Defense Trade: Issues Concerning the Use of Offsets in International Defense Sales

Defense Trade: Issues Concerning the Use of Offsets in
International Defense Sales (08-JUL-04, GAO-04-954T).

Views on defense offsets range from beliefs that they are both
positive and an unavoidable part of doing business overseas to
beliefs that they negatively affect the U.S. industrial base.
Defense offsets are often viewed as the key to foreign sales and
thus increased business on the prime contractor level. They can
also result in reduced unit costs to the U.S. military because of
the increased size of production runs. However, the use of a
foreign supplier by a U.S. prime contractor as a result of an
offset may lead to decreased business opportunities for U.S.
suppliers. Additionally, U.S. prime contractors may develop
long-term relationships with foreign suppliers, which may lead to
the transfer of capability from the U.S. defense industrial base.
As a result of congressional concerns about emerging trends in
defense offsets, GAO conducted a number of reviews and issued
multiple reports. Because of GAO's work in this area, Congress
asked us to provide our observations on offset issues.
Specifically, GAO is providing observations on (1) what
constitutes offsets and how they are used in defense trade, (2)
how that use has changed over time, and (3) the quality and
extent of information concerning offsets that is currently
available.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-04-954T
ACCNO: A10880
TITLE: Defense Trade: Issues Concerning the Use of Offsets in
International Defense Sales
DATE: 07/08/2004
SUBJECT: Defense operations
Exporting
Foreign sales
Foreign trade agreements
Foreign trade policies
International trade
Offsets (accounting)
Joint Strike Fighter

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GAO-04-954T

United States General Accounting Office

GAO Testimony

Before the Committee on Armed Services, House of Representatives

For Release on Delivery Expected at 9:00 a.m. EDT Thursday, July 8, 2004

DEFENSE TRADE

Issues Concerning the Use of Offsets in International Defense Sales

Statement of Katherine V. Schinasi
Managing Director, Acquisition and Sourcing Management

GAO-04-954T

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss issues surrounding the use of
defense offsets on the basis of our work going back almost 15 years.

As a result of congressional concerns about emerging trends in defense
offsets, we have conducted a number of reviews and issued multiple
reports. Because of our work in this area, you asked us to provide our
observations on offset issues. Specifically, we are providing our
observations on (1) what constitutes offsets and how they are used in
defense trade, (2) how that use has changed over time, and (3) the quality
and extent of information concerning offsets that is currently available.

Results in Brief

Defense offsets are the full range of industrial and commercial benefits
that firms provide to foreign governments as inducements or conditions for
the purchase of military goods and services. They include, for example,
coproduction arrangements and subcontracting, technology transfers,
in-country procurements, marketing and financial assistance, and joint
ventures. Foreign governments use offsets as a means of reducing the
financial impact of their purchases, obtaining valuable technology and
manufacturing know-how, supporting domestic employment, creating or
expanding their defense industries, and making the use of their national
funds for foreign purchases more politically palatable.

Over the almost 15-year period we have studied defense offsets, countries
buying U.S. defense items have become increasingly sophisticated in their
offset demands. These demands have included requiring offsets prior to
contract award and increasing the offset value as a percentage of contract
value. These demands are often based on developmental goals of the
purchasing country and have steadily increased in value so that today
these demands often equal and may exceed 100 percent of the value of the
transaction. It should be noted however, that purchasing countries often
use multipliers as a means of

encouraging companies to engage in certain activities to fulfill offset
obligations. While the use of such multipliers can lessen the dollar
effect of offset demands as a percentage of the related sale, their use
underscores the sophistication of countries using offsets as part of an
industrial policy. The Department of Defense's (DOD) current emphasis on
engaging in joint

1 A multiplier is used to increase the value of an offset project when
determining offset credit. For example, if a company helped facilitate a
$10,000 export of a product with particular importance, the country could
offer a multiplier of 5, thereby increasing the amount of offset credit to
$50,000.

GAO-04-954T

development programs can be viewed as an avenue for an even more
sophisticated offset. The expenditure of public funds by one country to
support a another country's weapon system development program will be
offset by access to developing technology that the first country could not
have individually afforded and subsequently the opportunity to take part
in producing the system and the jobs that production will create.

The current information available on offsets does not provide an adequate
basis for evaluating offset practices. Defense exports involving offsets
are small relative to the U.S. economy as a whole. As a result, it is
difficult to measure effects using national aggregated data. The lack of
reliable data on the impact of offsets on the U.S. economy has been a
concern for many years, and Congress has on numerous occasions required
federal agencies to take steps to define and address offset issues. Most
recently, in 1999, Congress established a national commission to report on
the extent and nature of offsets in defense trade. Currently, the
Department of Commerce reports to Congress on an annual basis on offset
agreements, as well as activities that U.S. companies engage in to fulfill
offset obligations. The Departments of Defense and State include limited
offset information when notifying Congress of large sales of defense items
to foreign countries. However, no direct linkage has been made between the
information collected on these sales and associated offset agreements and
any impact on the U.S. economy.

