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Trends and Challenges in Aerospace Offsets (1999)

Chapter: III. Papers: Offsets in Commercial and Military Aerospace: An Overview

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Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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III
PAPERS

Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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Offsets in Commercial and Military Aerospace: An Overview

David C. Mowery

University of California, Berkeley

Introduction

An offset is a provision in an international export transaction that commits the seller firm to provide technology, to procure locally produced components, or to provide other forms of technical and other assistance to firms in the purchaser nation that go beyond those deemed economically necessary to support the sale. Offsets typically are undertaken by the selling firm in response to formal or informal demands made by the government of the purchasing nation. Although the term has been applied mainly to exports of military systems by U.S. producers, a number of examples exist of similar provisions in U.S. firms' export of civilian products, especially when these products are capital- and technology-intensive goods that are purchased by state-owned or state-controlled firms. Thus, provisions in commercial transactions that closely resemble offsets are common in export markets for telecommunications equipment, power generation equipment, and commercial aircraft and engines. Nevertheless, care must be taken in describing all collaborative activities undertaken by U.S. exporters of these and other commercial products as offsets. As I point out below, a number of strictly economic factors also are driving increased collaboration with foreign firms in many of these industries.

As this last statement points out, the definition of an offset is often very difficult, and (especially in commercial exports) the perception of direct or indirect government pressure, the central defining characteristic of an offset, is often in the eye of the beholder rather than in objective data or other indicators. Another difficult issue in the measurement of the magnitude and economic effects of offsets is the distinction between "direct" and "indirect" offsets. Direct offsets

Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
×

generally are defined to be transactions that are related to the specific product being exported. In the case of a military aircraft, direct offsets may involve commitments by the U.S. exporter to purchase a fixed percentage of the components (typically measured by their value) for the systems being sold to a foreign nation from firms located in that nation. Indirect offsets, by contrast, involve commitments by the exporter to either purchase unrelated products or to provide other forms of technical or commercial assistance to firms in the purchasing nation that are valued at some percentage of the export sale. Needless to say, the measurement and analysis of indirect offsets is considerably more challenging than is true of direct offsets.

Offsets and similar provisions have been important features of U.S. military and civil aerospace exports for much of the postwar period. At least 28 U.S. aircraft and missile systems were manufactured by foreign firms under "co-production" agreements during 1947-1980, and more recent estimates (U.S. Office of Management and Budget, 1990) of offsets as a percentage of U.S. foreign military sales range as high as 98 percent (that is, nearly the entire value of the export sale is being offset by countervailing purchases or transfers). On the commercial side, virtually no new large commercial transport or engine for such aircraft has been developed and manufactured since the 1970s without significant participation by non-U.S. firms in technology development, manufacturing, or marketing.

Offsets resemble other forms of "countertrade," and they are similarly inefficient and trade distorting from an economic perspective. By substituting various forms of barter for monetary transactions, they reduce the efficiency of markets and distort trade flows. But the trade-distorting effects of aerospace offsets are not the primary reason for concern among executive branch and congressional policy makers. Instead, offsets are seen as a cause of potentially welfare-reducing employment effects and technology transfer to foreign firms. U.S. aerospace workers, among the best-paid manufacturing workers in the U.S. economy, are alleged to be losing employment opportunities because of the actions of U.S. firms and foreign governments to "export jobs" in this high-wage industry through offsets. In addition, the transfers of aerospace technologies to foreign firms are asserted to be strengthening foreign competitors to U.S. firms, reducing future U.S. competitiveness and the strength of the U.S. defense industrial base. Finally, the transfers of "dual-use" technologies through military and commercial offsets may be strengthening firms in nations that could be military adversaries in the future, thereby weakening national security.

The issues raised by aerospace offsets are as complex as they are emotional. In this paper I can do little more than survey these issues in a summary fashion, noting the origins and the factors driving the growth of military and commercial offsets. Immediately below, I discuss the factors that have contributed to the

Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
×

growth of international collaboration in military and civilian aerospace. I follow this survey with a summary and assessment of the policy questions created by collaboration in military and civil aerospace. The conclusion suggests some alternatives for consideration by policy makers in addressing the difficult tradeoffs and consequences of offsets.

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 1980s. Indeed, the available evidence suggests that indirect offsets now play a more prominent role in military exports, which makes it even more difficult to establish a connection between these provisions and employment losses in U.S. aerospace. Moreover, the effects of offset-related technology transfer on the fortunes of U.S. prime contractors in military and commercial airframes, avionics, or engines are very difficult to identify. Although little or no quantitative evidence has been collected on this issue, anecdotal evidence suggests that the negative consequences of offsets and similar transactions may be greatest among the U.S. firms that supply the prime contractors.

But here and elsewhere in aerospace, the most sensible policies to address offsets are those that are desirable on other grounds. These include continued efforts by U.S. negotiators to reduce the incidence of trade-distorting requirements in foreign government purchases, continued pressure by U.S. negotiators to reduce foreign government subsidization of "national champions," and policies that support adjustment by U.S. workers faced with intensified foreign competition. Rather than developing a specific set of policies to address offsets, the most sensible course of action seems to be one of pursuing liberalization in international trade and investment, while strengthening the weak infrastructure of public support for worker adjustment in this economy.

Origins and Growth of Offsets

In this section I summarize the postwar development of formal and informal offsets in the commercial and military aerospace sectors. As this very short history points out, military aerospace offsets have from their inception been closely linked to broader U.S. political and national security objectives. Indeed, offsets are to a substantial degree a creation of postwar U.S. military export policy. This short narrative also should make clear the complex interdependency between offset-related and other trends in the military and commercial portions of the U.S. aerospace industry. The growth of military aircraft offsets contributed to the subsequent increase in foreign participation in U.S. commercial airframe and engine development and manufacture, and vice versa.

Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
×
Military Offsets
Co-Production Agreements

During the early postwar period, the U.S. government made extensive use of co-production agreements in weapons sales to allies. Under the terms of such agreements, all or a substantial portion of the assembly of the weapons system purchased by a foreign government was produced by firms in the foreign nation. By guaranteeing that a portion of the costs of a purchase of U.S. weapons would remain within their nation in the form of domestic employment or manufacturing activity, such agreements made these purchases more attractive to foreign governments. Co-production agreements also contributed to the reconstruction of the European and Japanese economies during the 1950s and promoted commonality in the equipment used by Cold War allies. In addition, of course, by expanding markets for U.S. military equipment, co-production agreements lowered the unit costs of weapons systems purchased by the U.S. military.

Between 1947 and 1980, at least 44 different weapons systems, 28 of which were aircraft, missiles, or rotorcraft, were produced by foreign firms in 20 or more countries under licenses granted by U.S. producers. Until the late 1970s, co-production agreements did not involve transfers of systems design data for these weapons. In most cases, licensed co-production began with the assembly by foreign firms of knockdown kits from U.S. producers, followed by expansion in the range of locally produced components for incorporation into a weapons system.

Because they rarely included joint development or design activities, the co-production agreements of the 1947-1980 period transferred little by way of the design and systems integration skills needed for independent entry into the development and manufacture of military or civilian aircraft. But the aerospace industries of such nations as Great Britain, France, Japan, and West Germany retained formidable scientific and technological capabilities—World War II had destroyed production capacity, but had done little to permanently damage the skills of the scientific and technical work force in these nations. As a result, co-production agreements contributed to growth in production capacity in weapons systems and components in both Western Europe and Japan and enabled these industries to more fully utilize their long-established technical capabilities. Their interest in utilizing the technical and production capacity that co-production agreements helped restore, as well as dissatisfaction with the quality and quantity of technology transferred through these agreements, led European and Japanese firms and their governments to demand a greater role in joint development and design of components and systems during the 1970s and 1980s. Congressional passage of the Nunn-Roth-Warner amendment in 1986 created additional opportunities for transatlantic collaboration in weapons development.

