From the CIAO Atlas Map of Southeast Asia Map of Asia 

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Countertrade and Offsets Policies and Practices in the Arms Trade 

Susan Willett  and  Ian Anthony

Copenhagen Peace Research Institute

1. Introduction

Countertrade and offsets are forms of purchasing arrangements, which have become a common feature of arms transactions. The practice of using offsets among industrialised countries began in the 1960s and offsets are as old as industrial collaboration in armament production. 1 However, while twenty years ago only about 20 countries (mostly within the North Atlantic Treaty Organization (NATO)) had offset policies, now the figure is around a hundred and thirty. 2 Trading prospects are enhanced for both suppliers and recipients through Countertrade and offsets, as they override financial constraints on arms transactions. Trade is facilitated through a cashless, mutual exchange of needs.

This form of trade appears to be flourishing in the current climate, largely because of the recent changes that have occurred in the international arms market since the end of the Cold War. These changes have affected both the volume of the arms trade and also the means through which it is financed.

The decline in the global demand for weapon systems and the rising number of arms producers has made the global arms market increasingly competitive. A "buyers market" has enabled purchasers to extract ever more advantageous concessions from suppliers.

At the same time, major arms suppliers have become more reluctant to subordinate the economic aspects of the arms trade to foreign and security policy considerations than was the case. During the Cold War supplier governments (and the United States in particular) might have absorbed some of the costs of a given arms transfer in the name of solidarity against a common threat. The cross pressures from this combination of increased competition and greater attention to economic returns from arms transfers creates new a new mixture of problems and incentives for the actors participating in the arms trade.

After the Cold War the needs and problems of domestic arms industries combined with the lack of a clearly identifiable and large-scale politico-military threat mean that seller governments are more likely to want to maximize revenues from foreign sales and less likely to absorb the costs of any transaction. At the same time, an appeal to the seller government is likely to be the first recourse of a buyer who is unhappy with the way in which an offset agreement is being implemented. The nature of the arms trade means that this buyer may well be an important ally or friend.

Prime contractors now offer offsets and countertrade in order to secure a deal. However, in framing their bid these companies have an incentive to come up with the largest offset value possible (to attract the buyer) with the minimum performance requirement possible (to reduce their own costs).

Buyer governments have an incentive to review their countertrade and offset policies to improve the economic returns from costly arms transactions.

Under these conditions it has become more important to ask whether the specific offset and countertrade objectives that buyers and sellers set themselves are being achieved. This is a problem of measurement and evaluation.

The dramatic expansion in the number of arm transactions involving countertrade and offset agreements reported in the press suggests that the various forms of trade under these labels should be quantifiable. If that were so, then their impact on the international arms trade would be easier to evaluate. Unfortunately, this is not the case. Few governments apart from the United States attempt to monitor military related offsets in a systematic way. In the United States aggregate data on offsets is compiled from surveys of industry which are based on contracts for military export sales (i.e. those exports licensed under the Arms Export Control Act) that involve offset arrangements.

There are a variety of reasons for the lack of standardised data in this area. It is difficult to find appropriate instruments with which to measure a complex trading activity. The growing number of offset and countertrade agreements adds a problem of scale. However, the paucity of official data can also be explained by the fact that defence contractors are notoriously reluctant to reveal what they regard as highly sensitive commercial information.

One finding of a recent study in Sweden was that "the central problem in evaluating offset arrangements is to measure the effects and compare them with the goals set for the offset. If the goals are not formulated clearly, they will be difficult to interpret and any assessment risks being almost meaningless." (unofficial translation) 3

This study seeks to identify and discuss the difficulties associated with measuring and evaluating offsets and countertrade. The

Buyer governments have an incentive to review their counterstudy then tries to provide an insight into this emerging market trend. The study draws on an increasing amount of publicly available information on countertrade activities as well as a series of interviews conducted by one of the authors with defence analysts, company representatives and government officials in Europe and East Asia.

Classification of countertrade and offsets

This report does not attempt a detailed discussion of alternative definitions of offsets and countertrade or offer a new framework for classifying trading activities into different categories. These issues are discussed at length in a previous FIND report and elsewhere. 4 The issue of alternative definitions is taken up in the section on measurement and evaluation where relevant.

Offsets are industrial or commercial compensation practices required as a condition of purchase of defence articles and/or services. Offsets would include specific forms such as co-production, licensed production, sub-contractor production, and overseas investment or technology transfer. Countertrade is a generic term, which embraces a number of trading arrangements where some or all of the payments from arms buyers are compensated by the vendor purchasing goods and services. Countertrade would include specific forms such as barter, counter-purchase or buy-back 5 Offsets can be direct or indirect. Direct offsets are transactions that have a direct correspondence to the principal armaments export. Countries intent on building up or strengthening their defence industrial base tend to favour this form of countertrade arrangement. Examples of direct offsets include the manufacture of German designed naval patrol vessels in Indonesia by PT PAL and South Korean's deal to build diesel submarines designed by the German firm Howaldtswerke Deutsche Werfte (HDW).

Indirect offsets occur where products or services transferred in an offset arrangement are unrelated to the specific arms referred to in the export agreement—though they may still be military in character. In many developing countries where the industrial base and infrastructure are poorly developed, offsets are more likely to be of an indirect nature. In BAe's agreement to sell Hawk aircraft to Malaysia, for instance, there is an emphasis on skills training to improve Malaysia's human capital formation. In the case of Hawk transfers to Indonesia, BAe has put into place a student sponsorship scheme whereby aspiring aerospace engineers and business managers are sent to Cranfield, Bristol and Loughborough Universities for technical and managerial training. 6 Certain more industrialised countries in East Asia—such as Singapore, South Korea and Taiwan—are turning towards indirect offsets as a means to upgrade their civil technology base particularly in aerospace.

Coproduction: This form of agreement involves the purchaser being given a share in the manufacture of a foreign designed weapon system. Coproduction is highly favoured by recipients because of the employment and technology transfer implications of these types of deals. An example would be the coproduction of the British Harrier aircraft by McDonnell Douglas in the United States. Major suppliers are only likely to agree to coproduction arrangements where there are very real commercial advantages to this form of arrangement as a high degree of technology transfer is involved in such arrangements. In the case of the Harrier the agreement led to such close co-operation between British Aerospace and McDonnell Douglas that they went on to co-develop a successor aircraft, the AV-8B Harrier-2.

Licensed production: This takes place where the recipient obtains a share of the production work for its own order. The agreement may cover the assembly of an entire weapon system from imported kits or local production of parts or sub-systems. The agreement may be phased so that the local share of production rises over time. Under the terms of the 1991 South Korean $5.2 billion purchase of F-16 fighter aircraft from General Dynamics 12 aircraft are to be bought from the US plant, a further 36 are to be assembled in South Korea before, in the final phase, South Korea will produce parts and sub-systems for a further 72 aircraft. 7

Sub-contractor production: In this form of offset a prime contractor would substitute an existing supplier with one located in the buyer country. US company Boeing, for example, placed sub-contracts with British firms Racal, Plessey, Rediffusion and CF Taylor (Hurn) Ltd. and French companies Thomson-CSF, UTA Industries and SNECMA in the framework of agreements to sell E-3 AWACS aircraft to the United Kingdom and France. In some cases this led to the elimination of US sub-contractors from Boeing's network of suppliers.

Technology transfer: This term is widely used as an umbrella term to describe a large number of transactions. Yet it also has a more specific meaning in the framework of offsets. Technology transfers that occur as a result of an offset agreement may take the form of research and development conducted overseas or technical assistance provided to a foreign company or joint venture. Technology transfer may be associated with commitments for foreign direct investment made by the seller taking the form of capital to establish or expand a subsidiary or joint venture in the buyer country.

Barter: This relates to the direct exchange of goods-for-goods where no cash is involved. Although barter is as old as trade itself contemporary barter deals are more common than is often realised. Oil payments for arms are a widespread form of barter used in the Persian Gulf, for example. The Al Yamamah deal between the UK and Saudi Arabia which included the purchase of military aircraft with associated training and support, civil aircraft, helicopters, naval ships and construction projects is a classic case of barter. The contract is estimated at around [sterling]14 billion (roughly $21 billion) to the UK economy with an annual revenue of around [sterling]2 billion (over $3 billion). Part of the payment is made in crude oil of some 500,000 barrels per day sold at market prices from which British Aerospace and other defence contractors draw their payments. 8 Examples in East Asia include Malaysia's exchange of palm oil for the Russian built Mig-29s and Thailand's exchange of primary commodities, (mainly food products), for US built F-18s.

Counter-purchase: This form of exchange commits the arms seller to purchase a compensatory amount of commodities. In the context of developing countries this normally involves primary commodities. For instance, when Malaysia signed an MoU with the UK to purchase a range of defence equipment, included in the agreement was a commitment by the British company GEC Marconi to purchase some 40%-50% of the value of the Martello radar contract in exchange for tea and palm oil, estimated to be worth $350m. 9 The arms contractor can either market these counter-purchased goods themselves or employ a specialist commodity broker to do the job for them. On the whole defence firms try to avoid counter-purchases because they inevitably incur extra transaction costs. In addition many counter-purchase agreements impose quite rigid specifications relating to time for completion of the counter-purchase and penalties for non-performance.

Buy-back: Under a buy-back the original exporter agrees to accept as full or part payment products derived from the original exported product. For example, if the export consists of a turnkey production facility or an assembly line of machine tools the exporter may accept part of the output generated. In the joint purchase of F-16 fighter aircraft by Belgium, Denmark, the Netherlands and Norway the US Air Force agreed that 10 per cent (by value) of components in 650 of its own F-16s should be provided by the European production consortium created under the programme. 10 Several subsequent F-16 programmes have been modelled on this approach 11

Offset policies and motivations

As in the case of definitions of offsets and countertrade, this report is not primarily concerned with identifying the specific policies and motivations of given actors. Again, there is a significant literature, which can be consulted on these matters. 12 This section briefly summarises the existing policies of selected governments.

Although countertrade and offset deals have become a universal form of transaction within the international arms market there is notable diversity between the offset policies of different nations. Some buyer countries have limited interest in developing their defence industries and stress forms of offset and countertrade that either lower the cost of arms imports or generate benefits in non-military sectors. Other buyer countries are more interested in developing their defence industries than they are in other benefits.

At a more detailed level, different countries set different limits on things like the total value of offsets as a percentage of contract price, the balance between direct and indirect offsets, the time limits imposed on fulfilling offset obligations and the penalties imposed for failing to meet obligations.

Ron Matthews has identified a gradual shift in emphasis among developing countries away from counter-purchase towards what he calls "institutionalised military offsets." 13 Table 1 summarises certain characteristics of the offset practices of a range of buyer countries for which information is available.

Table 1. Summary of offset practices of selected buyers
Preferred arrangements Offset as % of contract value Responsible agency Fixed penalties
Austria Direct and indirect offsets; Countertrade 100 Ministry of Trade
Defence procurement agency
Spain Direct and indirect offsets 130 No formal procedures No
Finland Direct and indirect offsets 100 Ministry of Defence Yes
Greece Direct offsets;
60-100 Ministry of Defence Yes
Netherlands Direct and indirect offsets Ministry of Economic Affairs
Norway Indirect offsets;
50-100 Defence procurement agency No
Sweden Direct and indirect offsets 50-100 Defence procurement agency No
Denmark Ministry of Industry and Trade
United Kingdom Direct offsets No
Australia Direct and indirect offsets;
30 Defence procurement agency Yes
South Korea Direct and indirect offsets
Countertrade (buy-back)
30-60 Ministry of Defence Yes
Taiwan Direct and indirect offsets 30
Singapore Direct and indirect offsets 25-50 Ministry of Defence Yes
Indonesia Direct and indirect offsets 100 Ministry of Research Yes
Malaysia Direct and indirect offsets;
Countertrade (Counter-purchase)
Thailand Direct and indirect offsets;
Countertrade (Counter-purchase)
20 Ministry of Commerce
Philippines Direct and indirect offsets;
50 Ministry of Commerce and Industry Yes
Middle East
Saudi Arabia Indirect offsets;
35 Inter-Ministerial Committee No
UAE Indirect offsets;
60 Inter-ministerial



Source: DESO 1996 and GAO/NSIAD 96-65 Military Exports

Looking at the summary data it is clear that most buyers have multiple objectives, which include not only reducing the direct costs of purchasing defence equipment but also strengthening the military and non-military technology base.

