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agreement between most nations of the world, was established in 1947 as a result of the work of the United Nations Conference on Trade and Employment. The strategy behind this landmark agreement was to identify various protectionist measures and to convert them into tariffs to be reduced incrementally. During the 1994 “Uruguay Round” of trade negotiations, the Administration revised and updated the GATT by lowering tariffs further and by revising GATT's free trade rules in a “GATT 1994.” The Administration also was successful in negotiating specific plurilateral and multilateral trade agreements under the GATT framework. These negotiations established the World Trade Organization (WTO), a permanent organization designed to supervise the implementation of GATT and these supplemental trade agreements and to provide a forum for members to address issues affecting trade relations.

A fundamental tenet of free trade established in the original GATT is that GATT parties (now WTO members) may not take measures that cause discrimination against or among competitors based on noncommercial factors. This principle was intended to eliminate governmental interference that distorts commercial transactions otherwise governed by market forces. Two substantive provisions within GATT further this goal: Article 1 requires members to treat products from all other members equally (most favored nation or MFN treatment);4 and Article 3 requires members to treat foreign products at least as well as their own (national treatment)." The term "offsets" does not appear in the GATT, most likely because the use of offsets accelerated after the GATT was established.

Under these fundamental tenets, at least certain types of offsets would be prohibited. For example, a country presumably would violate MFN treatment if it required U.S. companies to fulfill 20% offset obligations, but required European companies to fulfill them at only 10%. Similarly, a country would violate national treatment if it required foreign manufacturers to fulfill offset obligations but did not require the same of national companies. The GATT also elaborated on these tenets by specifically prohibiting domestic content restrictions.For

** Id. art. 1.1 (“[A]ny advantage, favour. privilege or immunity granted by any contracting party to any product originating or destined for any other country shall be accorded immediately and unconditionally to the like product originating or destined for the territories of all other contracting parties.").

78 Id art. 3.4 ("[T]he products of the territory of any contracting party imported into the territory of another contracting party shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations, and requirements affecting their intemal sale, offering for sale, purchase, transportation, distribution or use."). See also art. 2.1(a) (Tariffs, the only acceptable trade barriers under GATT, are permitted as an exception to the national treatment rule, but still must be applied equally to all other members to fulfill the MFN requirement.).

76 Id. art. 3.5 (“No contracting party shall establish or maintain any internal quantitative regulation relating to the mixture, processing or use of products in specified amounts or proportions which requires, directly or indirectly, that any specified amount or proportion of any product must be supplied from domestic sources.").

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example, if a member purchased products from a foreign company, the member could not demand that some of those products be made of steel from that member's territory. Under this framework, however, it is unclear whether other types of offsets, such as requirements to transfer technology, would be prohibited.

Regardless of whether GATT's initial free trade provisions would have prohibited current day offset arrangements, other provisions created express exemptions that clearly permit the use of offsets in defense procurement. In particular, GATT explicitly exempts from its nondiscrimination rules any procurement for governmental purposes." In other words, countries may impose offsets under GATT when products are purchased for governmental purposes and not with a view to commercial resale. With respect to defense aerospace equipment, which is purchased solely for governmental purposes, the government procurement exemption would permit foreign countries to utilize offsets despite GATT's nondiscrimination provisions.

More importantly, GATT includes a provision allowing members to take any trade actions they consider necessary to protect their essential security interests.? Specifically mentioned are actions relating to traffic in arms, which, by definition, would be considered essential to national security. Thus, in light of the goverment procurement and national security exemptions, offsets are permitted under GATT for the purchase of defense aerospace articles by foreign governments. Nothing in the 1994 Uruguay Round GATT amendments altered the effect of these provisions.