These forces contributed to the growth of offset agreements, which in many cases supplemented or replaced the co-production arrangements that had charac-

Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
×

terized the weapons sales of the early postwar period. Rather than licensed assembly of the weapons system, these offset agreements provided for manufacture (and in some cases, development) by domestic firms in the foreign purchaser nation of components for a portion of the aircraft purchased for domestic use and, in some cases, for a portion of the entire production of the particular aircraft. Thus, in the "sale of the century" in 1976, General Dynamics agreed to assign a major production role for its F-16 fighter aircraft to domestic firms in prospective purchaser nations. This role included the production of components for the aircraft sold to European nations as well as for the aircraft sold to the U.S. Air Force. European producers in Norway, The Netherlands, Belgium, and Denmark were offered 40 percent of the value of production for the aircraft purchased by their respective armed services, as well as 10 percent of the value of production of the aircraft purchased by the U.S. Air Force and 15 percent of the value of production of aircraft purchased by other governments.

For much of the 1970s and 1980s, Defense Department policy treated the negotiation of offsets as an issue to be handled by U.S. military exporters, subject to government approval of any export licenses for sensitive technologies. These laissez-faire policies were altered by the Bush administration's announcement in April 1990 that "certain offsets for military exports were economically inefficient and market distorting" (U.S. Office of Management and Budget, 1990:23-24). The revised policy announced by the Bush administration gave the federal government the right to review offset arrangements negotiated by U.S. military exporters. The new policy led the Defense Department to restrict offsets in the 1990 negotiations over the sale of F/A-18 aircraft to the Republic of Korea: Offsets were limited to 30 percent of the total value of the transaction, not including the estimated value of the production offsets. These restrictions may have influenced the South Korean government's decision to purchase the F-16 rather than the F/ A-18.

An even more celebrated episode in the recent history of offsets, of course, is the U.S.-Japanese FSX/F-2 fighter aircraft co-development agreement. This episode reveals the complexities of the domestic politics that now underpin and influence international offset agreements. Japan's Self-Defense Forces have for decades purchased U.S. fighter aircraft, and a long list of these aircraft have been manufactured in Japan under co-production agreements. Just as was the case in Western Europe, however, domestic Japanese aerospace firms began pressuring the Japanese government for a larger role in the development and design of future military aircraft, and in the late 1980s advocated the independent development of an "all-Japanese" fighter aircraft. Japan's defense and foreign ministries resisted this pressure for both economic and political reasons, U.S. government negotiators insisted on a collaborative arrangement between U.S. and Japanese firms, and a compromise was announced in 1987. The next-generation Japanese fighter aircraft, then known as the FSX, would be developed jointly by General Dynam-

Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
×

ics (based on an extensive modification of the F-16) and powered by a U.S. military aircraft engine.

The announcement of the FSX project created considerable political controversy in the United States. Critics of the agreement argued that it would result in the transfer of critical dual-use technologies to Japanese firms whose capabilities in the commercial aircraft industry would be strengthened. Some also criticized the agreement for its failure to provide for reciprocal access by U.S. firms to jointly developed technologies resulting from the project. Much of this controversy reflected the high pitch of "Japan bashing" in U.S. political debate in 1987-1988, as U.S. firms in many industries seemed to be under severe competitive pressure from Japanese enterprises. But in other respects, the controversy over the FSX reflected the growing political saliency of offset and related technology transfer provisions of U.S. military exports, especially as the Cold War was ending. No longer were these arrangements judged solely in terms of their geopolitical or national security implications. In the post-Cold War era, the consequences of offsets for domestic employment, competitiveness, and economic welfare had for the first time become a topic of congressional debate.

After much discussion, a revised U.S.-Japanese agreement for the development of what became known as the F-2 was signed in 1988. The co-development project has progressed slowly (a prototype F-2 flew in 1995), and estimated development costs now appear closer to $4 billion than the original $1.1 billion estimate of 1987. The entire project, all of which is funded by the Japanese government, is now projected to cost $14 billion, $10.3 billion of which is associated with production-individual F-2 aircraft will cost $80 million (U.S. General Accounting Office, 1997; for earlier estimates of development cost overruns, see U.S. General Accounting Office, 1992). Government officials in both countries view the project as an overly ambitious first attempt at co-development among firms that lack a history of such activities. Despite the considerable political capital invested by U.S. negotiators in gaining access by U.S. firms to "flowbacks" of Japanese-developed technologies that were based on U.S. technical data, according to the U.S. General Accounting Office (1997), few U.S. firms have expressed interest in these technologies. Thus far, experts view the F-2 project as providing modest support for Japanese aircraft firms' system integration capabilities, but there are few examples of commercially relevant technology transfer from U.S. firms to the Japanese participants through this venture.

It is important to note that foreign sellers of weapons systems to the U.S. military services have to meet a number of performance requirements whose effects closely resemble those of offsets. "Buy American" requirements are commonly inserted into appropriations for major weapons systems by Congress, which handicap foreign bidders for contracts within such programs. Purchases by the U.S. military of "large," assembled weapons systems, such as the Harrier aircraft, the Ptarmigan military radio system, or even the Beretta military sidearm, all have contained stringent requirements for final assembly of the products

Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
×

in North American facilities, often by U.S. firms. These provisions are no less trade-distorting than the offset requirements of other nations.

Data on Trends in Military Offsets

Despite (or possibly, because of) their increasing political sensitivity, data on the economic significance of military offsets are very scarce. The U.S. Office of Management and Budget (1990) collected data on offsets during 1980-1987, which are reproduced in Table 1. More recent data on offsets, also included in Table 1, have been published in a recent study by the U.S. Department of Commerce (1996). All of these studies aggregate all military export transactions in reporting the incidence of offsets and therefore do not allow for a separate analysis of the role of offsets in exports of military aerospace products, as opposed to electronics or other weapons systems.

These data support three broad conclusions:

  • 1)  

    They are very sensitive to the inclusion or exclusion of individual transactions. As the 1996 Commerce Department study notes, the exclusion of two large military export sales from its 1993 data on offsets would shift the reported percentage of U.S. military exports accounted for by offsets from 34.4 percent to more than 69 percent.

  • 2)  

    The data for 1980-1987 are similarly sensitive to the inclusion or exclusion of specific transactions. Despite these flaws, a comparison of the data in Table 1 suggests no strong upward trend in the share of U.S. military exports

  • TABLE 1 Military Exports and Offsets, 1980-1994

    Year

    Exports (millions of current $)

    Offset Obligations (millions of current $)

    Offsets as Percentage of Exports

    1980

    6,541

    3,611

    55.2

    1981

    2,507

    2,195

    87.6

    1982

    2,594

    1,060

    40.9

    1983

    8,703

    4,471

    51.4

    1984

    5,523

    2,280

    41.3

    1985

    3,860

    2,434

    63.0

    1986

    2,209

    1,047

    47.4

    1987

    3,037

    2,987

    98.3

    1993

    13,945

    4,794

    34.4

    1994

    4,792

    2,049

    42.8

     

    SOURCES: U.S. Office of Management and Budget (1990); U.S. Department of Commerce (1996).

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

       

    accounted for by offsets. Indeed, if anything, these data suggest a modest downward trend. For the entire 1980-1987 period, offsets averaged 57.2 percent of military exports, whereas for 1993-1994, offsets accounted for 36.5 percent of exports (the Commerce Department study's reported an average of 54.8 percent for the 1993-1994 period that arbitrarily excludes two large military export sales to Taiwan and Saudi Arabia, without any justification).

    3)  

    The importance of indirect offsets, which by definition affect exports and employment outside of the aerospace sector, appears to have increased. The Office of Management and Budget study of offsets during 1980-1987 found that direct offsets accounted for 37 percent and indirect offsets 41 percent of all offset agreements (by value). The Commerce Department's 1996 study concluded that, during 1993-1994, direct offsets accounted for 31 percent and indirect offsets 62 percent of all offset agreements by value.

    These data are hardly definitive, but they suggest that direct offsets are declining in importance and indicate either a decline, or at a minimum, no evidence of increased offsets in recent U.S. military exports. A 1996 report by the U.S. General Accounting Office of offsets in U.S. military exports to the major purchasers of U.S. weapons systems in Western Europe, the Middle East, and Asia, however, reaches the opposite conclusion, asserting that ''Demands for offsets in foreign military procurement have increased in selected countries." The basis for this assertion is unclear—the General Accounting Office (GAO) report relied largely on case studies and interviews. This methodology means that the GAO report's conclusions could reflect pressures and conditions imposed on potential export sales that U.S. firms rejected, rather than the offset content of export sales actually made—the report fails to make a clear distinction on this point.