This makes the problem of evaluating offset implementation more complex than it would be if the only issue was reducing direct costs. In assessing cost reduction it would be sufficient to use information derived from survey responses based on company invoices. However, evaluating the transfer of technology (used here in the broad sense) makes measurement much more difficult. It is to these issues of how to measure offsets that the next section now turns.

2. Problems of evaluation and measurement

Assessing offset implementation

It was noted in the previous section that different actors have different interests in concluding offset agreements. Supplier governments would like to know the impact of offsets on their general balance of trade and on their industrial base. If the overall impact is negative then supplier governments would presumably only accept the practice of offsets in order to achieve countervailing foreign and security policy goals. Buyer governments would like to know the impact of offsets on their own industrial and technology base and the net impact of the offset agreement on the costs of the specific equipment purchase. Seller companies managing offsets would like to be sure that the costs they incur in any given bilateral offset arrangement are lower than the benefits they gain. Companies in the buyer country would like to be sure that they are receiving the benefits promised to them in the agreement.

Given these different perspectives it may be that no single instrument can satisfy all measurement needs. This section will survey the various forms of assessment currently being undertaken in different countries.

The United States

The United States has by far the most extensive data collection on the impact of offsets. In the 1980s the US Congress used amendments to the Trade and Tariff Act and the Defense Production Act to require the executive branch to report on offsets. Subsequently the office of the United States Trade Representative included surveys of offset practices by foreign states in the annual report on the National Trade Estimate on Foreign Trade Barriers. An inter-agency Coordinating Committee on Offset Reports including representatives from the Office of Management and Budget (which is part of the White House staff), the Bureau of Export Administration and Bureau of Economic Analysis (which are parts of the Department of Commerce) and from industry associations. In combination US agencies have generated data sets which provide the US government with a powerful analytical tool.

The core of the assessment by the US government is a survey of industry. Every year since 1985 the survey has been sent annually to a group of corporations selected from the list of the top 100 Department of Defense contractors. A copy of the survey questionnaire is attached to this report as an appendix.

The survey asks for information on the number of military export contracts that involved an offset commitment and aggregate sales and employment by the company. For each of contract involving an offset agreement information is requested about whether the offset was a condition of the contract or offered by the company as an inducement; a list of the names of parties to the offset agreement (including all foreign firms and foreign agencies); the types of articles and goods to be provided during the period of the contract; the value of the articles and goods provided; the time (i.e. employee hours) used in implementing offset agreements and whether the agreement was implemented by a US or non-US operation of the firm.

Using the information provided, the US government compiles an annual survey of the impact of offsets in defence trade. 14 The information is organised to address the following questions:

  1. What is the value of offset agreements (in dollar terms and as a share of total defence trade)?
  2. What is the employment effect in the United States from implementing offset agreements?
  3. In what industrial sectors do offset agreements take place?
  4. What is the distribution of offset agreements by region and country?
  5. Identified problems

While the US survey is the most comprehensive and detailed, there are some problems with it. First, the information gathering effort began as a voluntary survey and compliance by industry is partial. The questionnaire is sent to between 50 and 60 prime contractors. To indicate compliance, in 1988 36 companies returned the questionnaire and in 1995 26 companies returned the questionnaire. It should be noted that these numbers do not necessarily undermine the quality of the data since the Bureau of Economic Analysis has expressed confidence that the companies which provided data in fact represented a very high proportion of all US defence trade 15

Some companies and industrial associations objected to reporting offset data on several grounds. One objection was that publication of the data could increase customer knowledge and make it more difficult for US firms to achieve advantages in negotiations. Another objection was that aggregate data on offsets was likely to be misleading because the specific costs and benefits from offsets could only be assessed on a case-by-case basis. A third objection was that companies had to carry the costs of preparing and submitting the data.

A second problem with the reporting is that it is focused on large contracts with prime contractors. Small and medium-sized companies are not part of the offset survey. To address this problem the Bureau of Export Administration introduced questions about offsets into other surveys of small and medium-sized companies. This did not generate economic or statistical data but did provide information of other kinds.

In 1994 152 small and medium-sized companies reported involvement in offset arrangements. However, another 170 reported that they were not involved in offsets but had been negatively affected by offset arrangements. Companies, which elaborated on this usually, reported that they had previously been suppliers to prime contractors but had been replaced by foreign suppliers in the framework of an offset arrangement. A smaller number of companies reported that they had suffered because new foreign competitors had emerged as a result of capacities or technologies transferred from the United States under offset arrangements. A third group of companies reported that they had lost contracts because they refused to accept the offset demands made by a potential buyer. A fourth group of companies reported that they had suffered because companies, which previously supplied them, had gone out of business as a consequence of offset arrangements. It was then necessary for these companies to find new suppliers.

A third problem with the data generated in the US survey is that it is aggregated on a sectoral basis using the Standardised Industrial Classification (SIC) codes at a three or four digit level. The aggregate data therefore refers to broad categories of industrial goods such as "Aircraft" or "Aircraft parts".

A fourth problem is that the companies were asked to classify the offset arrangements in which their firm participated into broad categories of a type similar to those introduced in the introduction. No detailed instructions or guidelines are provided to assist in classification. Some of these classifications are not straightforward and different respondents could place a very similar transaction in different categories.

Buyer assessments

The United States has been primarily interested in assessing the impact of offsets from the perspective of a seller. Buyers confront slightly problems. In 1989 Barry Marvel identified four phases of assessment that buyers must pass through during the life of an offset arrangement. 16 Each phase involves different problems of assessment.

The first phase occurs during the evaluation of alternative proposed solutions to the stated requirement. Buyers may face a range of different proposed offsets that contain a balance of advantages and disadvantages. For example, evaluating different offset packages may involve trading-off greater industrial benefits but a less effective piece of defence equipment offered by one seller against lower industrial benefits but a more effective piece of defence equipment offered by another. The approach of the buyer to evaluating these kinds of trade-offs would reflect the balance in the procurement system between different interest groups (for example, the relative weight of the armed forces and the domestic defence industry).

The second phase occurs after the decision has been taken. Buyers always establish an instrument for measuring implementation of offset arrangements.

The third phase occurs if offsets are not being implemented as agreed. In particular, how to evaluate offsets if the seller and buyer have independent measurements that show different results—i.e. the seller claims to have met obligations while the buyer feels that offset arrangements have not been implemented.

The fourth phase is how to evaluate historical offset arrangements with a view to learning lessons and improving future performance.

Identified problems

Looking at the approaches taken by buyers in evaluating alternative offset arrangements there is considerable diversity in organisational arrangements.

Some countries have specialist independent agencies responsible for procurement of defence materiél. Other countries have units within the Ministry of Defence which advise on industrial questions. A third group of countries give authority to a specialist unit within the Ministry of Trade and Industry or its equivalent. A fourth group centralise decision authority in a unit which reports directly to the executive branch of government.

It may well be that the organisation of decision making has an impact on the weight given to different factors in making the final choice about what kind of balance of priorities should be sought in offset arrangements.

Once this determination is made and specific objectives established for offset arrangements, these arrangements must be written into the legal documents that will govern implementation. It is insufficient to state the objectives in general terms since this makes verification of implementation impossible. The requirements for offsets are often expressed as a percentage of the value of the agreement. This means that in order to credit a transaction against its offset commitment the seller has to express the specific goods and services in a unit of currency.

In some cases this may be straightforward because a market price exists which can easily be applied. This is easiest for countertrade (counter-purchase) arrangements that commit the seller to buy goods and services from the buyer country up to a specific value.

In other cases agreeing very fixed criteria for the programme at the beginning may reduce the problems of measurement. A good example of this is the structure of the 1975 agreement between the United States and the European Participating Governments (Belgium, Denmark, Norway and the Netherlands) relating to the procurement and production of the F-16 aircraft. 17 In the memorandum of understanding the parties defined value shares as a percentage of the unit flyaway price of the F-16 which was stated in the contract as a "not to exceed" price. 18 This unit flyaway price was then broken down into various elements such as airframe, radar and engine which were also set on a not to exceed basis. A method for subsequent price adjustment was agreed in the MoU and unit prices were revised in 1980, 1981 and 1982 when follow-on series production was agreed in the framework of the same MoU. The MoU agreed the number of aircraft to which the MoU would apply (348 for the European governments and 650 for the US Air Force). It also agreed that for the duration of the programme all calculations would use a fixed exchange rate established in the contract. The obligations of seller and buyer in meeting non-recurring production costs in the buyer countries were also established in the MoU.

This does not mean that there were no ambiguities or "loose ends" that could create problems in assessing the implementation of the programme. In such a complex programme this would be expecting too much. 19 Neither does it guarantee that it was a good agreement (which would require a different kind of evaluation). However, by reducing ambiguity these kinds of definitions created a rather clear basis for the buyers to measure whether the agreement was being implemented in a fair way. It was clear from the beginning that there were elements in the procurement programme to which the offset arrangements did not apply (such as mission equipment, spare parts and logistical support). It was also possible to estimate precisely the value of the offset arrangement in local currency at the beginning of the programme and "keep score" through the implementation phase.

This is reflected in an evaluation of the F-16 offset programme conducted by the Dutch Ministry of Economic Affairs in 1992 in which it was possible to measure the value of industrial involvement in the F-16 programme rather precisely. Based on this measurement the Ministry of Economic Affairs and Ministry of Defence could each make a confident assessment of the advantages and shortcomings of the programme. 20

In the Dutch case the offset arrangements were defined narrowly and clearly. However, in some cases the goals expressed by the buyer may not be easy to quantify as a currency unit. Some of the problems can be illustrated by taking Swedish goals for offset policy as an example.

The Swedish government guidelines for industrial collaboration (published in September 1983) give the lowest priority to counter-purchase arrangements (which are relatively easy to quantify and measure). 21 Instead, the highest priority is given to direct offsets that can generate development and contract work, lead to joint production, lead to licensed manufacturing or lead to sub-contracting. In cases of indirect offsets, the highest priority is given to establishing business ventures, technology transfers and cooperation.

These priorities are intended to give expression to broader objectives of Swedish industrial collaboration policy which are:

In an evaluation of offset arrangements in Sweden the National Accounting Agency (RRV, Riksrevisionsverket) observed that several of these objectives are rather general and inter-related, making it difficult to identify the role of any specific agreement in achieving them. The RRV evaluation suggested that if legal documents contain very broad formulations combined with an aggregated valuation of the offset requirement, these documents may be of very little value later either in establishing a method for assessing implementation or if it becomes necessary to begin a dispute procedure. 22

Nevertheless, it seems that this combination of general formulation and aggregate valuation is still the basis for some legal documents. For example, the Finnish contract to purchase McDonnell Douglas F/A-18 Hornet fighter aircraft includes a chapter on offsets. The offset obligation of McDonnell Douglas is set at 100 per cent of the value of the contract and should, according to the agreement, follow the offset rules in force in Finland. These rules specify the types of transactions, which may qualify for offset. They are:

As with the Swedish rules, these objectives are somewhat general and it would be difficult to express many measures that might be taken to achieve them in a currency unit or percentage that could be credited against an offset obligation. Under these conditions it may be that non-statistical measurements might be more appropriate.

