Total value of the offset agreement

Term (time period) of the offset agreement

Description of performance measures (i.e., “best efforts," liquidated damages)

With respect to the second category, offset transactions within the past year, U.S. firms must provide more detailed information:

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Country purchasing defense article

Description of defense article

Name of entity fulfilling offset transaction, including first tier subcontractors
Name of entity receiving benefits from offset transaction

Dollar value of offset credits claimed by fulfilling entity, including multipliers
Dollar value of offset transaction without multipliers

Description of the type of offset product or services provided (co-production,
technology transfer, etc.)

Broad industry category in which the offset transaction was fulfilled (e.g.,
aerospace, electronics, chemicals, industrial machinery, textiles, etc.)
Direct or indirect offset

Name of country in which offset was fulfilled

2.

Information Collected Is Inadequate to Understand the Problem

Firms supplying information on which industry was affected by the offset transaction use Standard Industrial Codes, which can be as vague as “industrial machinery” or “technical services." Although this is useful information to collect, it fails to provide sufficient detail to assess accurately the impact of offsets on domestic employment and sales. In addition, it cannot be used to identify suppliers that unknowingly lose business as a consequence of offsets. Finally, these reporting requirements apply only to defense offsets, leaving policy makers with little or no information on the consequences of civil aerospace offsets.

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Firms performing offset activities routinely provide more detailed information to the country that purchased the underlying export. Buyer countries carefully scrutinize this information to ensure that they get adequate value in exchange for the offset credits they award to U.S. contractors. Although firms readily provide detailed information on offset activities to foreign governments, they not required to produce copies of this information to the BXA. Nor are firms required to provide the BXA copies of transaction papers that are also available to the buyer country. 68 With access to this detailed information, BXA could identify with greater

"Briefing by Brad Botwin. Director, Strategic Analysis Division, Office of Strategic Industries and Economic Security, Bureau of Export Administration (Sept. 8, 1998) [hereinafter Botwin Briefing II].

67 Id.

68 Id.

accuracy those U.S. businesses adversely affected by direct and indirect offsets. After this information is aggregated (to protect the confidentiality of proprietary information) and published in the BXA's annual report on offsets, economists could better calculate the impact of offsets on U.S. employment and the industrial base.

C.

International Agreements Are Insufficient to Prevent Use of Offsets

Despite guidance from Congress, international agreements have not been utilized successfully to prohibit offsets in defense or civil aerospace sales. In order to consider potential international solutions to offset-related problems, it is necessary to understand the international framework under which offsets are regulated. Generally, the theory underlying free trade agreements is that offsets are “economically inefficient and market distorting." States that utilize them, however, have not been willing to forego their significant economic and social benefits, or at least have not been persuaded to do so. Although the Clinton Administration has been more active than its predecessors in attempting to negotiate international solutions, more pressure must be placed on foreign offenders to accept multilateral agreements barring this practice in the context of defense and civil aerospace purchases.

Because international agreements treat defense and civil aerospace transactions differently, they are discussed separately below. Generally, defense offsets are universally accepted as actions taken in the interest of national security. With respect to civil aerospace offsets, the Administration has been somewhat more successful in gaining agreement on the application of free trade rules. These rules are unclear, however, about whether offsets are prohibited. In fact, only the European Community (E.C.) and the U.S. have expressly agreed to to limit their own offset demands, expressly interpreting these rules to bar government offsets in the context of civil aerospace.

1.

International Agreements Relating to Defense Offsets

The Administration has a current mandate from Congress to negotiate with foreign countries to eliminate the effects of offsets on the defense industrial base. As mentioned above, in 1984 Congress added a new Section 309 to the Defense Production Act of 1950, requiring the President to submit to Congress an annual report on the impact of defense offsets. Congress augmented this system by requiring the President. as part of the 1989 Defense Authorization, to negotiate with foreign countries to eliminate those effects. The President was directed to report to Congress on the progress of international negotiations.70

"U.S. Office of Management and Budget, Offsets in Military Exports, 23 (April 16, 1990); see also Pub. L. 102-558 §123(a) (“certain offsets for military exports are economically inefficient and market distorting").

