Balance of Equity
Foreign customers utilize offset arrangements to re-balance any financial or social equity lost in the purchase of defense exports. For relatively smaller economies, the outflow of billions of dollars for large defense contracts invites social instability and political repercussions in the long term. Foreign governments may overlook investing in research and development, domestic infrastructure projects, or defense and commercial manufacturing in favor of short term security solutions.
To conclude a weapons sale, foreign governments contractually require aerospace and defense companies to invest directly or indirectly in their economies. Offset arrangements are seen by countries as opportunities to leverage foreign defense firms for additional economic inducements and investments. These investments offset trade imbalances, or counter the loss of jobs due to an arms sale – foreign investments may create economic multiplier effects that spread throughout a foreign country’s manufacturing and industrial supply chain.
Types of Offsets
Offsets in defense sales are categorized as either direct or indirect. Direct offsets connect directly to the defense sale, with specific emphasis on (1) co-production between a supplier firm and a purchasing country, (2) technology transfers, and (3) subcontracting rights. Indirect offsets are economic inducements that cover non-defense purchases and investments. Since offsets are utilized in both foreign military sales (FMS) and direct commercial sales (DCS), they are subject to the International Traffic in Arms Regulation (ITAR) and the Foreign Corrupt Practices Act (FCPA).
While offsets are essential for U.S. defense firms to compete in the global aerospace and defense market, they are viewed as market distorting by the U.S. Government. The role of the foreign government is perceived by the U.S. as intrusive in terms of price factors and open competition. As foreign countries’ price offsets through a multiplier function, a defense item’s perceived value is considered instead of the actual market price. For example, while a given offset may be worth $1 million dollars, a foreign country may believe it to be worth four times that at a value of $4 million dollars. This signals its strategic value to them, and indicates to U.S. defense firms what offsets they should provide within the original defense sale.
The U.S. Government is generally more concerned with the national security implications of offsets. Due to technology transfer exposure and product mirroring, foreign co-production affects U.S. industrial employment and future technological capabilities, collectively impeding upon domestic industries’ competitive edge.