106-1 Hearing: Defense Offsets: Are They Taking Away Our Jobs?, June 29, 1999

will generally have the largest effect on parts and components imports. It is
therefore important to distinguish imports of components and complete aircraft
when analyzing the effects of trade on employment.

In the 1990s, imported parts and components (including engines and engine
parts) were, on average, 71 percent of total aerospace imports. Figure 4 shows
that U.S. engines and parts imports represent a growing share of total aircraft
sales. This share rises from about 8 percent in 1981 to over 19 percent in 1997.
Between 1984 and 1997, this share increased by about 0.7 percentage points per
year. As a first approximation, the increase in parts imports reflects the direct
effects of offsets and all other forms of co-production and international out-
sourcing agreements. This measure is separate from the effects of increasing in-
ternational competition in final aircraft sales, as reflected in increased imports of
complete aircraft and reduced exports. This distinction will be important in pre-
dicting future jobs at risk.

Before turning to the analysis of future employment threats, we need to ex-
amine trends in some of the major components of aircraft employment. Figure 5
reports total employment in airframes (final assembly and integration), engines
and parts, and other parts and equipment. Several trends stand out in these data.
First, the bulk of employment in this industry is still in the airframe sector, com-
posed primarily of the major defense and commercial aircraft integrators. Sec-
ond, there appears to be a secular declining trend in employment in airframes,
engines, and parts. As a location for production, the United States is internation-
ally the least competitive in the engine sector. The United States has had roughly
balanced trade (exports equaling imports) in this sector in recent years and has
periodically experienced overall deficits in engine trade. This is remarkable, in
part, because two of the three major engine producers are based in the United
States (Almeida, 1997).

FIGURE 4 U.S. engines and parts imports as a growing share of total aircraft sales. Source: Economic Policy Institute analysis of AIAA (1996, 1997).

co-production arrangement involving Chinese assembly and co-production of its MD-82 and MD-90 aircraft. At least one of these aircraft has also been exported back to the United States.

When final aircraft assembly is transferred abroad, parts exports will increase even while total
industry employment and value akiled would decline, relative to what they would have been if those
aircraft had been assembled in the United States. In this case, it is inappropriate to treat parts and
component exports as net-job creators. Indentification of appropriate counterfactual analysis in such
cases will require detailed knowledge of offset sales contracts and whether or not such sales would
have taken place in the absence of voluntary or mandatory offset agreements.

There was no significant trend in the level of parts imports as a share of total acrospace imports in
this period. This is somewhat surprising because of the decline in military production (which involves
high levels of mandatory exports) and the relative increase in commercial aircraft markets noted
above. Thus, the level trend in this share suggests that commercial sales may have involved increasing
offsets in this period.

Note that Figure 4 uses a different basis (total aircraft shipments) from the analogous exhibit in our
prior research (Barber and Scott, 1995: Figure 8, p. 27). This change was made to improve the accu-
racy of our forecasts, us explained in the next section.

Third, there is some evidence of a stable or increasing trend in employment in the U.S. aircraft parts industry. This is illustrated in Figure 6, which compares employment in parts with employment in the much larger airframe sector. This comparison also reveals that employment in parts is somewhat more volatile than in the airframe sector. There are several possible explanations for these trends that are consistent with the evidence on rising parts imports shown in Figure 4. First, as the technological complexity of aircraft has increased it is likely that the number and value of components (electronics, for example) has also increased, as a share of value added. Second, modularization of component production has eliminated final assembly labor in a wide range of industries, from motor vehicles to electronics, so it is not surprising to observe evidence of that trend here. Finally, products counted as parts may substitute for production that used to take place within the plants of airframe manufacturers. Several examples of this are given in Box I that involve Chinese offsets and outsourcing, including doors,

FIGURE 5 Long-run decline in employment in aircraft production. Source: Economic
Policy Institute analysis of Bureau of Labor Statistics (1997) and AIAA (1996, 1997).