    The GAO report also indicates that indirect offsets are more common in military exports to newly industrializing and developing economies by a comparison with the industrial economies of Western Europe or Canada. This contrast reflects the far more highly developed armaments industries in the industrial economies, which now are anxious for additional work. The NICs and developing economies, however, have smaller armaments industries and (in many cases) broader developmental objectives associated with their offset strategies. But this contrast has two implications: (1) As U.S. arms exports are directed to newly industrialized and industrializing economies, rather than to NATO allies, one might anticipate a continuing rise in indirect offsets, relative to direct offsets, in the near term; and (2) in the longer term, if the newly industrialized and industrializing economies do pursue the development of indigenous armaments industries, their demands for offsets may shift from indirect to direct offsets.

    International Collaboration in Civil Aerospace

    There is no clear equivalent to offsets in the commercial aerospace industry,

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    although many observers agree that governments often play an important role in demanding concessions as part of their purchases of large commercial transports. The pervasive international collaboration that now characterizes the development, production, and marketing of large commercial transports has a more complex set of causes than government pressure alone. Among these causes, of course, is the legacy of previous co-production and offset agreements associated with foreign purchases of U.S. military aerospace products. And the currently high levels of international collaboration in civil aerospace are likely to produce additional pressures for direct and indirect offsets in future U.S. military exports. In this subsection, I review the development of international collaboration in civil aerospace so as to provide some context for these statements.

    The large commercial transport industry consists of two large manufacturing sectors—engines and airframes. With the exception of some large Japanese aerospace firms (Mitsubishi Heavy Industries and Kawasaki Heavy Industries), most major manufacturers of airframes do not engage in engine production, and vice versa. Moreover, since the early 1970s, large commercial transport airframes have been designed to accommodate more than one engine design within a given thrust class. The technological linkages between the engine and airframe industries remain critical—development of a new class of transports typically requires the introduction of a new class of engines—but the economic interdependence of individual engine and airframe manufacturers has if anything declined within the large commercial transport industry during the past 25 years. Accordingly, I discuss trends in international trade and market structure for each of these segments separately and follow this with a brief overview of another important segment of the U.S. industry, suppliers of components and subassemblies.

    Airframes

    In 1996, U.S. producers of airframes (SIC 3721), which includes large commercial transports and international trade data that are dominated by large commercial transports) exported goods valued at $19.0 billion, a sharp increase from 1995 exports of $13.9 billion and slightly above 1994 exports of $18.81 billion (Table 2). U.S. imports of these products amounted to $3.9 billion in 1996, up by 8 percent from their 1995 level of $3.65 billion (unpublished data, International Trade Administration, U.S. Department of Commerce, 1997). Valued in current dollars, exports display little strong upward or downward trend during the 1989-1996 period, a period characterized by sharp cutbacks in U.S. defense spending and wide fluctuations in orders.

    The forces that have led to increased international collaboration in airframe development, production, and marketing (see below) have also reduced the number of firms engaged in overall design, systems integration, final assembly, and marketing of large commercial transports. Since 1985, when Lockheed ceased production of the L-1011, there have been three producers of large commercial

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    TABLE 2 Aircraft Exports and Imports, 1989-1996 (billions of current year dollars)

     

    1989

    1992

    1993

    1994

    1995

    1996

    Aircraft exports

    14.3

    26.3

    21.3

    18.8

    13.9

    19.0

    Aircraft imports

    2.8

    3.9

    3.7

    3.7

    3.7

    3.9

    Engines and parts exports

    6.6

    6.7

    0.2

    6.4

    6.1

    6.8

    Engines and parts imports

    3.9

    5.8

    5.2

    5.3

    4.7

    5.6

    Aircraft parts and equipment exports

    8.7

    9.1

    9.1

    9.4

    10.0

    11.5

    Aircraft parts and equipment imports

    2.9

    3.1

    2.4

    2.5

    2.5

    3.3

    airframes: Boeing, McDonnell Douglas, and Airbus Industrie of Western Europe, a consortium of British, French, German, Spanish, and Dutch aerospace firms. The merger of Boeing and McDonnell Douglas has reduced this number to two. Since the mid-1970s, the market share of U.S. airframe producers, whether measured in terms of orders, deliveries, or order backlogs, has declined from more than 80 to 60-70 percent. Much of this decline in U.S. market share was absorbed by McDonnell Douglas.

    The importance of military-civil "spillovers," technologies developed for military aircraft and subsequently applied to civilian products, has declined significantly in airframes during the past 40 years. But military markets still account for a substantial portion of the revenues of the major U.S. airframe manufacturers. In 1993, 20 percent of Boeing's products and 60 percent of McDonnell Douglas's products (by value) were sold to the U.S. government, primarily to the military services (U.S. Department of Commerce, 1994). Moreover, for much of the past decade, sales trends in military and civil airframe markets have offset one another—during 1985-1991, defense aerospace shipments declined at an average rate of 2 percent per year, but commercial aerospace shipments grew at an average rate of 11 percent per year.

    Table 3 presents the market outlook for airframe manufacturers, based on recent forecasts by the Boeing Commercial Aircraft Company. The data confirm a long-standing trend of slower growth in passenger traffic in the industrial nations of Europe and North America, combined with relatively rapid traffic growth in the developing and newly industrialized nations of Asia and elsewhere (see Table 4). Passenger traffic in the Asia-Pacific region, characterized by rapid rates of economic growth and a relatively underdeveloped intra-regional airline network, is projected to grow more rapidly than traffic in any other region. Within

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    TABLE 3 Projected Airframe Demand (including replacement), 1997-2006

    Region

    Number of Aircraft Deliveries (% of total forecast deliveries)

    North America

    2,460 (33.8)

    Asia-Pacific

    1,750 (24.0)

    Western Europe

    2,070 (28.4)

    Rest of world

    1,000 (13.7)

     

    SOURCE: Boeing Commercial Aircraft Company (1997).

    TABLE 4 Projected Annual Growth in Passenger Seat Miles, 1997-2006 (in percent)

    Region

    Projected Annual Growth of Revenue Passenger Miles

    China and Hong Kong

    9.6

    Commonwealth of Independent States

    8.6

    South America

    7.1

    Japan and Korea

    6.8

    Southeast Asia

    6.5

    Central America

    5.9

    Africa

    5.5

    Southwest Asia

    5.4

    Europe

    5.2

    Middle East

    4.7

    North America

    4.2

    Oceania

    3.9

    this region, the domestic air traffic network of China is likely to grow rapidly and (combined with the low level of development of domestic Chinese air transport) may propel China to a position as the largest single market for large commercial transport in the world by the year 2000 (see Dornheim, 1994). The most recent market study by the U.S. Department of Commerce (1994) projects that China will purchase more than $40 billion in new aircraft during the next two decades.

    These market projections cover only "large" (80 passengers and more) commercial air transports. Although U.S. firms remain active in the development and production of turbojet- and piston-powered business and general aviation air-

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    craft, they have had little success in small, short- and medium-range commuter (20-40 seats) transports. The U.S. firm that was most active in this segment, Fairchild Aviation, entered into a joint venture with Saab Aircraft in 1980 that introduced the SF-340. The joint venture suffered from technological and management problems, however, and Saab eventually assumed sole ownership of the project. Fairchild has largely exited from developing or producing commuter transports. Boeing acquired DeHavilland of Canada, producer of several popular commuter aircraft in 1986, but sold the firm to Bombardier in 1992.

    The absence of U.S. airframe firms from this segment of the industry may have important consequences for their prospects in the developing nations of the world economy that are registering rapid rates of growth in passenger traffic. Short-haul, low-maintenance commuter aircraft are well suited to many of these markets, including substantial portions of China's domestic air transport system. In addition, these aircraft (e.g., the CASA/Nurtanio commuter air transport) are well suited to quick conversion from civilian to military air transport uses, which makes them attractive for purchase by governments seeking dual-use aircraft. In response to this market opportunity, Daewoo of South Korea has been co-developing a 33-seat commuter aircraft in partnership with Dornier of Germany. There are few established U.S. producers of such aircraft with whom Daewoo might team. Nonetheless, most South Korean and other Asian airframe manufacturers appear to see jet aircraft with 100-120 seats as the most promising segment of the market, and this segment is one in which McDonnell Douglas, Boeing, and Airbus Industrie all are able to develop and manufacture products (see Cole, 1994).