Non-statistical measurement

The approaches described have largely been based on measurable criteria such as value, time and technical performance. A different approach to assessing offset arrangements would be what is known as a Delphic approach—that is, an assessment based on the judgement of individuals involved in the programmes.

An example of this type of approach could be described as follows. Individuals involved in managing a particular project (from both the seller and buyer side) are interviewed and asked to provide a measurement of perceived success by grading different aspects of the offset arrangement against a scale of 1 through 5. The scale would range from "completely successful" to "completely unsuccessful" and would include questions like the performance of equipment transferred, new products generated, the value of new techniques in production, the usefulness of new business partners or contacts made etc. The responses would be collated and assessed in order to test what Farr calls "partner consensus" which could be summarised by saying that if all parties consider the project to be a success, then it is a success. 24 The evaluation would address questions such as: do both seller and buyer seem to be generally satisfied with the programme? If not, are there some areas of consensus? Where there is no consensus do seller and buyer identify the same shortcomings in the project?

One problem identified by Farr with implementing this approach was the tendency for programme manager rotation during what can be extended projects. If surveys are conducted at the end of a programme it may be that the individuals questioned have no knowledge or limited knowledge of decisions and events, which occurred, in earlier parts of the project. Several management teams may have come and gone during the programme. Therefore this approach would work best if it was established as a routine element of the project and carried out periodically rather than being seen as a one-time exercise.

A second problem could be the choice of agency, which was to carry out the evaluation and assessment. As noted above, there is no universal approach to the management of offsets in buyer countries. In making evaluation and assessment the weighting of different criteria may reflect the particular interests and expertise of the responsible agency. If the Ministry of Defence was to be responsible for an offset evaluation there might not be the expertise to assess the impact of indirect offsets if they were not defence-related. If responsibility rested with, for example, the Ministry of Trade there might not be the expertise to assess the impact of direct offsets on defence industrial capability. In countries where a specialist procurement agency combines both military and economic-industrial expertise a different problem exists in that the agency would in effect be asked to measure its own performance and may be reluctant to include findings that reflect badly on itself.

Case study approaches.

As noted earlier, there is no uniform approach to the management of offsets. The most common way in which the objectives and implementation of different approaches can be assessed is through case studies. The following sections include descriptions of and information about a range of different offset programmes from both a seller and buyer perspective.

3.Supplier perspectives

Changing approaches to offsets?

As noted in the opening section, offset arrangements were, until recently, confined to a small group of states in which the United States was typically the seller and one or more of its industrialised allies was the buyer. As offset arrangements have become more widespread, a larger number of states have had to gain experience in managing them from a seller and from a buyer perspective. France and the United Kingdom, as the major European suppliers of military equipment, have accepted countertrade and offset deals in all their various forms because it is often the only way they can sell to nations with sophisticated defence requirements. In addition to requests for production know-how, France and the UK have found increasing demands for more advanced training, long term support, future equipment upgrades and model replacement.

During the period when the United States was, by-and-large, the only provider of offsets US industry and, even more so, the US Congress was suspicious if not hostile to such arrangements. As recently as 1988 the US Congress included in the National Defense Authorization Act, Fiscal Year 1989 language intended to reduce the use of offsets. 25 Section 2505(b)(1) of the Act stated that :

No official of the United States may enter into a memorandum of understanding or other agreement with a foreign government that would require the transfer of United States defence technology to a foreign country or a foreign firm in connection with a contract that is subject to an offset arrangement if the implementation of such memorandum or agreement would significantly and adversely affect the defence industrial base of the United States and would result in a substantial loss to a United States firm.

By 1997 attitudes towards offset arrangements in the United States appear to have changed. Not only are offsets regarded as a fact of life, there are now positive benefits being attached to them by some erstwhile critics. The Aerospace Industries Association has stated in 1997 that a review of several case studies "indicates that these tools have benefited the US aerospace interests over the long-term." 26 There is some evidence, presented below, that the United Kingdom is also coming to present offsets in a more positive manner. The Offsets and Countertrade Manager at French company Matra Defense has stated that offsets can have a positive or a negative impact depending on how they are structured. Matra Defense tries to convince buyers "to use offsets and technology transfer to increase their strengths, develop truly competitive industries, make good products and services which will bring benefits after the end of the contract—rather than artificially subsidising economically unviable industries." (unofficial translation) 27 However, given the lack of data and analytical instruments to evaluate the true impact of offset arrangements, the basis for firm conclusions about the positive benefits of offset arrangements is unclear.

Nearly all recipients set offset targets as a percentage of the total value of the contract and refuse to consider any supplier unwilling to act on these terms in a defence sales agreement.

In general the management of offset requirements is coming to require more organisation and resources and increasingly involves companies in business areas outside their core business. New structures and divisions of defence companies, procurement agencies and financial institutions have evolved for the specific task of addressing offset arrangements. British Aerospace, for instance, has set up an offset and countertrade department as a result of the Al Yamamah deal with Saudi Arabia which involved a complex mix of direct and indirect offsets and countertrade elements. Much of the value of the weapons transfers were traded in oil, and thus constitute countertrade, but training and infrastructure development has included direct and indirect offset arrangements.

The growth in countertrade and offset transactions has led to the emergence of specialist brokers. Sometimes defence firms use offset brokers who work within merchant banks or accountancy firms such as Coopers & Lybrands. As offset arrangements have increased, rates for fulfilling obligations are edging up—even for large deals involving the most prominent international suppliers. 28 Moreover, countertrading organisations are becoming increasingly selective in the choice of recipients they sign up.

Interviews conducted with industry personnel and Defence Export Services Organisation (DESO) representatives in the UK suggest that problems often arise when a supplier company readily agrees to an offset deal which may represent a large percentage of the value of a defence contract—perhaps as much as 50-100 per cent— but is unable to deliver on their obligations. 29

Often only a fraction of this percentage will involve direct technology transfer, because the absorptive capability of the buyer country in terms of its industrial and technological infrastructure may constrain technology transfer. In these situations the onus is on the supplier company to think up imaginative ways to fulfil indirect offset obligations.

Failure to meet offset requirements usually results in the company being fined by the recipient government. To insure against such events defence suppliers take out a Performance Bond from banks. Because of the complexities of meeting offset arrangements it appears that companies often choose to default and pay a financial forfeit. In the long run this strategy backfires because companies that default acquire a bad reputation, and may fail to secure future contracts. 30

The experience of Russia is instructive in illustrating some of the dangers that a seller may face if too little thought is put into the structure of offset arrangements. In dealing with China in the period 1989-92 the Soviet and then Russian government entered into offset arrangements that proved to be very disadvantageous to its own manufacturers. The Russian government accepted arrangements that placed a counter-purchase responsibility on enterprises making the items exported. The agreements often required Russian enterprises to purchase items from China that had little or no resale potential in Russia—for example, Chinese-made clothes and textiles. This limited potential reflected several factors. First, the managers of Russian enterprises manufacturing fighter aircraft had no experience of distributing goods of the kind that they were obliged to buy. While the enterprises had internal retail outlets for use by their employees, these could not absorb the volume of items received in the offset arrangements. Second, there was little demand in Russia for these goods since locally manufactured items were available of the same price and quality as the Chinese goods purchased.

Subsequent offset arrangements were more carefully thought through. Russian negotiators have tried to minimise the offset component of arms deals with countries such as China and India and increase the amount of direct hard currency payment in any contract. However, in cases where it is considered necessary, offset arrangements are now managed differently.

In 1994 Malaysia agreed to buy 16 MiG-29M and 2 MiG-29UM fighter aircraft from Russia in a deal worth $780 million (at the June 1994 Ringgit/US dollar exchange rate). Two elements of the overall aircraft package were to be supplied by third parties. The training package was to be implemented by a team of Indian pilots, technicians and engineers who were already operating the MiG-29 in Indian Air Force service. The aircraft would receive an avionics upgrade from British company GEC Marconi, which supplied the aircraft with new tactical navigation and attack systems, a new identification/friend or foe (IFF) system and new UHF and VHF telecommunications.

The Russian parts of the agreement (together worth $690 million) included a commitment that 40 per cent of this value was to be offset through direct and indirect offsets as well as the counter-purchase of goods such as palm oil and textiles. 31 The offset element of the package was to be implemented as follows. The entire value of the contract was to be provided to Russia immediately. The Malaysian government was to borrow this money and a series of different lending options were considered including borrowing from banks in Singapore, a consortium of European banks or from the Russian Central Bank. Russian enterprises involved in the programme would guarantee to would buy goods in Malaysia up to a value of $150 million which would be credited to Russia's offset account. 32 In addition, the Russian government would provide certain services to Malaysia which would also be credited to Russia's offset account. In one joint initiative, Russian technicians would be assigned to the Aerospace Tech Systems Corp. This company, registered in Malaysia, is expected to provide repair and maintenance for the MiG-29 aircraft beyond the warranty period during which they are being maintained by Russian personnel under the original agreement. In a second initiative, Russian engineers and technicians provide courses at the University Sains Malaysia north of Kuala Lumpur. 33 By 1994 Russia had learned to construct and implement offset arrangements in a broadly similar manner to other arms suppliers.

Country case study: The United Kingdom

The UK is a significant exporter of arms and thus British defence manufacturers habitually incur offset obligations when selling overseas. Given this growth in offset obligations it might be assumed that a system for measuring their overall impact on UK industry has been developed and implemented. However, there is not much evidence that this is so. No documents or evaluations equivalent to the studies conducted by the US Office of Management and Budget or General Accounting Office are available in the UK.

There has been very little published evaluation of offset policies in the UK apart form the tentative work by Martin and Hartley. 34 There are a number of reasons for this. First there is very little data on offsets available. In the absence of public aggregate data, information has to be gleaned from interviews with industrialists and government officials—who are cautious about supplying details, citing the commercial confidentiality of the information. Second, government officials tend to be sensitive about criticisms of the effect of their offset policies—in particular any charge that a government-supported initiative may have a minor or even negative impact on UK employment.

Martin and Hartley's evaluation is based on a survey of UK defence firms involvement in offsets. The authors found that "a large majority of UK firms thought that offsets were becoming increasingly important requirement for achieving defence exports." 35 This observation is reinforced by the view of DESO, which has stated that "yesteryear's formula of best product, best price, and best delivery will no longer stand up to competition that offers attractive offset incentives. It is a buyers market. Over the past decade, offset has evolved into a highly effective marketing tool that differentiates between otherwise similar products in today's competitive marketplace. Offsets can mean the difference between success and failures, sale or no sale." 36

Apart from the issue of competitiveness, UK companies try to use offset arrangements as an element of their strategy of internationalisation. Through offset arrangements UK companies are trying to form long-term strategic relations with recipients to guarantee future work, as opposed to simply linking offset activities to individual sales. 37

In a recent example, the share of direct offsets offered by British Aerospace played a part in ensuring that the Hawk-100 jet trainer was chosen by the Royal Australian Air Force (RAAF) to replace the Italian Aermacchi MB-326H. The contract to purchase 40 Hawks has an initial value of US$800 m, which could rise to US$1.6bn over the 25-year life-span of the aircraft (taking into account the cost of spare parts and the support to be supplied by BAe). 38 About 80 per cent of the initial contract value is to be offset by coproduction and other forms of industrial cooperation with BAe and its sub-contractors. The first batch of 12 Hawk trainers will be manufactured by BAe in the UK, the remaining 28 will be assembled at the new facility at RAAF's Base Williamstown at Newcastle, 75 miles north of Sidney, incorporating components made under BAe Defence by 18 Australian manufacturers. Qantas the national airline of Australia, will be responsible for assembling and testing the Adour jet engines that will be used to power the 40 aircraft. The Adour engine is produced by a joint venture formed by the UK's Rolls Royce and France's Turbomeca. Under license to the joint venture, Australian companies will produce engine components. BAe is also considering Australia as the site for a regional maintenance centre for the trainers.