FIGURE 6 Employment in aircraft parts versus airframes. Source: Economic Policy Institute analysis of Bureau of Labor Statistics (1997) and AIAA (1996, 1997).

fins, stabilizers, and body parts for various types of commercial aircraft. As a
consequence of each of these trends, employment in airframe manufacturing ap-
pears to be declining, relative to both domestic and foreign parts production.
Thus, domestic workers in the airframe industry are correct to blame both
outsourcing and imports for job loss in their industry.

The higher level of variability in parts employment suggests that employ-
ment in parts production is more heavily affected by the business cycle than is
employment in the airframe sector. The secondary or sub-tier supplier base there-
fore appears to absorb a disproportionate share of the job losses that occur during
downturns, once we control for the long-run shift of employment out of engines
and airframes, as discussed above.

Jobs at Risk in the Future

In this section, employment effects of growing foreign competition, and also foreign outsourcing and other practices that encourage U.S, firms to shift component and parts production abroad, are briefly re-examined. As noted by several other contributors to this volume and other participants in the National Research Council conference (Wessner and Wolff, 1997), offsets are an important threat to domestic production in both military and commercial aircraft production. These problems are particularly important in the case of trade with large, nonmarket economies because of the role of and bargaining power exercised by government officials as the ultimate arbiters of all major import purchasing decisions. Some examples of current offset and co-production practices are illustrated in Box 1.

TRENDS AND CHALLENGES IN AEROSPACE OFFSETS

Bocing officials have acknowledged that their company does enter into voluntary
offsets "as a means of gaining market access" (Waldmann, 1997:6). Other ana-
lysts concluded that, although the issue of offsets is "not even on the radar screen"
at the present time, offsets will increase and become a “major factor over the next
decade or two" (Bozdogan 1997:27). These views are confirmed by closely ex-
amining the trends discussion above and their implications for future employ-
ment in the U.S. acrospace industry.

International competition threatens U.S. production in at least two distinct
ways. First, the market share of U.S. producers of commercial aircraft could de-
cline in the future as a result of market-share gains by Airbus Industric and/or
other potential new entrants to this market." This will impact U.S. cinployment
primarily by reducing U.S. exports because the majority of commercial aircraft
produced in the United States are now sold in export markets, as noted above.

The second threat to domestic employment is through increases in the for-
eign content of domestically produced aircraft as a result of increases in offsets
and other forms of international component outsourcing. Ultimately, such
outsourcing could help create new competitors to U.S. producers and hence exac-
erbate the first type of international competition. However, such secondary ef-
fccts are ignored here and only the effects of increases in the foreign content of
domestically produced aircraft on U.S. aerospace employment are considered.

The foundations for my estimate of the number of jobs at risk in the future
because offsets increase foreign competition are (1) the 1994 DRI/McGraw-Hill
study of the U.S. manufacturer market share, as reported in Barber and Scott
(1995:43-45) and (2) Boeing's cstimates of the future world market for commer-
cial aircraft. These estimates are used to forecast the future effects of increased
foreign competition on total (constant dollar) sales of U.S. acrospace products.

The potential job losses that could result from offsets and other types of
foreign outsourcing are estimated by extrapolating the current trend in the rate of
growth of aircraft engines and parts (see Figure 4) as a share of the value of total
domestic aircraft sales (military and commercial). I assume that real output re-
mains constant at the level that prevailed in 1994 and that the trend in the rate of
growth in the imported parts share continues through 2013.9

A recently released (Department of Labor, 1996) input-output-based em-
ployment requirements table is used to estimate the direct and indirect employ-
ment effects of trade for both types of employment threats. These procedures are
similar to those used in Barber and Scott. However, they differ in two respects.
First, use of the new input-output table provides industry-specific employment

*This analysis ignores competitive threats in the military and space sectors. Increased competition
in any of these other sectors could further reduce domestic employment opportunities in the acrospace
industry.