Historically, the U.S. government has maintained a "hands off" policy
toward defense offsets, viewing them as part of the transaction between
the contracting parties. Since offsets are one of the many factors
contributing to the globalization of the U.S. industrial base, studying
offset transactions could provide insights into what is occurring in the
industrial base and whether these transactions need to be considered on a
policy level by the U.S. government.

Offsets Are an Integral but Unregulated Part of International Defense
Trade Relationships

Offsets are an unregulated part of defense export sales. U.S. contractors
consider offsets an unavoidable cost of doing business overseas. These
officials have indicated that if they did not offer offsets, export sales
would be reduced and the positive effects of those exports on the U.S.
economy and defense industrial base would be lost. These positive effects
include both employment in the U.S. defense industry and orders for larger
production runs of U.S. weapon systems, thus reducing unit costs to the
U.S. military. They have also noted that many offset deals create new and
profitable business opportunities for themselves and other U.S.
businesses. Critics charge that negative aspects of offset transactions
limit or negate the economic and industrial benefits claimed to be
associated with defense export sales.

While offsets take many forms, direct offsets generally involve technology
transfer, coproduction tied to a weapon sale, and subcontracting for
defense-related products, whereas indirect offsets encompass almost any
economic activity not related to the defense sale. Offsets may result in
the development of long-term supplier relationships. On the one hand, the
U.S. prime contractor might have found a less costly supplier; on the
other hand, U.S. subcontractors may find reduced business opportunities,
resulting in the loss of capability in the U.S. industrial base. U.S.
companies also may find that they have contributed to the development of a
future competitor. We found that in one instance, a

Page 2 GAO-04-954T

U.S. subcontractor stated that it was required by a prime contractor to
grant a licensing agreement to a foreign company to produce a subsystem.
The foreign company subsequently developed a similar subsystem to compete
against the U.S. subcontractor. Offset-related technology transfer may
also affect national security. Currently, little is known about the effect
of offsets on increasing the foreign content in U.S. weapon systems
because information linking offsets to foreign content is not collected.
We have reported on the details of offset transactions in several reports,
most recently in our report Defense Trade: U.S. Contractors Employ Diverse
Activities To Meet Offset Obligations

(GAO/NSIAD-99-35, Dec. 18, 1998). That report and others are summarized in
appendixes to my statement today.

Offset Demands Have Changed Over Time

Over the period that we have been reporting on issues associated with
offsets, countries buying U.S. defense items have been increasing their
demands for offsets. Countries that prior to the 1990s did not require
offsets now require them as a matter of routine policy. In at least one
case this policy had been established in law. In some cases, purchasing
countries require preapproval of offset projects to ensure that they
accomplish their development goals as well as provide the stated economic
benefit. We have also found that the nature of the offset demanded varies
according to the objectives of the purchasing government and, to an
extent, the level of economic development.

Countries are also increasingly sophisticated in their management of
offsets to achieve specific regional industrial and employment goals. For
example, one country requires that companies distribute offset projects
across its various regions. Some countries establish time frames within
which an offset must be performed and include penalty clauses for
nonperformance within those time frames. An offset activity that is
considered valuable or very desirable-the introduction of a new industry
or technology transfer-will be encouraged through the use of multipliers.
Further, many countries will permit companies to "bank" offset credits to
be used to fulfill offset obligations associated with future sales of
defense goods in that country. These countries are managing the timing and
location of the economic activity prior to committing to purchase a
specific defense article. According to one U.S. company official,
companies have traded offset credits through industry associations and
individual contacts, and one country has established a company to
facilitate offset deals.

DOD's current emphasis on partnering with allied countries in development
programs has opened a new avenue for offset activity. In previous offset
agreements, the purpose of an offset was to encourage the purchase of
foreign defense goods by balancing the expenditure of public funds with a
perceived economic benefit. In joint development programs, the balance can
be achieved through the promise of access to technology that individually
the partnering countries could not have afforded to develop and the
opportunity to win part of the production work and the jobs that it will
create. This model is most apparent in the Joint Strike Fighter (JSF)
program. The JSF program has established a model in which countries become
partners at specified contribution levels. While there are financial
benefits connected with the contribution-for example, the waiver of
nonrecurring aircraft costs-the primary benefit will be access to advanced
technology and an advanced tactical aircraft that they could not afford to
develop on their own.

Page 3 GAO-04-954T

However, as we pointed out in our work on JSF program, this type of offset
comes with its

own unique set of concerns. International participants have significant
expectations regarding industrial return on the basis of their
contributions. Because the prime contractor, Lockheed Martin, bears the
major responsibility for managing partner industrial expectations, it will
need to balance its ability to meet program milestones against meeting
these expectations, which could be key to securing future sales of the JSF
for the company. The need to offset partner contributions through
industrial return has been highlighted in several recent news reports on
actions being taken by Lockheed Martin and its major commercial partners
to ensure that the partner countries share in the work being generated.