Id. § 825(c)(1) (“The President shall enter into negotiations with foreign countries that have a policy of requiring an offset arrangement in connection with the purchase of defense equipment or supplies from the United States. The negotiations should be conducted with a view to achieving an agreement with the countries concerned that would limit the adverse effects that

In addition to requiring the President to attempt to achieve an international solution, Congress directed the President to analyze potential domestic actions to counter offsets, such as offsets in favor of the U.S., demands for offset credits, reductions of U.S. assistance to foreign countries, and the utilization of alternative equivalent advantages.

As discussed in section III.A, the White House issued a statement in April 1990 in an effort to fulfill Congress' demand for greater clarity in U.S. policy on defense offsets. As part of this statement, the Administration emphasized the importance of its obligation to negotiate an international solution. The statement also mentioned the designation of the Department of Defense as lead negotiating agency:

The President has noted that the time has come to consult with our friends and allies regarding the use of offsets in defense procurements. He has, therefore, directed the Secretary of Defense, in coordination with the Secretary of State, to lead an interagency team to consult with foreign nations with a view to limiting the adverse effects of offsets on defense procurement. The interagency team will report periodically on the results of these consultations and forward any recommendations to the National Security Council."

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In 1992, Congress accepted and codified the President's defense offset policy, as well as the President's decision to delegate to the Department of Defense lead negotiating responsibility. Building on these strides, the legislation directed the President to include in each annual Section 309 Report a summary and analysis of any bilateral or multilateral negotiations the Administration had conducted. The 1992 legislation also required U.S. negotiators to consider the data and findings set forth in the report. Unfortunately, the Administration's attempts to achieve an international solution to problems related to defense offsets have been unsuccessful..

General Agreement on Tariffs and Trade and the World Trade
Organization

The General Agreement on Tariffs and Trade" clearly permits the use of offsets in the procurement of defense articles by foreign governments. The GATT, an international trade

such arrangements have on the defense industrial base of each such country.”).

"In 1989, President Bush had initially delegated these negotiating functions jointly to the Secretary of Defense and the USTR. in coordination with the Secretary of State. Ex. Or. No. 12661 of Dec. 22, 1988, 54 Fed. Reg. 779, effective Dec. 28, 1988, as amended by Ex. Or. No. 12697 of Dec. 22, 1989, 54 Fed. Reg. 53037; Ex. Or. No. 12716 of May 24, 1990, 55 Fed. Reg. 21831; Ex. Or. No. 12774 of Sept. 27, 1991, 56 Fed. Reg. 49835.

72 See Pub. L. 102-558, § 123.

"General Agreement on Tariffs and Trade, opened for signature Oct. 30, 1947, 61 Stat. A3. T.I.A.S. No. 1700. 55 U.N.T.S. 187 [hereinafter GATT].

agreement between most nations of the world, was established in 1947 as a result of the work of the United Nations Conference on Trade and Employment. The strategy behind this landmark agreement was to identify various protectionist measures and to convert them into tariffs to be reduced incrementally. During the 1994 “Uruguay Round" of trade negotiations, the Administration revised and updated the GATT by lowering tariffs further and by revising GATT's free trade rules in a "GATT 1994." The Administration also was successful in negotiating specific plurilateral and multilateral trade agreements under the GATT framework. These negotiations established the World Trade Organization (WTO), a permanent organization designed to supervise the implementation of GATT and these supplemental trade agreements and to provide a forum for members to address issues affecting trade relations.

