Economic Costs of Arms Exports: Subsidies and Offsets


Testimony of Lora Lumpe
Director, Arms Sales Monitoring Project
Federation of American Scientists

Subcommittee on Foreign Operations
Appropriations Committee
U.S. Senate

23 May 1995

Hearing on U.S. Conventional Arms Export Policy


The Federation of American Scientists is a democratically structured, public interest organization of natural and social scientists and engineers. Founded 50 years ago at Los Alamos by members of the Manhattan Project, FAS is dedicated to the abolition of nuclear weaponry and to the responsible use of science and technology. Included among the Federation's sponsors are over half of all living American Nobel Laureates.

Good morning, Mr. Chairman and members of the Committee. I appreciate the opportunity to appear before you today to present the views of the Federation of American Scientists on the economic costs of U.S. conventional arms transfer policy.

From 1986-1989, the United States government sold $29.1 billion of weaponry (in constant 1993 dollars) to developing countries through the Foreign Military Sales (FMS) program. During the following four years, which coincide with the end of the Cold War, the United States nearly doubled new sales agreements to $59.8 billion. In 1993 alone the United States sold $14.8 billion of weaponry and accounted for over 70 percent of all sales agreements made with developing countries.

A combination of factors are driving aggressive U.S. arms exporting today. Lingering Cold War strategic rationales for arms sales---the need to "maintain influence," "reward" allies and maintain military basing and other access rights---still play an important role. But economic imperatives---principally the desire to maintain as much of the current arms industrial base as possible---have clearly taken on greater importance in United States' arms sales decision-making. In fact, the major innovation in the Clinton Administration's conventional arms transfer policy, made public on 17 February, is that the Executive Branch will now consider the impact on the arms industry explicitly when deciding whether to approve an arms export.

Weapons industry lobbyists have long favored such a consideration. Since 1990, industry routinely provides Members of Congress and the Executive Branch with data on the employment, balance of trade and arms industrial base benefits which they allege will accrue from specific arms deals. McDonnell Douglas Corporation effectively employed such a strategy to win Executive and Congressional support for a highly controversial sale of 72 F-15E fighter-bombers to Saudi Arabia in 1992. Largely based on such self-interested analysis, Congress---which historically has acted as a moderating force on U.S. arms exports---has supported all of the more than $60 billion of post Cold War arms exports to the Third World.

McDonnell Douglas and the other contractors are obviously interested in seeing government approval for exports. Therefore, it is not surprising perhaps that industry routinely omits the negative half of the balance sheet. In addition to the alleged economic benefits of U.S. arms exports, there are also significant costs to the public. The global arms trade---including U.S. arms exports---entails enormous indirect economic costs, through the creation of potential direct threats to the United States. Others here will address this security paradox.

In addition, as the Project on Demilitarization and Democracy, the National Commission on Economic Conversion and Disarmament, and Bill Hartung have pointed out in various excellent publications, while militarization and warfare might be good for arms exporters, they are bad for other businesses. There is an opportunity cost involved in supporting arms exports,

I will focus today on specific examples of how taxpayer funds are currently used to market and finance weapons exports, and also discuss recent arms industry intiatives to expand such subsidies. In addition, I will explain how arms sales "offsets" call into question many of the arms industry's claims about the economic and security benefits of arms exports.

I) Direct Subsidies in Support of Arms Exports

Funds for marketing/promotional assistance and financing are spread across many programs and agencies, including those funded in the foreign aid appropriation, and appropriations for the Defense, Commerce, State and Justice Departments. According to a preliminary compilation by the General Accounting Office [GAO/NSIAD-95-110R], and a spreadsheet prepared by the National Commission for Economic Conversion, over $6.3 billion in taxpayer money was expended during fiscal year 1994 in support of arms exports.

At a time when Congress is questioning almost all public spending and is likely to abolish hundreds of federal programs and categories of assistance, this aid appears to be sacrosanct. In fact, at the behest of arms industry lobbyists, rather than cutting back on arms export subsidies, Congress and the Executive Branch are seeking to expand certain types of public support for arms exports.

