7th Offset Report - Aerospace Offset Issues

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Chapter 6
Aerospace Offset Issues

Offsets affect the U.S. aerospace industry more than any other major economic sector. These offsets have been documented in detail in previous offset reports.¹⁸ Since aerospace-related exports made up the majority of export sales and related offset agreements reported, the impact of offsets on the aerospace industry is a good indicator of the effect of offsets on the industrial competitiveness and trade of the United States as a whole.

Imports of aerospace products into the United States have increased rapidly in the last decade for a variety of reasons, one of which is the increase in aerospace-related offsets. Aerospace-related imports have increased in both strong and weak economies and despite the fact that the United States spends more on defense and commercial aerospace research and development than any other nation. As shown in Chart 6-1, aerospace imports increased from $12.2 billion in 1993 to $28 billion - an all time high - in 2000. Aerospace exports dropped from an all time high of $64.1 billion in 1998 to $54.7 billion in 2000.

Chart 6-1
International Trade in Aircraft, Aircraft Engines, and Parts
1993-2000 (in $ billions)

International Trade in Aircraft, Aircraft Engines, and Parts

The U.S. aerospace trade surplus reached an all time high of $40 billion in 1998, but then declined to approximately $27 billion in 2000. In the same two-year cycle, aerospace imports grew by nearly 21 percent.¹⁹

6.1 Importance of Export Markets

To highlight the importance of the export market for U.S. aerospace companies, more than half of the unit sales of newly built military aircraft were exported during the eight-year reporting period of 1993 to 2000. Table 6-1 below compares aircraft acquired by the U.S. Department of Defense for use by the armed services with military aircraft exports. During the eight year reporting period, Defense Department acquisitions exceeded exports in only one year - 1994. In 1997, military aircraft exports were more than double U.S. acquisitions. Overall, during the reporting period, military exports were nearly 57 percent of total unit sales.

Table 6-1: Importance of Defense Aircraft Exports
(Number of Newly Constructed Aircraft)

	Total Military Aircraft Acquisition		Military Aircraft Exports			Exports as % of Total
Year	Total	U.S. Defense	Total	FMS	Direct
1993	955	437	518	146	372	54.2%
1994	764	418	346	69	277	45.3%
1995	811	354	457	108	349	56.4%
1996	558	242	316	106	210	56.6%
1997	488	151	337	181	156	69.1%
1998	418	149	269	175	94	64.4%
1999	359	133	226	114	112	63.0%
2000	333	138	195	42	153	58.6%
Totals	4,686	2,022	2,664	941	1,723	56.9%

Note: FMS=Foreign Military Sales; Direct=Direct Exports by U.S. Defense Firms
Source: Aerospace Industries Association, Aerospace Facts and Figures, various issues

6.2 Trends in Aerospace

The aerospace infrastructure is becoming more global. Although the United States continues to maintain its position in first-tier integrator companies, global sourcing at the second and lower tiers is rising rapidly as an acceptable option - more so in the commercial area than in the military. In the last decade, some of the advantages of local sourcing, such as cost reductions in communications and transportation, have faded. In addition, many important aerospace technologies are available worldwide. Many European firms are technically comparable - and some superior to - U.S. firms in the production of various critical components, including gearboxes, ball screws, bearings, fasteners, forgings, investment castings, aluminum, diesel engines, machine tools, ejection seats, and steel. Other important trends in the U.S. aerospace industry are as follows:

The U.S. aerospace industry - which occupies a major industrial and strategic position in the U.S. economy - is not a growth sector. The constant dollar value of aerospace production actually declined 18 percent relative to the Gross Domestic Product and 14 percent relative to all U.S. manufacturing from 1993 to 2000.
U.S. prime contractors are becoming more specialized in the research, design, integration, and final assembly of aircraft. More work and responsibility is being shifted to major sub-assemblers, who have their own set of suppliers. The competition among major sub-assemblers, who provide major sub-components such as gas turbine engines, electrical systems, hydraulics, and cockpits, is fierce and leading to more global sourcing outside of the United States .
U.S. aerospace parts and components suppliers showed virtually no growth in productivity over the last 15 years. This is likely a result of declining sales, under-utilized capacity, antiquated defense procurement processes, and pricing pressures from overseas competitors, as well as pressure from customers.
Most new aerospace business is outside the United States . For the next 5-10 years, approximately two-thirds of the commercial aerospace market is forecast to be outside the United States . This will almost certainly lead to greater foreign sourcing and will pressure lower-tier U.S. suppliers to consider selling internationally.
Foreign ownership of U.S. aerospace part and component suppliers continues to increase. Foreign ownership usually leads to more imports initially, at least until the foreign owner becomes established in the United States .

