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While virtually all governments engage in offsets to one extent or another, five countries account for about 72 percent of new offset requirements, by value-the United Kingdom, the Netherlands, Switzerland, Saudi Arabia, and Taiwan. In the period that I have mentioned, 1993 to 1996, European countries demanded 94 new offset agreements worth about $10 billion in return for $11.3 billion in defense purchases. That is about a 90 percent offset rate.

The United Kingdom, I would note, has one of the most aggressive offset programs. Not only does Britain demand nearly 100 percent offsets against their United States military purchases, but the British Government also has established a program to assist their companies meet offset requirements demanded by other countries.

Canada's offset program is also quite aggressive, and is designed to enhance its general economic development, rather than its national security or defense industries in particular. Again, Canada tends to require 100 percent offsets, most of them indirect. It does so despite the fact that we offer special access to Canadian firms in our markets.

Is there a better way of sharing the benefits of defense trade than resorting to these offsets? Probably. The development and production of extensive weapons systems through international partnerships would be a better approach, in our view, for example.

Our allies have been reluctant to discuss and negotiate limits on offsets for a variety of reasons. I think some of them regard offsets as an economic win; others are responding to political factors; overcapacity and excess employment in the European defense industries have increased pressure for offsets in order to keep European defense facilities operating.

So where do we go from here, Mr. Chairman and members of the subcommittee? Official U.S. Government policy, as has been noted, is to avoid government involvement in offsets and to actively consult with friends and allies to limit the adverse affects of offsets in defense procurement. We have had discussions over the last few years with officials of the Dutch Government and the Canadian Government. It is particularly important, I think, to make progress with the Canadians, because they are a part of our North American industrial base, and they are our closest neighbor, of course, and largest trading partner.

Our objective remains to reduce and restrict offsets where possible. It will be difficult to stifle the demand for offsets, at least in the short term. It is a buyer's market for defense systems. We are unlikely to restrain or eliminate offsets by just complaining about them. We certainly will not eliminate them by unilaterally restricting our own defense contractors.

If we are serious about further constraining offsets, I think we need to consider ways to increase our leverage, including the following.

We need to continue our efforts at international negotiations on offset rules, both on transatlantic trade with our European allies and on Third Country markets where we compete with European manufacturers. As I have mentioned, recent discussions have indicated some receptivity to our ideas in this area. We need to collect accurate information on all foreign sourcing of parts and components and weapons systems down to the subcontractor level.

Finally, Mr. Chairman, we may need to take a closer look at the British program. I mentioned, in passing, that the British Government actually assists its companies in responding to offset requirements in order to make them more competitive and to bring the demanders of offsets to the negotiating table. That's fighting fire with fire, which we may need to consider under these circumstances.

That summarizes my statement, and I thank you for your patience on the time.

[The prepared statement of Mr. Majak follows:]

TESTIMONY OF R. ROGER MAJAK
ASSISTANT SECRETARY FOR EXPORT ADMINISTRATION

U.S. DEPARTMENT OF COMMERCE

BEFORE THE U.S. HOUSE OF REPRESENTATIVES

COMMITTEE ON GOVERNMENT REFORM SUBCOMMITTEE ON CRIMINAL JUSTICE, DRUG POLICY, AND

HUMAN RESOURCES

JUNE 29, 1999 10:00AM 2154 RAYBURN H.O.B.

Mr. Chairman and Members of the Subcommittee, thank you for inviting me to testify today on the topic of offsets in defense trade. We are pleased that you have decided to review this critical issue which impacts our economic and national security. This hearing is an opportunity to inform the subcommittee on this growing problem. We view it as an important next step to the staff report prepared for Representative Tierney on this issue last October.

The Bureau of Export Administration (BXA) has a long history of involvement in defense industrial base issues. Apart from our export licensing and regulation mission, BXA is involved in a number of programs designed to maintain and enhance the competitiveness of the U.S. defense manufacturing infrastructure. BXA regularly conducts assessments of various key sectors and provides the results to the Armed Services and industry groups; assists communities in base closure and reuse; and matches technology needs of small- and medium-sized businesses with the resources of the federal labor ries

As you are aware, in the mid 1980s, Congress enacted $309 of the Defense Production Act of 1950, as amended. This legislation tasked the Administration to prepare annual reports to Congress on the effects of offsets in defense trade on U.S. industry. The Office of Management and Budget chaired an interagency team, to which BXA belonged. In 1992, Congress amended the Defense Production Act and shifted the responsibility to the Department of Commerce where it was delegated to BXA.

To date, we have prepared three annual reports and are working on a fourth, which will be submitted later this summer. These reports are based largely on data collected from U.S. prime contractors, supplemented with data gathered from other surveys and outside research. As with the reports prepared by OMB, BXA coordinates this process with the Departments of Defense, Labor, State, and Treasury, and the Office of the U.S. Trade Representative.

To begin, I'd like to provide the offset definition that we use in the preparation of our annual reports: Offsets are industrial compensation practices mandated by foreign governments when purchasing defense-related articles and services. They can include coproduction, licensed

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production, subcontractor production, technology transfer, overseas investment, and countertrade.