    Although they are consistent with widespread perceptions within the U.S. aerospace industry that East Asia and the Pacific region are the growth markets of the future, the data in Table 4 also reveal that traffic growth in other developing regions of the world, such as the Middle East and Latin America, is projected to be high for at least the next ten years. Moreover, the combination of large, aging fleets of aircraft and more-stringent noise and pollution regulations mean that the demand for aircraft in the industrial nations will be substantial during this period as well. As Table 3 shows, the largest single market during 1997-2006, measured in units, is the North American market for narrow-body air transports, which will account for almost 34 percent of projected sales of these aircraft. Europe and North America jointly account for more than 60 percent of projected deliveries during this period, significantly outstripping the projected deliveries for the rapidly growing markets of Asia.

    All three major airframe producers were active in international alliances during the 1980s and 1990s. Airbus Industrie is itself a complex joint venture of the "national champions" of a number of European governments. Airbus Industrie has thus far not entered into risk-sharing subcontracting relationships or other forms of alliances with non-European firms. The consortium's lack of involvement in such alliances may well be due to the concern by its members, a group

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    that includes a number of state-owned firms, over the employment and associated political consequences of significant shifts of work to foreign alliance partners.

    Both Boeing and McDonnell Douglas also pursued international joint ventures during this period. In the case of Boeing, international collaboration emerged out of international subcontracting relationships that began with the fabrication of components for the 747. More recently, Boeing has teamed with a consortium of Japanese aerospace firms (Japan Aircraft Development Corporation, made up of Mitsubishi Heavy Industries, Kawasaki Heavy Industries, and Fuji Heavy Industries). This alliance combines sharing of development costs, limited joint development of portions of the airframe, production of fuselage and other large components, and some joint finance of aircraft sales for the Boeing 767 and the 777. Boeing also has involved Short Brothers of Northern Ireland, Aeritalia of Italy, and Saab-Scania of Sweden in risk-sharing relationships in the development of the 777. But Boeing's most prominent joint venture partner remains the Japanese consortium. The participation by the Japanese consortium in both development projects has been supported in part by grants and low-interest loans from the Japanese government. Similar public financial assistance has been extended to Boeing's European risk-sharing partners.

    Boeing has allowed its European and Japanese collaborators, especially the latter, to expand their roles beyond those of traditional suppliers and subcontractors in moving from the 767 to the 777 projects. Having mastered the production technology for the main body sections, wing ribs, and other body parts of the 767, the Japanese are gaining additional experience in the 777 project from their production of fuselage panels, the tail fuselage structure, the aft bulkhead, and the wing center section (the portion of the wing that enters the body of the aircraft). The next step, an equity partnership,1 could involve foreign partners in designing, developing, testing, producing, marketing, selling, and providing after-sales support for the entire aircraft. Although Boeing now "outsources" a much larger share of the development and component manufacture for these aircraft, the U.S. firm retains undisputed management and marketing control of both the 767 and 777 projects.

    McDonnell Douglas adopted a different strategy for international collaboration from that of Boeing. Following a series of unsuccessful attempts at collaboration with European aerospace firms (see Mowery, 1987), McDonnell Douglas largely avoided risk-sharing ventures in new aircraft development. One consequence of the firm's lack of international partners was a lack of new aircraft, as McDonnell Douglas introduced only one new aircraft (the MD-11), which is a derivative of a 25-year-old design, during the past decade. Rather than relying on

    1  

    Boeing was willing to accept such an arrangement in the 777 venture, but the Japanese participants rejected it, fearing political repercussions in the United States.

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    foreign risk-sharing partners for the development and manufacture of new commercial aircraft, however, McDonnell Douglas established a venture with the Shanghai Aviation Industrial Corporation, licensing the assembly of MD-80 and MD-90 aircraft for use in China's domestic air transport system. McDonnell Douglas's most recent attempt to enter an alliance aimed at global markets occurred in 1991 with the signature of a Memorandum of Understanding (MoU) between McDonnell Douglas and the state-controlled Taiwan Aerospace Company for the development of the MD- 12. The announcement of this MoU sparked considerable political debate within the United States over the "loss" of a strategic U.S. industry and an equally vociferous storm of Taiwanese criticism of an agreement that combined high costs, great risk, and a U.S. partner that had serious managerial, production, and marketing weaknesses. The MD-12 joint venture fell apart within six months of the signature of the original MoU. The failure of McDonnell Douglas to develop a more effective international collaboration strategy contributed to this firm's failure to expand its product line sufficiently to remain a viable competitor and, therefore, was an important factor in the firm's demise as an independent producer of large commercial aircraft.

    Aircraft Engines

    The trends in international collaboration that characterize the airframe segment of the global aerospace industry are apparent in engines as well. There is no counterpart to Airbus Industrie within the commercial transport engine business, although Rolls Royce was government owned during 1971-1987. Despite the absence of a publicly financed competitor, U.S. producers of commercial jet engines have pursued numerous international joint ventures. Measured in 1992 dollars, U.S. shipments of aircraft engines declined sharply during 1989-1995, from $25.2 billion to $16.5 billion. The 1995 figure for shipments, however, represents a modest increase from the 1994 level of $15.9 billion (1992 dollars), and unpublished Commerce Department data forecast growth to $17.2 billion and $22.4 billion, respectively, in 1996 and 1997. Exports have remained steady, valued in current dollars at 6.6 billion in 1989, $6.1 billion in 1995, and $6.8 billion in 1996 (see Table 2). Imports, on the other hand, display modest growth during this period, from $3.9 billion in 1989 to $5.6 billion in 1996. The leading sources of U.S. imports of these products are France, the United Kingdom, and Canada.

    As in the airframe segment, three large firms dominate global production of aircraft engines for large commercial transports: General Electric, the Pratt & Whitney unit of United Technologies, and Rolls Royce of Great Britain. As of 1992, 53 percent of large commercial transports in service in the world's fleet were powered by Pratt & Whitney engines and 27 percent were powered by General Electric engines (U.S. International Trade Commission, 1994); Rolls Royce engines accounted for the majority of the remaining 20 percent. Among these three producers, the firm experiencing the most significant growth in market share

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    during the past two decades has been General Electric, which has made effective use of its joint venture with SNECMA and CFM International.

    The market outlook for turbojet and turbofan engines obviously tracks that for airframes closely, and the emerging markets of the newly industrializing regions of East Asia are among the most attractive markets for aircraft engines. The possibilities for "retrofitting" older airframes with new, high-bypass engines mean that some of the industrial nation markets that face significant new restrictions on engine noise may account for a larger portion of future sales. The North American and European markets are likely to account for a majority of near-term demand (i.e., deliveries over the next decade).

    The importance of France and Canada as sources of U.S. imports stems from the role of SNECMA as a major source of components for General Electric engines and from the role of Pratt & Whitney of Canada, a large subsidiary of the dominant U.S. and global supplier of engines. Japan and South Korea together account for less than 3 percent of U.S. imports of aircraft engines and parts throughout this period. The prominent role of France as a destination for U.S. exports reflects shipments of General Electric engines to SNECMA for final assembly in France, as well as the large sales of CFM International engines to Airbus Industrie, located in France. In contrast to their minimal role as import sources, Japan and South Korea together account for almost 10 percent of U.S. exports during this period because of the large fleets of long-haul, four-engine commercial transports operated by each nation's airlines.

    Despite the absence of a well-subsidized "regional champion" competitor in this industry comparable to Airbus Industrie, all three major global producers of aircraft engines are heavily involved in international joint ventures. Pratt & Whitney and Rolls Royce are teamed in International Aero Engines (IAE), a five nation, seven-firm venture that involves Mitsubishi Heavy Industries, Kawasaki Heavy Industries, Ishikawajima-Harima Heavy Industries, Fiat, and MTU of Germany, in addition to the two principal firms. In contrast to the Boeing joint ventures with foreign firms, IAE is an entity with considerable autonomy from its "senior parents," Pratt & Whitney and Rolls Royce. IAE's primary product, the V2500 engine, experienced severe difficulties in development that were attributable in part to the efforts of the venture's senior participants (Rolls Royce and Pratt & Whitney) to restrict technology flows among the participants (see Mowery, 1987, 1988). The V2500 engine joint venture has expanded the participation of Germany's MTU and Italy's Fiat beyond their roles in previous projects with Pratt & Whitney in the medium- and high-thrust classes (respectively, 35,000-40,000 pounds of thrust and above 60,000).