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Although the Agreement on Government Procurement" was intended to extend nondiscrimination rules to government procurement, its provisions continue to allow countries to use defense offsets to further national security interests. As GATT was being updated in 1994, the Administration and representatives from other countries felt the issue of government procurement should be addressed. These countries adopted the Government Procurement

"Id art. 3.8(a) (“The provisions of this article shall not apply to laws, regulations or requirements governing the procurement by governmental agencies of products purchased for governmental purposes and not with a view to commercial resale or with a view to use in the production of goods for commercial sale.").

781d. art. 21 (“Nothing in this Agreement shall be construed ... to prevent any contracting party from taking any action which it considers necessary for the protection of its security interests (i) relating to fissionable materials or the materials for which they are derived; (or) (ii) relating to the traffic in arms, ammunition and implements of war and to such traffic in other goods and materials as is carried on directly or indirectly for the purpose of supplying a military establishment.").

"Agreement on Government Procurement. Apr. 10. 1979, T.I.A.S. No. 10403. 1235 U.N.T.S. 258. as amended in Uruguay Round Trade Agreements, Sept. 27, 1994, H. Doc. No. 103-316 (hereinatter Government Procurement Agreement).

Agreement to close the exemption left by the GATT and to extend MFN and national treatment rules to any government procurement covered by the Agreement. 80

In light of the burgeoning use of offsets since the GATT was first established, and based on several decades of experience with GATT, the Agreement went beyond GATT's original provisions to state expressly that offsets are impermissible. This provision was a great step forward in defining the practice and attempting to eliminate its effects.

There are several drawbacks and exemptions in the Agreement, however, that virtually eradicate its significance with respect to defense purchases. First, as a “plurilateral" agreement, the Government Procurement Agreement is binding only between countries that choose to sign it. Unlike other agreements, its adoption is not required as a prerequisite to membership in the WTO. In addition, since this Agreement represents only an introductory effort to apply free trade rules to government purchases, it does not cover all government procurement. Rather than a comprehensive agreement, this pact allows each Party to determine the types of products and services it will govern.2 Other impediments are that the Agreement covers purchases only above a certain monetary value and that "developing” countries are permitted to negotiate offsets as part of their accession to the agreement.


More importantly, the Agreement creates an exception, similar to its GATT counterpart, that exempts actions taken in the interest of national security.84 In other words, countries may

to 1d. art. 3.1 ("[E]ach Party shall provide immediately and unconditionally to the products, services and suppliers of other Parties offering products or services of the Parties, treatment no less favourable than: (a) that accorded to domestic products, services and suppliers [national treatment); and (b) that accorded to products, services and suppliers of any other Party [MFN].”).

''Id art. 16.1 (**Entities shall not, in the qualification and selection of suppliers, products or services, or in the evaluation of tenders and awards of contracts, impose, seek or consider offsets."). A footnote defines offsets as measures used to encourage local development or improve the balance-of-payments accounts by means of domestic content, licensing of technology, investment requirements, counter-trade or similar requirements.”

82Signatories generally do not apply the Agreement to a significant number of defense purchases. The U.S., for example. does not apply the Agreement to many purchases by the Department of Defense.

8?Agreement on Government Procurement art. 16.2 ("[A] developing country may at the time of accession negotiate conditions for the use of offsets, such as requirements for the incorporation of domestic content.“).

"Id. art. 23.1 ("Nothing in this Agreement shall be construed to prevent any Party from taking any action or not disclosing any information which it considers necessary for the protection of its essential security interests relating to the procurement of arms. ammunition or

impose offset requirements when they determine such arrangements serve their security interests. The effect of this exception is the same as its effect within the GATT -- it virtually engulfs the rule, at least with respect to purchases of defense aerospace equipment.