Fulfilling offset obligations is not a costless exercise and, not surprisingly, a market in offset credits has developed whereby those firms with credits over and above their own immediate obligations can sell them to others who have a shortfall. 39

The nurturing of strategic relationships through offsets is most apparent in the case of the Al Yamamah programme with Saudi Arabia. The Al Yamamah programme (which accounts for a large share of the UK's total arms exports) is in effect an open ended contract involving a large offset requirement. Signed in Riyadh on 17 February 1986, Al Yamamah 1 comprised a protocol agreement on the purchase of UK arms. British Aerospace (BAe) was designated the prime contractor. The contract covered the supply of 48 Tornado IDS aircraft, 24 Tornado ADV aircraft, 30 Hawk Mk-65 advanced trainers, 30 Pilatus (Swiss) PC-9 basic trainers, 2 Jetsream-31 trainers, Sea Eagle, Sky Flash and ALARM air-launched missiles and ground based equipment and support for the aircraft. Saudi Arabia arranged for much of the purchase to be paid in oil, using an intermediary bank to grant BAe a $2.25 billion loan. It is hoped that as long as UK companies and the British government perform well on its offset obligations the Saudi government is likely to continue to purchase UK defence equipment. Despite the apparent success of the deal it has not been without its problems.

Saudi Arabia was the first Gulf state to have initiated obligatory economic offsets for arms sales. The Saudi government's intention was to use offsets to establish high technology industries and a high technology skill base amongst its workforce. Under the first phase of the programme, the UK and Saudi Arabian governments initially negotiated some 17 offset projects, five of which were later cancelled. In May 1995, nine years after the programme was agreed, only seven projects have been officially approved with five up and running. 40

The seven offset projects approved under the first phase of Al Yamamah involve the following:

Under the second phase of Al Yamamah, worth an estimated [sterling]6-[sterling]7.5 billion ($9-12 billion) a further 11 offset projects have been approved. The deal which was signed on 1 July 1988, divided the purchases into two phases. The first covered the purchase of 48 additional Tornado IDS aircraft plus weapons and associated support and three Vosper Thornycroft Sandown Class minehunters. The Kingdom signed the [sterling]4 billion contract for these additional Tornadoes on 28 January 1993. In September 1994 additional BAe Hawk and Pilatus PC-9 trainer aircraft were purchased, also as part of this phase. Phase two involves orders for three additional Sandown Class minehunters, 88 Westland helicopters (the WS-70L Blackhawk to be built under license from Sikorsky of the US, some of which will be armed with TOW anti-tank missile launchers), a new airbase, naval base and helicopter facilities in Saudi Arabia, the integration of a command and control air defence system, additional guided weapons, 15 BAe-125 and Bae-146 civil aircraft.

The offset arrangements were initially placed at 30-35% of the contract value, but for the Al Yamamah 2 offset programme, this is reported to have been reduced to 25%. 41

The offset projects defined in this phase include a reinvestment of $1.5 billion in the hydraulic engineering and petrochemical sectors, a 12 million gallon water purification plant in the East of Saudi Arabia (in co-operation with Kuligan of the USA) and a $10.6 million automobile oil recycling facility (in co-operation with GVU of Germany). In addition a number of joint-ventures have been set up with UK firms, such as a computer assembly plant involving Intersys Micronics of the UK. British Aerospace has placed sub-contracts with Al Salam Aircraft Co. for depot maintenance of Tornado aircraft over four years. 42 The Saudi FAL group of companies has created a joint venture with Vosper Thornycroft to offer technical assistance and training in maintenance of both civilian and naval ships. 43

The Saudi Arabian government has used its arms procurement policy as part of a long-term goal to develop high technology industries including, if possible, defence industrial capabilities. Offsets would contribute to the development of the Saudi economy by broadening its industrial base, creating a technical skills base in the domestic workforce and increasing exports. In addition, the government hoped that offsets would encourage domestic investment opportunities for Saudi investors who have traditionally invested abroad.

So far, however, these economic advantages seem to have proved illusory. Delays in signing arms contracts have slowed up the implementation of offsets and the number of jobs created through the offset programme is reported to be only in the hundreds. 44 In response, the Saudi government has resolved to put greater pressure on suppliers to increase their offset activity, particularly as the domestic political pressure on the Saudi government to improve the distribution of wealth has been mounting.

The disappointment of the Saudi regime with the performance of UK offsets, underlines that measuring the delivery of offsets accurately is not the only problem. Buyers may have unrealistic or exaggerated expectations about what kind of industrial development potential can be derived from offsets. Moreover, during the period of negotiating the contents of offset arrangements the industrial development opportunities offered should be matched to the existing infrastructure and human capacity in the buyer.

The public position of the UK government is to disapprove of state-sponsored countertrade financing as economically inefficient. 45 However, Saudi Arabia is not the only case in which barter and other forms of countertrade are used as a form of finance. Former Minister of Defence Michael Portillo acknowledged in the case of the Philippines that budget constraints for defence spending would require barter trade as one form of financing. Britain and the Philippines signed their first defence co-operation agreement in February 1996. This statement signals a pragmatic recognition that unconventional financing may be a condition of competitiveness.

One aspect of the UK's arms transfer policy which is not officially identified as countertrade, involves the use of the Overseas Development Administrations aid budget to 'sweeten" arms deals. In November 1994 several newspaper reports hinted at the link between arms sales to Indonesia and 'sweeteners" in the form of aid. 46 The ODA claimed there was no basis for the claims of a link between aid to Indonesia and the sale of defence equipment. However, Robin Cook, the Labour foreign affairs spokesman, said that " it is very difficult to ignore the pattern that is beginning to emerge in a number of countries, big rises in aid to them have been followed by big arms orders". 47 The negotiations for a large arms deal with the Indonesian government involving Scorpion APCs, water cannon, and Hawks coincided with an ODA announcement that [sterling]70m of aid for a power station and road project had been agreed. This coincidence replicated the ODA funded Pergau project in Malaysia linked to Hawk deal and the sale of tanks to Nigeria when British aid to that country rose from [sterling]6.3m in 1988-89 to [sterling]67.7m in 1989-90. Such practices have raised a public outcry, which have led to official investigations iby the National Audit Office into charges malpractice by Her Majesties Government.

Country case study: France

The growth in French participation in offset arrangements has been dated from the end of the 1980s. At this time France shifted from what has been described as "passive" countertrading to "active" countertrading—compelled by the changing conditions in the international arms market. 48 The defence budgets of many of France's most important clients in the developing world (in particular in the Middle East) were constrained by heavy debt burdens and the falling price of oil. After the cold war, offsets have achieved greater prominence, driven by the need to secure sales in a buyers market.

While French exporters have accepted the need to engage in offset arrangements, several of the published analyses indicate an awareness of potential risks associated with the practice. One recent analysis identifies contradictions in the use of offsets. According to this, the logic of seller is commercial and focuses on prompt execution of a contract while the logic of the buyer may be political (implementing industrial policy) and call for structural measures that produce benefits in the medium to long-term. 49 It is often difficult for the seller to understand what the buyer really wants to achieve (in particular through indirect offsets).

Specialist units within the Ministry of Defence along with a section within the DREE (Direction des Relations Economique Extérieures) are the government agencies responsible for implementing French offset obligations. A unit within the export financing agency COFACE provides some expert assistance on an as-needed basis.

In France one private sector agency, the Association pour la Compensation des Echanges Commerciaux (ACECO), has specialised in studying the impact of offsets. ACECO is an industry association funded by fees from its members. It is not directly focused on the defence industry—though it lists many defence firms among its membership. ACECO identified four obstacles to the evaluation of offsets. These were the relatively poor mechanisms existing in companies for monitoring offsets, the level of confidentiality surrounding the projects, the diverse nature of projects accepted by offset committees and the time gap between the agreement and its implementation.

The published findings of the studies are of a general kind. For example, four priorities are identified for sellers to achieve success in offset arrangements. These are regular high-level dialogue between the parties, a mix of direct and indirect offsets, adoption of multipliers adapted to measuring the degree of technology transfers and the adoption of a wider perspective in evaluating offsets.

Initial ACECO studies have argued that the practice employed by most buyers of using an offset committee to designate specific projects as qualifying under contracted offset obligations is not ideal. This practice leads to a proliferation of projects whose main purpose is to satisfy the committee rather than produce an real benefits. ACECO recommends instead the policy "demand less to achieve more" on the basis that very ambitious objectives combined with very rigid guidelines produces an unrealistic expectations that cannot be realised. Under these conditions both the seller and the buyer may be losers in the transaction. 50

Two primary risks identified, which can lead to negative consequences from offset arrangements, are the danger that technologies transferred will be mis-applied or ineffectively applied by the buyer and the danger that employment among French sub-contractors will move to the buyer.

The danger from the ineffective application of the production capacities or technologies transferred is customer dissatisfaction. There are two identified dangers from the movement of sub-contracts to the buyer. The first is to the companies which previously performed the work and the second is to the prime contractor. Whereas the offset arrangements may lead to dispersion of sub-contracts (both geographically and in terms of the number of firms participating in production), the prime contractor may prefer to develop a deeper relationship with a small group of suppliers.

French companies have had to become more creative in offset arrangements, which are now routinely used in marketing. According to Berthault it is now widely recognised in France that:

"The requirement for an indirect offset with all arms exports will soon be unavoidable. In this context of widespread and ever increasing offset demands, there will be a need to improve communications between the defence industry (which has traditionally been rather isolated) and other large sectors of industrial activity. Particularly for large contracts, the latter might be able to assist arms exporters with their offset programmes such that both sectors benefit from the resulting co-operation". 51

Until now the main French emphasis has been on managing offsets for existing customers. The United Arab Emirates, which is one of France's largest customers, has insisted on a number of indirect offsets involving French companies. In February 1993 GIAT Industries secured a contract to supply the UAE armed forces with its new generation Leclerc tank plus recovery vehicles and associated equipment and services. 52 Small countries such as the United Arab Emirates (which has a population of less than 3 million people) which invest a large amount of their national resources into defence are very likely to try and use procurement programmes to further a variety of policy objectives. The UAE's offset policy isto improve the economy's diversity through attracting investments in new business and services. Accordingly GIAT's offset commitments include 53 :

Apart from GIAT Industries, two other French companies (Thompson-CSF and Aerospatiale) also have large indirect offset commitments in UAE. 54

French defence firms have experienced considerable difficulties in identifying suitable offset opportunities in UAE as government policy insists that offsets programmes are limited to the non-oil sector and prefers labour intensive projects. In an effort to make it easier for foreign companies to do offset business, the UAE government encouraged the creation of a new investment bank, UAE Special Investments, with the help of Chase Manhatten and Finasa Emirates. The new bank plans to acquire assets up to $1 billion and defence contractors with offset obligations are able to take a share in the company. Finasa Emirates is acting as a broker, bringing investors into the company and arranging deal structures, while Chase Manhatten has the responsibility for managing local investments and identifying and prioritising offset projects in conjunction with the government. For investments to be counted as credits toward an offset obligation, they need to be approved by the United Emirates Offsets Group (UOG). This initiative is designed to reduce the risk to the obligated companies through indirect investments. Benefits also accrue to contractors through the pooling of ideas, resources, management and capital.

The growing financial constraints experienced by many Gulf states in the 1990s led to a drop in military orders from France. French defence firms have increasingly directed their sales efforts towards East Asia, where dynamic economic growth and rising military expenditures offer potential sales. Countries in this region have different demands in comparison to Gulf clients. They insist on technology transfer through offset arrangements to build up industrial capabilities in both the military and civil spheres.

Under these conditions it can be anticipated that France will devote an increasing amount of resources to the question of managing offsets.

4. Offsets: Recipient perspectives

The previous section underlined the difficulty that sellers have in defining offset arrangements and measuring their delivery. This section will address the issue from a buyer perspective. While procurement by their domestic armed forces is still the main source of sales for most defence firms, the Asia-Pacific equipment market is emerging as one of the most important for international sales. These countries all have a policy of using offset arrangements as an element in their industrial policy.