Data Not Available to Evaluate the Need for an Offsets Policy

Based on our work on defense industrial base issues we have concluded that
DOD needs to improve its knowledge of the supplier base at the lower tiers
to enable it to better understand who its suppliers are and what
vulnerabilities may exist. Congress has on numerous occasions attempted to
gain increased knowledge about offsets issues and has urged the executive
branch to take steps to mitigate the adverse effects of offsets. (See app.
1.) We believe that there is a relationship between offsets and DOD's
supplier base. To properly manage its supplier base and ensure that U.S.
technology is protected, DOD needs to understand the uses and effects of
offsets.

Evaluating offsets and identifying their effects on industrial sectors or
the U.S. economy as a whole is difficult. Although we have identified
instances of the impact of offsets on individual companies, we have not
quantified the impact of offsets on the overall U.S. economy or on
subsectors of the U.S. industry. First, according to officials from large
defense firms and an association representing U.S. suppliers, obtaining
reliable information on the impact of offsets is difficult because company
officials are generally not aware that a particular offset arrangement
caused them to lose or gain business. As a result, it is difficult to
isolate the effects of offsets from the numerous other factors affecting
specific industry sectors. Additionally, technology is transferred
overseas for reasons other than to fulfill an offset obligation. In some
instances, alliances such as joint ventures may be formed to gain access
to the European market without being the result of offsets. Likewise,
European companies may gain access to U.S. technology as they gain access
to the U.S. market through acquisitions of small and medium-sized U.S.
defense companies. Second, defense exports involving offsets are small
relative to the U.S. economy as a whole, making it difficult to measure
any effects using national aggregated data.

The lack of reliable data on the impact of offsets on the U.S. economy has
been a concern for many years, prompting Congress to enact legislation
requiring three federal agencies (the Departments of Commerce, Defense,
and State) to collect data on offsets. The Defense Production Act of 1950
as amended3 requires the President to report annually to Congress on the
impact of offsets on U.S. defense preparedness, industrial
competitiveness, employment, and trade. Commerce prepares the report, and
requires companies to annually report

2 Joint Strike Fighter Acquisition: Cooperative Program Needs Greater
Oversight to Ensure Goals Are Met
(GAO-03-775, July 21, 2003) and Joint Strike Fighter Acquisition: Managing
Competing Pressures Is Critical
to Achieving Program Goals (GAO-03-1012T, July 21, 2003).
3 50 U.S.C. App. S: 2099.

Page 4 GAO-04-954T

(1) offset agreements entered into during the previous year that are
valued at more than $5 million and are associated with the sales of
defense articles or services and (2) completed offset transactions being
used to meet existing offset commitments that have a credit value of at
least $250,000. The required information includes the name of the country
purchasing the defense item or service for which the offset is required,
the credit value of the offset, the actual dollar value of the offset, and
a description of the type of offset.

The Departments of Defense and State report to Congress on offset
information pertaining to individual sales of defense items. The Arms
Export Control Act, as amended,4 requires the President to notify Congress
of any agreements to sell defense articles or services over a certain
amount. The President delegated this reporting function to the Secretary
of Defense for foreign military sales agreements and to the Secretary of
State for commercial sales of defense items that require an export
license. Beginning in 1994,5 the law was amended to require that the
congressional notification contain a statement of whether or not an offset
agreement was associated with the sale and a description of it. This
requirement applies to both government-to-government and commercial sales
of defense articles.

Congress also legislated that the President develop an offset policy and
negotiate with foreign countries to mitigate the adverse effect of
offsets. The National Defense Authorization Act for Fiscal Year 1989
directed the President to establish a comprehensive offset policy
addressing (1) technology transfer, (2) the application of offset
arrangements, and (3) the effects of offset arrangements on specific
subsectors of the U.S. industrial base. It also directed that the policy
address preventing or ameliorating any serious adverse effects on such
subsectors.6 In 1990 the President issued a policy statement recognizing
that certain offsets are economically inefficient and market distorting
but reaffirms the U.S. government's traditional policy of noninvolvement
in offset arrangements.7 The policy statement did not address technology
transfer or the effects of offsets on specific subsectors.

In 1992 the Defense Production Act Amendments of 1992 directed the
Secretary of Defense to lead an interagency team to consult with foreign
nations on limiting the adverse effects of offsets.8 According to Defense
Department officials, the interagency team began to meet in 1999. As of
September 1, 2000, the interagency committee had met with representatives
of the governments of Canada, France, Great Britain, and the Netherlands
and had sent letters to other nations that had memorandums of
understanding with the U.S. government requesting meetings to discuss
offsets. The committee had also begun to consult with industry.

In 1999 Congress passed the Defense Offsets Disclosure Act of 1999, which
expressed the sense of Congress that (1) the executive branch should try
to establish reasonable, businessfriendly standards for the use of offsets
with foreign counterparts for use in international business transactions
and that (2) the U.S. government should raise offset issues in

4 22 U.S.C. S: 2776.
5 Pub L. 103-236.
6 Pub. L. 100-456 S: 825.
7 Congress incorporated this policy statement into statute with the
Defense Production Act Amendments of
1992, Pub. L. 102-558 S: 123.
8 Pub. L. 102-558 S: 123.