Marketing Arms The Pentagon spent over $1 million of public money in incremental costs to display American-made weaponry at international arms bazaars/air shows last year. Additional money was spent to transport and demonstrate aircraft and other combat systems in the field for potential purchasing nations. Taxpayers also underwrite the costs of developing, printing and distributing arms sales promotional material, such as the Defense Security Assistance Agency's "Catalog of U.S. Defense Articles and Services" and State Department's Defense Trade News.

Several military training programs which serve various U.S. policy objectives also serve to expose, interest and train potential customers in the use of U.S. military equipment. Some portion of the following programs' budgets deal with weapons training, or transfers of militarily-useful equipment.

  • International Military Education & Training (including IMET from Peacekeeping account)
  • Military-to-Military Contact Program
  • International Narcotics Control (and other counter-narcotics programs)
  • Anti-terrorism Assistance
  • International Criminal Justice (and other police training programs)
Public monies are used for personnel costs to administer U.S. arms export programs. This includes the costs for all personnel at, or contracted by, the Commerce, Defense and State Departments and their associated agencies, and each of the military services, involved in arms export promotion and administration (excluding those positions funded by the administrative surcharge included in FMS). The principal agencies will be the Defense Security Assistance Agency (including personnel overseas) and the State Department Office of Defense Trade Control; the Defense Intelligence Agency also serves as the security assistance liaison in certain countries.

Financing Arms Exports Grant Foreign Military Financing (FMF) represents the bulk of the United States' annual subsidy for arms exports. This aid has leveled out at $3.15 billion for each of the past two fiscal years, down from a high of more than $5 billion in the mid-1980s. Over the past decade, the government has given countries of the world $40.5 billion with which to purchase American-made weapons.

As public pressure to reduce foreign aid has squeezed grant FMF, the government has returned to direct and guaranteed loans. For fiscal year 1995 Congress appropriated $47.9 million to underwrite loans of $619.6 million for Turkey and Greece. In the early 1980s, the Reagan administration moved away from loans because of the difficulty of several allies to meet their debt obligations. A report sent to Congress in January of this year showed more than $16 billion of Pentagon-financed loans for arms exports out- standing as of 30 September 1994. The report showed that the Pentagon had rescheduled many countries' debt, meaning that the borrowing country had convinced the Pentagon that, unless terms of repayment were eased, default was imminent. Several countries pri- marily Liberia, Niger, Somalia, Sudan, and Zaire were $190 million in arrears as of 30 September. The government will likely have to write off the debt of these war-torn, impoverished countries.

In a costly case not reflected in the Pentagon report, the White House announced in November 1990, during the build up to `Operation Desert Storm', that it was forgiving $7.1 billion in weapons debt owed by Egypt. Even more expensive to taxpayers, Congress annually appropriates $1.2 billion in foreign aid (so called "Economic Support Fund") to allow Israel to meet its military debt obligations to the United States government some $7.5 billion, according to the report.

The Export-Import Bank now provides another source of taxpayer subsidized financing for some arms exports. Under a 1988 law, Ex-Im can finance weapons sales to be used for counter-narcotics purposes. Congress enacted a law last year permits the Bank to finance sales of non-lethal military items and services, if the primary end use is for non-military activities. Ex-Im is limited to using 10 percent of its $15 billion authority to finance weapons exports.

Despite these several sources of financing, the arms industry continues to seek the establishment of a "Defense Export Finance Facility" to provide U.S. government guaran- tees for commercial loans. Under the current plan, either the arms purchasing country or the arms selling corporation would pay a fee to cover the contingent liability of the mar- ket-rate loan. Although no appropriation would be required, the United States government would be liable for repayment in case of default. There is no cap on the amount that may be guaranteed under the current plan, exposing the American public to very high liability. In addition, the current initiative would authorize loan guarantees for NATO and major non-NATO allies (which includes credit risky Turkey), as well as cash-strapped Eastern European countries and members of the Asian Pacific Economic Council.

Additional taxpayer financing of weapons occurs through covert arms transfer operations. The CIA transferred billions of dollars of weaponry to Afghanistan and Angola during the late 1980s. As such programs are classified, it is impossible for us to speculate as to current costs to the public.