"The year 1994 is taken as a base for comparison with the estimates developed in Barber and Scott (1995:40-47).

EFFECTS OF OFFSETS, OUTSOURCING, AND FOREIGN COMPETITION

151

TABLE 6 Potential Job Losses Attributable to Increased Foreign Content of
Aircraft Made in the United States and Total Jobs at Risk Due to Foreign
Competition, 1994-2013

SOURCE: Economic Policy Institute analysis of DRI/McGraw-Hill (1994: 9-11) and Boeing Company (1994: Appendix C).

multipliers that are much more accurate (and significantly smaller) than those
used in the prior study. Second, the share of imported parts and components in
aircraft sales is used to estimate the effects of outsourcing. This is a much more
precise and appropriate base than the one used in our previous research (trends in
total imports as a share of total aerospace sales).

The resulting projections of output and job losses are shown in Table 6. The
first panel in the table reports the effects of increased foreign outsourcing, assum-
ing that the trend of increasing foreign content of the past decade continues into
the future. The first column of results shows the annual loss in output, relative to

YAYWAY AND CHALLENGES IN AEROSPACE OFFSETS

the base year of 1994 in constant dollars. Employment losses are calculated,
using the multipliers described above, at the end point of each period. Cumulative
losses in output are shown for informational purposes only and are not directly
used to calculate employment effects. The employment losses shown are the per-
manent losses of job opportunities, based on the given annual reductions in do-
mestic output. More than half of all jobs resulting from a given amount of expen-
diture on aircraft are located in the aircraft and parts industries (direct jobs).
Within ten years (by 2003) of the base year, 22,596 aerospace jobs will have been
eliminated by outsourcing, plus an additional 16,902 indirect jobs in industries
that provide inputs to the aerospace industry, for a total loss of 39,498 jobs. Within
two decades, offsets and other forms of foreign outsourcing could eliminate
46,083 aerospace jobs and 34.470 jobs in other industries for a total loss of 60,553
jobs. The direct jobs lost in 2013 would equal 9.6 percent of total aircraft employ
ment in 1994,

This estimate of job loss may be too small for several reasons. First.
Bozdogan (1997) and others appear to suggest that the growth of offset activity
could accelerate in the future. Second, these estimates do not include any "indi-
reet offsets" in other acrospace or nonaerospace sectors. However, recent reports
from the U.S. Department of Commerce (Department of Commerce, BXA, 1996)
suggest that indirect offsets are increasing as a share of total offsets, at least in the
military sector. Finally, the buse of production in 1994 is quite low because the
recovery in aircraft production had not yet occurred (see Table 3). If a later base
year were assumed, or if we assume that the trend rate of growth in output is
positive, then job losses as a result of outsourcing will increase. On the other
hand, some suggest that the level of outsourcing is constant or leveling off
(Waldmann. 1997). If so, then the outsourcing estimates in Table 6 may be too
high.

The threat of reductions in the U.S. share of the world commercial aircraft
market could have an even larger effect on employment than outsourcing in the
next two decades, as shown in the second panel of Table 6. In this case the U.S.

The U.S. market share trend line was derived from historie data (1970-1992), combined with
DRI/McGraw-Hill market share projections (1994-2000) and then extrapolated to 2013. Estimated
Just commercial jet aircraft sales are derived from the difference between the 1989-1993 average
U.S. revenue market share (73.5 percent) and the projected market share described above, using
Boeing forecasts for constant 1994 dollar global revenues through 2013. Estimated job losses are
derived from Bureau of Labor Statistics (1996) input-output data on the jobs supported by final de
mand for aircraft, expressed in 1987 dollars for the year 1993, which reports that 13.748 total jobs
(7.865 direct and 5,883 indirect) were supported in 1993 by each $1 million (1987 dollars) in final
demand for aircraft. Consparable estimates, expressed in constant 1994 dollars (adjusted for changes
in aerospace prices hetween 1987 and 1994) are 11,184 total jobs (6,398 direct and 4,786 indirect) per
$1 million of final demand (1994 dollars). These figures were then multiplied by projected revenue
losses, from the 1994 base, to estimated lost jobs, as described in the text.