Page 5 GAO-04-954T

discussions with other industrialized nations and should enter into
discussions through multilateral forums to establish standards for the use
of offsets in international defense trade.9 That act also established the
National Commission on the Use of Offsets in Defense Trade. As we reported
in May of last year, the Commission's final report and recommendations are
still pending. An interim report was published in February 2001, based on
the last Commission meeting held in December 2000. 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.

CONCLUSIONS

Offsets are an element in international defense trade, the nature and
importance of which have changed over time. Despite the many congressional
attempts to force the development of information that would enable an
accurate evaluation of the role--both positive and negative--played by
offsets, this information has not been developed. The same would appear
true for the many times Congress has urged action to address the perceived
adverse effects of offsets. The last action--establishing the National
Commission on Offsets in Defense Trade--appeared to be a culmination of
many prior efforts. However, because of circumstances the Commission never
achieved its purpose. The Committee may want to consider reinvigorating
that process and combining it with a specific direction to the executive
branch to enter into multilateral talks, particularly with our closest
allies, to discuss how offsets may result in market distortions and to
determine whether steps can be taken to mitigate the adverse effects while
protecting the interests of all involved.

*** *** ***

Mr. Chairman, this concludes my statement. I would be happy to respond to
any questions
that you or members of the Committee may have.

This statement is based on the results of our work on offsets (see app. 2)
and related issues
(see app. 3) from our reports issued from April 1990 through May 2004, and
therefore agency
comments were not requested. All of the reviews were done according to
generally
accepted government auditing standards.

Contacts and Acknowledgments
For future questions regarding this testimony, please contact Katherine
Schinasi, (202) 512
4841. Individuals making key contributions to this testimony include
Thomas Denomme,
Paula Haurilesko, and Lillian Slodkowski.

9 Pub. L. 106-113, App. G.

Page 6 GAO-04-954T

Selected Legislation Concerning Offsets

Page 7

(1) Requires
the President
to establish
a
comprehensive
offset policy
that
addresses the
effect of
offsets on
specific
subsectors of
the
industrial
base and how
to prevent or
ameliorate
any serious
adverse
effects on
those
subsectors.
(2) Directed Required the
the President Directed the President to
to enter into President to (1) designate
negotiations "make every the Secretary
with foreign effort" to of Defense to
countries to achieve an lead an
limit the agreement interagency
adverse that would team to
effect of limit the consult with
offsets on adverse foreign
the defense effects of nations on
industrial offsets limiting the
base. during adverse
Requires the negotiations effects of
President to of memoranda offsets in
report to of defense
Congress understanding procurement
every year between the and (2) report
for four United States annually on
years and other the results of
(1989-92) on countries. the
the status of consultations.
negotiations.
(3) Required
a report by
March 15,
1990,
discussing
actions the
United States
could take in
reaction to
offsets, such
as requiring
an offset or
other
equivalent
advantage
when buying
goods from a
country that
Actions to requires U.S.
mitigate firms to
adverse offer
effects offsets.
(1) Designated
the Secretary
Requires the of Commerce to
President's prepare the
annual report annual report
be a on offsets,
"detailed" and required
study that Requires the report to
includes (1) firms address the
summaries of entering into cumulative
interagency a defense effect of
studies on the contract offset
effects of subject to an agreements on
offsets, (2) offset domestic
the long- and arrangement defense
short-term exceeding $50 productive
effects of million to capability,
Requires the offsets, and notify the especially the
President to (3) the direct Secretary of lower-tier
submit an annual and indirect Defense of subcontractors
report on the effects on the proposed or suppliers,
impact of lower-tier sale. and the effect
offsets on the defense on the defense
defense subcontractors technology
preparedness, and base of
industrial non-defense technology
competitiveness, industry transfers that
employment, and sectors. occur to
Information trade of the fulfill offset
gathering United States. agreements.
National
Defense Defense National Defense Defense
Production Act Production Act Defense Authorization Production Act
Amendments of Amendments of Authorization Act for Amendments of
1984 (Pub. L. 1986 (Pub. L. Act, Fiscal Fiscal Years 1992 (Pub. L.
98-265) 99-441) Year 1989 1990 and 1991 102-558)
(Pub. L. (Pub. L.
Statute 1984 1986 1988 100-456) 1989 101-189) 1992