    The General Electric-SNECMA venture, CFM International, has been active since the early 1970s, developing and manufacturing the successful CFM56, a high-bypass, low-thrust engine that effectively enabled General Electric to reenter the civilian jet engine industry. General Electric also relies on SNECMA extensively as a supplier of components for its high-thrust engines, the CF6 se-

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    ries. Indeed, General Electric has benefited substantially from Airbus Industrie's success, since it is a major supplier of engines for the consortium.

    Suppliers of Parts and Components

    The industrial structure of the world's commercial aircraft industry is noteworthy for its combination of a very small number of large, global firms engaged in product development, systems integration, final assembly, and marketing, and a very large group of firms, most of which are far smaller and engaged in the production of parts and components for these "prime contractors." Surprisingly little is known about the structure of the U.S. "supplier tier," but estimates of the number of U.S. supplier firms in the 1980s ranged as high as 20,000. Many of these firms supply components for both military and commercial airframes and engines. Since the early 1980s, this population of firms appears to have shrunk considerably, as a result of declining sales of commercial and military aircraft. The U.S. Air Force Association asserted that between 1982 and 1987, nearly 15,000 suppliers exited from the defense aerospace components business (quoted in U.S. Department of Commerce, 1993:20-21). Moreover, the number of U.S. firms supplying Boeing and McDonnell Douglas shrank from more than 11,000 to less than 4,000 during the 1980s, a period of rising shipments of aircraft.

    Despite these apparent declines in the number of supplier firms, this sector of the U.S. aircraft industry continues to register a significant trade surplus that if anything has grown since 1989. U.S. exports of aircraft parts and equipment grew from $8.7 billion in 1989 to $11.5 billion in 1996, and this sector's trade surplus grew from roughly $5.9 billion to nearly $8 billion in the same period (see Table 2). Although the supplier tier appears to have undergone considerable upheaval and considerable exit by firms during the past 15 years, its trade performance since the late 1980s has been quite strong. As I note below, increased international collaboration among airframe and engine producers produces market opportunities, as well as intensified competitive pressure, for this segment of the aerospace industry. Partly in response to the increased international collaboration involving their customer firms, some suppliers also have begun to pursue international joint ventures; a joint venture was formed in 1987 between the Bendix aircraft brake division of Allied Signal Aerospace of the United States and Dunlop Aerospace of Great Britain to supply wheels and carbon brakes to the Airbus A330 and A340 (Donne, 1987).

    Motives for International Collaboration in Large Commercial Transports

    The central motives for international collaboration in most industries are threefold: (1) access to markets, (2) access to technology, and (3) access to capital. For U.S. commercial aircraft firms, the first and third of these motives have been central to their international partnerships. In the airframe industry, the pres-

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    ence of Airbus has increased the importance of both motives. The second motive has played an important role in the decision of Japanese firms to team with U.S. airframe and engine producers. Moreover, the enhanced technological capabilities of non-U.S. commercial aircraft firms, especially suppliers of parts and subassemblies, has made them more attractive to U.S. firms as potential partners in international joint ventures. Many of the European, Japanese, Taiwanese, and South Korean firms that now seek to enhance their technological capabilities through partnerships with U.S. aircraft firms were aided in their early postwar development by technology-sharing and co-production agreements covering foreign sales of U.S. military aircraft (Mowery, 1987; Moran and Mowery, 1995).

    U.S. airframe and engine firms now are more concerned with improving their access to foreign markets and capital because of changes in their domestic and international competitive and technological environment. The technological environment for U.S. airframe and engine producers has changed in several critical aspects. The importance of military research and development and procurement as a source of revenues and technologies applicable to commercial aircraft has declined since the 1950s and 1960s because of growing divergence between military and civilian performance requirements, as well as changes in military procurement objectives (i.e., far fewer large transports and tankers are being developed for military markets). Declining military-commercial technology spillovers and steadily increasing development costs for new products (estimates of the development costs for the Boeing 777 range as high as $4 billion; see Holusha, 1994) have greatly increased the risks associated with new product development. Joint ventures with foreign firms that are able and willing to contribute development funds are one mechanism for spreading these forbidding risks.2 Moreover, the interest of many foreign governments, including those of Great Britain, Japan, and Italy, in supporting their domestic aerospace industry often means that various public subsidies (e.g., low-interest or no-interest loans) are available to the prospective partners of U.S. firms. For all their protests against foreign governments' subsidies for Airbus, U.S. airframe firms also have reduced their cost of the capital for these large development projects through collaboration with subsidized foreign partners.

    The "technology access" motive operates for both U.S. and foreign firms within these joint ventures. International collaboration provides a way for U.S. firms to realize some returns to more-mature components of their corporate technological portfolios, especially in negotiations with foreign firms interested in using an international joint venture as a way to acquire skills in commercial aircraft design and manufacture. Although U.S. firms typically restrict access by their partner firms to specific aspects of a new airframe or engine, they may

    2  

    According to interviews in industry and government, Boeing decided to enter into a risk-sharing subcontracting agreement with its Japanese partners in developing the 767 only after several potential U.S. subcontractors rejected such a risk-sharing joint venture (Mowery, 1987, 1988).

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    effectively be able to realize some return to their project management skills and more-mature technological capabilities by bringing a foreign firm into a project as a junior partner or pupil.3 The nature of these capabilities (they are highly ''tacit" and depend on know-how) may make it difficult to realize a profit from them through an arms-length sale or licensing agreement.

    It would be a mistake, however, to assume that all of the technology-related benefits in these joint ventures flow from U.S. to foreign firms. The Boeing Company, for example, has benefited from access to high-quality manufacturing skills in its 767 production-sharing arrangements with its Japanese risk-sharing subcontractors. Among the primary foreign technological assets of interest to U.S. firms that sought to collaborate with East Asian firms (e.g., McDonnell Douglas and Taiwan Aerospace) were the capabilities in manufacturing management and quality of these enterprises.

    Market access appears to be at least as important as access to capital or technology in the decisions by U.S. firms to seek foreign partners in developing and manufacturing new airframes and engines. As I have noted elsewhere (Mowery, 1994), the increasing importance of nontariff barriers in international trade, including such barriers as performance requirements or offsets, has been responsible for much of the recent growth in international joint ventures in a broad array of industries, from steel to semiconductors and automobiles. The early appearance and enduring importance of international collaboration in the large commercial transport market reflect the fact that it is one of the most highly politicized high-technology markets, perhaps second only to telecommunications equipment. In addition, of course, the combination of rising development costs and slower demand growth in their domestic markets means that rapid and substantial penetration of foreign markets is now indispensable to the success of new products developed by U.S. and European firms.

    The commercial aircraft industry's status as an important source of high-wage employment, its dual-use technologies and production facilities, and its frequent requirements for government financial support all mean that foreign governments play a prominent role in their domestic aerospace industries. Within Western Europe, the desire of national governments to sustain domestic aerospace industries that were valued in part for their national security benefits influenced the formation of the Airbus Industrie consortium (see Mowery, 1987). Moreover, many foreign airlines have long been directly government owned or subject to substantial "administrative guidance" in their purchasing decisions. The export markets faced by U.S. producers of commercial aircraft thus often require some form of economic concession to gain access.

    3  

    According to Aviation Week and Space Technology (1977:201), Boeing's Japanese risk-sharing subcontractors for the 767 project paid the U.S. firm more than $140 million as a royalty for Boeing's production and design experience, as well as its global sales and product support network.