The base of comparison in this example includes only those workers employed in aircraft and
parts (Standard Industrial Classification 372).

EFFECTS OF OFFSETS, OUTSOURCING, AND FOREIGN COMPETITION

133

share of the world market for commercial aircraft, which has been declining since
at least 1970, could fall from approximately 80 percent in 1990 to 50 percent in
2003 and 35 percent in 2013, using the assumptions made by Barber and Scott
(1995: Figure 11. p. 44). The new multipliers described above are used to esti
mate the employment effects of the output losses implied by these forecasts, By
2003, 26,999 dineet jobs and 20,195 indirect jobs could be lost, for a total or
47.194 jobs lost in aerospace and related industries. Within two decades, 77,031
direct jobs and a total of 134,650 direct and indirect jobs could be lost because of
declining U.S. shares of the world market.

The effects of outsourcing and potential losses of international market share
are combined in the last panel of Table 6. By 2003, 49,595 direct and a total of
86,692 direct and indirect jobs could be lost in aerospace and related industries.
By 2013, these totals increase to 123,114 direct and 213,202 total jobs lost. The
direct jobs lost in 2013 would represent 23.6 percent of the total jobs in aircraft
production in 1995. Although foreign competition will not eliminate the U.S.
aerospace industry in the next two decades, it could greatly undermine employ
ment in this critical high-skill, high-wage industry that, for at least four decades,
has been one of America's leading export sectors.

These estimates of jobs at risk hold domestic output and labor requirements
constant at levels prevailing in the mid-1990s. Other factors could increase of
decrease actual employment in the aerospace industry. Given these assumptions,
productivity growth would also reduce employment in the industry. On the other
hand, if aircraft and parts exports continue to grow, they would put upward pres-
sure on employment."

This paper does not forecast the impact of changes in overall demand, or of
productivity growth. However, it is likely that overall U.S. uerospace employ
ment will follow a declining trend in the future. Both productivity growth and
increased foreign competition will put substantial downward pressure on em-
ployment. Despite the strong upsurge in aerospace exports and revenues between
1995 and 1997, based on data in Table 3, aircraft sales and industry revenues
remained 18 and 22% below their previous eyelical peaks (in constant 1987 del-
lars) in the early 1990s. The sharp increase in BU market shares between 1992
and 1995 (Figure 3) and the continued improvement in Airbus shares of aircraft
sales in 1997, suggest that the U.S. share of the commercial aircraft market may
be declining more rapidly than was assumed in Table 6. The surplus in aircraft
parts, reflects, in part, aftermarket sales of the existing base of aircraft, which is
dominated by US-made planes. Rapid growth in the global stock of Airbus
aircraft, and the retirement of older U.S.-made models, will begin to erode this
surplus within the next five to ten years.

12The need to consider productivity and output growth was noted by David Mowery, who also pointed out that the U.S. trade surplus in aircraft parts and equipment has grown for the past 8 years.

154

TRENDS AND CHALLENGES IN AEROSPACE OFFSETS

For these reasons, U.S. aerospace employment is likely to decline in the future. Offsets, outsourcing, increased foreign competition and productivity growth will all contribute to these declines. While it is not possible to say which of these factors will be most important, they are all related to the decline of the U.S. as a competitive location for aerospace production, and the falling market shares of U.S.-based aircraft integrators. Expected future job losses in the aerospace industry can only be avoided or reduced through sharp improvements in the competitiveness of the U.S., and of aerospace firms based in this country.

CONCLUSIONS AND POLICY ALTERNATIVES

Other countries are actively targeting the commercial aircraft industry. The
Chinese and other Asian governments are using trade and industrial policies to
capture production and technologies from the United States. Many of these sys-
tems were developed with public support. The U.S. aerospace industry stands at
the edge of a precipice. If the challenges it faces are not addressed, at least 215,000
additional jobs in aerospace and related industries will be eliminated over the
next two decades.