Countries with established defence industries (such as South Korea, Singapore and Indonesia) use offsets to channel work into their defence industries and to expand their defence production capabilities. Defence industrialisation is believed to yield benefits such as technological spin-offs, employment generation, balance of payments advantages and the security of supply of weapon systems. The spiralling costs associated with the purchase of defence equipment, combined with concerns about unemployment and industrial competitiveness have encouraged East Asian governments to seek greater economic benefits from arms transactions. Countries like South Korea, Singapore and Indonesia have begun to use offsets to access sophisticated technologies to enhance the competitiveness of their emerging civil industries such as aerospace and electronics. 55

Utilizing defence contracts as a means of accessing civil technology has arisen as a way of getting around sections of the General Agreement on Tariffs and Trade (GATT) which prohibit the practice of offsets in government procurement except for the procurement of military weapons.

The kind of offset programmes sought by recipients depend on their offset programme goals, which in turn are motivated by their industrial and economic development needs. In ASEAN countries where the defence industrial base and infrastructure is poorly developed or non-existent offsets are likely to be indirect and targeted at building civil industries and services. Economies such as South Korea, with a significant defence industrial capacity, usually insist on a high level of direct offsets or indirect offsets either targeted at defence industries (what the French call semi-direct offsets) or at associated high technology sectors such as aerospace and electronics.

Among the possible approaches, many recipients because of the employment and technology transfer implications favour direct offsets including licensed production and coproduction. There are often limitations in these arrangements, however, since the production runs associated with purchases of complex systems are often short. Under these conditions indigenous defence production is a costly business. To maximise the economic benefits the buyer is likely to insist that the seller purchase some output from capacities established under the programme. This type of offset can usually be calculated and monitored relatively easily provided that the obligations on the seller are clear. These are expressed as a percentage of the total value of the contract price and fulfilled in a set time period.

Under conditions of reduced arms procurement spending, countries that have traditionally pursued national approaches to defence industrial development have come under a gradually increasing pressure to co-operate in transnational defence programmes. Offset arrangements are becoming one important form of international co-operation. The United Kingdom offers a good example of this process.

The UK as an offset recipient

In the 1970s, with the growth in unemployment and the spiralling costs of defence equipment, the government sought domestic industrial benefits when buying off-the-shelf equipment. However, until the mid-1980s UK purchases with offsets were relatively small and attracted little public attention.

Most offset deals with the UK have involved US companies, who reportedly find the implementation of defence related offsets in the UK relatively unproblematic. The UK has a sophisticated and diverse industrial base and many US companies already conduct business there. Defence industrial co-operation is made easier by the long experience of collaboration and information sharing between governments and industry. This does not mean that there are no difficulties involved from the seller perspective and these difficulties may be growing in response to changes in the UK approach to offset management.Many of these changes have been brought about by the combination of the increasing emphasis on "value for money" in UK procurement policy together with lessons learned from past programmes.

In 1986 the UK government purchased seven E-3 Sentry airborne warning and control systems (AWACS) from Boeing at an estimated cost of some $1,150 million. The award followed the failure of UK firms to develop an airborne early version of the Nimrod maritime surveillance aircraft. Opponents of the decision to abandon the UK programme (on which around $1,300 million had already been spent) highlighted the effect of buying a US system on the UK defence industrial workforce. To soften the blow the UK government promised substantial offsets from Boeing designed to retain jobs in the UK aerospace and electronics industries. Boeing initially offered a 100% offset deal claiming that it would generate 40 000 man years of work for British industry spread over a five year period. The MoD claimed that the job losses resulting from the cancellation of the Nimrod project would be equalled if not exceeded by the job gains from the offset. When the contract was finally signed the offset was to be worth 130% of the contract value and spread over an eight year period.

Many questions have been raised about the nature of the offset work that Boeing offered. Press reports alleged that offset projects were concentrated in the low technology end of the defence industry and that some of the work would have been placed with UK contractors regardless. The volume of the offset work was alleged to be a lot lower than anticipated and as a result far fewer jobs were retained than had been promised. These assertions prompted an investigation by the Parliamentary Defence Committee into the AWACS offset agreement. 56 Evidence was taken from Boeing, UK industry and the MoD and the subsequent report provides one of the most detailed insights into the impact of offsets in the UK The report also provided the guidelines for current offset policy in the UK. These guidelines are summarised in table 4.1.

Probably the most important findings of the investigation were related to the questions of first, how to count offset obligations and second, industrial co-operation at the company level. Most important in the first case was the fact that contracts with the UK company Rolls Royce were credited to Boeing in the offset calculation. However, many airlines that place orders for Boeing aircraft make the provision of Rolls-Royce engines a condition of the contract. 57 Boeing would have been obliged to buy these engines in order to sell their aircraft.

A second controversial finding was evidence that some of the companies established under the agreement seemed to have no long-term financial prospects. They seemed instead to be 'shell" companies, which Boeing gave money in order to meet their offset obligation. As soon as the offset obligation was met, these companies would close. This was less investment than a cost of doing business. Moreover, it was suspected that Boeing might have recovered these costs as a price premium, if not in the first stage of the AWACS contract then in subsequent phases of the life-cycle support of the aircraft.

Accordingly, the UK government tried to shape new guidelines to meet some of these concerns. Under the new arrangements offsets are not mandatory, but they are used as an assessment factor in contract evaluations. 58 Offsets are encouraged for weapon sales worth more than [sterling]10 million and a majority of recent agreements require 100% of the sale to be offset. An offset may be higher than 100% of the contract value—for instance in the case of the MoD's [sterling]1 billion (roughly $1.6 billion) purchase of the CH-47 Chinook support helicopter from Boeing, the UK government has been offered a 200% offset deal. 59

Table 4.1 UK Offset Guidelines and Agreements

Category Offset Guidelines Offset Agreements
Long term Objectives Compensation for loss of work in the UK DIB Agreements reflect guidelines
Threshold for Offsets All defence contracts valued at over [sterling]10 million Most contracts valued over threshold
Offset Type All offsets must be defence related Agreements reflect this stipulation
Multipliers Offset credit can be negotiated Offset credit is often negotiated
Banking Permitted in certain circumstances Banking permitted in most agreements
Penalties Not stated No penalties, agreements call for "best efforts" to fulfill obligations
Performance period Not to exceed delivery period Ranges from 3-13 years
Local content Offset activity must be placed with a government registered firm Offset credits are not recognised if firm is not registered with MoD
New business Offset activities must be new and consist of products not previously purchased from new suppliers, on new contracts valued at over $50,000. New agreements stipulate that credit is only given for new business
Oversight Offset proposals commonly submitted at a time of contract approval Several agreements have regular

Reporting of offset activity

Source: US GAO 1996

The UK government has attempted to increase the benefits derived from offset in recent years. During the negotiations that led to the decision by the UK to buy the McDonnell Douglas AH-64 Apache Longbow attack helicopter US officials noticed a more aggressive pursuit of offsets and more attention to the details of offset arrangements from their UK counterparts. 60

This approach has also been reflected in how offset credits are determined and recorded. Recent agreements have insisted that a company's existing business is not eligible for offset credit and that any purchase orders of new equipment or subcontracts for offset credit must be placed with a firm that is formally listed on the government's defence company register. 61 In this way it is hoped that the problems identified with the AWACS programme can be avoided in future.

In addition, it is now being said that offsets are about "more than dollars and pounds". One of the most important features of offsets in the eyes of UK officials is as an instrument to develop company-to-company ties between UK defence contractors. In monitoring whether these ties are developing satisfactory way government officials will rely mostly on the views of the companies involved regarding whether and how they are benefiting from offsets.

In addition, the Defence Export Services Organisation (DESO) is investing more resources in developing the offset-related aspects of contracts and monitoring contract implementation. This has led to new procedures being created for surveying UK companies as well as DESO representation at meetings where offsets are discussed. The effort to link contractors in the selling country (usually the United States) with UK contractors is made easier by restricting the participation in offsets to companies already registered with the Ministry of Defence. This makes it easier to collect information and monitor implementation.

The fact that offset implementation is being undertaken by DESO (part of the Ministry of Defence) rather than by the defence industry unit within the Department of Trade and Industry indicates the fact that in the minds of officials offsets are still tied to procurement policy rather than defence industrial policy. The first requirement is that the systems being bought are necessary and affordable. 62 Offsets are seen as one way of extracting the best terms of trade.

DESO officials do have some reservations about the growing use of offsets and their effectiveness, however. First, they accept that there are costs to managing offsets" and are concerned that these costs are growing. As additional bilateral agreements are signed with new countries that include offset arrangements there is concern that an offset management bureaucracy may become a significant overhead both in DESO itself and in companies. Second, although they state as a requirement that contracts should not include any price premium for offset implementation, it is assumed that seller companies will find a way to pass on to the UK procurement agency at least some of the costs that they incur in setting up offsets. Third, the measurement problems identified in chapter 2 have not been solved in particular with regard to indirect offsets.

The balance between costs and benefits in offset relations will continue to be monitored.

Table 4.2. Recent UK offset arrangements 1985-95

Weapon System
Value of agreement
Year Supplier firm Offset summary Offset %
$1.1 billion
1986 Boeing Direct and indirect; worth $1.5 billion over 8 years. Supply of parts, equipment and support for Boeing aircraft; 250 UK firms received work by 1991. 130
EH-101 helicopter sub-systems 1991 IBM Direct, subcontracts 100
C-130J Hercules [sterling]1.3 billion 1994 Lockheed Direct (at least 10 per cent) and indirect; subcontracts to 36 UK companies. 75
Orion 2000 MPA[sterling]2bn Lockheed Martin 50% direct (all with aerospace companies) and 50% indirect. 100
AH-64D Longbow Apache$4 billion 1995 McDonnell Douglas Direct; subcontracts, technology transfer and training. 100

Source: Joanna Spear, 1997.

Offsets in East Asia

The use of direct and indirect offsets has become a growing feature of the technology transfer process in East Asia. Many governments in the region set offset targets as a percentage of the total value of the contract and refuse to consider any supplier unwilling to accept these terms in a defence sales agreement. Direct offsets are widely used throughout the region to build up indigenous defence industrial capabilities. However, the nature of offset policies within the region varies depending on the level of industrialisation of the economy and in particular the level of defence industrialisation.

firm Offset summary It is possible to establish a typology of different levels of arms production capability. 63 The following types of activity can been identified:

  1. Simple maintenance
  2. Overhaul, refurbishment and rudimentary modification;
  3. Assembly of imported components, simple licensed production;
  4. Local production of some components or raw materials;
  5. Final assembly of less sophisticated weapons that include some local components;
  6. Coproduction of less sophisticated weapons;
  7. Limited improvements to license-produced arms;
  8. Production of less sophisticated weapons with a high content of local components;
  9. Production of more advanced weapons with limited local components
  10. Independent research, development and production of less sophisticated weapons;
  11. Independent research, development and production of advanced weapons that include foreign components;
  12. Independent research, development and production of advanced weapons.

Using this typology countries at early stages of indigenisation (stages 1-5) include Thailand, Malaysia and the Philippines (where complete knockdown kit assembly, overhaul and maintenance are the main defence industrial activities). Singapore and Indonesia are at stages 5, 6 and 7 (engaged in the final assembly of less sophisticated weapons such as small arms, ammunition and artillery systems and the co-production or complete licensed production of weapons platforms such as helicopters and transport aircraft). South Korea finds itself at a plateau around stages 8, 9 and 10 (limited local research, development and production of advanced weapons, independent production of less sophisticated weapons).

None of the countries under examination have freed themselves from dependence upon imported technology. The general lack of indigenous research and development capacity, venture capital and skilled labour combined with the lack of domestic demand make it expensive and difficult to keep up with technological advances in the major producers (who are also the main arms suppliers).