GAO-04-954T

Appendix I

(1) Directed
the United
States
government to
enter into
discussions
through
multilateral
forums to
establish
standards for
the use of
offsets in
international
defense trade.
(2) Required
the National
Commission on
the Use of
Offsets in
Defense Trade
to submit an
analysis of
proposals for
unilateral,
bilateral, or
multilateral
measures to
reduce the
detrimental
effect of
offsets and to
identify the
Actions to appropriate
mitigate agencies to
adverse monitor the use
effects of offsets.
Requires the
Secretary of
Established a Defense to
National report to
Commission on Congress by
Amended the Use of March 1, 2005,
sections Offsets in on the effect
36(b) and (c) Defense Trade. of offset
of the Arms Required a arrangements
Export report within on specific
Control Act 12 months on subsectors of
to require (1) the the U.S.
that collateral industrial
notifications impact of base; what
to Congress offsets on actions have
of impending industry been taken to
sales of sectors prevent or
defense goods unrelated to mitigate any
(2) indicate the item sold, serious
Required whether any (2) the role of adverse
companies offset offsets with effects, and
to notify agreement is respect to U.S. the extent to
Commerce proposed in competitiveness which offsets
Department connection in and other
officials with the sale international arrangements
when and required trade, and (3) have provided
entering a description the impact on for technology
into a of the offset national transfer that
contract agreement security of would
that is proposed. technology significantly
subject to transferred to and adversely
an offset fulfill offset affect the
agreement obligations. national
exceeding technology and
Information $5 million industrial
gathering in value. base.
Foreign
Relations
Authorization Department of
Act, Fiscal Defense Offsets Defense
Years 1994 Disclosure Act Appropriations
and 1995 of 1999 (Pub. Act, 2004
(Pub. L. L. 106-113, (Pub. L.
Statute 1994 103-236) 1999 App. G) 2003 108-87)

GAO-04-954T

Source: GAO analysis.

Page 8

Appendix I

Appendix II

GAO Reports on Defense Offsets, 1990-2003

Defense Trade: Report and Recommendations of the Defense Offsets
Commission Still Pending (GAO-03-649, May 30, 2003)

GAO found that the final report and recommendations of the National
Commission on the Use of Offsets was still pending although its mandated
reporting date was October 2001. The Commission had issued an interim
report in February 2001 calling for additional work on the issues raised.
However, the last Commission meeting was held December 4, 2000, and no
further activity had occurred. The 2001 change in presidential
administrations resulted in vacancies in the five executive branch
positions on the Commission, which were never filled.

Defense Trade: The Use of Intellectual Property Generated at Department of
Energy's Laboratories to Satisfy Offset Requirements (GAO-01-271R, Jan. 8,
2001)

GAO found that the use of Department of Energy laboratories' intellectual
property and services to satisfy defense contractors' offset requirements
has been limited. GAO identified 14 instances from as early as 1995, all
at one laboratory, where the laboratory's intellectual property and
services were involved in offset projects. The 14 instances, valued at
about $200 million, involved 4 intellectual property licenses and 10
service arrangements through which laboratory personnel performed
training, workshops, and other services for various foreign countries. In
addition to the 14 offset projects, we were informed by three other
laboratories of other offers to use the laboratories' intellectual
property and services of laboratory personnel to meet potential offset
requirements. These offers did not result in specific projects because the
weapon system sales did not take place.

Defense Trade: Observations on Issues Concerning Offsets (GAO-01-278T,
Dec. 15, 2000)

GAO provided a statement for the record to the National Commission on the
Use of Offsets that summarized its work on defense offsets. GAO commented
that views on the effects of offsets were divided between those that saw
them as damaging to the U.S. industrial base and those that believed them
an unavoidable part of doing business overseas. GAO also pointed out that
demands for offsets had increased over time and that data to quantify the
impact of offsets were not available.

Defense Trade: Data Collection and Coordination on Offsets (GAO-01-83R,
Oct. 26, 2000)

GAO determined that three federal agencies-the Departments of Commerce,
Defense, and State-are required by law to report to Congress on defense
offsets, although other federal agencies may collect related data. The
Department of Commerce was the primary agency collecting data on offsets
and is required to submit an annual report to Congress. GAO also found
that federal agencies generally had not coordinated defense offset data
collection

Page 9 GAO-04-954T

Appendix II

efforts. This lack of coordination might not be significant because (1)
the type of data being collected by each of the reporting agencies differs
or (2) the time period for reporting to Congress differs. However, federal
agencies were coordinating on reporting and some policy issues.

Defense Trade: U.S. Contractors Employ Diverse Activities to Meet Offset
Obligations (GAO/NSIAD-99-35, Dec. 18, 1998)

GAO examined over 100 offset transactions of six major U.S. defense
contractors to determine the types of activities in which U.S. contractors
engage to fulfill offset obligations. GAO found that companies had
undertaken a variety of activities to satisfy offset requirements, such as
coproduction and subcontracting related to defense items, technology
transfers, in-country procurements, marketing assistance, financial
assistance, and investments or joint ventures. Coproduction tied to a
weapon sale, subcontracting for defense-related products, and technology
transferred were transactions commonly found in the arrangements reviewed.
The long-term supplier relationships that develop through these activities
might have resulted in reduced business opportunities for some U.S. firms.
Nonetheless, the value of the export sale, in the transactions examined,
greatly exceeded the amount of work placed overseas.

