Defense Trade: Report and Recommendations of the Defense Offsets 
Commission Still Pending (30-MAY-03, GAO-03-649).		 
                                                                 
Export sales of defense-related products often include		 
"offsets"-- industrial and commercial benefits, such as 	 
technology transfer, which U.S. companies provide to foreign	 
governments as incentives or conditions for purchasing military  
goods and services. Over the past decade, offsets have increased 
and in 1998, they totaled about $3 billion per year. In December 
2000, GAO reported that countries are becoming increasingly	 
sophisticated in their use of offsets to achieve regional	 
industrial and employment goals. In 1999, Congress established a 
National Commission to report on the extent and nature of offsets
in international defense trade by October 2001. The Director of  
the Office of Management and Budget (OMB) was designated chair of
the Commission. Congress also required the President to report,  
within 90 days after the Commission's final report, on the	 
feasibility and desirability of seeking a multilateral treaty	 
with international trading partners on standards for use of	 
defense offsets. GAO's report responds to the congressional	 
mandate for GAO to monitor and periodically report on the	 
President's progress in reaching a multilateral treaty. 	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-03-649 					        
    ACCNO:   A07034						        
  TITLE:     Defense Trade: Report and Recommendations of the Defense 
Offsets Commission Still Pending				 
     DATE:   05/30/2003 
  SUBJECT:   Data collection					 
	     Exporting						 
	     Foreign sales					 
	     Offsets (accounting)				 

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GAO-03-649

Report to Congressional Committees

United States General Accounting Office

GAO

May 2003 DEFENSE TRADE Report and Recommendations of the Defense Offsets
Commission Still Pending

GAO- 03- 649

In February 2001, the National Commission on the Use of Offsets in Defense
Trade issued an interim report, Status Report of the Presidential
Commission on Offsets in International Trade. However, the Commission*s

final report and recommendations are still pending* a year and a half
after its mandated reporting date. The last Commission meeting was held on
December 4, 2000, and no further activity is apparent. The 2001 change in
presidential administrations resulted in vacancies in the five executive
branch positions on the Commission, which have yet to be filled.

The interim report describes the extent and nature of defense- related
offsets in both defense and commercial trade. For example: The cost to U.
S. exporters of implementing defense offset transactions is

a fraction of the transactions* value.

The extent of defense offsets relative to defense exports has remained
stable over time; however, offset demands may have grown qualitatively.

Most defense offset transactions are with developed nations and are
associated with the export of aerospace products.

Because U. S. policy considers offsets *market distorting,* it places no
international restrictions on defense offsets and leaves responsibility
for their negotiation and implementation with U. S. exporters.

The report also describes the effect that defense offsets transactions and
agreements may have on the U. S. defense supplier base. For example, the
Commission reported that while offsets may facilitate defense export
sales* which can help maintain the economic viability of certain U. S.
firms* offsets can also supplant a significant amount of work and jobs
that would go to U. S. firms if export sales occurred without offsets. The
Commission also reported that U. S. technology transfers through offsets
often improved foreign firms* competitiveness but rarely resulted in
technology transfer back to the United States. And while it found that
technology transferred through offsets did not appear to create a security
risk beyond that posed by other transfers by U. S. firms, it cautioned
that offsets could exacerbate any existing weaknesses in U. S. export
control processes.

While the National Commission*s report remains pending and the President
has not decided on a defense offsets multilateral treaty, Congress
required GAO to monitor and periodically report to it on the progress in
reaching a multilateral treaty. The Commission on the Future of the United
States Aerospace Industry called for the pursuit of a multilateral
solution to curtail offset demands in defense trade. It suggested that
reactivating the National Commission may be the best alternative for
developing recommendations on negotiating a multilateral agreement.

In commenting on a draft of this report, OMB officials provided technical
comments, which were incorporated as appropriate. Export sales of defense-
related products often include *offsets**

industrial and commercial benefits, such as technology transfer, which U.
S. companies provide to foreign governments as incentives or conditions
for purchasing military goods and services.

Over the past decade, offsets have increased and in 1998, they totaled
about $3 billion per year. In December 2000, GAO reported that countries
are becoming increasingly sophisticated in their

use of offsets to achieve regional industrial and employment goals.

In 1999, Congress established a National Commission to report on the
extent and nature of offsets in international defense trade by October
2001. The Director of the Office of Management and Budget (OMB) was
designated chair of the Commission. Congress also

required the President to report, within 90 days after the Commission*s
final report, on the feasibility and desirability of seeking a
multilateral treaty with international trading partners on

standards for use of defense offsets.