Research & Development Subsidies/Recoupment Fees On top of the more than $6.5 billion in marketing and financing assistance, arms exporters are given a massive boost through taxpayer-subsidized research, development, testing and evaluation of weapons systems for U.S. forces, as well as the establishment of the production line for the weaponry.

The Pentagon spends over $30 billion of public money annually to develop arms. In most cases, the government contracts out for R&D up front. In cases where a company expends its own funds to initiate R&D, it is reimbursed by the Pentagon under the Independent Research and Development program. Because they do not have to pay these costs, arms manufacturers make a handsome profit on exports of weapons systems. Because they do not have to pay any portion of the weapon development costs, foreign customers also realize substantial benefit, at the expense of U.S. taxpayers.

Since the 1960s, the DOD has as a matter of policy added a charge to both industry-negotiated Direct Commercial Sales and to government-negotiated Foreign Military Sales (FMS) in order to recover a fair proportion of the U.S. government's sunk costs of R&D, testing, evaluation and production of weapons systems. In 1976, the requirement to recoup some part of these costs on FMS of major equipment was enacted into law (Arms Export Control Act, Section 21(e)(1)(B)). The fees average five percent of the weapon's sale value, although on occasion they rise to 25 percent, depending on how much of the weapon system the Pentagon procured.

Industry has lobbied vigorously against the fee since 1991, arguing that it raises the price of U.S. weapons and makes them uncompetitive in the arms bazaar. (U.S. market share belies this claim.) In 1992 the Bush Administration abolished recoupment fees on direct commercial arms sales. Since then, the administration and industry have argued that recoupment fees on FMS must be repealed in order to restore equal treatment between the two programs. Maintaining recoupment fees on FMS but not on direct commercial sales makes government-negotiated sales more expensive. The Pentagon argues that without equal treatment, buyers will go the commercial route, which entails less government oversight.

As it currently stands, the recoupment law also allows the Pentagon to waive the fee on foreign military sales if the export would promote standardization of forces with NATO or major non-NATO allies, like Japan. Under this provision, the Defense Department waived $272 million of recoupment fees in 1994.

The money recovered through recoupment fees is returned to the Treasury as general deficit reduction. If a low-end, five percent fee was charged on all $12.8 billion of government-negotiated arms sales in 1994, the U.S. deficit would have decreased by $640 million. If such fees were applied to industry-direct sales, perhaps another $100-200 million of red ink would be eliminated. Instead, of the above-mentioned loopholes have reduced the Treasury's take to only $150-170 million annually.

A better way to restore equal treatment, channel buyers back toward government-negotiated sales, and treat the citizens of the country fairly would be to reinstate recoupment fees on commercial sales. Congress should mandate recoupment fees on all exports of military equipment developed with taxpayer funds, including direct commercial sales and sales to NATO and major non-NATO allies. With the end of the Cold War, the benefits of subsidizing our wealthy allies' defense must be weighed against the cost to taxpayers.

II) Arms Sales `Offsets'

As maintenance of jobs and the military industrial base has become a primary justification for U.S. weapons exports, offset agreements---the largely unregulated and secretive side deals which routinely accompany arms sales---deserve increased attention from policy makers. Through these side deals, a buyer seeks economic benefits to "offset" the cost of an arms purchase.

In testimony before the House Energy and Commerce subcommittee last June, General Accounting Office (GAO) Assistant Comptroller Frank Conahan testified that offsets "reduce the employment, defense industrial base, and other economic benefits that normally accrue to the United States from weapons exports. Certain types of offsets have resulted in a loss of some production work and business for U.S. prime contractors and subcontractors as well as for companies in nondefense businesses."

Offsets come in two basic varieties. "Direct" offsets involve transfer of military technology, typically by granting a license to the recipient country to produce the weapon system being purchased, its components or subcomponents; and "indirect" offsets---which - may involve the counter-importation of some unrelated product into the arms-selling country, investment in the buying country, or commercial technology transfer to the buy- ing country.

