Executive Summary

This is the eighth annual report on the impact of offsets in defense trade prepared pursuant to Section 309 of the Defense Production Act of 1950,¹as amended (DPA).  The Department of Commerce’s Bureau of Industry and Security (BIS) has been delegated responsibility for preparing the reports required under Section 309.  The report analyzes the impact of offsets on the defense preparedness, industrial competitiveness, employment, and trade of the United States.  To assess the impact of offsets in defense trade, the Department of Commerce obtained data from U.S. defense firms involved in defense exports and related offsets and supplemented this information with statistics from the Bureau of the Census and the National Science Foundation. 

This report covers offset agreements and offset transactions entered into from 1993 through 2002.  This report (i) discusses the changes in the industrial base during the reporting period; (ii) provides summaries of offset agreements and transactions for the reporting period; and (iii) analyzes the impact of defense-related offsets specifically on the aerospace industry.

Offset Activity

Agreements

Total offset activity can be measured by the number and value of new offset agreements entered into between U.S. defense contractors and foreign governments.

Offset Agreements, 2001-2002:  U.S. defense contractors reported entering into 35 new offset agreements with 14 countries in 2001 and 41 new offset agreements with 17 countries in 2002.  For 2001, new U.S. offset-related defense export contract values totaled $7.0 billion.  New offset agreements attached to these exports had a total value of $5.5 billion, equaling a 78.1 percent offset requirement.  For 2002, new U.S. offset-related defense export contract values climbed to $7.4 billion, with new offset agreements attached to these exports having a total value of $6.1 billion, or an 82.3 percent offset requirement.

European nations received offsets equal to 95.8 percent of the total export values in 2001 and 94.3 percent in 2002, down from 111.1 percent in 2000.  For non-European nations, though, the average offset requirement was 55.1 percent in 2001 and 77.3 percent in 2002, up significantly from 50.0 percent in 2000. 

Offset Agreements, 1993-2002:  U.S. companies reported entering into 434 offset agreements with 36 countries during the time period from 1993 to 2002.  U.S. companies reported export sales of 181 different defense systems or subsystems with a total value of $63.6 billion.  Offset agreements related to those export contracts were valued at $41.8 billion, or 65.7 percent of the export contract value.  Sales of aerospace defense systems (i.e., aircraft, engines, and missiles) were valued at $53.6 billion and accounted for nearly 82 percent of the total export contracts.

Over the ten-year period, European countries alone accounted for nearly two-thirds (65 percent) of the value of offset agreements but less than half (46 percent) of the value of related export contracts.  European offset demands continued to increase over the ten year period, although more slowly than the demands from other countries.  Between 1993 and 2002, European offset demands as a percentage of exports increased by 16 percentage points, going from 78.3 percent to 94.3 percent; for the rest of the world, the increase was almost 55 percentage points, rising from 22.5 percent to 77.3 percent.

Asian countries are capturing an increasing share of offset agreements and export contracts as well as demanding higher offsets.  In 2000, Asia accounted for only 2.8 percent of the value of offset agreements; in 2002, Asian countries accounted for 64.8 percent of the total.  In contrast, European agreements secured 78 percent of the total value of offset agreements in 2000, but only 34 percent of agreements in 2002.  Furthermore, Asian offset requirements reached 52.3 percent in 2001, and grew to 78.4 percent in 2002.  The region’s 1993-2000 average offset requirement was only 26.2 percent. 

The data indicate that the level of the demands from non-European nations as a group is rising as well.  For 1993-2000, the average offset requirement for non-European countries totaled only 33.9 percent; for 1993-2002, the average requirement rose to 42.4 percent.

In a country-by-country analysis, Austria led Europe and the rest of the world in terms of its offset requirement percentage.  On average, sales of U.S. weapons systems to Austria were associated with offset agreements worth 174.2 percent of the value of the weapon systems.  Other countries with offset percentages greater than the value of the weapon systems exported were the Netherlands (120.5 percent), South Africa (116.7 percent), Greece (110.5 percent), and Sweden (103.9 percent).