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    Building on precedents established in U.S. exports of military aircraft, foreign purchasers of U.S. commercial transports in the late 1960s and 1970s began demanding that their purchases contain some domestic content, perhaps by purchasing components from local producers (in other cases, U.S. airframe and engine firms would guarantee "offsetting" purchases of other commodities, including a large shipment of Polish hams in one celebrated case). During the subsequent 20 years, however, and again in parallel with developments in foreign markets for U.S. military aircraft, foreign governments have demanded that U.S. firms offer more-generous benefits, including opportunities for their firms to participate in developing and producing more-complex components. Needless to say, this form of collaboration involves more-intense interaction and higher levels of technology transfer among the participating firms. The importance of market access as a motive for these international joint ventures is so great that relaxation of any remaining domestic antitrust restrictions on joint product development (in 1993 the National Cooperative Research Act of 1984 was amended to allow joint production ventures) seems unlikely to result in U.S. firms choosing to collaborate with their domestic rivals rather than foreign firms (see Mowery [1987, 1988] for additional discussions of the role of domestic antitrust policy in the international collaborative strategies of U.S. firms).

    Consequences of Civil and Military Aerospace Offsets

    Concern over the consequences of civil and military aerospace offsets has increased considerably during the past decade. The brief discussion of the FSX controversy illustrates the changing political attitudes toward military aerospace collaboration. Within the civil aerospace industry, offsets have sparked considerable labor-management friction, and disputes over foreign outsourcing contributed to a lengthy strike against the Boeing Company in 1996.

    Criticism of offsets in both civil and military aerospace is based on the belief that international collaboration contributes to job losses in the U.S. aerospace industry and the belief that the technology transfers supported by these agreements work against the long-term competitiveness and potentially the long-term national security of the United States. In this view, U.S. military and civil aerospace contractors, especially the prime contractors, are following in the footsteps of U.S. predecessors in the consumer electronics, semiconductor, and other industries, "giving away the future" through one-way transfers of technology that will ultimately strengthen their competitors and result in the entry by foreign competitors into an industry long dominated by U.S. firms.

    On the other side, defenders of collaboration argue that international collaboration yields important commercial and technological benefits to U.S. firms, and that without such arrangements, U.S. military and civil aerospace firms would lose foreign sales, creating more serious employment losses among their U.S. work force. These defenders further argue that the technology outflows are care-

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    fully managed and are unlikely by themselves to sufficiently strengthen foreign firms to the point that these offshore partners would become direct competitors of the prime contractors.

    It is virtually impossible to evaluate the employment, technological, or competitive effects of international collaboration in a rigorous manner with the available data. Publicly available data on employment and shipments are highly aggregated and cannot be linked to individual firms or product lines so as to allow one to analyze the employment or other effects of individual agreements. Moreover, even if more-detailed data were available, isolating the effects of international collaboration and separating these effects from those produced by numerous other influences (exchange rates, defense spending, business cycles) is impossible. Analyses of aerospace such as those of Scott (1997) cannot separate the effects of offsets from the myriad of other forces affecting aerospace employment or shipments.

    Employment Effects

    By far the most important factor depressing employment in the U.S. domestic aerospace industry during the past decade is the behavior of defense procurement spending in the United States and other industrial economies. Measured in constant 1997 dollars, U.S. Defense Department spending on procurement has dropped from roughly $370 billion in FY 1987 to less than $240 billion in FY 1997. The presidential budget for FY 1997 requested funds sufficient to purchase 73 military aircraft, a dramatic drop from the requested procurement level of 337 military aircraft in FY 1990 and 497 in FY 1985. Reductions in defense spending also have occurred in most Western European nations, which reduces their demand for U.S. weapons systems and intensifies competition between U.S. and European producers in European and foreign markets. The employment consequences of military and civil offsets are minuscule by comparison with those resulting from these enormous shifts in government procurement.

    Two other factors further complicate the analysis of the employment consequences of offsets. First, as noted above, a large and apparently growing fraction of the offsets associated with military export sales are indirect offsets, which involve transactions affecting industries other than aerospace. Obviously, the employment effects of these arrangements are both more diffuse and even more difficult to trace. A more fundamental issue, however, makes simplistic job-counting exercises futile. Foreign purchasers of U.S. exports pay for these products by exporting to the United States—over the long term, U.S. imports and exports must approximately balance one another,4 and U.S. aerospace exports are indeed

    4  

    Recent U.S. current-account deficits, reflecting a chronic excess of U.S. imports over exports, have resulted in foreign nationals accumulating future claims on U.S. output that eventually can be made good by purchasing U.S. exports.

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    offset in full by U.S. purchases of imported goods. The real effects of offsets are their distortion of the offsetting trade flows—for example, rather than importing Canadian potash in compensation for Canadian purchases of aircraft, an offset means that U.S. citizens increase imports of avionics or aerospace components above what they otherwise would obtain. The employment effects associated with offsets therefore center on the relative labor intensity of the goods imported as a result of the offsets versus those that would have been imported in the absence of these arrangements. The data requirements for the necessary counterfactual model of trade flows are forbidding and prevent a true accounting of the employment effects of offsets. But these effects are likely to be quite small. Indeed, the 1990 study of military offsets by the U.S. Office of Management and Budget, the only recent study to attempt a rigorous analysis of the employment effects of these offsets, concluded that:

    "The effects of offsets on total U.S. employment are minor. That is to say, military sales abroad with contractually required offsets are likely to increase domestic employment by somewhat more (by about 2500 employee years [roughly 600 jobs] per year) than would comparable sales without offsets. This is true largely because offsets are a substitute for (but are less labor intensive than) the imports that would replace them to finance the foreign sales" (1990:53). The effects of offsets on aerospace industry employment thus appear to be minor. This finding does not justify opposition to public policies designed to aid the adjustment of aerospace workers to the upheavals in their industry resulting from changing patterns of defense procurement. Indeed, this finding underlines the point that a sensible federal policy toward the domestic employment consequences of offsets should be part of a portfolio of federal programs to facilitate adjustment by workers to broader trends of intensified global competition and expanded foreign trade rather than designing adjustment policies that attempt to deal with the specific (and unidentifiable) employment consequences of offsets.

    Effects of International Collaboration on Commercial Competitiveness

    What are the competitive consequences of collaboration between U.S. and foreign commercial airframe and engine firms? It is difficult to construct a credible counterfactual case to answer this question. The two U.S. firms that have been most successful in establishing and managing these undertakings, Boeing and General Electric, have maintained access to important foreign markets, while simultaneously financing ambitious new product development programs. The U.S. firm that has been least successful in international joint ventures, McDonnell Douglas, was squeezed out of the large commercial transport industry in large part because of its inability to bring new products to market in a timely fashion.

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    On the other hand, McDonnell Douglas's international joint venture in China significantly enhanced its access to this large market.

    Moreover, despite criticism of U.S. firms for "giving away the future" through these joint ventures (see Prestowitz, 1992; Reich, 1986; Reich and Mankin, 1986; and a very different view in Reich, 1990), which critics claimed would build up robust foreign competitors that would enter the large commercial transport industry, there is little evidence of imminent entry by Fiat, Aeritalia, Mitsubishi Heavy Industries, Shorts Brothers, or Saab Aircraft into the large commercial aircraft industry. Indeed, the costs and risks associated with such entry are forbidding and have contributed to the decline in the number of producers of airframes and engines. As the Commerce Department's senior aerospace analyst, Sally Bath, pointed out in her remarks at the National Research Council's June 1997 Workshop on Aerospace Offsets (Bath, 1997), there is virtually no evidence that their engagement in military offset and co-production arrangements significantly enhanced the technological or competitive capabilities of the Airbus Industrie member firms.

    The most serious competitive consequences of collaboration between U.S. and foreign airframe and engine firms appear to have been felt by the supplier tier of the U.S. aerospace industry (see Mowery, 1987; Friedman and Samuels, 1992). Many supplier firms are relatively small and lack strong proprietary technological capabilities. In this industry, as in other U.S. manufacturing industries, the relationship between suppliers and the "prime contractor" firms has often been adversarial, with limited sharing of technology, management skills, or financing. The involvement of foreign firms as risk-sharing subcontractors with U.S. prime contractors has strengthened their technological capabilities and has intensified competitive pressures on U.S. supplier firms. These competitive pressures, in combination with reductions in U.S. defense spending, have contributed to the exit of large numbers of firms from this segment of the U.S. commercial and defense aircraft industries. This consequence of international collaboration is worth noting, because it could produce a more restrictive U.S. government policy toward international collaboration in this industry. At the same time that it has intensified competitive pressure on U.S. suppliers, however, increased international teaming in the commercial aircraft industry, which includes the use by foreign firms of U.S. suppliers, has contributed to robust demand for exports of U.S. components and parts.

