Offset agreement
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. The incentive for the exporter results from the conditioning of the core transaction to the acceptance of the offset obligation.
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, 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."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.
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. 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. 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. 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." 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 buying 300 tanks from defense company S. The total sale contract is $400 million and Nation P requests offset of 120%. Defense Company S 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. 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 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 translates nation P's attached value into the credit value that eventually accounts for the fulfillment of the agreed sum of $480M ; 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
Indirect Offsets
Nation P controls not only the supply of the military systems or services, but also the implementation of the offsets according to the offset agreement included or related to the main supply contract. This control is within the Minister of Defense and/or Ministry of Economy or Finance, or Ministry of Industry and Trade. Often arms importing nations establish special agencies for the supervision of the defense offsets.
Types of offset
Offset proposals often make a distinction between direct and indirect offset.Direct offset is a side agreement that is directly related to the main product/service that is bought/sold, that is military equipment, systems, or services. They may be also called military offsets. For example, a buyer of military equipment may be given the right to produce a component of a related technology in the buyer's country.
Indirect offsets are side agreements that are not directly related to the product/service that is bought/sold. Most people refer to such category of offsets as civilian offsets, though there are many indirect offsets that are not civilian offsets. Indirect offsets may take the form of services, investments, counter-trade and/or co-production. For instance, Greek companies produce part of the Lockheed C-130 that they bought from U.S. The Greek co-production is a U.S. direct offset. Or, in a more sophisticated form of offset involving three countries, Portugal is in charge of the maintenance of Kuwaiti Lockheed Martin aircraft. This is a Portuguese "direct offset", since Portugal bought the aircraft, and is partner in charge of their maintenance. An investment in a security software company of Romania, or in assisting the export and marketing in difficult areas of a Belgian environmental company are other forms of actual indirect offsets.
The most common types of direct/indirect offsets are:
The most complete and accurate list of actual offsets can be found in the BIS Annual Reports to Congress, where all forms of registered offset are codified, according to the old Standard Industrial Classification.