GAO*s report responds to the congressional mandate for GAO to monitor and
periodically report on

the President*s progress in reaching a multilateral treaty.

www. gao. gov/ cgi- bin/ getrpt? GAO- 03- 649. To view the full product,
including the scope and methodology, click on the link above. For more
information, contact Katherine V. Schinasi at (202) 512- 4841 or
schinasik@ gao. gov. Highlights of GAO- 03- 649, a report to

Congressional Committees

May 2003

DEFENSE TRADE

Report and Recommendations of the Defense Offsets Commission Still Pending

Page i GAO- 03- 649 Defense Trade Letter 1 Results in Brief 2 Background 3
Commission*s Findings on Extent and Nature of Defense- Related

Offsets 4 Status of the Commission*s Work 5 Conclusions 6 Agency Comments
6 Scope and Methodology 6 Table

Table 1: Commission*s Potential Policy Recommendations, with Advantages
and Disadvantages 5 Abbreviation

OMB Office of Management and Budget Contents

This is a work of the U. S. Government and is not subject to copyright
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materials separately from GAO*s product.

Page 1 GAO- 03- 649 Defense Trade

May 30, 2003 The Honorable Richard G. Lugar Chairman The Honorable Joseph
R. Biden, Jr. Ranking Minority Member Committee on Foreign Relations
United States Senate

The Honorable Henry J. Hyde Chairman The Honorable Tom Lantos Ranking
Minority Member Committee on International Relations House of
Representatives

Export sales of defense- related products often include *offsets**
industrial and commercial benefits, such as technology transfer, which U.
S. companies provide to foreign governments as incentives or conditions
for purchasing military goods and services. They include, for example,
coproduction arrangements and subcontracting, technology transfers,
incountry procurements, marketing and financial assistance, and joint
ventures. In December 2000, we reported that countries are becoming
increasingly sophisticated in their use of offsets to achieve regional
industrial and employment goals. 1 Since 1993, when the Department of
Commerce began collecting data on these transactions, defense offsets have
increased. In 1998, defense offsets totaled approximately $3 billion. The
increasing use of offsets in defense trade has generated congressional
concern because offsets can distort the price of defense contracts and
undermine competitiveness.

In an effort to identify current offset practices, the impacts of offsets
on the U. S. economy, and their role in increasing dependence on foreign
sources for defense goods, in 1999, Congress established a Commission 2 to
report to it on the extent and nature of offsets in international defense

1 U. S. General Accounting Office, Defense Trade: Observations on Issues
Concerning Offsets, GAO- 01- 278T (Washington, D. C.: Dec. 15, 2000). 2
Defense Offsets Disclosure Act of 1999, Public Law 106- 133, section 1247.

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 03- 649 Defense Trade

trade. Congress also required the President to review and report, within
90 days after the Commission*s final report to Congress, the feasibility
and desirability of seeking a multilateral treaty on standards for use of
offsets in defense trade. Congress further required us to monitor and
periodically report to it on the progress in reaching a multilateral
treaty.

A final report and recommendations from the National Commission on the Use
of Offsets in Defense Trade are still pending, although under the Defense
Offsets Disclosure Act of 1999 the report was required to be issued by
October 2001. However, the 2001 change in presidential administrations
resulted in vacancies in the five executive branch positions on the
Commission, which have yet to be filled. The Commission*s interim report*
Status Report of the Presidential Commission on Offsets in International
Trade, issued February 2001* describes the extent and impact of offsets in
both defense and commercial trade. 3 The report also describes the effect
of defense offset transactions and agreements entered into by U. S. firms
over a 6- year period. For example, the Commission reported that while
industry estimates and other evidence indicate that offsets facilitate
exports, they also supplant a significant amount of work and jobs that
would go to U. S. firms if export sales occurred without offsets. The
Commission also reported that in a number of cases, U. S. technology
transfers improved foreign firms* competitiveness but rarely resulted in
technology transfer back to the United States.