Following the industrialized countries' lead, and seeing that the competitive market would bear it, in the late 1970s and 1980s many developing countries began routinely to require some raw percentage of the contract value of arms sales be reinvested in their economic development through offsets. Some Congressional observers have likened this practice to a massive foreign aid program being run by defense contractors. Kuwait, Saudi Arabia, South Korea, and Turkey, to name a few, have established offset guidelines for arms imports. With the increasingly competitive state of the arms market in the 1990s, countries that in the past were satisfied simply to buy sophisticated American weaponry now demand offsets as well.

The Taiwanese legislature, for example, retroactively demanded Taiwan's first ever offset from an American firm for the September 1992 sale of F-16 combat aircraft to Taiwan. After the U.S. and Taiwanese governments completed the $6 billion deal, the Taiwanese legislature blocked payments unless the manufacturer of the plane, Lockheed, provided Taiwan with technology and production contracts related to the aircraft. In July 1993 Lockheed signed a 10-year "Industrial Cooperation Agreement" worth $1.1 billion which ensures production of some of the aircraft parts in Taiwan and the creation of depot maintenance centers there.

In the current buyer's market, U.S. manufacturers are engaged in an offset bidding war with each other and with European competitors. In January 1994, Israel finalized a $2 billion purchase of combat aircraft. Two American arms manufacturing giants----McDon- nell Douglas and Lockheed---were in fierce competition for the deal, each trying to outbid the other in terms of price, technology, and offset packages. To cinch the Israeli sale, McDonnell Douglas will provide offsets benefitting Israeli industry for 50 to 100 percent of the sale's value. At the same time, Israel will purchase the F-15E aircraft with U.S. military aid, which is restricted to purchases from the United States. In this way, U.S. taxpayers subsidize twice-over the development of foreign militaries and foreign industries, at the ex- pense of our own manufacturing base.

On some occasions, offset agreements extracted have been worth more than the actual value of the weapons sold. The $950 million sale of Apache attack helicopters to the Netherlands earlier this year included offsets worth 150 percent of the contract value.

Freshman Senator Russell Feingold (D-WI) added an amendment to last year's State Department Authorization Act requiring "real time" notification to Congress of information on any direct or indirect offset agreements under consideration as part of an arms sale subject to Congressional approval. Information will be included in the notifications requir- ed under the Arms Export Control Act, which provide Congress with 30 days in most cases to consider the pending sale. (The State Department is still drafting regulations to implement the requirement.)

Sen. Feingold became interested in offsets when a Wisconsin heavy machine manufacturer nearly lost a contract for paper-making equipment in an offset connected to the 1992 sale of F/A-18 fighters to Finland. Northrop Corporation, a subcontractor involved in the deal, offered an "incentive payment" to a U.S. firm to purchase the machine from Valmet Corporation, a Finnish company.

If American workers realized that American arms firms were underwriting their foreign competition, public opposition to arms sales would likely increase. In its 1990 report, the OMB conducted case studies of F/A-18 aircraft sales to Australia, Canada and Spain to assess the short- and potential long-term economic impacts of both direct and indirect offset transactions. "Certainly, a substantial short term gain in business was achieved through direct offsets....Canadian firms were particularly successful in turning what was originally offset work into long term, business opportunities....The total impact that offsets have on U.S. industry is complex and intertwined with other economic factors. However, it appears that offsets have contributed to the strengthening of foreign competi- tors in Australia, Canada and Spain," OMB concluded.

Industry lobbyists contend that offsets are essential to making foreign sales, and they have masterfully played up the argument that arms exports preserve American jobs and the defense industrial base. The arms-sales-for-jobs frenzy peaked in 1992, when McDonnell Douglas claimed that if the United States did not sell 72 F-15E fighter-bombers to Saudi Arabia, 40,000 jobs would be lost. The highly controversial sale was pushed through Congress largely on the strength of this claim. McDonnell Douglas did not advertise the fact that Saudi Arabia requires a 30 percent offset to all major contracts, and accordingly $2.7 billion of business would benefit Saudi workers and the Saudi economy, most likely at the expense of American workers in defense and other industries.

Real time and public reporting of offsets is needed if false or exaggerated claims of employment benefits are to be answered, and constituencies that may be negatively impacted are to be alerted before arms sales are finalized. In a July 1993 fact sheet on his proposed amendment, Sen. Feingold said: "Foreign military sales are often justified on the basis of the employment produced for the defense industry by such sales. If, however, such sales are accompanied by offset agreements that result in the loss of American jobs and business in defense and other sectors, that information ought to be made available to Congress at the time the sale is being considered."

