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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

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--> 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

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--> 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.

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--> 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-

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--> 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-

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--> 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

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--> 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).

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-->     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,

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--> 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

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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.

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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.

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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

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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

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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,

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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

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--> 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.

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--> 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

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--> 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.

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--> 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. References Aviation Week and Space Technology. 1977. "Japanese doubts rising over F-15. P-3C." June 6, pp. 201-207. Barber, R. 1997. Assumptions and questions. In C.W. Wessner and A.W. Wolff, eds., Policy Issues in Aerospace Offsets: Report of a Workshop . Washington, D.C.: National Academy Press. Bath, S. 1997. The Airbus experience. In C.W. Wessner and A.W. Wolff, eds., Policy Issues in Aerospace Offsets: Report of a Workshop. Washington, D.C.: National Academy Press. Boeing Commercial Aircraft Company. 1997. 1997 Current Market Outlook. Seattle, Wash.: Boeing Corporation. Cole, J. 1994. "Boeing to expand China operations, names new president for unit there." Wall Street Journal, August 9, p. A2. Cyert, R.M., and D.C. Mowery, eds. 1987. Technology and Employment : Innovation and Growth in the U.S. Economy. Washington, D.C.: National Academy Press. Donne, M. 1987. "Dunlop joins U.S. group in Airbus contract bid." Financial Times. September 17, p. 6. Dornheim, M.A. 1994. "Airframe makers temper bullish predictions." Aviation Week and Space Technology, March 14, pp. 72-72. Friedman, D.B., and R.J. Samuels. 1992. How to Succeed without Really Flying: The Japan Aircraft Industry and Japan's Technology Ideology. Paper presented at the National Bureau of Economic Research conference on Japan and the U.S. in Pacific Asia. April 1-3. Holusha, J. 1994. "Can Boeing's new baby fly financially?" New York Times, March 27, Section 3, p. 1.

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--> Moran, T.H., and D.C. Mowery. 1995. Aerospace. Daedalus Mowery, D.C. 1987. Alliance Politics and Economics: Multinational Joint Ventures in Commercial Aircraft. Cambridge, Mass.: Ballinger. Mowery, D.C. 1988. Joint ventures in the U.S. commercial aircraft industry." In D.C. Mowery, ed., International Collaborative Ventures in U.S. Manufacturing . Cambridge, Mass.: Ballinger. Mowery, D.C. 1994. Science and Technology Policy in Interdependent Economies. Boston, Mass.: Kluwer. National Research Council. 1994. High-Stakes Aviation: U.S.-Japan Technology Linkages in Transport Aircraft. Committee on Japan. Washington, D.C.: National Academy Press. Prestowitz, C.V. 1992. The McDonnell Douglas-Taiwan Aerospace agreement: selling off our birthright." Journal of Policy Analysis and Management 11:482-486. Reich, R.B. 1986. "A Faustian bargain with the Japanese." New York Times, April 6, Section 3, p. 2. Reich, R.B. 1990. Who is us? Harvard Business Review. Reich, R.B., and E.D. Mankin. 1986. Joint ventures with Japan give away our future. Harvard Business Review. Scott, R. 1997. Trends and issues in aerospace employment. In C.W. Wessner and A.W. Wolff, eds., Policy Issues in Aerospace Offsets: Report of a Workshop. Washington, D.C.: National Academy Press. p. 32-33. Shenon, P. 1997. "U.S. increases its lead in world market for weapons." New York Times, August 16, p. A3. U.S. Department of Commerce, International Trade Administration. 1993. U.S. Industrial Outlook 1993. Washington, D.C.: U.S. Department of Commerce. U.S. Department of Commerce, International Trade Administration. 1994. U.S. Industrial Outlook 1994. Washington, D.C.: U.S. Department of Commerce. U.S. Department of Commerce, Bureau of Export Administration. 1996. Offsets in Defense Trade. Washington, D.C.: U.S. Department of Commerce. U.S. Department of Commerce. 1997. Unpublished data, International Trade Administration, U.S. Department of Commerce, Washington, D.C. U.S. General Accounting Office. 1992. U.S.-Japan Co-development: Update of the FSX Program. Washington, D.C.: U.S. General Accounting Office. U.S. General Accounting Office. 1994a. Military Exports: Concerns over Offsets Generated with U.S. Foreign Military Financing Program Funds. Washington, D.C.: U.S. General Accounting Office. U.S. General Accounting Office. 1994b. Multiple Employment Training Programs: Conflicting Requirements Hamper Delivery of Services. Washington, D.C.: U.S. General Accounting Office. U.S. General Accounting Office. 1996. Military Exports: Offset Demands Continue to Grow. Washington, D.C.: U.S. General Accounting Office. U.S. General Accounting Office. 1997. U.S.-Japan Aircraft. Agreement on F-2 Production. Washington, D.C.: U.S. General Accounting Office. U.S. International Trade Commission. 1994. Industry & Trade Summary : Aircraft and Reaction Engines, Other Gas Turbines, and Parts. Washington, D.C.: U.S. International Trade Commission. U.S. Office of Management and Budget. 1990. Study of Military Offsets. Washington, D.C.: U.S. Office of Management and Budget.