offsets are neither optional nor voluntary on the part of the U.S. defense/ aerospace industry. They are mandated, either by the laws, regulations, or expectations of our customer countries; or they are dictated by competitive forces at work in the international marketplace. International sales are won on the basis of four fundamental criteria: price (low price or best value for the dollar), technical performance (how well does the product or system work?), offsets (industrial benefits provided to the customer country), and politics (regional favoritism, in-country political forces, buy-local preferences, etc.) In sales where the competitors' prices and technical performance specifications are too close to call and where politics cannot be affected, offsets are often not only a requirement, but are actually the key to winning the sale. No U.S. aerospace company would voluntarily offer offsets to a customer. Offsets are expensive, difficult to manage, risky, time-consuming, politically unpalatable at home, and, in general, a nuisance. The fact is, except in some unusual cases, U.S. aerospace companies cannot win international sales without offsets. To refuse the customer's offset requirement or expectation of offsets is to walk away from the sale and turn it over to the competitor. Issue: The Impact of Offsets on Aerospace Employment Industry Experience It will be rightly observed that in the course of fulfilling an offset obligation, a U.S. aerospace company may subcontract the manufacture of some of its components to foreign suppliers. It may also be asserted that this subcontract work typically has been or could be done by domestic workers or U.S. suppliers. Therefore—and this is a dangerous conclusion—the aerospace company is exporting U.S. jobs. In fact, the DIOA finds that offsets are a significant factor contributing to aerospace employment in America. Not that the offset function itself employs so many people, but that offsets, being a key element to international sales, help ensure ongoing jobs to the thousands of U.S. aerospace workers who build the aircraft, vehicles, weapons, and systems that are sold to international customers.

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--> The Aerospace Industries Association estimates that current total defense/aerospace employment in the United States is about 850,000 (not counting the U.S. military forces and civil servants). The companies that employ these 850,000 workers had combined sales in 1997 of $130 billion. Of that, about $50 billion was defense sales, $9.4 billion of which was exported to international customers. Using these figures, the proportions for work-force sizes can be easily calculated: Of the total 1997 work force, approximately 325,000 were in the defense sector, and 60,000 of these were employed in producing defense products for export. These workers rely on the success of international marketing and offset efforts for their jobs. If the data were available for commercial aerospace sales and offsets, it could be demonstrated that the figure of 60,000 jobs created or sustained as a result, in part, of offsets is actually much higher. In this paper, however, we focus only on the defense sector. The fundamental flaw in the logic used by those who voice concern about offsets is this: The very jobs alleged to be exported by offsets are actually created and/or preserved by this practice. The tens of thousands of aerospace workers and suppliers who support the assembly lines for production of new F-15, F-16, and C-130 aircraft and the Apache, Cobra, and Blackhawk helicopters are now almost totally dependent on international sales for their livelihood. The international sales are won, in part, through effective offset commitments. Are jobs exported in offset programs? Yes, a few, although ''re-exported" might be a better term. Some of the work the aerospace prime contractors have traditionally done in-house is now placed in the manufacturing facilities of customer countries. Some of the subcontracts that have been traditionally bid solely to U.S. suppliers are now also bid to and won by suppliers in the customer countries. According to the U.S. Department of Commerce, to whom the aerospace companies annually report their offset activity, this amounts to about $3 billion worth of offset credits. Understanding Offset Credits It is important to understand that offset credits do not translate directly to dollars and hence to jobs. Due to mechanisms such as incentive multipliers, third-party joint venture formations, and offset projects that do not involve U.S.-based work, aerospace companies are often able to satisfy significant portions of their offset obligations without large expenditures and without impacting their labor base and supplier pool. So what does $3 billion in offset credits mean in terms of actual defense/aerospace jobs? First, about half of the $3 billion was done as "indirect offsets," meaning mostly non-defense offset projects. Second, although no industry-wide research has been done on the effects of offset crediting mechanisms such as multipliers, one can safely suggest that at least half of the $1.5 billion in "direct" defense-related offset credits had little or nothing to do with actual jobs and sub-