Exporting Military Know-How

Indirect offsets are interesting mainly to fill out arms industry claims about the economic benefits of particular deals. Direct offsets, however, are a security issue.

Countries able to absorb the it prefer military technology transfers to indirect offsets. Arms sales are now routinely accompanied by co-production or commercial licensing ar- rangements, whereby a production line for the weapon system or its components is set up in the recipient country. Where the buyer cannot absorb such technology transfer, a depot for servicing and maintenance of the weapon system might be established.

A prime example of direct offsets is the $5.2 billion Korean Fighter Program (KFP) deal of 1991. South Korea contracted to purchase twelve off-the-shelf F-16C/D fighters and thirty-six aircraft kits for assembly in Korea. In addition, Korea---which is developing an indigenous fighter aircraft production capability with the help of Lockheed, as required by KFP offsets---purchased the right to manufacture seventy-two F-16s under license. Through previous offsets, Korean Air Lines and Daewoo Heavy Industries already produced some F-16 parts, and Samsung Aerospace produced parts for the F/A-18 fighter. But that level of experience was nothing "compared to the level of manufacture and production line man- agement contemplated under the KFP," according to the General Accounting Office (GAO). On top of the transfer of manufacturing and assembly know-how, Korea received 30 percent of the contract value, more than $1.5 billion, in undisclosed indirect offsets.

When Congress was considering the Korean Fighter Program in August 1991, the GAO was unable to calculate whether the sale will result in more U.S. jobs gained than lost. U.S. production will be limited, and Korea will be manufacturing most of the airframe for 72 of 120 aircraft purchased. Of the remaining 48 planes, European partners in the F-16 program are entitled to 15 percent work-share from a previous offset. Only twelve of these planes are to be shipped whole; the other 36 will be exported in kits to be assembled in Korea.

On 25 June 1992, thousands of F-16 production line workers gathered at the gates of General Dynamics' (GD) Fort Worth factory for a "Fairness Rally" in protest of the coproduction deal. George Kourpias, International President of the Machinists and Aero- space Workers union, told the workers: "GD originally wanted to bring 500 Korean work- ers here....our union put a stop to that scheme. At least for now. But the state of mind of the company has not changed. They still see no merit in working with us to convert to become a part of the post cold war era....Right here in Fort Worth, 3,000 of our brothers and sisters have been laid off in the past two years....this week, another 500....And the company wanted those of you left to teach Koreans how to do your jobs." The Samsung Aerospace workers were later trained in Turkey, where GD has another F-16 coproduction facility.

Members of Congress had pushed for Korean purchase of planes manufactured in the United States. Rep. Richard Gephardt (D-MO) said: "General Dynamics, not unlike McDonnell Douglas in my district, has had to...lay-off a large number of U.S. workers in the past year. These workers are capable of manufacturing a majority of the parts to be used in the F-16 and the KFP, and they should be reemployed for this purpose." To such complaints, industry and government officials respond that fifty percent of something is better than one hundred percent of nothing.

Currently, United States law, as codified in the Arms Export Control Act, encourages the transfer of production technology to NATO and "major Non-NATO allies." This law treats the transfer of military production technology no differently than the sale of armaments, merely requiring that Congress be notified of contracts of $14 million or more. Congress is then given thirty days within which to contest the arrangement (fifteen days for NATO member countries).

The result is what might be termed the proliferation of military-industrial complexes around the world. In the 1950s, only five developing countries produced major military equipment (aircraft, armored vehicles, missiles or naval craft), small arms, and/or ammuni- tion. By the early 1980s this number had risen to 54, with 36 of these countries producing major military equipment. Brazil, India, Israel, Singapore, South Africa, South Korea, Taiwan and Turkey are among those developing countries with significant arms industry today.

