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ANNUAL REPORT ON DISCRIMINATION IN FOREIGN GOVERNMENT

PROCUREMENT
Office of the United States Trade Representative

April 30, 1999

Offsets in Defense Trade

When purchasing defense systems from U.S. defense prime contractors, many U.S. trading partners require compensation in the form of offsets as a condition of purchase in either government-to-government or commercial sales of defense articles and/or defense services. Offsets include mandatory coproduction, licensed production, subcontractor production, technology transfer, countertrade, and foreign investment. Offsets may be directly related to the weapon system being exported, or they may take the form of compensation unrelated to the exported item, such as foreign investment or countertrade.

Prime contractors view offset arrangements as a necessity for success in the international marketplace. However, offset requirements cause prime contractors to select subcontractors based on their being located in the country requiring the offset versus best value, thereby adversely affecting potential U.S. subcontractors. Originally designed to enhance allied national security, offsets increasingly have become economic development tools for the countries that demand them. Furthermore, there has been a recent trend to fulfill offset requirements with nondefense products versus defense products.

Mr. MICA. Thank you for your testimony. We will withhold questions until we have heard from the Honorable Alfred Volkman, who is the Acting Deputy Under Secretary of Defense for Commercial and International Programs with the Department of Defense.

Welcome, sir. You are recognized.

Mr. VOLKMAN. Good morning, Mr. Chairman, members of the subcommittee. I appreciate this opportunity to participate in these discussions on the subject of offsets in international trade.

As almost all of our panelists have noted this morning, there is no consensus on the subject of offsets. Government agencies have a range of views on the topic, and industry opinion on the matter is also divided. There is no definitive evidence of the effect of offsets on the U.S. economy. Views on their effect are generally divided between those who accept offsets as an unavoidable cost of doing business overseas and those who believe that offsets negatively affect the defense industrial base and other U.S. interests.

It is difficult to accurately measure the impact of offsets on the overall U.S. economy and on specific industry sectors that are cr cal to defense. The GAO reports that U.S. defense companies advised them that without offsets, most export sales would not be made and the positive effects on the U.S. economy and defense industrial base would be lost. In addition, company officials indicated that export sales provided employment for the defense industry and orders for larger production runs, thus reducing unit costs to the U.S. military. They also noted that many offset deals created new profitable business opportunities for themselves and other U.S. companies.

Critics, however, charge that offsets have effects that limit or negate the economic and defense industrial base benefits that claim to be associated with defense export sales.

In response to concerns raised by the impact of offsets, the President issued a policy statement in 1990 that reaffirmed DOD's longstanding policy of not encouraging or participating directly in offset arrangements. This policy statement also recognizes that certain offsets are economically inefficient, and directed that an interagency team led my DOD, in coordination with the Department of State, consult with foreign nations on limiting adverse effects of offsets in defense procurement.

The Department of Defense fully supports the policies articulated by the Congress and the administration concerning the need to negotiate with friendly and allied governments to eliminate the harmful effects of offsets in defense trade. My office has been actively engaged in discussing offsets with key allies during our regular meetings on reciprocal defense procurement activities. In addition, we have cosponsored seminars, organized by independent organizations such as the National Research Council, to better understand and deal with the complex and growing world of offset demands in international trade.

More recently, we initiated action to lead an interagency team, including representatives from the Department of State, Department of Commerce, Department of Labor, and the Office of the U.S. Trade Representative that has met bilaterally with officials from Canada and the Netherlands on the subject of the harmful effects of offset demands in defense trade.

Our allies consistently tell us that they need offsets because they perceive that the U.S. defense market is not open to them due, at least in part, to protectionist legislation. In particular, they cite congressional reluctance to change Buy America and small business preference legislation. We believe that offsets should be considered as one, among many, practices that distort defense trade, and consequently, negotiating the offset issue by itself does not give the United States a strong bargaining position.

Furthermore, officials from the defense industry have expressed concern about any unilateral action by the U.S. Government that would limit the use of offsets, stating that such action, as Mr. Johnson said earlier, would place U.S. exporters at a competitive disadvantage in winning overseas defense contracts.

The Department of Defense is prepared to continue to work with other Federal agencies, our allies, and the defense industry to monitor the employment and effect of offsets in international trade, to ensure that U.S. Government policies of action or inaction do not compromise broader U.S. national interests. The DOD will continue to support U.S. industry interests when they are forced to comply with foreign government-mandated offsets, while working to discourage our foreign friends and allies from requiring offsets. However, the Department would be very concerned over any U.S. Government actions that would diminish the competitiveness of the U.S. defense industry or harm the Department's efforts to achieve military interoperability with our allies.

Mr. Chairman, thank you very much for this opportunity. I am prepared to answer any questions you may have. Thank you.

[The prepared statement of Mr. Volkman follows:]

STATEMENT BY

MR. ALFRED VOLKMAN

ACTING DEPUTY UNDER SECRETARY OF DEFENSE

(INTERNATIONAL PROGRAMS)

TO THE

SUBCOMMITTEE on CRIMINAL JUSTICE, DRUG POLICY, and

HUMAN RESOURCES

OF THE

HOUSE COMMITTEE on GOVERNMENT REFORM

JUNE 29, 1999

Good afternoon Mr. Chairman, and members of the Subcommittee. I want to thank you for this opportunity to participate in discussions on the subject of offsets in international trade. The Department of Defense is keenly aware of the many issues associated with offsets in defense trade. We are also aware of the many ambiguities associated with offsets and offset issues. I look forward to contributing the DoD perspective to this discussion

As the members of this Subcommittee know very well, there is no national consensus on the subject of offsets. Government agencies have a range of views on the topic and industry opinion on the matter is divided. There is no definitive evidence of the effects of offsets on the US economy. Views on their effects are generally divided between those who accept offsets as an unavoidable cost of doing business overseas and those who believe that offsets negatively affect the defense industrial base and other US interests. It is difficult to accurately measure the impact of offsets on the overall US economy and on specific industry sectors that are critical to defense.

With the end of the Cold War, military establishments around the world have been decreasing their force structures and spending by significant amounts. The decline in defense spending has served to highlight the linkages between the economics of international trade in armaments and political-military · security issues: Naturally, this has lead to a debate on the US policy toward offsets.

The GAO has reported that US defense companies advised them that without offsets most export sales would not be made, and the positive effects on the US economy and defense industrial base derived from our dominant position in defense sales abroad would be lost. In addition, company officials indicated that export sales provide employment for the defense industry and orders for larger production runs, thus reducing unit costs to the US military. They also

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