Offsets in Defense Trade Fifth Annual Report To Congress - United States Department of Commerce - Illustration - Statistical Data Included

DISAM Journal, Fall, 2001

Prepared By The U.S. Department of Commerce

[The following material is extracted from an May 2001 U.S. Department of Commerce study entitled, Offsets in Defense Trade, a Study Conducted Under Section 309 of the Defense Production Act of 1950, as amended. (1) The report was produced by the Strategic Analysis Division in the Office of Strategic Industries and Economic Security of the Bureau of Export Administration (BXA). This report covers the six-year period from 1993 through 1998. Some of the footnotes and tables have been omitted; the footnote and table numbers remain the same as in the original. Complete copies are available for sale from the Government Printing Office by calling (866) 512-1800 and requesting publication #003-009-00722-4.]

Introduction

Legislation and Regulations

In 1984, Congress enacted amendments to the Defense Production Act of 1950, which included the addition of Section 309. (3) Section 309 requires the President to submit an annual report on the impact of offsets on the United States to the then Committee on Banking, Finance, and Urban Affairs of the House of Representatives and the Committee on Banking, Housing, and Urban Affairs of the Senate.

When Section 309 was first enacted, the Office of Management and Budget (OMB) was appointed the interagency coordinator in the preparation of the annual offsets report for the Congress. The report was to be produced in consultation with the Departments of Commerce, Defense, and Labor, and the Office of the United States Trade Representative. This interagency reporting requirement continued, with minor adjustments, until 1992, when the Congress amended Section 309 by requiring the Secretary of Commerce to perform the interagency coordination role. (4) The Department of Commerce sent its first annual report to Congress in 1996.

Section 309 authorizes the Secretary to develop and administer regulations to collect required offset data from the defense industry for the report. This responsibility was delegated to the Department's Bureau of Export Administration (BXA). The Department's offset regulations were published in the Federal Register in 1994 (59 FR 61796, Dec. 2, 1994, codified at 15 CFR Part 701). The 1992 amendments to section 309 also reduced the offset agreement threshold from $50 million to $5 million for U.S. firms entering in to foreign defense sales contracts subject to offset agreements. On a per-transaction level, firms report all offset transactions for which they receive offset credits of $250,000 or more. An itemized list of information that is collected annually from industry is in Section 701.4 of the Department's offset regulations.

The official U.S. government policy, developed in 1990, views offsets as economically inefficient and market distorting. Offsets introduce a new element into the purchase decision unrelated to the price or quality of the products. The policy states that the U.S. government will not encourage or enter into any such agreements itself nor provide financing for such arrangements. The decision whether to engage in offsets, and the responsibility for negotiating and implementing offset arrangements, resides with the companies involved. The U.S. policy also calls for consultations with our allies regarding limiting the adverse effects of offsets in defense procurements. (5)

1.2 Offset Definitions

While there are different definitions of offsets used by industry and government for different purposes, for this report offsets in defense trade are industrial compensation practices required as a condition of purchase in either government-to-government or commercial sales of defense articles and/or defense services as specified in the International Traffic in Arms Regulations.

1.21 Offset Agreements

Offset agreements are commercial contracts between a defense firm and a foreign government. As noted above, the United States government does not actually enter into any offset agreements. Only in rare instances are offset agreements concluded between a defense firm and a foreign firm. The purchasing government decides how much compensation is required and what type of offset it desires. Firms can propose various products and services, but ultimately it is the foreign government's decision what the offset will entail. The value of the offset, and therefore the credit amount the defense firm receives for providing that offset, is assigned by the foreign government as well. Offset agreements specify a certain percentage of the value of the export sale. (6)

Penalties are used to motivate defense firms to fulfill their offset obligation in the time allotted by the contract. There are several different kinds of penalties: liquidated damages, nonperformance measures, and best efforts. For liquidated damages, if a firm falls to fulfill all offsets by the stipulated deadline, it must pay a percentage (usually 5-20 percent) of the total value of the export contract. The percentage is specified in the contract non-performance penalties dictate that firms must pay a prearranged percent (2-10 percent) of all obligations not fulfilled in the allotted time. In best efforts clauses, there really is no penalty for non-fulfillment of the contract; the firm is judged to be acting in good faith to meet its obligations. However, firms' reputations can be jeopardized if offset obligations are not fulfilled as stated in the contract; non-fulfillment would likely result in the U.S. defense firm being excluded from future procurements by that purchasing government.