In a seminal 1991 study (Global Arms Trade), the Congressional Office of Technol- ogy Assessment chronicled the coproduction phenomenon. The report noted that "in 1988 the United States was engaged in transferring the production technology for approximately 70 major weapons systems to foreign countries, about the same number as its NATO allies and the former Soviet Union combined." Production of top-line equipment---such as American M1A1 tanks, Russian MiG-31 fighters, and advanced European diesel submarines---is being licensed. U.S. licensing of weapons production has, over the past two decades, "contributed to the emergence of new centers of advanced defense industry and technology, first in Europe, next in the Western Pacific, and increasingly in developing nations around the globe," OTA testified last June.

Glenn Rudd, Deputy Director of the Defense Security Assistance Agency (DSAA)---the Pentagon's sales department---defended the direct offset policy in a 1989 House Armed Services Committee hearing: "Selective use of coproduction has facilitated the achievement of U.S. goals of enhanced cooperative defense. It's helped to rebuild NATO and Japan....It has helped standardization of equipment with friends and allies and promot- ed regional stability through the improvement of industrial capabilities of certain countries."

Because of the initial capital investment and the requirement to pay licensing, royal- ty and technical assistance fees, licensed production or coproduction costs much more than buying weapons off the shelf. In order to recoup these investment costs, and to reduce the unit cost for their militaries, coproducers will seek to enter the export market.

The decision to help establish a new military industry is now made on business terms; no longer are the security implications the primary consideration. But at the same time, arms production and exports by our allies are increasingly viewed as a security threat, as well as unwanted economic competition. The chief of Naval Intelligence, Rear Adm. Edward Sheafer, Jr., testified before Congress in February 1992 that "Western Europe, our closest military partner and one of our largest economic partners, poses no military threat to the United States except through export of arms that are roughly equal to ours in overall lethality and technical sophistication."

The expanding numbers of arms suppliers profoundly complicate efforts to achieve limits on international arms transfers through negotiated arms control or multilateral arms embargoes. Opponents of global arms sales limits today cite the technologically so- phisticated and commercially oriented European industry as the primary obstacle---"If we don't sell, the Europeans will."

Perhaps the most important security implication of coproduction deals is the irrevocable transfer of industrial technologies and manufacturing know-how, needed not only in conventional weapons production, but also for the possible development of long-range missiles and weapons of mass destruction. American sales of production technology to the Shah lie at the heart of Iran's current military industry, and licensed production from the Soviet Union, China, Brazil and others, provide the foundation of Iraqi weapons industry today.

A frequent justification for U.S. arms transfers has been that the withholding of parts, servicing or ammunition provides a mechanism for control over the recipients' use of the weaponry; however, the increasing number of suppliers of the same weapons and components is eroding any such leverage. For example, sixteen countries now produce parts for, or assemble F-16 fighters. Thus, it was no surprise when the Pakistani Defense Minister said in February 1993 that, although the United States government had cut off sales of spare parts for Pakistan's F-16s (because of concerns about Pakistan's nuclear weapons program), "no plane has been grounded due to that reason." Pakistan, he said, was "acquiring necessary spare parts from the open market, though they were quite expen- sive." (Pakistan was even acquiring spares directly from U.S. manufacturers.)

U.S. Coproduction contracts usually contain a provision to limit production levels and prohibit sales or transfer to third countries without prior U.S. government consent. However, numerous cases of overproduction and illegal transfer have been reported.

Japan Aviation Electronics Industry (JAE) was fined $10 million in 1992 for illegal sales of weapons components produced under an American license. JAE was authorized to manufacture gyroscopes and accelerometers for the Japanese military's F-4 fighter jets, but from 1984-1987, JAE transferred more than $7 million worth of the navigational components to Iran, in contravention of the United States declared policy against arms sales to that country.

In 1988 GAO disclosed that South Korea had violated the terms of a license for the manufacture of M-16A1 machine guns, producing in excess of the licensed quantities and exporting them without U.S. approval. The State Department classified the names of the recipients, but Rep. Larry Hopkins (R-KY) disclosed that they were "hostile countries." The Pentagon maintained it had been unaware of any violation. According to the DSAA's Glenn Rudd, the K-2 rifle is a "Koreanized" version of the M-16, "but different enough according to our Army people that it could not be considered the same rifle." This case demonstrates the difficulty of controlling "indigenous" production that is based on licensed designs.