Given the pace of technological change within military systems and the costs of trying to reach stage 12 (independent research, development and production of advanced weapons) at least one country in the region, Singapore, has concentrated on strategies such as add-on or add-up engineering or retrofitting. Add-on engineering involves integrating components from various sources into new weapon systems. Retrofitting involves integrating components from various sources into an existing weapons platform to enhance its operational effectiveness and lengthen its in-service life. Singapore has chosen to specialise in developing sub-systems that can be used in retrofitting, drawing in particular on the strength of its civil electronics base.

The desire of East Asian countries to establish indigenous defence industrial capacity results from a combination of strategic, political and economic considerations. Strategic factors included ensuring security of supply and (in the case of South Korea) regional power aspirations and the security dilemma posed by North Korea. The political incentive to establish a defence industrial base has often arisen as a result of the central role of the military in political affairs in South Korea, Singapore, Thailand and (to a lesser extent) Indonesia. Economic incentives to acquire defence industrial capabilities are associated with the general development of strategic industries such as aerospace and electronics, to which defence production is closely allied. The end of the Cold War, far from reducing the desire for defence industrialisation, has strengthened the resolve of many East Asian countries to enhance their defence industrial base—largely as a result of the growing sense of regional insecurity and uncertainty. The expulsion of the United States from bases in the Philippines and the end of a regional Russian military presence has created fears of a "power vacuum" in which China may be tempted to use military pressure to achieve political objectives. Military expenditure in the region is rising and defence industrialisation has accelerated.

Direct industrial offsets have been the main mechanism through which South Korea, Singapore and Indonesia have gained access to military technology. Thailand and Malaysia are also pursuing aggressive offset policies in an attempt to expand their embryonic defence industrial bases. During the Cold War attempts to acquire defence industrial capabilities were often frustrated by export restrictions of the major supplier nations (particularly those of the United States who is by far the dominant supplier of military technology in the region). Recently, however, East Asian recipients have found that their demands for technology transfer through offset agreements are being met with greater ease.

The combination of externally driven threat considerations and internally driven economic aspirations are likely to continue to stimulate defence industrialisation through direct and indirect offset arrangements for the foreseeable future.

In the absence of a coherent policy of denial among Western suppliers, the growing demand for offsets is likely to be met. Furthermore, as the countries in the region learn how to deal with Western suppliers, they are able to extract ever more generous offset and countertrade deals by playing one supplier against another.

South Korea

South Korea's policy has developed alongside the evolution of the indigenous defence industry from the late 1960s. The United States through export regulations strictly controlled this early phase of defence industrialisation (made possible by the US military assistance programme). While the US encouraged South Korea to develop the capability to produce and support low-tech equipment, there was no encouragement to the produce more complex equipment. US technical assistance included transfers of military technology, scientific and engineering exchanges and licensed production of selected weapon systems. 64 A total of 124 free technology data packages were transferred to the Korean defence industry from the US, which helped to establish certain across the board capabilities within the Korean defence industry in the 1970s.

The US administration began to restrict the supply of free technology data packages from 1980 onwards as sensitivity grew about the intellectual property rights of US defence manufacturers. Thereafter, South Korea was only able to secure production capability in the aviation, radar and vehicle sectors by buying rights. From 1985 onwards South Korea adopted a formal countertrade and offset policy to maximise the benefits form arms transactions. The stated aim of the government's offset policy was to acquire key advanced technologies required for defence and commercial industry research, development and production; enhance depot maintenance capability; improve opportunities for manufacturing equipment and its components; provide the capacity to repair and overhaul foreign military equipment and opportunities to export defence related products.

In the 1990s Korea enjoyed a remarkable growth in civilian science and technology capabilities. The defence industry lagged behind partly as a result of the decline in domestic defence expenditures and export markets, but also because of the increasing restrictions being imposed on technology transfer by the US. The utilisation of defence production lines is currently low and firms that are financially exposed as result of defence over-capacities losing their preference for defence contracting. At the same time the government wants to be able to build more technologically advanced weapons.

Although the US government remains committed South Korea's security, it has become increasingly sensitive to the potential commercial implications of military technology transfer. The US has become more circumspect about its offset policies towards South Korea, imposing from its side a 30 per cent limit on offset deals. South Korea has begun to look elsewhere for sources of military technology. European suppliers could find themselves well placed to penetrate this market if they offer offsets that incorporate a high degree of technology transfer to the defence or aerospace industries.

European defence suppliers currently compete most effectively in markets where the US has no equipment that meets South Korean requirements. South Korea's tender for diesel submarines was secured by Howaldtswerke Deutsche Werft (HDW) of Kiel in Germany. The US no longer produces diesel submarines. Similarly, the US was unable to meet Seoul's requirement for light transport aircraft, which was won by CASA of Spain.

In future it may be that the main advantage European suppliers have is their willingness to transfer technology. For example Matra of France won a contract to supply Mistral man-portable surface-to-air missiles although the South Korean military preferred the US FIM-92 Stinger missile. This is because the Defence Technology Security Agency within the Department of Defence is reluctant to release technologies associated with portable surface-to-air missiles.

It is possible that US restrictions could erode if potential markets could be lost to European and Russian competitors. In February 1995 the Clinton Administration released its Conventional Arms Transfer policy which mentioned the preservation of the US defence industrial base as one criterion taken into account in licensing decisions.

With the high priority attached to economic and social development in the post-Cold War era, South Korea's offset policy was reviewed in 1992 to enhance the economic benefits from foreign purchases.

Positive spin-offs to the civil economy from government procurement are identified as essential if defence investments are to be justified. Technology transfer and training (already a high priority in South Korean offset policies) has received increased emphasis since 1992 with a focus on the aerospace industry. The government's emphasis on the Korean Fighter Programme (KFP) is partly justified through the expected impact on the civilian aerospace industry. The cost of producing F-16 fighter aircraft in Korea (estimated at 1.2 times the cost of purchasing aircraft made in the United States) is thought to be good value for money because of the potential development of the civil aerospace market. 65 KFP is expected to serve as a catalyst for developing an understanding of generic aerospace technologies. These trends show a shift in emphasis away from insistence on direct offsets that aid defence industrialisation towards indirect offsets to aid the development of high technology civil industries.

The South Korean government uses multipliers that value offset credits at a level exceeding the financial cost of providing them in cases where there are considered to be particularly important technology transfers.

Table 4.3: South Korea: Offset Guidelines and Agreements

Category Offset Guidelines Offset agreement
Date Offset requirements began before 1985. Latest version published in January 1992 1985-94
Programme Objectives Acquire key advanced technologies required for defence and commercial industry research, development and production; enhance depot maintenance capability: enhance opportunities for manufacturing equipment and its components; and provide opportunities to repair and overhaul foreign military equipment and to export defence related products Agreements were generally consistent with the guidelines. However certain offset projects had no relationship to the weapon system being purchased.
Offset Threshold Military procurements exceeding $5 million are subject to offset. Several offset agreements prior to 1992 involved contracts that were below the current $5million threshold.
Offset Type Direct offsets are still preferred, but indirect offsets are favoured where they benefit the civil aerospace industry Agreements are generally consistent with the guidelines and reflect a willingness to accept indirect offsets, especially those involving technology transfer and training, that will contribute to economic development.
Percentage At least 30%of contract value Since 1985 contracts have generally required at least 30% offset and frequently more.
Multipliers Limited use of multipliers. Facilities, equipment, and tooling provided by the contractor free of charge, are given a multiplier of 2x their actual cost. Several offset agreements have provided multipliers that were larger than published guidelines, especially for technology transfer and training. eg. providing on-the-job training for Korean engineers at a US contractors plant was valued at 10x the cost of providing training.
Banking Permitted Banking excess credits allowed several individual agreements.
Penalties 10% of unfulfilled obligations Agreements consistent with performance

Source: GAO/NSIAD-96-65 Military Exports

Offsets to ASEAN countries

Offsets have become an essential feature of arms transactions with the ASEAN region. They are an import mechanism through which technology is accessed for both defence and civil industries. While in the 1980s countertrade policies tended to be somewhat ad hoc, more recently offset and technology transfer policies have become increasingly aggressive as ASEAN governments learn more about securing offset and countertrade concessions from major suppliers. 66 Some ASEAN governments appear to target their offset demands more coherently than in the past, trying to maximise economic benefits.

The level of defence industrialisation in ASEAN is far lower than it is in North-East Asia and this affects the character of offset and countertrade policies. Only Singapore and Indonesia have achieved notable levels of defence industrialisation. Malaysia and Thailand are a lot less industrialised in spite of their ambitious public plans for greater self-sufficiency in defence production. Counter-purchase remains an important element of offsets in these two countries.

This section will concentrate on trends in Malaysia, Thailand, Philippines, Indonesia and Singapore.


Malaysia is becoming increasingly adept at extracting offset deals from arms transactions. However, the definition of offsets used by Malaysians is vague and the general term "reciprocity" may be more appropriate. Malaysia accepts a considerable proportion of investment and countertrade arrangements when counting offsets. All six contracts awarded under the 1988 [sterling]1 billion Malaysia/UK memorandum of understanding (MOU) involved countertrade and offsets. Offsets averaged 50-60 per cent of individual contract values. The balance was in favour of indirect or semi-direct offsets (defence goods and services not related to the product being purchased). The rest of the contract value was covered by counterpurchase of commodities, semi-manufactured and manufactured goods. The British Aerospace sale of 32 Hawk aircraft is estimated to have cost Malaysia $560 million (though these figure included communications equipment). 67 This contract included indirect offset obligations (such as training engineers) but BAe is also committed to direct technology transfer to Airod (Malaysia's aircraft maintenance and overhaul company) to allow that company to perform repair and overhaul of the Hawks.

In December 1993 the Malaysian government signed an agreement with McDonnell Douglas for the purchase of eight F-18 fighter aircraft and 25 Harpoon missiles for the Royal Malaysian Airforce (RMAF) valued at an estimated $500 million (1993 prices). The deal involves an offset agreement to the value of $250 million to be carried out over five years. 68 Direct offsets involve the production of parts and components though the programme also involves indirect offsets. One hundred and twenty-two candidates were identified for various offset projects. McDonnell Douglas agreed to the offset requirements to secure the Hornet sale and to secure a long term partnership with Malaysia—which has become the largest market for the company in South East Asia.

To develop the Malaysian aerospace industry Prime Minister Datuk Seri Dr Mahathir Mohamad has advocated developing a European-style system of international alliances in South East Asia whereby several countries divide manufacturing tasks, drawing technical support from Europe and the US. 69 Mahathir identified microelectronics, software, electronic warfare and composite materials as areas in which technologies should be accessed through countertrade arrangements and joint ventures. The performance of countertrade is monitored closely by Unit Khas, a department of the Malaysian Ministry of Trade.


The Philippines, with a foreign exchange crisis and a moribund economy, has limited capacity to procure weapon systems. However it has a desire to modernise its armed forces, which operate obsolete weapon systems. The Philippines recent altercations with the Chinese over the aptly named Mischief Reef in the Spratly Islands have intensified their resolve to enhance their maritime capability. The government has earmarked 50 billion peso ($1.9 billion) to be spent over five years to procure modern ships and combat aircraft. Ministry of Defence officials have made a 350 billion peso ($13 billion) budget request for a 15 year equipment programme which is under discussion. 70

Countertrade offers the government a way to fulfil its plans under budget constraints. However, experience with offset programmes has not been encouraging. Attempts by the Philippines Aerospace Development Corporation (PADC) to establish a direct offset programme related to the acquisition of 18 Italian built Siai-Marchetti S.211 aircraft are regarded as having been a farce since PADC has never responded to a request to identify the things they would like to produce. The programme has never progressed beyond paperwork. 71

In a second offset arrangement in 1988 Agusta agreed to barter helicopters for prawns.


