Offsets are compensatory trade agreements, reciprocal trade agreements, between an exporting foreign company, or possibly a government acting as intermediary, and an importing entity. Offset agreements often involve trade in military goods and services and are alternatively called: industrial compensations, industrial cooperation, offsets, industrial and regional benefits, balances, juste retour or equilibrium, to define mechanisms more complex than counter-trade. Counter-trade can also be considered one of the many forms of defense offset, to compensate a purchasing country.Counter-trade is an indirect offset. As a general introduction to the topic see J. Brauer -J. P. Dunne Arms Trade Offsets and Development, 2005 (Martin, 1996, Udis and Maskus, 1991). The incentive for the exporter results from the conditioning of the core transaction to the acceptance of the offset obligation.Ianakiev, Gueorgui (2014), " Defence Offsets : Regulation and Impact on the Integration of the European Defence Equipment Market ", in Bellais, Renaud (ed) (2014), "The Evolving Boundaries of Defence : An Assessment of Recent Shifts in Defence Activities ", Emerald Group Publishing Limited.
The main difference between a generic offset and counter-trade, both common practices in the international defense trade, is the involvement of money. In counter-trade, goods are paid through barters or other mechanisms without the exchange of money, while in other generic offsets money is the main medium of exchange.
Definition Offsets can be defined as provisions to an import agreement, between an exporting foreign company, or possibly a government acting as intermediary, and an importing public entity, that oblige the exporter to undertake activities in order to satisfy a second objective of the importing entity, distinct from the acquisition of the goods and/or services that form the core transaction. The incentive for the exporter results from the conditioning of the core transaction to the acceptance of the offset obligation.
Often, the proclaimed aim of this process is to even-up a country's balance of trade. However, some forms of offsets transactions do not represent trade flows going from the initial importer towards the initial exporter. Offsets are frequently an integral part of international defense contracts.
Offset as unfair burden The U.S. government's definition of offset agreement is the most crucial, since the U.S. aerospace and defense industry is the biggest exporter of aerospace and defence products, and therefore engaged in the majority of the world's offsets. The U.S. has a Commerce Department Division, the Bureau of Industry and Security (BIS), that deals specifically with U.S. defense offset agreements with foreign nations as a main subset of U.S. industrial security. BIS - whose main task is protecting U.S. security from the point of view of export of high technology, fostering commercially acceptable U.S. foreign policy, and protecting U.S. economic interests - deals with U.S. aerospace and defense companies that export defense products, systems or services, involving "offset agreements," that is, those sales' collateral or additional agreements requested by purchasers. BIS defines offsets as "mandatory compensations required by foreign governments when purchasing weapon systems and services."BIS, Annual Report, 2006 p. 28. See also the definition: "Offset: Compensation practices required as a condition of purchase in either government-to-government or commercial sales of "defense articles" and/or "defense services" as defined by the Arms Export Control Act (22 U.S.C. § 2751, et seq.) and the International Traffic in Arms Regulations (22 C.F.R. §§ 120-130). – BIS, 2007. For a Glossary on Defense Offsets see Appendix E, p. 30
The U.S. government underlines the compulsory aspect of this trade practice, since the United States, with other weapons exporting countries, such as Germany and France, opposes offsets as forms of protectionism and harmful transgressions of free market rules. These governments frown on offset agreements, consider them to be both market distorting and inefficient. In 2002, U.S. companies had 49% of global defense industry export, EU% 35. Data from AECMA 2002 Facts and Figures.. In 2007, according to SIPRI open source data, the U.S. percentage of global export in arms was 61%.
Offset as partnership In 2008 the Brazilian Minister of Strategic Affairs, speaking of a major defense purchase by his country, highlighted this key point: "We will not simply be buyers or clients, but partners." The competition by different companies "in offering comparable weapons to a country" is also on the level of "sharing" or "partnership" with the purchaser, Roberto Mangabeira Unger added.
Offset as marketing tool In weapons trade, defense contractors are fully aware that offsets are powerful marketing tools to motivate the purchase, by showing and giving additional advantages for the purchasing country besides investing in military equipment.Lloyd J. Dumas, Do offsets mitigate or magnify the military burden? in J. Brauer - J.P. Dunne, Arms Trade and Economic Development. Theory, Policy, and Cases in Arms Trade Offset London-New York, 2004, The U.S. defense industry position seems to be more practical, and somewhat quietly nonaligned with U.S. government economic or political assessment of defense offsets. Generally speaking, one can understand offsets as a widespread sales technique. As such, they are not restricted to weapons sale, they belong to commerce itself, in the same way that rebates, price-pack deals, or loyalty rewards programs do. Understanding "defense offsets" to be part of a sales technique helps to curb the justified yet excessive emphasis on their mandatory nature.