Military Offsets: Regulations Needed to Implement Prohibition on Incentive
Payments (GAO/NSIAD-97-189, Aug. 12, 1997)

GAO reviewed the status of the State Department's efforts to issue
regulations implementing the Feingold Amendment (Pub. L. 103-236, section
733, Apr. 30, 1994, 22 U.S.C. S: 2779a). The Feingold Amendment prohibits
U.S. contractors from making incentive payments to a U.S. company or
individual to induce or persuade the contractors to buy goods or services
from a foreign country that has an offset agreement with the contractor.
At the time of this report, the amendment applied only to the sale of
defense articles or services sold under the Arms

Export Control Act, not commercial sales. GAO also found that the State
Department had made little progress in developing the needed regulations.

Military Exports: Offset Demands Continue to Grow (GAO/NSIAD-96-65, Apr.
12, 1996)

GAO examined the experience of 9 U.S. companies with 10 countries in Asia,
Europe, and the Middle East in 76 offset agreements. GAO found that, over
a 10-year period, demands for offsets in foreign military procurement had
increased in terms of requiring more technology transfer, higher offset
percentages, and higher local content. Countries that previously did not
require offsets now require them as a matter of policy, and many countries
were now focused on longer-term offset deals to pursue industrial policy
goals. Also, the type of offset project required varied according to each
country's industrial and economic development needs. For example,
countries with developed economies encouraged offsets related to the
defense or aerospace industries; whereas, countries with

1 The Defense Offsets Disclosure Act of 1999 (Pub. L. 106-113, App. G S:
1246) expanded the prohibition to include items licensed under the Arms
Export Control Act, i.e., commercial sales.

Page 10 GAO-04-954T

Appendix II

less industrialized economies generally pursued indirect offsets to help
create profitable businesses and build their country's infrastructure.

Military Exports: Concerns Over Offsets Generated With U.S. Foreign
Military Financing Program Funds (GAO/NSIAD-94-127, June 22, 1994)2

GAO examined offset transactions associated with weapon sales to countries
that received grants or loans from the U.S. Foreign Military Financing
Program. At the time of this review, four countries-Egypt, Greece, Israel,
and Turkey-were the largest recipients of Foreign Military Financing
Program funds. GAO found that all four countries were obtaining offsets in
purchases funded by the Program. Thus, these countries benefited from the
Program by (1) using U.S. funds to purchase weapon systems and (2)
developing their industrial bases through offset requirements, such as
technology transfer and directed subcontracting. At the time this report
was issued, U.S. laws, regulations, and policies did not preclude offsets

when purchasers were using Foreign Military Financing Program funds.

Military Exports: Implementation of Recent Offset Legislation
(GAO/NSIAD-9113, Dec. 17, 1990)

GAO examined the implementation of the National Defense Authorization Act,
Fiscal Year 1989 (Pub. L. 100-456), which (1) directed the President to
establish a comprehensive offset policy and enter into negotiations with
foreign governments about limiting the adverse effects of offsets and (2)
required U.S. industry to notify the Secretary of Defense of offset
arrangements exceeding $50 million. GAO found that the President's April
1990 policy statement on offsets did not specifically discuss technology
transfers and the effects of offsets on U.S. industrial base subsectors,
as required by the law. Additionally, the President directed that an
interagency team consult-not negotiate-with foreign nations. Finally, at
the time of the report, the Department of Defense had not developed
regulations, in accordance with the law, requiring U.S. industry
notification.

Defense Production Act: Offsets in Military Exports and Proposed
Amendments to the Act (GAO/NSIAD-90-164, Apr. 19, 1990)

GAO reviewed (1) the administration's 1988 report to the Congress, Offsets
in Military Exports, and (2) proposed amendments to the Defense Production
Act of 1950, under Senate bill 1379. GAO found that the results of the
methodology used to prepare the defense preparedness and employment
sections of the 1988 report were of limited value because, although they
provided an assessment of the overall impact of offsets on U.S. industry,
they did not identify the effect on more specific industry sectors
critical to defense. Additionally, the use of differing assumptions in
applying that methodology to the sections on defense preparedness and
employment made the analyses of the two sections inconsistent and

2 GAO also testified on this issue before the Subcommittee on Commerce,
Consumer Protection, and Competitiveness, House Committee on Energy and
Commerce. See Military Sales: Concerns Over Offsets Generated Using U.S.
Foreign Military Financing Program Funds (GAO/T-NSIAD-94-215, June 22,
1994).

3 The Defense Federal Acquisition Regulation Supplement partially
addressed this in 1994 when it precluded U.S. companies from recovering
offset-related costs if the sale was financed with nonrepayable foreign
military financing grants.

Page 11 GAO-04-954T

Appendix II

appeared contradictory. Regarding Senate bill 1379 as well as the Defense
Production Act itself, GAO stated the need to better provide for
disclosing significant differing agency views in the annual report.4

4 Senate bill 1379 was not passed, although similar language on offsets
was included in the Defense Production Act Amendments of 1992 (Pub. L.
102-558).