In South East Asia Indonesia pioneered the use of direct offset programmes under the management of Dr B. J. Habibie, the Minister for Research and Technology. Ten defence sector state-owned enterprises have been vehicles for transfers of technology from overseas and have helped accelerate Indonesia's defence industrialisation.

Indonesia's aim has been to become self-sufficient in weapon systems, to become independent in naval shipbuilding and to create a regionally dominant civil and military aircraft industry through joint ventures. While the success of the weapon systems may be debated, the naval and air objectives have been met. IPTN at Bandung is now an established regional aircraft manufacturer. The company is an "offset creation" established in 1976 on the basis of licensing agreements with MBB of Germany. The naval offset programme has, after transfers of technology under direct offset agreements, allowed the shipyard in Sarabaya to divorce itself from its German partner and embark on an independent shipbuilding programme. A patrol vessel has been built to the yards own design, and construction of a frigate is planned with entirely local technology.

Indonesia has collaborated extensively with European and American aircraft manufacturers since the 1970s and without this co-operation far less progress would have been made. Indutri Pesawat Terbang Nusantara (IPTN), the state-owned aeronautics company, manufactures a variety of aircraft components and sections ranging from wing trailing flaps for Boeing 737 aircraft to cockpits, fuselage, and fin connections for Airbus aircraft. IPTN also produces the 35-seat CASA-235 aircraft (under a licensing agreement with Spain) and a variety of helicopters including the Bell 412 (USA), Eurocopter BO105 (FR Germany) and the NES-332 Super Puma (France). Indonesia is self sufficient in the production of airframe parts for the BO105. IPTN's Universal Maintenance Centre is rapidly becoming a major competitor in the South East Asian engine overhaul and repair business. IPTN plans to embark upon the development of a 100 seat commuter jet aircraft in the near future. 72

IPTN has 25 collaborative agreements with US, European and Japanese companies. 73 Indonesia has or is negotiating offset deals with Boeing, Lockheed Martin (formerly General Dynamics), Fokker, BAe, Airbus Industries, McDonnell Douglas, General Electric and Rolls Royce.

If the Indonesian government buys F-16A/B fighter aircraft it has demanded buy-backs for components worth 30 per cent of the contract value. 74 This is although the aircraft in question would be bought from the US government and not from Lockheed Martin. The aircraft were originally built for Pakistan but never delivered.

The Indonesian airforce has ordered 24 Hawk 100/200 armed jet trainer aircraft. IPTN has received offset work from BAe relating to the first stage of the contract. 75 Although the Indonesia government was keen to secure direct industrial offsets from the Hawk contract, British Aerospace and GEC could not identify direct offset opportunities. In the end an agreement was reached for IPTN to produce the pylons for weapons delivered by the aircraft. In addition BAe has agreed to assist in securing the international airworthiness certification for the Indonesian built CN 250 transport aircraft and this will be counted as an indirect offset. The offset deal on the last batch of Hawks is open in the sense that IPTN can now bid commercially to supply components and parts for UK aircraft.

The reluctance of BAe and GEC to provide technology transfer slowed down the conclusion of the Hawk contract. These delays frustrated the Indonesian armed forces who would have preferred an off-the-shelf purchase if this would have avoided delays.

Interviews with Western defence company representatives in Jakarta confirmed Indonesia's move away from direct towards indirect offsets that involve infrastructure investments and human resource development. 76 The Indonesian aerospace industry faces a lack of skills and management experience (particularly at middle management level). There are some gifted leaders like Habibie and an abundance of cheap but skilled manual labour at the bottom of the aerospace workforce, but there is a notable 'skills gap" in the middle. BAe's emphasis in offset arrangements has focused on training. A student sponsorship scheme has been put in place whereby engineers are sent to Cranfield, Bristol, and Loughborough Universities for technical and managerial training. The British government sponsors some students through the British Council. The programme has been established for 4-5 years and some of the first students have already returned to Indonesia and gone into the aerospace industry.

Examples of technology transfer and joint production include a joint-venture programme between IPTN and CASA of Spain to develop the CN235 transport aircraft; an agreement with Lürssen Werft of Germany for the transfer of technology to PT PAL shipyard to produce fast patrol boats; 77 a joint production agreement between PT Len and Siemans to produce a transceiver; a number of joint ventures between GEC and IPTN (on an avionics programme), with PT PAL (on marine technologies) and PT Len (on naval command systems). GEC is also committed to training PT Len to manufacture some parts of the Nautis shipborne command system for world wide markets. 78 GEC will export these products from Indonesia while providing marketing skills, infrastructure and networks from other parts of the company.

Indonesian companies are beginning to find themselves involved in countertrade deals from the seller side as they develop products that can be marketed abroad. IPTN has sold aircraft to Malaysia under a barter agreement which involved Indonesia importing Malaysian built Proton cars. In another case IPTN sold equipment to Thailand in exchange for rice.


In its recent round of arms purchase, the Thai government has insisted on countertrade, usually involving the counter-purchase of primary products. In 1996 the Ministry of Finance demanded a barter and counter-purchase agreement to offset the costs of the planned purchase of eight McDonnell Douglas F-18C/D fighters. McDonnell Douglas accepted an undisclosed amount of Thai primary produce (rubber and fruit) as part payment for the aircraft. Government policy normally requires barter worth up to 30 per cent of contract value. 79

Thailand has very little defence industrial capability beyond small arms and ammunition production, although it has ambitious plans to expand its defence industrial base in the future. To this end it has begun to insist upon direct industrial offsets. In February 1996 it was reported that a German consortium bid was enhanced with offset and countertrade as part of a bid to supply the Thai Navy with submarines. The consortium, including Howaldtswerke Deutsche Werft AG, Ferrostaal AG and Thyssen Nordseewerke offered a package combining an offset agreement with countertrade. 80

The Thai countertrade policy appears ill defined, reflecting a broader lack of coherence in Thai defence procurement policy. However, it would appear that the Thai government is becoming more adept at playing off bidders against each other to gain better countertrade concessions.


Singapore has achieved an enviable reputation for successful implementation of countertrade policy, which is sometimes referred to as the Build-Operate-Transfer (BOT) programme. Through this offsets have been used to build up domestic defence capabilities. Singapore's defence industry was established in 1967 to provide a strategic in-country capability to produce ordnance and munitions and to provide maintenance and other services to the Singapore Armed Forces (SAF) at the lowest possible cost. Thirty years later Singapore Technologies (ST) has 46 subsidiaries with 12,000 employees and annual sales in excess of US$2 billion in aerospace, marine, ordnance and industrial products and services. 81 Offsets and coproduction arrangements have allowed ST to strengthen its base of products and services and keep abreast of overseas developments.

In the 1980s Singaporean offset requirements were somewhat ad hoc, but more recently it has adopted a formal policy that requires a 30% offset goal for all major arms purchases. Most offset arrangements emphasise defence-related projects. These are usually production related (buy-back provisions or subcontracting). Many are direct offsets and often associated with the Singapore F-16 acquisition programme. For instance Singapore Aerospace makes precision airframe and engine parts for customers like Aerospatiale, Lockheed Martin, LTV Aerospace and Defence, Northrop-Grumman and Turbomeca. Products include the aft engine access doors for the F-16 fighter, rudder assemblies for the S.211 jet trainer, nozzle supports and jet pipes for General Electric F 404 engines.

Alternatively offsets have involved establishing a Singapore firm as a service centre for a weapon system. Since 1975 SAe has been heavily involved in depot level maintenance for A-4 fighters and C-130 transport aircraft for the US armed forces as well as overhauling fighters and transports for the Singapore Air Force. The group also undertakes maintenance and structural repairs for older aircraft still in service in the South East Asian region such as the F-5 Tiger, BAC Strikemaster, Hawker Hunter, Shorts Skyvan, Bell and Aerospatiale helicopters and Siai Marchetti trainer aircraft. In addition SA Engines won a contract worth over $50 million from the US Air Force for overhauling the Allison T56 engines used by the C-130 aircraft.

In 1977 Aerospatiale teamed up with Singapore Aerospace maintenance Co (SAMCO) to set up Samaero Company Pte Ltd to service French-built helicopters operating in the region. In 1981 French aerospace trading company Ofema signed on as a third partner, extending the activities into marketing and supporting French Turbomeca engines. Currently Aerospatiale holds a 65% share in Samaero with 25% held by Singapore Aerospace and 10% by Ofema. In 1983 Samero entered into a partnership with Composite Technologies Inc of the US and Samco set up CTI Singapore which offers helicopter rotor-blade repair facilities for Aerospatiale, Bell and MBB helicopters.

The government also seeks technology transfer and training. Most offset agreements include multipliers or provide offset credits in excess of contractor costs for highly desired projects. Most foreign firms involved in the provision of offsets to Singapore have found the business environment manageable. 82

Singapore's Ministry of Defence Resources and Planning Department has responsibility for implementing offset policy guidelines that set out the terms and conditions for local assembly and licensing arrangements and minimum contract values. The practical affect of this policy is visible in the acquisition of mine counter measures vessels (MCMVs) for the Singapore Navy. Singapore Shipbuilding and Engineering is building 3 minehunters derived from Swedish Landsort designs. The first of class was built in Sweden in 1994. 83 Offset terms were not compulsory but their incorporation appeared to be decisive in this contract. The tender described the MCMV programme as a licensed build with transfer of technology possibly through a joint venture. Local build was stipulated to provide continuous maintenance facilities. Under an earlier contract for six missile corvettes (the Urchin project) now completed, the programme called for technology transfer through direct offsets. German company Lürssen built the hull for the first vessel at its yard in Bremen, but subsequent hulls were built in Singapore.

The successful application of local-build conditions may have been contributing factors, which led to the establishment of a written policy.

Table 4.4: Singapore: Offset Guidelines and Agreements

Category Offset Guidelines Offset Agreements
Programme objectives Assist the Ministry of Defence in building up Singapore's capabilities to provide necessary maintenance, production, and upgrade capability to support equipment and systems the Ministry has procured. To be accomplished through technology transfer, technical assistance, participation in research and development, and marketing assistance. Consistent with the guidelines
Offset threshold All major purchases of equipment, material, and services; however, the guidelines do not provide a specific threshold. Most offset agreements involve purchases valued at over $5 million.
Offset type Direct offset is preferred but indirect offset is acceptable Most include a mix of direct and indirect
Offset percentage At least 30 percent of the main contract value, expressed as a goal Ranged from 25% to 30%
Multipliers Not stated Some agreements provided multipliers for activities such as technology transfer (values at up to 10x the cost) training or technical assistance.
Banking Not stated Permitted banking in most agreements
Penalties 10 percent of unfulfilled obligations 3 to 5 percent of unfulfilled agreements
Performance period Concurrent with the duration of the main contract up to a maximum of 10 years, plus a 1 year grace period Agreements are generally consistent with the guidelines
Targeting Firms owned by the Ministry of Defence are given first preference on bidding for work with foreign contractors. Agreements are generally consistent with the guidelines. The Ministry of Defence is very involved in selecting Singaporean firms that foreign defence contractors must work with.

Source: GAO 1996


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Note 1: Hammond, G. T., "The role of offsets in arms collaboration", in Ethan Kapstein ed., Global Arms Production: Policy dilemmas for the 1990s, (Lanham books: New York 1992). Back.

Note 2: Wood D. Australian Defence Offsets Program, Proceedings of Defence Offsets Seminar, (Department of Defence: Canberra, 1992). Back.

Note 3: Offset: kompensationsavtal vid upphandling av försvarsmateriel från utlandet (Offset: compensation agreements associated with the purchase of defence materiél from abroad), Riksrevisionsverket, RRV 1995:44, p. 29. Back.

