Increase in Offsets Programs
One mechanism increasingly used by such countries is “offsets.” An offset is an obligation imposed on a foreign contractor to invest in the purchasing country’s economy in an amount usually set as a percentage of the value of the sale to that country. For example, Contractor A sells military aircraft to Country B for $500,000,000. Country B has an offset policy set at 60% of the value of the sale. Contractor A is obligated to invest $300,000,000 in Country B’s economy. By some reports, there are now 120 countries that require offset obligations on foreign military sales. Twenty-three countries began offset programs from 2000 to 2011 alone. One reason is that demand for military investment is on the rise, particularly among developing countries. In fact, it is estimated that during the next decade, the value of offset obligations to countries outside of the US and EU will be in the hundreds of billions of US dollars.
Offset Programs Greatly Vary Among Countries
Offset programs vary among countries in their focus, terms, and sophistication. Some offset programs require investments to be made in certain sectors of the economy, while others don’t. The amount of the offset also varies greatly, in some cases exceeding the value of the sale. Most countries allow for both direct offsets–where the required investment is directly related to the goods or services imported by the purchasing country pursuant to the sales agreement–and indirect offsets–where the investment is unrelated to the goods or services purchased. Some countries have established government agencies responsible for oversight and enforceability of offsets. This includes, in some cases, standardized legal agreements which set out fixed terms and specific penalties for non-compliance. Under some programs, offset obligations can be traded and assumed by third parties. Other programs provide for “multipliers,” where an investment’s actual value is multiplied by a specified factor (e.g., an investment of $100,000,000 is multiplied by 3 to equal a value of $300,000,000), where the investment is made in an economic sector favored by the purchasing country.
When done properly, offset programs can benefit the developing countries requiring them. These benefits are broad. They can reduce trade imbalances as instruments of counter-trade, increase foreign investment, create jobs, develop manufacturing and services industries, increase technology transfer, industrialize and diversify economies, even allow borrowing against offset commitments. Israel, Japan and Spain are examples of countries generally considered to have benefited by effective offset programs.
However, if mishandled, offset programs can also backfire. Offset programs have been criticized in some countries as sources of corruption. Some programs have led to waste and squandered opportunities for economic growth. This often is the result of poorly designed and managed programs, including improper legal arrangements and ineffective enforcement mechanisms. Problems can also arise when contractors are pressured to invest and participate in projects well beyond their core competencies. In such cases investments often go badly.
What Makes an Effective Offset Program?
Offset policies and programs must be tailored to the specific circumstances and needs of the country to be effective. First, offset programs are most effective when they have a clear focus. Key questions to ask include: “What sectors of the economy are most critical to develop first?” “Is our objective to increase our own military production and service or our commercial sector?” “What type of technology would be most advantageous for our economy at this stage?” “What type of training programs would we most benefit from?” Second, offset programs must be carefully established and regulated. This includes creating a government agency to oversee the program, sufficiently resourced and with well-trained staff. Having proper legal documentation and advice is also important. The program must be credible to potential contractors, well managed, and clearly focused for the offset obligations to provide results. Third, offset programs must operate in a way that is a win-win for the investing contractors as well as the purchasing country. Offsets should result in economic growth for the country and value for the contractors. When done right, offset programs can be effective in meeting the competing demands of national security and economic development.