    Outside of the supplier tier within the U.S. commercial aircraft industry, the rise of international joint ventures is much more a response to changing international competitiveness rather than a cause of eroding U.S. competitiveness. In the absence of far-reaching and unlikely changes in the nature of restrictions to market access and significant restrictions on foreign governments' ability to subsidize domestic aerospace firms (an equally unlikely possibility that I discuss below), international collaboration seems likely to continue. Indeed, such

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    collaboration seems to be indispensable to the survival and vitality of the prime contractor firms within the U.S. commercial transport industry.

    Outlook

    The forecasts of regional demand for large commercial transports discussed above suggest that, despite the importance of the North American market for the next decade, a large share of near-term growth in demand, and a growing share of long-term growth, lies in foreign markets. Moreover, many of these foreign markets, especially those in Asia, are in economies undergoing rapid industrialization and significant improvements in indigenous technological capabilities. As a result, the number of foreign firms with the requisite design, engineering, and production skills to supply U.S. aerospace firms, or to work with them in developing new products, continues to grow. The costs and associated risks of new product development in commercial aircraft also display little sign of abating. Although formal barriers to market access are not growing, nontariff barriers appear to remain significant. Privatization of the airlines that serve as the customers for U.S. exporters of airframes and engines for large commercial transports may reduce the influence of home country governments, but this is a matter of degree. As a result, internationalization of product development and manufacturing activities in the commercial aircraft industry is almost certain to continue.

    Two recent developments will affect collaboration in civil aerospace. The first is the rapid growth of the Chinese market for civil aircraft. As China's economy continues to grow rapidly, demand for air travel in China is projected to grow more rapidly than any other market. At present, entry into the Chinese market is closely controlled by the central government, and foreign manufacturers of commercial aircraft face significant demands for direct and indirect offsets. Because overt government pressure for various types of performance requirements in civilian products is subject to discipline under the World Trade Organization's (WTO) Uruguay Round accords, the terms under which China is allowed to join the WTO may constrain these demands for offsets. Successful demands by Chinese negotiators for lengthy transition periods in meeting provisions of the WTO agreement, however, could mean that demands for offsets will remain intense for the next two decades.

    A second development with very uncertain consequences for international collaboration in civil aerospace is the merger of Boeing and McDonnell Douglas, which became effective in August 1997. The consequences of this merger for offsets are uncertain for a number of reasons, most prominent among which is the fact that Boeing has committed itself to maintain the product lines of McDonnell Douglas's civil aircraft division for a decade and to manage this division as an independent subsidiary. Beyond this commitment, made to address objections by the Commission of the European Union to the merger, little is yet known about the role that McDonnell Douglas's civil aircraft operations will play within the

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    combined enterprise. To the extent that Boeing is able to control McDonnell Douglas's marketing decisions, it may succeed in removing one (relatively weak) competitor from a portion of its foreign markets. Such a policy could reduce the purely commercial pressures on Boeing to provide opportunities for collaboration with foreign firms to gain access to their markets. Moreover, McDonnell Douglas's substantial operations in China may provide additional opportunities for Boeing to penetrate this important market without providing additional offsets. The merger thus may remove one modest source of pressure on the leading U.S. airframe producer to expand its international collaborative efforts. But the complex nature of the motives for these collaborative undertakings means that the effects of the merger on Boeing's international activities are likely to be small.

    The very large aerospace industry of the former Soviet Union has undergone considerable rationalization and restructuring, and at least some Russian firms now appear poised to enter foreign markets, mainly within the Commonwealth of Independent States (CIS), for civilian aircraft. The data in Table 4 forecast growth in revenue passenger miles in the CIS states during 1997-2006 that is second only to China. The CIS market may be relatively unattractive to U.S. or European producers because of severe financial constraints of prospective customers and a consequently high reliance on countertrade. But these markets may prove attractive to Russian aerospace firms, providing a relatively noncompetitive market within which to develop experience, improve quality and product support, expand production, and move down learning curves, etc. Russian aerospace firms are likely to become more effective competitors to U.S. and European firms sometime in the next century, and should it develop, such competition will intensify pressure on U.S. and European firms to provide more generous terms in their export sales. Alternatively, Russian and other CIS aerospace firms may develop into attractive partners for U.S. or European aerospace exporters. The revival of Russia's civilian aerospace sector thus is likely to provide yet another impetus to increased international collaboration.

    The revival of Russia's military aerospace industry, combined with the collapse of its domestic market, could also have significant effects on the future of military aerospace offsets. Not only Russia, but virtually all of the NATO governments are reducing their procurement budgets, simultaneously with rapid growth in defense spending in the former Warsaw Pact nations, Latin America, and China. Many of the NATO allies also have significant domestic military aerospace industries, which will seek foreign markets more aggressively in the future. Competition among U.S., European, and former Warsaw Pact aerospace firms in export markets thus seems likely to intensify considerably. Should this forecast prove to be true, pressure on U.S. firms to offer more generous offset terms could intensify. Thus far, U.S. exporters of military weapons appear if anything to be increasing their market share—the Congressional Research Service reports that in 1996, U.S. firms accounted for 35.5 percent of international arms sales, a share more than twice as large as that of the next leading exporter,

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
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    Great Britain (Shenon, 1997). Moreover, if the trends identified in the recent Commerce Department survey of military offsets remain valid, this increased market share has not come at the cost of more-generous offset agreements. But in the absence of data on the share of offsets in U.S. military exports in 1996, this conclusion remains speculative.

    Policy Issues

    Although there is little compelling evidence that offsets have been a significant contributor to recent employment declines in the U.S. aerospace industry, they do distort trade flows and therefore reduce economic efficiency and welfare in the United States. But designing a policy to address offsets alone is ill-advised, in view of their modest economic effects. Instead, dealing with the causes and consequences of aerospace offsets should be addressed as one element of overall policies to deal with international trade and investment, as well as the adjustment needs of U.S. workers affected by these trade and investment flows. In other words, offsets per se are not the central issue for policy in the aerospace industry; instead, U.S. trade policy must focus on reducing governments' resort to subsidies, market access restrictions, and performance requirements in sales of military and civil aircraft. Domestic policies complementing these international policies would provide a stronger infrastructure for assisting workers displaced by trade, technology, and other causes of economic change. Internationalization in the aerospace and other U.S. industries is a fact of life. The policy challenge is adjusting to this reality in international and domestic policies.

    Corporate Policies

    The discussion in this subsection focuses on government policies. Discussions of offsets and other forms of international collaboration frequently recommend new approaches or responsibilities by managers in consulting with their workers, meeting on an informal or formal basis with policy makers, etc. (see Barber, 1997, and the report of the Committee on Japan of the National Research Council, 1994). Greater consultation and discussion between management and workers within firms engaged in international collaborative ventures seems eminently sensible and advisable. But consultations between management and workers over aerospace firms' plans for future international collaboration are a matter of corporate self-interest, and exhortations from policy makers are likely to have little influence on U.S. firms' use of such discussions. There are no policy-induced impediments to these consultations. Similarly, recommendations for an industry-government advisory council on aerospace issues (National Research Council, 1994) seem unlikely to change either the quality of information available to policy makers or the willingness of corporate managers to share sensitive information on international collaborative arrangements with policy makers. Such

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    a forum might serve as a useful "neutral ground" for union leadership and senior corporate management to discuss long-term trends in the aerospace industry, and such consultations would be beneficial. Beyond this role, however, the utility of an advisory committee whose formation and public statements are not driven by a specific, imminent crisis is very limited.5 Moreover, because offsets and other forms of international collaboration are affected by a number of policies or impending policy initiatives that are well within the purview of federal policy makers, this discussion focuses on these policies rather than the creation of yet another federal advisory committee.