Page 12 GAO-04-954T

Appendix III

GAO Reports on Issues Related to Defense Offsets, 1994-2004

Joint Strike Fighter Acquisition: Observations on the Supplier Base
(GAO04-554, May 3, 2004)

GAO reported that subcontract awards for the Joint Strike Fighter (JSF)
had been made to 16 foreign countries. These included the eight partner
countries and France, Germany, India, Israel, Poland, Russia, Spain, and
Switzerland. However, the majority of subcontracts were with U.S. firms.
The second major recipient of subcontract dollars on the JSF program was
the United Kingdom. GAO also reported that the Buy American Act and the
Preference for Domestic Specialty Metals clause implementing the Berry
Amendment apply to the purchase of manufactured end products and that only
one of the JSF prime contractors was under contract in the current phase
of the program to deliver manufactured end products. GAO found that the
information maintained by the JSF program office, while greater than
required, was not sufficient to provide a complete picture of the supplier
base.

Joint Strike Fighter Acquisition: Cooperative Program Needs Greater
Oversight to Ensure Goals are Met (GAO-03-775, July 21, 2003)1

GAO found that the JSF program faces management challenges that are made
more difficult because of international participation. The Department of
Defense (DOD) expects to benefit from partners' financial contributions
and access to foreign industrial capabilities, while partner countries
expect to benefit from access to advanced U.S. technology and industrial
return through contracts for their defense companies. Because the prime
contractor bears the responsibility for managing partners' industrial
expectations, it will be forced to balance its ability to meet program
milestones against meeting those expectations, which could be the key to
securing future sales of the JSF for the company. While steps have been
taken to position the program for success, additional attention on the
part of DOD and the program office could help minimize the risks
associated with implementing the international program. DOD and the
program office need to maintain a significant knowledge base to enable
adequate oversight that can ensure that the program is carried out to the
satisfaction of both the United States and the international partners.

Defense Trade: Contractors Engage in Varied International Alliances

(GAO/NSIAD-00-213, Sept. 7, 2000)

GAO surveyed four large U.S. contractors, reviewed four weapon system
programs, and studied three foreign-owned U.S. companies to determine (1)
what types of

1 GAO also testified on this issue before the Subcommittee on National
Security, Emerging Threats, and International Relations, House Committee
on Government Reform. See Joint Strike Fighter Acquisition: Managing
Competing Pressures Is Critical to Achieving Program Goals (GAO-031012T,
July 21, 2003).

Page 13 GAO-04-954T

Appendix III

alliances U.S. and European defense companies are establishing and the
reasons for forming alliances; (2) why companies prefer certain types of
alliances over others, and (3) whether U.S. laws, regulations, policies,
and practices influence a company's decision to form an alliance or the
type of alliance chosen. GAO found that U.S. and European companies
created teams, joint ventures, and subsidiaries and sometimes merged with
or acquired another company to access and increase their competitiveness
in another country's market. Large U.S. companies preferred to engage in
flexible alliances, such as teaming, whenever possible to increase company
capabilities without forming permanent relationships, and access unique
technology needed to meet military requirements. Companies that wanted to
satisfy European governments' desire for greater industrial participation
formed joint ventures in which companies shared risk, decision making,
work, and technology. Subsidiaries were not a favored approach for U.S.
companies because in the fragmented European market a subsidiary in one
country had no impact on market access in another country. However,
European acquisitions of small and medium-sized U.S. defense companies
were common because they provided access to the U.S. market, which is the
world's largest. The companies reviewed did not consider the U.S. legal
and regulatory environment to be a major impediment to forming an alliance
or to be a principal determinant of the type of alliance chosen.

Defense Trade: Department of Defense Savings From Export Sales are
Difficult to Capture (GAO/NSIAD-99-191, Sept. 17, 1999)

GAO reviewed the sales of five major weapon systems-The Hellfire Missile,
Advanced Medium Range Air-to-Air Missile (AMRAAM), High Mobility
Multipurpose Wheeled Vehicle (HMMWV), Black Hawk Helicopter, and Aegis
Weapon System-to determine whether DOD is maximizing the cost benefits of
export sales. DOD saved at least $342 million on its purchases of the five
systems because either the department or its contractors also exported the
systems to foreign governments. However, the full impact of contractor
direct sales on the price of weapon systems could not be assessed because
sufficient information was not available. Nonetheless, DOD could have
realized greater savings had it (1) combined purchases for foreign
governments with purchases for the U.S. military; (2) negotiated prices
for export sales without giving up U.S. system price reductions; (3)
required the contractor to perform work in the most economical manner,
even if offset agreements were affected; or (4) ensured that the export
prices always included a proportionate share of the sustaining engineering
and program management costs.