And allegations have long persisted that Israeli arms manufacturers have illegally incorporated U.S. designs and technology into their weapons and exported them to countries the U.S. would not sell to for human rights or foreign policy reasons (China, South Africa, Chile, Ethiopia...). [See the April 1992 report by the State Department In- spector General.]

In a 1989 report, the GAO examined eighteen coproduction programs and found at least five cases of unauthorized transfer. In addition, GAO examined five supposedly closed-out programs, four of which continued some production.

These examples and others point to a lack of enforcement of license terms. The DOD is responsible for negotiating most major coproduction agreements and managing their implementation, although military technology transfers are licensed under the State Department's Direct Commercial Sales program, as well. The State Department is responsible for oversight of resale of U.S.-supplied defense equipment, including all copro- duction output, and for resolving issues of non-compliance. However, former Rep. Nicho- las Mavroules stated at a 1989 House Armed Services hearing that "there is virtually no ability of our government to monitor or enforce compliance."

At the same hearing, the GAO reported that, "With few exceptions, no coproduc- tion programs were directly monitored to ensure compliance with MOUs [Memorandum of Understanding---the contract governing the coproduction deal] either by the responsible military services or by government personnel overseas. Although 15 of the 18 MOUs we examined contain restrictions on both production quantities and third-party sales, they do not require or permit U.S. monitoring or oversight. With the exception of the recent Stinger agreements, which give the United States the right to inventory missiles produced abroad, DOD coproduction guidance and MOU provisions do not include monitoring for compliance with restrictions...."

Over the years, the GAO has made many useful recommendations to strengthen oversight of coproduction programs, among them:

DOD needs to regularly update its directives and guidance on coproduction and ensure that the office assigned oversight responsibilities still exists, and is staffed! It needs to provide more, and clearer guidance on closing out mature programs.

DOD should make certain that its regulations require military services or overseas security assistance offices to assure compliance with coproduction agreements. DOD should station a representative in the foreign prime contractor's firm for a period of time, as they used to do. DOD currently relies on the foreign country to provide production reports but does not verify the reports.

DOD should Include a verification provision for all countries' agreements, and not verify programs selectively.

To preserve objectivity and independence in contract verification, DOD may wish to consider separating this function from contract implementation, once production is fully underway, and to fund it from the administrative fees it collects from FMS cases generally, rather than at the buyers' expense.

To maintain indirect control over the quantity of end items coproduced, DOD should not transfer a 100 percent production capability; critical components should be limited through the DOD's Foreign Military Sales (FMS) program.

Congress should be notified of all coproduction contracts. Notifications should include a section on whether DOD has negotiated compliance-related access provisions.

After World War II, liberal coproduction and licensed production of weapons was justfied as needed in order to rebuild European arms industries, and to standardize NATO and other allied forces. But today the United States is rightfully more worried about re- gional instability than the spread of communism. And coproduction deals have the effect of fomenting regional militarism through the proliferation of conventional weapons, while eroding suppliers' control over transferred military capabilities. They foster a more com- petitive arms market, which will lead to less discriminate sales and still more technology transfer in the future.

A laissez-faire policy on offsets makes less sense now than ever before. The government should be working to aid conversion of the U.S. economy away from Cold War-level military production toward more competitive commercial production. By assisting foreign industries with U.S. commercial technology and access to the U.S. market, indirect offsets have the effect of supporting jobs in the arms industry at the cost of com- mercial jobs.

Following are recommendations for reforming U.S. offset policies:

--The United States should strictly limit the export of military production technology. A move in this direction would not be unprecedented. President Carter, as part of his con- ventional arms transfer policy in 1977, included a ban on coproduction of major military equipment to most non-NATO countries. The policy gave way to Cold War pressures, but today's radically changed circumstances warrant a resumption of the ban.

--As a corollary to unilateral restraint, the United States should negotiate with the other producers of major military equipment (primarily Europe, Russia, and China) to restrain the proliferation of production capabilities to countries that do not already produce such systems. This would force some countries either to purchase weapons off-the-shelf, or else to put up the massive expenditures needed for research and development to go it alone.