Examining the national security exemption in more detail, there is an argument that indirect offsets, or offset obligations not directly related to the purchase of defense equipment, are not "essential” to protect national security and, for this reason, could be prohibited under the Agreement. As mentioned earlier, a striking trend in aerospace transactions is the increase in indirect offsets. In the purchase of military aircraft, for example, countries have begun to demand indirect offsets in unrelated sectors, such as agriculture or transportation. These unrelated fields are in no way related to the military defense or security of the demanding party.Ss

As an additional complicating factor, however, the national security exemption provides that the burden of making this determination lies with the country claiming the exemption (nothing prevents a Party from “taking any action ... it considers necessary'). Notably, the U.S. takes the position that such determinations are not reviewable by any international appeals mechanisms.* Thus, any attempt to bar defense offsets internationally not only would to include defense acquisitions within the Agreement's scope, but would have to overcome this obstacle to enforcement as well.

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The North American Free Trade Agreement, like the GATT and the Government Procurement Agreement, allows offsets in the purchase of defense aerospace equipment in the interest of national security. NAFTA officially entered into force on January 1, 1994, creating a free trade area between Canada, Mexico, and the U.S. GATT expressly allows free trade areas such as NAFTA and recognizes that their primary purpose is to go beyond merely identifying and lowering tariffs. Instead, parties establishing free trade areas are required to eliminate tariffs in substantially all trade between the Parties. NAFTA is intended to work in conjunction with

war materials, or to procurement indispensable for national security or for national defence purposes.").

SS See generally section I.C. Although some may argue that the distinction between direct and indirect offsets is vague, U.S. defense manufacturers are required under current law to submit to BXE various information about offset agreements they perform, including whether they are direct or indirect. To date, companies have not encountered difficulty with this requirement.

36 Although the WTO offers dispute scttlement mechanisms, the position of the U.S. government is that national security determinations are not reviewable. An example is the U.S. response to recent WTO challenges to the Helms-Burton sanctions against Cuba.

87North American Free Trade Agreement. Dec. 17, 1992, Can.-Mex.-U.S., H. Doc. No. 103-159, 32 I.L.M. 289.605 (1993) (hereinafter NAFTA).

GATT by utilizing many of its free trade rules. 88

In addition to incorporating GATT’s nondiscrimination rules for the three signatories, NAFTA addresses the issue of government procurement in a separate, distinct chapter with rules and conditions much like the Agreement on Government Procurement. This chapter explicitly prohibits offsets and provides a definition almost identical to the definition in the Government Procurement Agreement.

This prohibition does little, however, to prevent offsets in the arena of defense contracting. Besides relating to only three countries, NAFTA applies only to government entities, products, and services listed in separate annexes, which exclude significant defense purchases. In addition, NAFTA governs only transactions over a certain monetary threshold. The most important exception, however, is that NAFTA, like GATT and the Government Procurement Agreement, allows countries to take any trade restrictive actions they consider to be in their national security interests, both generally and in the specific context of government procurement.

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The U.S. has made one other attempt to limit offsets in defense procurement, although unsuccessfully. The Administration participated in negotiations in 1992 and 1993 to create a NATO “Code of Conduct,” which was to include a list of “Principles for Improving Defense Trade Among the Allies." Among these principles was a relatively weak effort to identify and reduce offsets, at least among NATO countries. Although the U.S. officially viewed this language as providing inadequate discipline on offsets, the entire Code failed for various other reasons and negotiations were never resumed.

The Administration's strategy since this attempt has been to suspend further international

88 Id. art. 301 (specifying that each Party must accord national treatment to the goods of other Parties in accordance with Article 3 of the GATT).

89 Id. art. 1003(1)(a) (requiring national treatment); art. 1003(1Xb) (requiring nondiscrimination); and art. 1003(2) (prohibiting discrimination based on foreign ownership of local suppliers).

90 Id. art. 2102 (creating a general national security exemption); and art. 1021 (creating an exemption for national security in government procurement).

91 1996 Section 309 Report at 68-69 (“[C]ountries will progressively reduce, towards timely elimination, their offset requirements, once they have noted real progress in the opening up of markets, in the transfer of technology, and in the participation in common research, development and production programmes. This process towards elimination will be reciprocal, and will take into account the different approaches to defense trade among members of the alliance.“).

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