A fundamental tenet of free trade established in the original GATT is that GATT parties (now WTO members) may not take measures that cause discrimination against or among competitors based on noncommercial factors. This principle was intended to eliminate governmental interference that distorts commercial transactions otherwise governed by market forces. Two substantive provisions within GATT further this goal: Article 1 requires members to treat products from all other members equally (most favored nation or MFN treatment); and Article 3 requires members to treat foreign products at least as well as their own (national treatment)." The term "offsets" does not appear in the GATT, most likely because the use of offsets accelerated after the GATT was established.

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Under these fundamental tenets, at least certain types of offsets would be prohibited. For example, a country presumably would violate MFN treatment if it required U.S. companies to fulfill 20% offset obligations, but required European companies to fulfill them at only 10%. Similarly, a country would violate national treatment if it required foreign manufacturers to fulfill offset obligations but did not require the same of national companies. The GATT also elaborated on these tenets by specifically prohibiting domestic content restrictions." For

**Id. art. 1.1 (“[A]ny advantage, favour, privilege or immunity granted by any contracting party to any product originating or destined for any other country shall be accorded immediately and unconditionally to the like product originating or destined for the territories of all other contracting parties.").

"Id. art. 3.4 (“[T]he products of the territory of any contracting party imported into the territory of another contracting party shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations, and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use."). See also art. 2.1(a) (Tariffs, the only acceptable trade barriers under GATT, are permitted as an exception to the national treatment rule, but still must be applied equally to all other members to fulfill the MFN requirement.).

76 Id. art. 3.5 (“No contracting party shall establish or maintain any internal quantitative regulation relating to the mixture, processing or use of products in specified amounts or proportions which requires, directly or indirectly, that any specified amount or proportion of any product must be supplied from domestic sources.").

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example, if a member purchased products from a foreign company, the member could not demand that some of those products be made of steel from that member's territory. Under this framework, however, it is unclear whether other types of offsets, such as requirements to transfer technology, would be prohibited.

Regardless of whether GATT's initial free trade provisions would have prohibited current day offset arrangements, other provisions created express exemptions that clearly permit the use of offsets in defense procurement. In particular, GATT explicitly exempts from its nondiscrimination rules any procurement for governmental purposes.” In other words, countries may impose offsets under GATT when products are purchased for governmental purposes and not with a view to commercial resale. With respect to defense aerospace equipment, which is purchased solely for governmental purposes, the government procurement exemption would permit foreign countries to utilize offsets despite GATT's nondiscrimination provisions.

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More importantly, GATT includes a provision allowing members to take any trade actions they consider necessary to protect their essential security interests. Specifically mentioned are actions relating to traffic in arms, which, by definition, would be considered essential to national security. Thus, in light of the government procurement and national security exemptions, offsets are permitted under GATT for the purchase of defense aerospace articles by foreign governments. Nothing in the 1994 Uruguay Round GATT amendments altered the effect of these provisions.

b. Agreement on Government Procurement

Although the Agreement on Government Procurement" was intended to extend nondiscrimination rules to government procurement, its provisions continue to allow countries to use defense offsets to further national security interests. As GATT was being updated in 1994, the Administration and representatives from other countries felt the issue of government procurement should be addressed. These countries adopted the Government Procurement

"Id. art. 3.8(a) (“The provisions of this article shall not apply to laws, regulations or requirements governing the procurement by governmental agencies of products purchased for governmental purposes and not with a view to commercial resale or with a view to use in the production of goods for commercial sale.”).

78 Id. art. 21 ("Nothing in this Agreement shall be construed... to prevent any contracting party from taking any action which it considers necessary for the protection of its security interests (i) relating to fissionable materials or the materials for which they are derived; [or] (ii) relating to the traffic in arms, ammunition and implements of war and to such traffic in other goods and materials as is carried on directly or indirectly for the purpose of supplying a military establishment.").

"Agreement on Government Procurement, Apr. 10. 1979, T.I.A.S. No. 10403, 1235 U.N.T.S. 258. as amended in Uruguay Round Trade Agreements, Sept. 27, 1994, H. Doc. No. 103-316 [hereinafter Government Procurement Agreement].