Transactions

Offset activity can also be measured by the number and value of individual offset transactions carried out in fulfillment of offset agreements during the reporting period.

Offset Transactions, 2001-2002:  U.S. companies reported offset transactions with a total actual value of $2.6 billion in both 2001 and 2002.  The 2001 figure represents a 53 percent increase from the 2000 total of $1.7 billion, but is only slightly higher than the average annual value of offset transactions ($2.3 billion) during the ten-year period from 1993 to 2002.  The percentage of the value of offset transactions classified as indirect rose during 2001 and 2002, reaching 63.8 percent in 2002, compared with 35.9 percent of the value in direct transactions that year.  The remaining 0.3 percent of the value was unspecified.

Offset Transactions, 1993-2002:  For 1993-2002, U.S. companies reported 5,903 offset transactions executed in 35 countries.  These offset transactions were related to 230 defense systems under existing offset agreements.  The actual value of the offset transactions from 1993 to 2002 was $23.5 billion.  Indirect offsets accounted for 58.2 percent of the total value of transactions and direct offsets made up 39.1 percent.  The remaining 2.7 percent of the value was unspecified.

The multiplier for all transactions during 2001-2002 was 1.265; this means that purchasing countries granted, on average, $1.265 of offset credit for each $1 in actual offset transaction value for those two years.  For 1993-2002, the total multiplier was 1.224. 

Findings

The Asian share of total export contracts and the region’s level of offset demands have experienced dramatic growth in recent years.  Individual countries in other non-European regions of the world are also demanding and receiving increased levels of offsets; non-European reached 77 percent of the value of the sales.  At the same time, increases in Western European offset demands are moderating, with requirements in 2001 and 2002 remaining around 95 percent of the value of the agreement, but still well above other regions of the world.   

By combining BIS offsets data with aerospace industry data from the Census Bureau’s 2001 Annual Survey of Manufactures (ASM) (the most recent data published), the impact on defense productive capacity can be estimated.  According to comparable BIS data for 2001, U.S. defense exports with offset agreements attached totaled $7.0 billion.  Using ASM information on value added per aerospace worker, BIS estimates that (assuming 100 percent export content) these exports sustained 42,440 work-years in 2001. 

In 2001, subcontracting, purchasing, co-production, and licensing transactions (those most likely to shift sales from U.S. suppliers to overseas firms) were valued at $1.9 billion.  Dividing $1.9 billion by $165,858 (the value added by each worker in the aerospace industry in 2001) results in the loss of approximately 11,460 work-years in 2001.

Based on these calculations, it appears that defense export sales had a net positive effect on employment in the defense sector during the period from 1993 to 2001, although the net positive effect was diminished by the offset agreements.  This calculation assumes that industry would not have received these defense export contracts if it had not entered into the related offset agreements.  It should also be noted that the above analysis does not include an additional

$9 billion of offsets in technology transfer, training, overseas investment, and marketing transactions, because the impact of these transactions on the U.S. defense industrial base is difficult to calculate.  Nor does this calculation include consideration of the long-term effect of creating new or enhanced competitors. 

Purpose of Report

The DPA Section 309(b)(1) requires BIS to identify the cumulative effects of offset agreements on “the full range of domestic defense productive capability with special attention paid to the firms serving as lower-tier subcontractors or suppliers” and “the domestic defense technology base as a consequence of the technology transfers associated with such offset agreements.”  To address the effects of offsets on defense productive capability, this analysis compares 2001 offset transactions dealing with transportation equipment and electronic equipment to 2001 value added from these two industries, as reported in the Census Bureau’s most recent Annual Survey of Manufactures.  Over time, the lost future opportunity of offset transactions can negatively affect capacity utilization and ultimately, domestic productive capability.  Value added, in turn, is a measurement of the productive capability of an entire industry, encompassing productivity of labor, efficient capital use, and full production capacity.  In sum, 2001 offset transactions related to transportation equipment and electronic equipment totaled 1.4 percent of the 2001 value added for both industries.  This value does not indicate that the domestic defense productive capability declined by 1.4 percent, but it is instead a measure of lost potential opportunity, with corresponding impacts on capacity utilization and in the end, domestic productive capability.