Note 4: Ahlström, M., Försvarsrelaterad offset, FOA Rapport C 10341, Feb. 1992. See also the list of further reading appended to this report. Back.

Note 5: Ron Matthews "Offset to decline for Britain's Defence Industrial Base?" RUSI Journal, Winter 1991. Back.

Note 6: Interview with Tim Martin, British Aerospace representative Jakarta, 30 October 1995. Back.

Note 7: Matthews ibid, p 59. Back.

Note 8: Abdulla M. Al-Ghrair and Hooper, N., 'saudi Arabia and Offsets" in Stephen Martin (ed) The Economics of Offsets: defence Procurement and Countertrade, (Harwood Academic Publishers: Amsterdam 1996), p. 233 Back.

Note 9: This example is used by Ron Matthews "Offset to decline for Britain's Defence Industrial Base?" RUSI Journal, Winter 1991, p. 59. Back.

Note 10: Dörfer, I., Arms Deal: the selling of the F-16, ( 1983). Back.

Note 11: For example, in Turkey and South Korea. This form of contractual arrangement is becoming increasingly common with arms deals in East Asia, where recipients are eager to become part of the supplier chain in the international arms business. Back.

Note 12: Ahlström, M., Försvarsrelaterad offset, FOA Rapport C 10341, Feb. 1992. See also the list of further reading appended to this report. Back.

Note 13: Matthews Ibid, p 60. Back.

Note 14: The most recent survey is US Department of Commerce, Offsets in Defence Trade, Bureau of Export Administration, Office of Strategic Industries and Economic Security Strategic Analysis Division, Washington DC, May 1996. Back.

Note 15: White House Offsets in Military Exports, Office of Management and Budget, December 1988, p. 7. Back.

Note 16: K. Barry Marvel, "The evolving world of international offset contracting", Military Technology, Oct. 1989, pp. 42-49. Back.

Note 17: The full memorandum of understanding is attached as an appendix to Dörfer, I., Arms Deal: the selling of the F-16, (1983). Back.

Note 18: The flyaway cost of an aircraft is the cost of an aircraft which can fly but not fight. That is, it will include the airframe, engine, navigation radar and electronics but exclude weapon systems, fire control systems and special mission equipment. Back.

Note 19: For example, the agreement also stated that European participating states would receive a fixed share (15 per cent) of the value of third party sales but did not define the unit price to be applied. These matters were to be decided through later consultation. Back.

Note 20: The Netherlands Offset Policy 1974-92 and the Involvement of the Netherlands Industry in the Defence Procurement Policy, Ministry of Economic Affairs, The Hague 1992. Back.

Note 21: FMV Industrial Collaboration: Governmental Guidelines for Industrial Collaboration, Försvarsmateriélverket (Defence Materiél Administration), Sept. 1983. Back.

Note 22: Offset: kompensationsavtal vid upphandling av försvarsmateriel från utlandet (Offset: compensation agreements associated with the purchase of defence materiél from abroad), Riksrevisionsverket, RRV 1995:44, p. 31. Back.

Note 23: Finnish Ministry of Defence, Offset Agreement, 11 March 1992. Back.

Note 24: Farr, M., "Managing international collaboration projects: Rx for success", in Ethan Kapstein ed. Global Arms Production: Policy dilemmas for the 1990s, (Lanham books: New York 1992), p. 185. Back.

Note 25: Public Law 100-456, 102 Stat. 1918. Back.

Note 26: Vadas, D., Tools of the Trade: Why offsets, outsourcing and joint ventures are crucial to US Aerospace, Aerospace Industries Association, 11 March 1997. Back.

Note 27: Paecht, P., "The impact of offsets on the strategy of an industrial group", in Quels Marches pour Les Materiels de Defense, avec Quelles Perspectives pour les Exportations Francaises?, Centre Francais du commerce exterieur, 3 Oct. 1995, p. 91. Back.

Note 28: Interview with Lesley Shanson journalist with Offsets and Counter-trade Journal, May 1996, London. Back.

Note 29: Interview with DESO officials, 24 March 1997, Ministry of Defence, London and BAe representatives, 6 Sept. 1996, BAe, Farnborough. Back.

Note 30: Apparently many UK companies have chosen to default having found that their offset commitment to onerous. Companies often over commit themselves to offset deals in order to secure sales, then find themselves in an impossible situation in terms of meeting the terms of the contract. Interview with a DESO representative 12 April 1996. Back.

Note 31: Asian Recorder, 2-8 July 1994, p. 24070; Aviation Week & Space Technology, 8 Aug. 1994, p. 28; "MiG-29 Planes to be Delivered to Malaysia", ITAR-TASS in English, 17 Aug. 1994 in FBIS-SOV-94-160, 18 Aug. 1994, p. 11. Back.

Note 32: Asian Recorder, 2-8 July 1994, p. 24070. Back.

Note 33: Defense News, 10-16 March 1997, p. 16. Back.

Note 34: Martin S. and Hartley K. "Defence Equipment, Exports and Offsets: The UK Experience" Defence Analysis, Vol 11, No 1 Back.

Note 35: Martin and Hartley Ibid p24. Back.

Note 36: DESO "Offset: The Extra Dimension", DESO Offset Information, Feb. 1997. Back.

Note 37: Interview with DESO representative, Ministry of Defence, London, 26 March 1997. Back.

Note 38: "Australia Chooses BAe Hawk Due to Large Offset Package", Countertrade and Offsets, Vol . 15, no. 1, Jan. 13 1997, p. 7 Back.

Note 39: Martin and Hartley Ibid. p. 25 Back.

Note 40: Jane's Defence Weekly 6 May 1995, p. 35. Back.

Note 41: To finance the contract British Petroleum (BP) and Royal Dutch/Shell buy 400,000 barrels of crude oil per day from Saudi Arabia at a low fixed price which these companies then resell on the world market. The price was fixed at a level thought to counter any significant drop in the oil prices. Back.

Note 42: Al Salam Aircraft Co. was established as a joint venture with Boeing to meet a US offset obligation. Defense News, 24-30 March 1997, p. 44. Back.

Note 43: Jane's Defence Weekly, 6 May 1995, p. 33. Back.

Note 44: "Getting economic offsets into gear", Jane's Defence Weekly, 6 May 1995, p. 33. Back.

Note 45: Counter Trade and Offsets Vol X14, No. 4, 26 Feb. 1996. Back.

Note 46: See for example Nicholas Timmins "Indonesia aid and arms link is denied" The Independent 14 Novemeber 1994 and Michael Durham and Hugh O'shaughnessy "UK in Secret [sterling]2bn arms bid, Observer 13 November 1994. Back.

Note 47: Ibid. Back.

Note 48: Griffin J. C. and Ruse W., "Counter-trade as a Third World Strategy of Development", Third World Quarterly, Vol. 8, No. 1, Jan. 1986, p. 201. Back.

Note 49: Gauchery-Lacroix, L., La part significative prise par les offsets dans les contrats d"exportation d"armements", in Quels Marches pour Les Materiels de Defense, avec Quelles Perspectives pour les Exportations Francaises?, Centre Francais du Commerce Exterieur, 3 Oct. 1995, p. 69. Back.

Note 50: This policy is recommended in part based on the French experience in places like United Arab Emirates (discussed below) and partly on French experience of offsets from a buyer perspective. France was rather satisfied with the implementation of offset agreements by the US company Boeing and the Canadian company Bombardier under different contracts. Back.

Note 51: Berthault D. "Por une politique d"exportation clairment definic, maitrisee et audacieuse" L"Armament (NS), No. 43, Juillet-Aout 1994, p. 31-35. Back.

Note 52: Reed, C., "Offsets: creating collateral benefits", Jane's DefenceWeekly 18 March 1995. Back.

Note 53: Bonsignore, E., "Of arms and offsets", Military Technology, March 1997, pp. 13-22; Defense News, 10-16 March 1997, p. 42. Back.

Note 54: Reed, C., "Offsets: creating collateral benefits", Jane's DefenceWeekly 18 March 1995. Back.

Note 55: This observation was made on extensive field trips to the region in Oct.-Nov. 1995 and April-May 1996,where a number of officials were interviewed from both industry and the Ministries of Defence in the region. This observation was latter confirmed by DESO officials at the Ministry of Defence in London, 24 March 1997. Back.

Note 56: HCP 286 The Working of the AWACS Offset Agreement, House of Commons, Defence Committee, London, HMSO, 1989. Back.

Note 57: In particular, many Boeing-747 aircraft are equipped with versions of the Rolls-Royce RB-211. Back.

Note 58: In interviews in London, 29 May 1997 representatives of Lockheed Martin cooperating with UK company GKN to develop the Tracer armoured vehicle stated that in spite of the official statement, in their experience offsets have recently become mandatory for success in the UK market. Back.

Note 59: This offer is conditional on the RAF procuring more than 30 CH-47s. Below this number a minimum offset of 100% would be included in any agreement. Back.

Note 60: McNamara, T., "The CAT Policy and USG Assistance in Specific Procurement Cases", Defense Trade News, vol. 7 no. 1, May 1996, p. 5. This was confirmed by representatives of the company in London in discussions on 28-29 May 1997. Back.

Note 61: US General Accounting Office, Report to Congressional Requesters ,Military Exports: Offset Demands Continue to Grow, GAO/NSIAD-95-96 US Government Printing Office, Washington, April 1996, p24. Back.

Note 62: Fixed price contracting has become almost standard in UK procurement and a recurring phrase in recent years in discussions with defence ministry officials has been "cost is an independent variable". Back.

Note 63: Krause, K., Arms and the State: Patterns of Military Production and Trade, (Cambridge University Press: Cambridge 1992), p. 172. Back.

Note 64: Hwang, Dong Joon, 'south Korea's Defence Industry: An Asset for the US" Backgrounder No 38, Asian Studies Center, Heritage Foundation, Washington DC, December 10, 1985. Back.

Note 65: Hwang, Dong Joon, 'south Korea's Defence Industry: An Asset for the US" Backgrounder No 38, Asian Studies Center, Heritage Foundation, Washington DC, December 10, 1985, p. 10. Back.

Note 66: Shanson, L., "Building on Offsets", Jane's Defence Weekly, 15 Dec. 1990 Back.

Note 67: Shanson, L., "BAe Hawk deal moves closer", Jane's Defence Weekly, 22 September, 1990. Back.

Note 68: Fauziah Ismail, "Malaysia: McDonnell Douglas Eyes Opportunities in Region", Business-Times, 18 July 1994. Back.

Note 69: Azhar Ghazali, "Malaysia Looks Towards Collaborative Alliances", Business-Times, 19 Oct. 1994. Back.

Note 70: Counter Trade and Offsets ibid. Back.

Note 71: Shanson L., "Building on Offsets", Jane's Defence Weekly, 15 Dec. 1996. Back.

Note 72: United States General Accounting Office, Asian Aeronautics GAO/NSIAD-94-149, US Government Printing Office, Washington DC, 1994, p. 9. Back.

Note 73: Matthews, R., "Indonesian strategy is put to the test", Jane's Defence Weekly, 20 March 1993. Back.

Note 74: "Indonesia wants F-16 offsets", Flight International, 15-21 May 1996 Back.

Note 75: Ibid Back.

Note 76: Interview with Tim Martin, British Aerospace representative in Jakarta 30 Oct. 1995. Back.

Note 77: Jakarta Post, 18 Nov. 1995. Back.

Note 78: Interview with Dick Marston GEC representative, Jakarta 2 Nov. 1995. Back.

Note 79: "Trade demands delay Thai F-18 purchase", Flight International, 22-28 May 1996. Back.

Note 80: Counter Trade and Offset Vol XIV, No 4 February 26, 1996 Back.

Note 81: Boey, D., "A firm product base", Jane's Defence Weekly, 3 April 1993. Back.

Note 82: US GAO 1995 p. 26 Back.

Note 83: Defence Industry Digest February 1994, p. 11. Back.