--All coproduction and licensed production programs should be negotiated as government-to-government sales by the Department of Defense, and not be licensed by the State Department under its Direct Commercial Sales program. Currently there are two channels within the Pentagon's sales program for transferring production technology: Memoranda of Understanding, and FMS Letters of Offer and Acceptance, each with its own set of directives and procedures. To facilitate oversight, these separate programs should be consolidated.

--The Pentagon should be required to notify Congress of coproduction or licensed production of major weapons systems or components with any country, of any dollar value, and to explain, at a minimum, why it is in the interest of national security to provide that country with an independent arms production capability. Additionally, Michael T. Klare has suggested an "impact statement" be required for each coproduction deal, examining consequences for regional security, U.S. trade and employment.

Quarterly reports by the Pentagon required by the Arms Export Control Act should be expanded to include information on all government-to-government coproduction agree- ments valued at $1 million or more. The report should list the articles to be produced, how many, and by whom; restrictions on third-country transfers; and a description of con- trols incorporated into the agreement to ensure compliance. The reports should be available to the public, so that coproduction trends can be monitored by independent analysts.

--DOD should assume full responsibility for end-use verification, production limits and assurance that technology is not being unlawfully incorporated into "indigenous" weapons. The State Department, which currently is responsible, has a poor track record in this area; the need for vigorous investigation and enforcement of compliance often conflicts with the imperatives of diplomacy.

Inspection of coproduction or arms production incorporating U.S. technology should be agreed as a term of the license. Mandatory prior approval by the State and Defense Departments should be required before exports incorporating U.S. technology or produced under a U.S. license may proceed. Current law calls for a cessation of arms sales to a country found violating license provisions, yet this sanction has never been invoked. Meaningful, but realistic, sanctions for violations should be devised and enforced.

--The government should negotiate with European governments to limit indirect offsets, with a goal toward banning them. These negotiations would have two thrusts: they would seek to limit offset demands from Europe as a buyer, and seek agreement with European suppliers to limit offsets offered to developing countries. Since 1984, the U.S. government has held bilateral consultations with many of its NATO allies to discuss "measures to limit the adverse effects of offsets on the defense industrial base of each country," but with little apparent effect thus far. No effort to cooperatively limit offsets provided to developing countries has been disclosed.

--U.S. industry and government should have to disclose offsets at the time of Congressional notification of proposed weapons sales, in order to gauge their effect on the "jobs" equation. The government should also compile offsets in a data base so that the cumulative effect may be assessed. The reporting requirement introduced by Sen. Feingold should be signed into law, and both that provision and the Commerce Department reporting requirement passed into law in 1992, should be implemented and overseen rigorously.

--The government should limit or ban offsets when only U.S. arms manufacturers are competing for a sale to either European or developing countries. This is not without prece- dent. In Summer 1989, the Administration intervened in offset negotiations for the Korean Fighter Program. General Dynamics and McDonnell Douglas were competing for the sale and were driving offsets up into the 100 percent range, on top of a major coproduction license. The government capped offsets at 30 percent of contract value.

Verifying the absence of indirect offsets would be difficult; however, if subcontractors or other segments of U.S. industry are hurt by offsets, they should be able to, at a minimum, ensure that the government has been duly notified of such deals. If offsets have not been reported to Commerce, as required by law, punitive measures could be taken.

--Ban all offsets on arms sales funded or financed by U.S. military aid. The Arms Export Control Act currently discourages direct offsets for weapons financed by U.S. aid, but does not address indirect offsets at all. During Fiscal Years 1984-1992 the United States gave Israel over $1.2 billion of offsets on arms sales paid for entirely with grant military assis- tance. GAO made this same recommendation in [GAO/NSIAD-94-127]. They examined 48 sales to the four largest FMF recipients Israel, Egypt, Turkey and Greece over an unspec- ified time period. These contracts, valued at $11.6 billion and paid for with U.S. military aid, included offsets worth at least $4.7 billion, effectively increasing the assistance to $16.3 billion. The result, according to Rep. Cardiss Collins, Chair of the Commerce, Consumer Protection, and Competitiveness Subcommittee, is that "American taxpayers are actually paying to move defense-related production, and American jobs, to foreign countries."


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