In Barber and Scott (1995) we develop a broad range of policy recommenda-
tions that are needed to restore and maintain the international competitiveness of
the U.S. aerospace industry. These include:

⚫ creation of an aerospace executive and an interagency task force within
the National Economic Council;

⚫ promotion of aerospace production and employment through reform of
government regulatory processes, including those that encourage firms to
engage in offsets, and new programs to stimulate domestic demand for
aerospace research and products; and

negotiating fair international trade agreements, including new initiatives
to bring China into compliance with the GATT codes and their own!
Memos of Understanding and other agreements with the United States.
These policies, taken as a whole, could constitute the initiation of a coordi-
nated industrial policy for the acrospace sector. The United States is unique among
developed and many of the larger developing nations in its refusal to develop and
implement conscious and coherent industrial policies for the aerospace industry.
The United States clearly has industrial policies for this sector, but they are unco-
ordinated, incoherent, and frequently internally contradictory.

Discussion and debate over the past two years, as reflected in the National
Research Council conference (Wessner and Wolf, 1997) and in other papers in
this volume, clearly suggest that a new national system for monitoring commer-
cial offsets is urgently needed. This system should encompass both mandatory
and voluntary offsets.

Additional measures are also needed to address the causes of offset and

outsourcing problems. Defense demand has apparently stabilized, and the industry has begun to recover from a global aircraft glut, but the recovery has had only a small positive effect on industry employment. Foreign competition is now the most important future threat to domestic aircraft demand, as shown above. Rising imports of engines, parts, and components, in particular, are the result of offset deals that Boeing and McDonnell Douglas have made with foreign governments to trade aircraft sales for production and technology transfer. Offsets are the result of a prisoners' dilemma problem. In China, for example, there is effectively only one major buyer in this rapidly growing market (the government), and all three major assemblers are competing for sales by offering offsets. These companies are giving away more technology and production than would be warranted if the market were competitively structured.

Controlling Offsets

U.S. trade problems could be greatly improved through further agreements
with the EU. The United States should open negotiations to revise the 1992 Air-
craft Agreement with the EU, which technically expired in 1994 when it was
excluded from the Uruguay Round Trade Agreements. In addition to reopening
the subsidies provisions (which U.S. manufacturers feel are far too weak), there is
an opportunity to fix the prisoners' dilemma problem from the supplier's side by
prohibiting the export of jobs and technologies in exchange for sales. The EU
may also be motivated to participate in such talks because of unresolved concerns
about the merger of Bocing and McDonnell Douglas. U.S. firms have opposed a
unilateral limit on offsets because they believe it would result in lost sales to
Airbus. A new U.S.-EU agreement could benefit both Bocing and Airbus by
restoring a competitive balance to this industry.

One precedent for government regulation of unfair sales practices is the For-
eign Corrupt Practices Act (FCPA) of 1977, which was adopted after the discov-
ery of a $12 million bribe paid in a sale of Lockheed L-1011 aircraft. Despite
harsh penalties (both fines and imprisonment), the temptation to cheat may still
he irresistible. It was recently reported that General Dynamics paid a $100 mil-
lion bribe for a Korean military aircraft sale. One problem with the FCPA is that
it was imposed unilaterally, and only on U.S. firms. The FCPA approach can
serve as a model, but it must be modified to solve the aerospace trade problem.

The solution to the prisoners' dilemma is to impose a new marketing limit
(no offsets in exchange for sales) multilaterally. The United States and the EU
should adopt essentially identical measures proscribing such behavior by firms
based in cach region. This agreement would reduce the trade and jobs-distorting
use of offsets worldwide. This measure should be acceptable to both U.S. and
European aircraft manufacturers, because all would experience higher levels of
future sales and production than they would without the agreement.

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