6.3 Aerospace Offsets

The following points highlight the effects of offsets on the aerospace industry during the 1993 to 2000 reporting period:

The U.S. aerospace industry represents the major target of offset activity. Aerospace system export contracts totaled $42.8 billion (89 percent of all exports related to offsets) and accounted for $25.9 billion of the offset agreements (87 percent of the agreement total).
Transactions involving aerospace products and services totaled (at least) $11.27 billion, or 62.6 percent of the value of all transactions for the eight-year reporting period. (In addition, 10-15 percent of the transactions classified as "unspecified" may also be aerospace items.)
Approximately 58 percent ($6.53 billion) of the aerospace transactions were classified as direct offset transactions; 37 percent ($4.15 billion) were indirect; and five percent ($586 million) were unspecified. Also, 42 percent ($4.75 billion) of the offset transactions were categorized as Subcontracts; 26 percent ($2.95 billion) as Purchases; and 14 percent ($1.56 billion) as technology transfers. These three categories combined accounted for 82 percent of the total value of aerospace-related offset transactions.
Aerospace parts trade has expanded rapidly and the U.S. aerospace industry maintains a surplus in parts trade. Imports of parts and components for aircraft and aircraft engines into the United States more than doubled, from $5.8 billion in 1993 to $11.8 billion in 2000. This includes both civilian and military items. Exports of parts and components also grew, from $13.8 to $23.7 billion - an expansion of 72 percent during the reporting period.
Offsets impacted both military and commercial aerospace markets. Aerospace subcontractor companies normally supply both military and commercial parts.
Offsets played a significant role in the increase of aircraft and engine parts imports. Military part and component imports rose 82 percent from $2.23 in 1993 to $4.1 billion in 2000. The eight-year total was $25.4 billion. Over the same period, aerospace subcontracts (direct offsets) totaled $4.75 billion (i.e., 18.7 percent of the total military parts imports).
An additional $2.95 billion of aerospace offsets were purchases (indirect offsets). Adding purchases and subcontracts together, the resulting figure of $7.69 billion represents 10.75 percent of total part and component imports of $71.5 billion (civilian $46.1 billion and military $25.4 billion) for the period. ²⁰
Offsets may permanently displace U.S. companies in certain circumstances. It is a fallacy to think of offsets as one-time events that end once an offset agreement is completed. A foreign offset recipient can continue selling product in the United States long after the initial offset transactions are completed. In addition, technology transfers, training, credit assistance, and other offset transactions can bolster the capabilities of foreign vendors and contribute to imports as well, but to an extent that is not yet known. In sum, it appears that the total impact of aerospace offsets is greater than the nominal value of the offsets.

Foreign vendors also can use offsets to gain entry into the U.S. market to supplement markets in their home countries. This expands their sales base and helps them compete, potentially displacing American suppliers in both commercial and military markets.

Defense downsizing increased the average age of military aircraft in the U.S. fleet. This shifted subcontractor work toward replacement and repair parts. Offset agreements associated with the purchase of "off-the-shelf" aircraft provide an opportunity for foreign vendors to supply parts and components (direct offsets) for aircraft destined for the host country, and an additional opportunity to compete in the existing U.S. (and foreign) replacement markets (indirect offsets).

¹⁸See e.g., U.S. Department of Commerce Report, Offsets in Defense Trade , October 1999, pages 35-55.

¹⁹See Aerospace Industries Association publication, Aerospace Facts & Figures , 2001/2002 (and prior editions).

²⁰ The $2.95 billion in indirect offsets includes military and civilian applications, although the split is not known. If treated as all civilian, the ratio to total civilian imports is still only about 6 percent. This implies that the majority of civilian imports are manufactured by competitive foreign firms, many of whom may have benefited from offsets in the past.

Chapter 6 Aerospace Offset Issues

Chart 6-1 International Trade in Aircraft, Aircraft Engines, and Parts 1993-2000 (in $ billions)