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--> contract work. Thus, of $3 billion in offset credits, only an estimated $500-$750 million would have been subcontract work. Returning to the aggregate figures, if the U.S. aerospace industry had $130 billion in sales and employed 850,000 workers, then how many workers would be associated with $500-$750 million in actual offset defense subcontracting? About 4,000. In other words, for the 60,000 U.S. defense/aerospace workers whose jobs are sustained by international military sales, about 4,000 jobs are provided to our international customers under offset programs. It is not a bad exchange, particularly when one considers that if the U.S. defense companies had been prevented from engaging in offsets, they would have lost the sales which gave rise to the 60,000 jobs. David Mowery in Offsets in Commercial and Military Aerospace characterizes the impact of offsets on aerospace employment as "minuscule." In the face of analyses such as Jobs on the Wing, Mowery states, "Overall, it is difficult to make a credible case that offsets in both military and commercial aerospace account for any but a small fraction of the sharp declines in aerospace employment since the 1980's." The DIOA agrees. Issue: Impact of Offsets on the Subcontractor Community Industry Experience Although the subcontractors sometimes feel like pawns in the offset process, the fact is that they are the beneficiaries of the prime contractors' international marketing successes. In the aggregate, 40 percent of the work that comes to a subcontractor is for export and probably has an offset obligation attached to it. The subcontractor may not be aware, for example, that his order for 50 shipsets of machined brackets for a pilot's seat will be delivered in the end to Italy and Taiwan, and that his prime contractor had to undertake offset obligations to win the contract. Most second- and third-tier suppliers are never asked to participate in offset programs in the customer countries and thus are unwitting beneficiaries of the efforts of the offset managers to find other ways to offset that particular piece of the aircraft's value. From time to time it is necessary to give a purchase order to a firm in the customer country for a component that has been historically manufactured by a U.S. supplier. Such orders are placed, first, on the basis of competition, and second as "split orders" wherever possible to lessen the impact to the U.S. supplier and to retain the capability to manufacture the part in the United States. This is particularly true of critical, complex, or long-lead parts. The DIOA notes that the U.S. Department of Commerce's annual report on Offsets in Defense Trade includes a section of anecdotes from suppliers who feel they have been hurt by offset programs from the primes. It should be pointed out

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--> that these anecdotal experiences are neither sustained nor verified by the 100+ preceding pages of empirical data collected by the Bureau for Export Administration. Furthermore, there has been no effort to determine the amount of work these suppliers received as a result of present or prior international sales by the prime contractors. There was, of course, no acknowledgment of benefit from the supplier when he received purchase orders in connection with such business, even though it was the prime contractor's offset program that had helped win the sales. Addressing the Impact on Sub-Tier Suppliers The DIOA acknowledges that the second- and third-tier suppliers are sometimes affected by offsets. Most of the time they are the beneficiaries of international sales. Occasionally, they lose work to foreign suppliers. The following suggestions are offered with respect to the sub-tier supplier situation: The Department of Commerce should conduct a more rigorous study of the effects of offsets on the suppliers, including the amount of work done by suppliers for eventual export. Suppliers who are losing contracts to foreign competitors should study their operations and take steps to become more productive and more competitive. For aerospace producers at all levels who have employees displaced by the internationalization of aerospace work, government programs to provide retraining and job placement should be improved and reemphasized. Issue: Lessening The Impact of Offsets Industry Experience Offset managers and aerospace contractors are not insensitive to the concerns of their work force and supplier base. On the contrary, there is universal appreciation for the obvious: Without its employees and its suppliers, a production company is dead. The DIOA believes it is important for those affected by offset programs to understand the efforts an offset manager goes through to lessen the impact of offsets on the company's workers and supplier base. Offset Contracts In an offset agreement with a customer, the offset manager will negotiate for contract provisions that promise the lowest possible offset amount, offer the longest possible period of performance,

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--> provide for the widest possible spectrum of allowable projects, establish the most favorable crediting mechanisms for offset projects (including multipliers and lump sums for special projects), and authorize the longest possible list of eligible parties to participate in the offset effort. Multipliers The government offset administrators in many customer countries (Korea, Turkey, Australia, Singapore, Taiwan, Israel, Greece, Finland, and others) allow multipliers for offset projects meeting certain criteria. For example, an offset project directed to a key company in an economically depressed region of the country may receive $10 of offset credit for every $1 of project value. The U.S. aerospace company will focus on these highly incentivized project areas and, as a result, may reduce the offset effort to as little as one-tenth of the original obligation. Technical Assistance and Training Many international customers of U.S. aerospace products lack the technical know-how to operate and maintain the equipment they are buying. For offset projects, the manufacturers will often send technical specialists to the customers' facilities to perform training and assist the customers' technicians and operators in gaining much-needed expertise. The offset credits awarded for such projects usually are many times the expense incurred by the U.S. company. Financing Many customers of U.S. aerospace companies are the developing countries of the world whose defense budgets are small and who have limited experience in financing the acquisition of major aerospace or defense systems. The U.S. contractors will often provide assistance to their customers in approaching major Western investment banks or in structuring highly specialized financing schemes. The customer countries will award sizable amounts of offset credits for such assistance. Market Development Large aerospace companies frequently have a network of business contacts throughout the world that can be of assistance to firms in the customer countries for finding new export markets for their products. Millions of dollars of offset credits can be earned as such exports begin to flow from the customer countries.