Defense Trade: Weaknesses Exist in DOD Foreign Subcontract Data

(GAO/NSIAD-99-8, Nov. 13, 1998)

GAO reviewed (1) DOD's reported trends on contracts performed outside the
United States, (2) DOD's use of foreign subcontract information, and (3)
the completeness and accuracy of how DOD collects and manages its data.
From fiscal year 1987 through fiscal year 1997, DOD's prime contract
awards outside the United States remained about 5.5 percent of total DOD
contract awards. These contracts tended to be concentrated in countries
such as Germany, Italy, Japan, South Korea, and the

Page 14 GAO-04-954T

Appendix III

United Kingdom and in sectors such as services, fuel, and construction.
DOD's Office of Foreign Contracting and industrial base offices each
collect and use foreign subcontract data but do not exchange data with one
another. Additionally, the Office of Foreign Contracting, which is
responsible for collecting foreign subcontract information from prime
contractors and first-tier subcontractors, had no process or procedures to
systematically ensure that contractors were complying with the foreign
subcontract reporting requirement. Furthermore, the office lacked
standards and procedures for managing its database, which had caused
numerous data entry errors that compromised the database's usefulness.

U.S.-Japan Fighter Aircraft: Agreement on F-2 Production (GAO/NSIAD-9776,
Feb. 11, 1997)

This report examined issues relating to the F-2 fighter aircraft
program-known as the FS-X program during the development phase-such as (1)
the proportion of production work that will be done in the United States,
(2) the status of technology transfers from Japan to the United States and
whether these technologies are of interest to U.S. government and
industry, and (3) the program's potential contributions to Japan's future
aerospace industry. Under the F-2 production agreements, signed on July
30, 1996, U.S. industry was expected to receive about 40-percent
workshare, based on estimated production costs and a constant exchange
rate of 110 yen/dollar. The U.S. workshare was to be monitored through
verifying that Japan has awarded contracts to U.S. companies, although the
value of the contracts would not be tracked. Transfers of technology from
Japan to the United States were generally in accordance with the
development agreements, although U.S. access to some technologies has been
limited because of disagreements over whether these technologies are
derived from U.S. technical data-to which the United States is entitled to
free and automatic access-or Japanese indigenous technologies-for which
U.S. companies would have to pay a licensing fee to use. The United States
conducted several technology visits to explore the potential benefits of
F-2 technologies but found that some technologies were too costly to
produce or not advanced enough to be of interest. However, officials at
one company indicated that tooling techniques from the F-2 program were
being applied to the Joint Advanced Strike Technology program. DOD
officials believed that the F-2 program would significantly enhance
Japan's systems integration capability but would not provide significant
new capability in engine production.

Export Controls: Sensitive Machine Tool Exports to China (GAO/NSIAD-974,
Nov. 19, 1996)

In September 1994, the Department of Commerce approved an export of
machine tools to China. The machine tools were to be used to produce parts
for commercial aircraft that would be built in China under a contract with
McDonnell Douglas but were subsequently diverted to a Chinese facility in
Nanchang engaged in military production. GAO reviewed (1) the military and
civil applications of the equipment and whether these military
applications were important to China's military modernization plans and
(2) the process for approving the export licenses and how

Page 15 GAO-04-954T

Appendix III

the process addressed the risks associated with the export, and determined
whether export control license conditions were violated and what the U.S.
government's response was. GAO found that, although the equipment was not
state-of-the-art, it had military and civil applications, and China needed
machine tools to upgrade both its military and civil aircraft production
capabilities. The Commerce Department had approved the export, subject to
conditions to mitigate the risk of diversion. The movement of the machine
tools to Nanchang violated key conditions in the Commerce export licenses.
However, before it could be misused, the diverted equipment was relocated
to a facility associated with the McDonnell Douglas aircraft project.
Commerce's enforcement office did not formally investigate the export
control violations until 6 months after the violations were first
reported, and the Justice Department was overseeing a criminal
investigation at the time of the report.

Asian Aeronautics: Technology Acquisition Drives Industry Development

(GAO/NSIAD-94-140, May 4, 1994)

GAO reviewed (1) the approaches that selected Asian nations used to
develop their aeronautics industries, (2) the level of aeronautics
development that each country had achieved, and (3) the implications of
this development for the U.S. aeronautics industry. China, Japan,
Indonesia, and Taiwan appeared intent on developing their own aeronautics
industries by acquiring technologies developed in the West and improving
them over time. These countries were developing their aeronautics
industries using (1) strong government support; (2) the importation of
technologies; (3) a strong emphasis on applied research rather than basic
research; and (4) direct, synergistic links between military and civil
aeronautics projects. The Asian countries reviewed often required
technology to be transferred as a condition of purchasing Western
equipment. These transfers can occur through such activities as
subcontracting, licensed production, and codevelopment. The four countries
differed in the level of aeronautics development, with Japan being the
most advanced and China the slowest to develop, and each could be expected
to continue to develop at varying rates because of differences in their
political and economic environments. It appeared unlikely that Asian
aeronautics companies would compete directly with U.S. aircraft builders
in the immediate future, but some industry observers believed that in the
long term, cooperative aeronautics technology transfers to Asia could help
to create a new competitor for the U.S. aeronautics industry.

(120367)

Page 16 GAO-04-954T

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