The interim report includes potential policy recommendations that,
according to the Commission, require additional deliberation of the
possible advantages and disadvantages of each. However, the Commission has
not met since December 4, 2000. Since the President*s report on the
feasibility and desirability of a multilateral offsets treaty is not
required until 90 days after the Commission*s final report is submitted to
Congress, the President has not reported. Subsequent to the Commission*s
last meeting, another commission, set up to evaluate the health of the
aerospace industry, recommended that the United States pursue a
multilateral solution to curtail offset demands. That commission also
suggested that reactivating the National Commission on the Use of Offsets

3 To address the use of offsets in commercial trade, the President
established the Presidential Council on the Use of Offsets in Commercial
Trade. Membership of the Council was identical to the Commission. Results
in Brief

Page 3 GAO- 03- 649 Defense Trade

in Defense Trade may be the best alternative for developing policy
recommendations on this issue.

In commenting on a draft of this report, the Office of Management and
Budget officials provided technical comments, which were incorporated as
appropriate.

Foreign governments often seek defense offsets to reduce the financial
impact of their purchases, obtain valuable technology and manufacturing
know- how, enhance domestic employment, create or expand their defense
industries, and make the use of their national funds for foreign purchases
more politically palatable. However, Congress has expressed concern about
the use of offsets in defense trade because they can undermine fairness
and competitiveness and distort the price of contracts. Offsets are
frequently negotiated in connection with the purchase of U. S. aerospace
systems, such as military or commercial aircraft, and sometimes in

connection with the purchase of U. S. goods and services in other high-
tech industries, such as power generation or telecommunications.

The Defense Offsets Disclosure Act of 1999 4 established, as the sense of
Congress, the need to  pursue efforts to address trade fairness by
establishing reasonable,

business- friendly standards for the use of offsets in international trade
between the Unites States and its trading partners and competitors; 
require the Secretary of Defense, the Secretary of State, the Secretary of

Commerce, and the United States Trade Representative, or their designees,
to discuss with industrialized nations the need for reasonable standards
to govern the role of offsets in international trade;  enter into
discussions regarding the establishment of multilateral

standards for the use of offsets in international defense trade through
the appropriate multilateral forum; and  include in those discussions the
distortions produced by other benefits

and subsidies provided by various countries, such as export financing. The
act also established a National Commission on the Use of Offsets in
Defense Trade, requiring the President, with the concurrence of
congressional leaders, to appoint 11 members to the Commission. The act

4 Defense Offsets Disclosure Act of 1999, Public Law 106- 133, section
1244. Background

Page 4 GAO- 03- 649 Defense Trade

required the Commission to submit a report to Congress addressing all
aspects of the use of offsets in international defense trade within a year
of its establishment. It also specified that the Commission include 5
members

from the executive branch, 3 from industry, 1 from labor, and 2 members
from academia. In October 2000, the President appointed the 11 members.
The act designated the Office of Management and Budget (OMB) member as the
chair of the Commission. Since the change of administrations in

2001, the President has not appointed new executive branch members.
Consequently, the Commission has ceased activity and has not issued its
final report. The Commission released its interim report in February 2001.
The report

described the following extent and nature of defense- related offsets. 
The cost to U. S. exporters of implementing defense offset transactions is
a

fraction of the transaction value.  The extent of defense offset
agreements relative to defense exports has

remained stable over time; however, offset demands may have grown
qualitatively.  Most defense offset transactions are with developed
nations.  Most defense offsets are associated with the export of
aerospace products.

 The most common types of defense offset transactions are
counterpurchases, subcontracts, and technology transfers.  There are no
international restrictions on defense offsets. U. S. policy

considers offsets *market distorting* and leaves responsibility for their
negotiation and implementation with U. S. exporters.

The Commission also found the following on the impacts of defense offsets:

 Offsets have a direct effect on U. S. jobs by facilitating exports, but
they also supplant a significant amount of work and jobs that would go to
U. S. firms if export sales occurred without offsets.  In some cases,
offsets hurt the U. S. defense supplier base by transferring

work to foreign firms, but the erosion has yet to show up in overall trade
statistics.  At the same time, defense export sales may be important to
the economic viability of aerospace firms and may provide an incentive for
their

development of new defense products and technologies.  In a number of
cases, U. S. technology transfers improved foreign firms*

competitiveness but rarely resulted in technology transfer back to the
United States. Commission*s

Findings on Extent and Nature of Defense- Related Offsets

Page 5 GAO- 03- 649 Defense Trade

 Technology transferred to foreign firms through offsets does not appear
to pose a special security risk above and beyond that posed by other
technology transfers by U. S. firms.  However, recent examples show that
U. S. export control processes are not

flawless in preventing the transfer of sensitive technology abroad and
that offsets could exacerbate any leakages. The Commission*s interim
report outlines areas for future Commission study and several potential
recommendations. However, the Commission has yet to determine whether
these potential policy recommendations are feasible or desirable.