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--> Investments and Joint Ventures This is a wonderful example of a win-win situation in the offset business. The U.S. aerospace company will find a U.S. firm who has a particular technology of interest to a firm in the customer country. The offset manager will then act as a marriage broker between the two firms, assisting in the formation of the joint venture, overseeing and sometimes participating in the investment, ensuring that technologies are properly licensed, and then collecting offset credits for the business generated by the joint venture. Such a business not only benefits the customer country but also opens up a new, international branch of the U.S. partner. Non-U.S. Transactions Many offset transactions involve the transfer of work from one international supplier to another. For example, an airplane manufacturer has landing gear components built in Israel for an offset obligation there. When the offset program is finished in Israel, the landing gear work is moved to the United Kingdom to be applied against a new offset commitment there. Such work transfers have no impact at all on U.S. jobs. Similarly, some countertrade transactions will involve the shipment of commercial goods between two non-U.S. countries, thus not affecting U.S. jobs nor creating increased competition at home. Through these and other such creative methods, offset managers are able to greatly lessen the employment impact of offset obligations while still providing projects of significant value to the customer countries. Do offset administrators in the customer countries feel cheated when they see that they are only getting, for example, an aggregate of 4,000 jobs worth of aerospace work for their billions of dollars of expenditures on U.S. equipment? Not at all. It is they who provide the incentives and multipliers, and it is they who approve the offset projects presented to them by the U.S. offset managers. Although the system is a nuisance, it can work to the benefit of both parties. Issue: Technology Transfer in Offset Programs Industry Experience Technology transfer is, indeed, frequently an element of offset programs. It is highly desired by the customer countries and is almost always encouraged by large multipliers and incentives in terms of offset credits awarded. In this way, technology transfer projects tend to lessen the jobs impact of offset programs by substituting technology transferred for actual work transferred and provide a low-cost, mutually satisfactory means to fulfill an offset obligation. The key issues in technology transfer projects are:

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--> Does the technology sent offshore in any way compromise U.S. security interests? Is the provider of the technology creating a foreign competitor? U.S. Security With respect to the impact on U.S. security, the DIOA points out that the U.S. government operates a sophisticated export controls mechanism through which all requests to export technology must pass. Data export licenses and technical assistance agreements are issued by the U.S. government prior to the delivery of any aerospace technology into the hands of a foreign entity. The DIOA is persuaded that this mechanism is working well and that those who have concerns with the sensitivity of data exported under offset programs (or any international joint venture) should address their concerns to the U.S. State Department. Creating Competitors Concerning the creation of foreign competitors through technology transfers, views are more subjective. One must ask, however, if an aerospace company gives away a core technology, in the interest of fulfilling an offset program, does it thus create a competitor for itself? We believe that companies are not that shortsighted. And if the company is so short-sighted, it deserves to be put out of business by the foreign firms it helps establish. Moreover, it should be noted that, even with technology transfers, the cost to enter and remain in today's aerospace industry is prohibitive. The trend for aerospace companies has been exit, not entry. Kenneth Flamm, in The Policy Context for Military Aerospace Offsets , addresses at some length a concern that the waiving of research and development (R&D) recoupment costs in technology transfers is, in effect, selling the U.S. taxpayer short. The DIOA would argue that the U.S. taxpayers' primary payoffs for their R&D expenditures come as the aircraft or defense systems so developed are delivered to the U.S. forces. Any R&D recoupments paid by foreign concerns are simply additional revenue for the U.S. government. Where such recoupments are waived in the interest of providing an incentive for the foreign government to buy American, the U.S. taxpayer still benefits because of the economies of scale that arise from the increased quantities sold offshore. The Department of Defense's unit price for defense systems goes down because costs are spread over a greater number of units. DIOA Recommendations International offsets are anything but a perfect business practice, and as such can be improved. In the best of worlds, they can even be done away with. But we

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--> do not foresee "some grand agreement" as a near-term solution to offsets or to any aspect of the practice. Solutions will evolve with the changing nature of international business. The DIOA offers the following recommendations to guide the process: 1.   Take no unilateral action. Offsets are an established element of international trade. Our foreign trading partners will continue to demand them, and our international competitors will continue to offer them. Consequently, any unilateral action on the part of the United States to prevent its companies from engaging in offsets would be highly detrimental to the international business interests of the U.S. defense/aerospace industry. 2.   Improve the data collection process. The DIOA agrees that regular reports to the U.S. government on offset performance can be helpful to any who want to understand the magnitude and impacts of this unusual business practice. We suggest, however, that improvements could be made in the data collection process and would offer our assistance to the U.S. Department of Commerce in modifying its survey questionnaires and report forms so as to gather more accurate, meaningful offset data. 3.   Continue with multilateral discussions. The DIOA welcomes any mutual concessions that could be made between the United States and its trading partners that would limit the practice of offsets without imperiling the international marketing process. 4.   Maintain dialogue. As long as the various parties who are interested in offsets—the prime contractors, the subcontractors, the labor unions, the government, etc.—are talking to each other, there is hope for progress toward a consensus. And if, in the unhappy event that a consensus is not within reach, there is still value in understanding one another's positions. The DIOA will continue to support efforts to maintain a dialog on offset issues. 5.   Keep offsets in perspective. In terms of the aggregate U.S. aerospace business and the national trade balance, the impact of offsets is small. True, offsets are sometimes highly influential in securing international sales, but the ebb and flow of aerospace jobs and technologies due to specific offset transactions are dwarfed by other factors such as defense downsizing and industry restructuring. The U.S. government has wisely adopted a "hands off" national offset policy, and unless or until significant harm—or even the risk of significant harm—can be demonstrated, we will do well to leave this powerful marketing tool in the hands of the defense/aerospace firms where it can be used to secure jobs for their employees and suppliers.

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