Often, defense offsets are more motivating than the primary defense acquisition, for personal or political reasons. This may seem irrational, but it is part of commerce. If one adds the prevalent political aspect of spending huge public funds on modern weapons, then the motivating significance of defense offsets could not be underestimated in contemporary decision processes of democracies.Markunsen describes (and opposes) defense offsets not as economy or politics, but as "political economy." Most EU countries have their Ministries of Economy in charge, or at least heavily involved in, the offset business, since they understand offsets precisely as "political economy." Prime defense contractors are well aware of offsets' power in the psychologies of democracies. As anyone can understand, the seller will include the cost of the "Envelope B," that is, of the offset and its added value for the purchaser, in its total cost. In other words, the client will pay for the offset; it is not a free lunch.And the connected question: are defense offsets a benefit to the buyer greater than a negotiation for a weapons acquisition off-the-shelf? See on this point J. Brauer and J.P. Dunne, Arms Trade and Economic Development. Theory, policy, and cases in arms trade offsets. Routledge, Abingdon - New York 2004 But the key question is: to what extent is the offset proposal a factor in the consideration of defense contractor's tender during the evaluation and the decision procedures? Transparency International clearly summarizes that using offsets as marketing tools makes offsets "the ideal playground for corruption":
The universe of this military niche of offsets trade is sophisticated and less innocuous than commonly believed. In 2000 Daniel Pearl wrote an article about the universe of offsets: "could the sale of U.S. weapons in the Persian Gulf help an oil concern unload gasoline stations in Europe? Yes, under the new logic of international arms deals."April 20, 2000 - Offset Requirements Of Defense Deals Often Have Little To Do With Purchaser -- By Daniel Pearl – Staff Reporter of the Wall Street Journal Pearl describes the new-found world of indirect offsets: The market size of the international offset business is related to the volume of international weapons trade in the world. According to SIPRI, in 2007 there were US$51 billion of weapons exports, an approximate value because it is open source, and not all weapons deals data are open source information.
Defense offset example
As an example of a defense offset proposal, we could describe a hypothetical case of Nation P (Purchaser) buying 300 tanks from defense company S (Seller, of Nation S).<ref>See also U.S. Bureau for Industry and Security'''s example to explain the offset. BIS Annual Report 2007, p. 136.</ref> The total sale contract is $400 million and Nation P (Purchaser) requests offset of 120%. Defense Company S (Seller) is obliged to fulfill an offset equal to 120% of the sales contract, that is $480M. Nation P agrees on a list of specific offset deals and programs to fulfill the agreed total obligation with Company S (Seller). The offset agreement includes both direct and indirect offsets.
Nation P also assigns a credit value for each typology of offsets offered by Company S. The credit value for the offset obligations is not the "actual value," but it is the "actual value" by a multiplier, that expresses the degree of interest of Nation P (Purchaser) in the proposed offsets. In other words, something deemed very valuable by nation P will have a high multiplier that expresses the importance and the value to Nation P of that type of offset. The multiplier (for instance 2, or 5, or 7) translates nation P's attached value into the credit value that eventually accounts for the fulfillment of the agreed sum of $480M (120% of offset); it is evident that with no multipliers, 120% offset would be nonsense. Most of the offset packages are divided into direct and indirect offsets. Here is a hypothetical, complex offset offer, divided into direct and indirect offsets in Nation P.
Direct Offsets (military and related to the product of the Company S, i.e. the tanks in this example)
Co-production: Nation P chooses one or more local companies to manufacture some components of the tanks, such as turrets and some of the internal components. The actual value of the components is $70 million. Nation P assigns a multiplier of 3, since this develops capabilities of its military industrial base and creates jobs in Nation P. The total credit value for the fulfillment of the overall offset obligation is $70M x 3 = $210M.
Indirect Offsets (civilian and other agreements not related to the production of the weapons item, the tanks. They could be also military or security related, but not directly connected with the main acquisition, i.e., the tanks)
Foreign Direct Investments: Company S makes investments in 5 (defense or non-defense) companies in Nation P. The total value of the investments is $14.5M, and the multiplier is 4, a high multiplier, since Nation "P" suffers from a chronic lack of Foreign Direct Investments. This makes an additional credit value for Company S of $58M.
Technology Transfer: Company S provides water desalination technologies to one Nation P company. This technology is particularly appreciated by Nation "P". Its actual value is $20M, but the credit value is 7 times the actual value, that is, $140M.
Export Assistance and Marketing: Company S provides commercial assistance to market products and services of a Nation "P" company in a difficult market, such as, for instance, the Middle East. The assistance is offered for 8 years, at the value of $3M per year. Nation P considers this assistance to export as important to create new revenue streams and jobs for its company, and sets a multiplier of 3. Credit value: $72M. (Since company S is not an expert on marketing and export assistance, it may hire a specialist company to subcontract the job. Such a subcontractor is also known as an "offset fulfiller").