Table 1: Commission*s Potential Policy Recommendations, with Advantages
and Disadvantages Potential Commission recommendation Possible advantages
Possible disadvantages

The U. S. government could seek a multilateral agreement with its trading
partners to reduce or prohibit the use of offsets in defense trade.

 Could diminish adverse effects on U. S. jobs, economic competitiveness,
and national security.

 Could attract support from labor and industry groups.

 Would likely reduce U. S. export sales.

 May be difficult to monitor and enforce.

 The United States may be asked to provide concessions, such as greater
access to the U. S. defense procurement market. The U. S. government could
work cooperatively with other countries to shift the type of offsets they
request away from defense subcontracting or production.

 Could help reduce adverse effects of offsets on U. S. economy and
national security.

 Could provide foreign governments with needed political support to
import major U. S. defense systems.

 Could be tried bilaterally as well as multilaterally, and on a pilot
basis.

 Could yield technological and economic benefits to U. S. exporters and
other U. S. firms.

 Some foreign governments may not be willing to shift their offset
demands.

 A shift in the types of offsets currently sought by foreign nations
could alter the competitive playing field.

 Does not focus on reducing or eliminating defense offsets.

 Could undermine the competitiveness of non- defense industries.

The U. S government could increase foreign firms* involvement in the
research and development stages of new defense systems to reduce their
governments* subsequent demand for offsets.

 Could help reduce offset demands.

 Could facilitate reciprocal technology transfer.

 Foreign firms* participation in subsequent production of the defense
system* a natural extension of their initial involvement* would result in
few adjustment costs relative to offsets.

 No assurance that participating nations would reduce offset demands. 
Participating nations may demand work

guarantees, which are similar in effect to offsets.

Source: Status Report of the Presidential Commission on Offsets in
International Trade.

According to the interim report, the Commission was to continue its
deliberations and prepare a final report and recommendations by October
2001. The final report is still pending. Further, according to OMB
officials, the President has not determined the feasibility and
desirability of seeking a multilateral treaty on standards for use of
offsets in defense trade. Status of the

Commission*s Work

Page 6 GAO- 03- 649 Defense Trade

However, the issue of defense offsets has continued to raise concerns. The
Commission on the Future of the United States Aerospace Industry
recommended that the United States pursue a multilateral solution to
curtail offset demands and suggested that reactivating the Commission may
be the best alternative for developing policy recommendations on this
issue.

As a major factor in the competitiveness of a company*s offer to sell
goods and services, offsets are an accepted feature of defense trade.
However, their use has been shown to distort markets. Recognition that
unilateral U. S. government constraints could limit U. S. company
competitiveness has led Congress to establish a commission to address the
use of offsets in defense trade. It also led Congress to require the
President to determine the feasibility of a multilateral treaty on
standards for the use of offsets. While the Commission has taken concrete
steps toward fulfilling its mandate, it has not completed its work in that
it has not issued a final report. In addition, the President has not
reported on the feasibility and desirability of a multilateral treaty.
However, the President*s report is not due until 90 days after the
Commission*s final report to Congress under the Defense Offsets Disclosure
Act of 1999.

In commenting on a draft of this report, OMB officials provided technical
comments, which were incorporated as appropriate.

To determine the progress in reaching a multilateral treaty, we reviewed
legislation pertaining to offsets to determine the roles and
responsibilities of the presidential Commission. In addition, we reviewed
the Commission*s interim report to identify its potential recommendations
to the President. We also interviewed several officials from the
Department of Commerce, the Office of Management and Budget, and the
Office of the United States Trade Representative who had knowledge of the

Commission*s deliberations. We conducted our work from January through May
2003 in accordance with generally accepted government standards.

We are sending copies of this report to the Secretaries of Commerce,
Defense, and State, and the Director, Office of Management and Budget.
Copies will be made available to others on request. In addition, this
report Conclusions

Agency Comments Scope and Methodology

Page 7 GAO- 03- 649 Defense Trade

will be available at no charge on the GAO Web site at http:// www. gao.
gov. If you have questions, please contact me at (202) 512- 4841. Major
contributors to this report were Thomas J. Denomme, Gregory K. Harmon,
John Neumann, Karen M. Sloan, Robert L. Ackley, and Marie P. Ahearn.

Katherine V. Schinasi Director Acquisition and Sourcing Management

(120224)

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