To identify the effects on the domestic defense technology base, this analysis compares total 2001 technology transfer transactions for aerospace manufacturing and electronic component industries to total 2001 research and development (R&D) spending for aerospace manufacturing industries.  These two industries were chosen for their involvement in the most frequent and the highest levels of offset transactions for 2001.  Offset transactions that involved technology transfer for these two industries in 2001 totaled $421 million.  This value is equivalent to 1.9 percent of total R&D spending for those two industries in 2001.  For aerospace manufacturing alone, the value of technology transfer offsets as a percentage of total R&D spending for the sector totaled 4.8 percent. 

While there are no indications from other U.S. Government agencies that domestic defense productive capability has decreased cumulatively because of offsets, there is also no indication that offsets enhance defense productive capability, especially for lower tier subcontractors.  The recent growth in new defense industrial subcontractors described and foreseen by officials with the Department of Defense (DoD)² illustrate that the supplier base is improving.  However, DoD officials attribute much of that growth to new, high-tech defense subcontractors that supply weapons systems almost exclusively marketed to the U.S. government.  These new suppliers do not contribute to those systems sold abroad – those systems with related offset agreements.

Contents of Report

 Sec. 309(d)(1) of the DPA, as amended, requires this report to include five specific analyses (Subparts A-E).  The net assessment of the elements of the industrial base and technology base covered by the report, required in Subpart (A), is featured in Chapter 5.  The six sectors of the industrial base most commonly involved in offset transactions are:  Transportation equipment, electronic/electrical equipment, industrial machinery, business services, technical services and consultants, and measuring and analyzing instrumentation.  These industrial sectors comprise   85 percent of all offsets transactions.  A full listing of industrial sectors – based on SIC (Standard Industrial Classification) codes – affected by offsets appears in Chapter 2 along with a full discussion by SIC code in Chapter 5.  Appendix D provides a more specific breakout by SIC code. 

As required by Subpart (D), a detailed summary of offset arrangements – in the form of agreements and transactions – concluded during 1993-2002 is provided in Chapter 2.  Chapter 4 provides a more detailed analysis of aggregated offset agreements for 1993-2002 as well as in 2001 and 2002 specifically.  Included in this analysis are data that indicate a small number of U.S. companies and weapon systems dominated offset agreements during the reporting period.  The top five companies (of 39 reporting offset agreements) accounted for 79.5 percent of the value of defense export contracts and 79.0 percent of the value of offset agreements reported for 1993-2002. 

Chapter 5 provides a similar more detailed analysis of offset transactions aggregated from 1993 to 2002 as well as in 2001 and 2002, specifically.  For example, more than half (51.6 percent) of the total value of offset transactions for the ten-year period fell into the transportation equipment group (SIC 37) that includes aircraft, guided missiles, ships, and motor vehicles.

Although the Department of Commerce is authorized in Subpart (B) to make recommendations for appropriate remedial action, at this time, no recommendations are provided.  In addition, as described in Chapter 7, no other government agencies or interagency groups have conducted offset studies since the previous Annual Report on Offsets in Defense Trade.  In the past, the Department of Commerce, through the Bureau of Industry and Security has participated in a Department of Defense-led Interagency Offsets Steering Committee (the Committee), which includes representatives from the Departments of Defense, State, Treasury, and Labor, and the Office of the U.S. Trade Representative.  However, the Committee conducted no activities this year, and accordingly, there are no findings or recommendations of any interagency studies to be summarized, as required by Subpart (C).  Furthermore, no bilateral or multilateral negotiations relating to the use of offsets were conducted during the past year.  As such, the following report does not feature a summary of those negotiations, as required by Subpart (E).