    Trade and Related International Policies

    With this in mind, the four most important areas for policy to address offsets and other trade issues in aerospace are (1) completion of the WTO accession agreement with China, ensuring that meaningful disciplines are imposed on Chinese government procurement within the near term (i.e., less than 15 years); (2) continued efforts to strengthen the existing WTO agreements on government procurement, subsidies, and trade-related investment measures (TRIMs); (3) enforcement and improvement of existing U.S.-European Union agreements on aerospace trade, including the 1979 Agreement on Trade in Large Civil Aircraft and the 1992 U.S.-European Union agreement on commercial aerospace subsidies; and (4) completion of negotiations over the proposed NATO Code of Conduct for intra-alliance trade in weapons systems.

    The existing array of policy tools with which to address foreign government-mandated offsets is in fact quite extensive, albeit much more comprehensive in its coverage of civil aerospace trade than of military exports. Existing WTO agreements without exception provide extensive loopholes for national security-related transactions, and U.S. trade negotiators have used these in the past to justify a variety of decisions, such as restrictions on machine tool imports. Nevertheless, the proposed NATO Code of Conduct could introduce important disciplines into intra-alliance trade and might serve as a template for eventual extension to cover military sales to other foreign markets for U.S. weapons, such as Latin America and Asia, that are expected to expand rapidly in the next decade.

    Two other U.S. policies that exert a powerful influence on the incidence of offsets in foreign military sales also should be reviewed and revised in conjunc-

    5  

    The most credible recent recommendation for such an advisory committee, which was contained in the recent report of the Committee on Japan of the National Research Council (1994), compares the role of an aerospace advisory committee favorably with that of the National Advisory Committee on Semiconductors (NACS). But the (very brief) prominence and influence of NACS were largely driven by the perceived crisis of competitiveness and trade in the U.S. semiconductors of the 1980s, and the NACS' role as a forum for the creation of a long-term "shared vision" has been almost nonexistent.

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    tion with any multilateral negotiations over military offsets. At present, a substantial exception to U.S. official policy (articulated in a White House April 1990 statement) sanctions foreign governments' use of offsets in export sales financed by U.S. taxpayers through the U.S. Foreign Military Financing (FMF) program. The primary recipients of this aid are Turkey, Greece, Egypt, and Israel, and according to the U.S. General Accounting Office (1994a), all four nations have obtained offsets for FMF sales of U.S. weapons. Imposition of stronger prohibitions on offsets in these sales might at least reduce the extent of U.S. taxpayer subsidies to foreign government use of trade-distorting measures in association with U.S. military exports.

    A second set of U.S. policies affecting military offsets that merit review and possibly elimination as part of multilateral negotiations is the "domestic content" provisions that are imposed by Congress or the Pentagon in many procurement programs. The "buy American" provisions and the U.S. Defense Department's insistence on North American sources of supply for weapons being purchased in substantial quantities from foreign producers operate in much the same way as foreign government offsets. Progress in any international negotiations over disciplines on offsets is unlikely without some willingness by the U.S. government to accept greater discipline on its use of these policies.

    Domestic Adjustment Policies

    Even the most effective set of international agreements, however, will not reverse the powerful trends that are increasing international collaboration in the military and civil aerospace industries. These trends may well increase the instability of aerospace employment and are likely to displace additional workers. Maintaining and liberalizing international trade in goods and technology in aerospace and other industries will remain difficult in the absence of a more coherent program of government assistance to aid workers (as opposed to their employers) in adjusting to the consequences of trade liberalization and economic change. Current public policies to support investments of public and private funds in work force adjustment are best described as chaotic. Federal policies to support adjustment by displaced workers remain a patchwork of categorical programs, many of which are encumbered with complex eligibility requirements that limit their effectiveness. The U.S. General Accounting Office (1994b) found 154 federal employee training programs with a total budget of $25 billion in the federal budget for 1993-1994, an estimate that includes almost $9 billion in student loan programs. Among the largest programs designed to assist workers' adjustment to economic change are Trade Adjustment Assistance (TAA), which accounted for $215 million in 1993-1994 spending, and the Job Training Partnership Act (JTPA), which (including its Job Corps component) accounted for $5.2 billion.

    The TAA program is aimed specifically at the "losers" from internationalization, workers displaced by import competition. Paradoxically, political support

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    for TAA (and, therefore, funding) has crumbled during a period of rapid expansion in import penetration of the U.S. economy. One reason for this program's limited political support may be its poor track record. TAA's requirements for ascertaining that a worker has been displaced by imports, as opposed to the myriad of other potential causes, severely delay the delivery of income support payments and virtually preclude retraining for displaced workers.6 These problems in this program illustrate the serious handicaps imposed on ''adjustment assistance" programs by strict eligibility requirements that are based on the cause of displacement. However politically appealing such requirements may be, they can impair the success of programs designed to support worker adjustment.

    The other major federal program for meeting the needs of displaced workers is the JTPA, created in 1982 to replace the Comprehensive Employment Training Act. JTPA's primary assistance to displaced workers, however, remains focused on job search assistance, and the structure of its service delivery system is such that workers with relatively low skills, who are often harder to place in new jobs, tend to be underserved. JTPA also provides relatively little by way of education in basic skills (Cyert and Mowery, 1987), which reinforces a tendency for the program to deal more effectively with relatively better-educated workers within the displaced population.

    In summary, the potential economic returns to a stronger set of institutions for the support of investments in the skills of the U.S. labor force appear to be substantial, particularly in an era of rapid internationalization and economic change. But more-effective policies require cooperation among institutions (public education, local government, organized labor, and employers) over which the federal government exercises little direct control and will be difficult to develop in a political atmosphere of considerable mistrust between business and the federal government. Improvements in programs for displaced workers also are hampered by limited understanding of the factors that are most important to program success.

    Conclusion

    For decades, aerospace has presented extreme cases, either in timing or magnitude, of "globalization" trends visible in other industries throughout the U.S. economy. This industry has been closely linked with national security policies, it has been a long-time beneficiary of federal funding of military and civil research and development programs, and it has experienced "alliance-based" internation-

    6  

    One 1979 study of TAA's operations during the late 1970s found that workers received their first payments on average of 14 months after layoff (Corson et al., 1979). More-recent evaluations of TAA (U.S. General Accounting Office, 1994b) found that program participants received no training in their first 15 weeks of unemployment.

    Suggested Citation:"III. Papers: Offsets in Commercial and Military Aerospace: An Overview." National Research Council. 1999. Trends and Challenges in Aerospace Offsets. Washington, DC: The National Academies Press. doi: 10.17226/6315.
    ×

    alization to a greater extent than most other high-technology industries in the postwar United States. The issues of offsets and international collaboration are most appropriately viewed in this light. The forces giving rise to them are not unique to aerospace, although they may be more visible and powerful in this sector. And the policies to address their consequences also should not be conceptualized as "unique" in some sense to aerospace. The challenges created by internationalization in civil and military aerospace will be present for decades to come in most U.S. manufacturing and service industries.

    As such, it is also worth noting that these challenges are themselves the fruits of a 50-year U.S. policy of support for economic reconstruction and development, support for trade liberalization, and engagement with the international community that has been spectacularly successful. Dealing with these results of success is vastly preferable to dealing with the far more dangerous world that would have attended the failure of such policies.

    Acknowledgements

    This paper is based on remarks prepared for the conference organized by the National Research Council's Board on Science, Technology and Economic Policy on "Policy Issues in Aerospace Offsets" held in Washington, D.C., June 9, 1997. Research for this paper was supported by the Alfred P. Sloan Foundation and by the Air Force Office of Scientific Research.

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    The granting of offsets to promote exports of major aircraft systems has been a source of significant controversy. Critics believe that offsets undermine the U.S. manufacturing base; lead to the transfer of commercial technology, possibly affecting national security; and result in the loss of high-wage jobs. Defenders of the practice argue that offsets are a fact of commercial life and can result in net U.S. job gains.

    In an effort to focus the offsets debate on analytical issues, the White House National Economic Council asked the National Research Council to convene expert academicians, representatives from the aerospace industry, and top government officials to discuss the impact of offsets on the U.S. economy. To ensure a rigorous discussion encompassing all points of view, the conference included a series of papers outlining the positions of key participants. This resulting volume offers a comprehensive and up-to-date analysis of the impact of aerospace offsets.

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