Offsets can be either direct or indirect. Direct offsets, as the name implies, are forms of compensation directly related to the weapon system or other defense article being purchased. An example of a direct offset would be the production of a wing component for a fighter in the purchasing nation. Indirect offsets, in contrast, are those fulfilled in a wide variety of ways not related to the system that is purchased. Examples of indirect offsets include the sale of nondefense products manufactured in the buyer country or the development of non-defense industries, such as software. What is the problem with offsets? Why has BXA and the rest of the interagency community focused so much attention on the issue? There is no doubt that offsets are a reality of the international defense marketplace. Practically every country that purchases modern weapon systems demands offsets, whether they call them offsets or, as our British allies prefer, "industrial participation," or, as our friends to the north refer to them, “industrial regional benefits," or, in Israel, "industrial cooperation." Regardless of the label attached to the practices, the fact is that a U.S. prime contractor cannot even hope to bid in most cases without offering an offset package along with its sales proposal.

The official U.S. Government policy, developed during the Bush Administration, 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 directs 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. U.S. policy also calls for consultations with our friends and allies regarding limiting the adverse effects of offsets in defense procurement. In light of some of our activities and consultations with our allies, which I will describe, I will later offer a statement of principles to be considered which will strengthen our position in negotiating for an end to offsets.

As the Committee will hear today, some argue that offsets facilitate U.S. exports and improve U.S. competitiveness; that they are a reality of the marketplace; and that they promote national security by enhancing weapon system interoperability. Others will counter that offsets are a misuse of the national security waiver for government defense procurement; they enhance the position of foreign competitors; and they have adverse employment, industrial, and technological impacts on the U.S. subcontractor base. All of these arguments have merit. The real question is, can we and should we do something to control offsets?

The prime contractors see offsets as a necessary evil, a reality of doing business in the international marketplace. They will continue to agree to offset arrangements as long as they are a mandatory condition of the sale, and they fear any unilateral moves on the part of the U.S. government to limit the use of offsets in international defense trade. Their position is understandable, as their actions are based on self interest.

Let me provide an example: The United States provides Israel with grant money to purchase U.S. defense systems. Right now, Boeing and Lockheed Martin are in a virtual dogfight over a $2.5

billion contract with the Israeli government for the purchase of fighter aircraft. The focus seems not to be on whether Boeing's F-15 or Lockheed Martin's F-16 is the better plane. Rather, the decision seems to hinge on who can promise the most offset work in Israel. The Israeli government was expected to announce its selection a month ago; instead, both contractors were asked to augment their bids. Now, the decision is on hold, waiting for the incoming government. American taxpayers provided the grant aid for this purchase, and the U.S. economy will bear the further cost of the offset arrangements, as the deal may result in technology transfer and displacement of U.S. subcontractor work.

Let me spend a few minutes going over some of the data from our 1998 report to Congress to give you an understanding of the scope and magnitude of offsets. New offset agreements with all foreign countries totaled $15.1 billion and supported $29.1 billion in export contracts from 1993 to 1996. This is about 52 percent of the value of the export contracts. For 1995-1996, the average offset jumped to about 80 percent. Preliminary figures for 1997 indicate that the average offset as a percent of export contract value is above those reported for 1993-1996. Based on our discussions with U.S. prime contractors, we expect that average to continue to climb toward 100 percent or more in the near future.

We also measure offset transactions, which are activities, like coproduction, technology transfer and countertrade, carried out by U.S. companies to fulfill agreements entered into in the same year or earlier. Transactions reached $9.2 billion between 1993 and 1996. About 38 percent of the transactions were direct offsets, 58 percent indirect, and 4 percent unspecified. About threefourths of the actual value of all transactions were subcontracting activity, purchases, or technology transfer arrangements with our allies. This contradicts the notion that offsets do not have a widespread impact on our nation's industrial base; many offset-related transaction result in displacement of U.S. subcontractor work, lost revenue, and inevitably lost jobs for U.S. suppliers.

The adverse impact of offsets goes beyond the suppliers in the defense prime contractor's sector. Between 1993 and 1996, over 90 percent of the new offset agreements and offset transactions referenced exports of U.S. aerospace weapon systems, primarily aircraft, engines, and missiles. However, almost half of the offset transactions were fulfilled with non-aerospace products. This means that our aerospace prime contractors are fulfilling their offset responsiblities through activities in other sectors of the U.S. economy. We have heard complaints from groups like the American Shipbuilders Association, whose members have lost potential sales due to offset arrangements. In fact, our database shows almost $800 million in shipbuilding-related offset activities between 1993 and 1997. This industry has been impacted by offsets, despite not having offset agreements of their own or even defense export sales.

Another illustration of the widespread impact of offsets on our defense industrial base is that nearly 83 percent of the more than $9 billion in offset transactions were manufactured products. Three-fourths of the offset transactions fell into three major industry groupings:

Transportation Equipment (48 percent); a sub-group, SIC 372 - Aircraft and Parts,
alone accounted for 33 percent
Electronic and Electrical Equipment (16 percent); and
Industrial Machinery (9 percent).

1. SIC 37

2. SIC 36 3. SIC 35

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