GAO-01-83R Defense Trade

United States General Accounting Office

Washington, DC 20548

October 26, 2000

The Honorable John L. Mica

Chairman, Subcommittee on Criminal Justice, Drug

 Policy and Human Resources

Committee on Government Reform

House of Representatives

Subject: Defense Trade: Data Collection and Coordination on Offsets

Dear Mr. Chairman:

Defense offsets have gained increasing attention in recent years because of the

potential impact they may have on the U.S. economy and national security. Defense

offsets are the full range of industrial and commercial benefits that firms provide to

foreign governments as inducements or conditions for the purchase of military goods

and services. They include, for example, coproduction arrangements and

subcontracting, technology transfers, in-country procurements, marketing and

financial assistance, and joint ventures. Views on the effects of offsets are divided

between those who believe they are an unavoidable part of doing business overseas

and those who believe they negatively affect the U.S. industrial base.

In 1984 and again in 1999, the Congress placed data collection and reporting

requirements on the administration in an attempt to obtain information as a basis for

an analysis of the impact of offsets on the U.S. industrial base. On June 29, 1999, you

chaired a hearing to discuss concerns raised by opponents of offsets and explore

both sides of the issue.1

 As a result of that hearing, you asked us to review the

administration’s data collection and policy coordination efforts concerning offsets.

Accordingly, you asked us to determine (1) the number of federal agencies collecting

data on offsets and the type of data they collect and (2) the extent of coordination

among federal agencies for data collection and policymaking related to offsets.

RESULTS IN BRIEF

Three federal agencies are required by law to report to the Congress on defense

offsets, although other agencies may collect related data. The Department of

 

1

 “Defense Offsets: Are They Taking Away Our Jobs?” Hearing before the Subcommittee on Criminal

Justice, Drug Policy, and Human Resources of the Committee on Government Reform, House of

Representatives, June 29, 1999.
Page 2 GAO-01-83R Defense Trade

Commerce, the primary agency collecting data on offsets, is required by the Defense

Production Act of 1950 to submit an annual report to the Congress on offsets. The

Department of Defense is required by the Arms Export Control Act to report offset

information to the Congress as part of the information it reports on Foreign Military

Sales of defense items to foreign governments. Similarly, the Department of State is

required by that Act to report on offset information related to commercial sales of

defense items. The Department of Defense also maintains databases that collect data

related but not specific to offsets. For example, Defense’s Office of Foreign

Contracting maintains a record of the extent of foreign participation in defense

contracts.

Coordination of data collection on offsets is limited. This lack of coordination,

however, may not be significant because the agencies charged with collecting offsets

data collect different data covering different time periods or about different offset

situations. For example, Commerce collects data on offset activity whereas Defense

and State collect information on prospective offsets based on proposed sales.

Commerce does, however, coordinate its congressional report with a variety of other

agencies. Further, Department of Defense agencies have coordinated on policy

changes affecting offsets such as the recent clarification on cost recovery for costs

incurred to implement offset agreements. Additional coordination may occur once

the National Commission on the Use of Offsets, established by the Defense Offsets

Disclosure Act of 1999, begins its work.

BACKGROUND

The rising cost of defense equipment, limited defense budgets, concerns about

employment levels, and the importance of industrial competitiveness in a global

economy have led governments to leverage their imports of major weapon systems so

as to yield benefits for their domestic economies. Offsets are one way to achieve

these benefits. Such programs are often an essential part of weapons procurement

and allow the purchasing government to build public support for large expenditures

of public funds.

Foreign governments can obtain military equipment through the foreign military sales

program operated by the Department of Defense (DOD) or directly from defense

contractors through commercial sales. These transactions are often accompanied by

offset agreements between U.S. defense contractors and purchasing governments.

Companies may undertake a broad array of activities such as co-production and

subcontracting, technology transfers, in-country procurements, marketing and

financial assistance and joint ventures to satisfy offset requirements. Offset

agreements may specify a level of offset required and the types of activities that are

eligible for offset credit. An offset may relate to the defense item being sold (direct

offset) or to some other defense item or even non-defense goods or services (indirect

offset). Using offsets, foreign governments can reduce the financial impact of

procuring U.S. defense products, obtain technology and manufacturing knowledge,

support domestic employment, and create or expand their own defense and

commercial industries.

The value of an offset obligation can exceed 100 percent of the value of the export

contract. However, countries can grant offset credit that is greater than the dollar
Page 3 GAO-01-83R Defense Trade

value of the activity to encourage companies to undertake highly desirable offset

activities. For example, a country may grant offset credit for advanced technology or

training activities based on what the country would have paid to procure or develop

the training or technology. Countries may also offer large multipliers to encourage

desired activities.2

AGENCIES COLLECTING DATA ON OFFSETS

Three federal agencies collect data specifically on defense offsets to support reports

to the Congress that are required by law. These are the Department of Commerce,

the Department of Defense, and the Department of State. Other agencies may collect

data related to offsets but the purpose and use of the data is generally not related to

offsets.

The Department of Commerce has the primary data collection role. The Defense

Production Act of 1950,3

 requires the Department of Commerce to report annually to

the Congress on the impact of offsets on the U.S. defense preparedness, industrial

competitiveness, employment, and trade. The regulations4

 implementing the law

require companies to annually report such information as the names of the country

purchasing the defense item or service for which the offset is required, the credit

value of the offset, the actual dollar value of the offset, and a description of the type

of offset. Specifically, Commerce requires companies to report (1) offset agreements

entered into during the previous year that are valued at more than $5 million and are

associated with sales of defense articles or services and (2) completed offset

transactions being used to meet existing offset commitments that have a credit value

of at least $250,000. A complete list of the information Commerce collects is included

in enclosure I.

The Departments of Defense and State report offset information to the Congress

pertaining to individual sales of defense items. The Arms Export Control Act5

requires the President to notify the Congress of any agreements to sell defense

articles or services over a certain amount. The President delegated this reporting

function to the Secretary of Defense for foreign military sales agreements and to the

Secretary of State for commercial sales of defense items that require an export

license.

Prior to November 29, 1999, the law required that the congressional notification

contain only a statement of whether or not an offset agreement was associated with

the sale, if that fact was known. The Defense Offsets Disclosure Act of 19996

amended the Arms Export Control Act to require a description of the offset

agreement. The Defense Security Cooperation Agency, which is responsible for

preparing notification packages for the Secretary of Defense, has not provided

guidance on what specific information industry is to report. The State Department is

 

2

 A multiplier is used to increase the value of an offset project when determining offset credit. For

example, if a company helped facilitate a $10,000 export of a product with particular importance, the

country could offer a multiplier of 5, thereby increasing the amount of offset credit to $50,000.

3

 50 USC app. §2099, as amended.

4

 15 CFR Part 701.

5

 22 USC 2776, as amended.

6

 22 USC 2776 (b)(1) and (c)(1) as amended by section 1245 in appendix G of P.L. 106-113.
Page 4 GAO-01-83R Defense Trade

drafting guidance that it plans to issue late in 2000 to respond to the increased

reporting requirement.

In addition to the information needed to comply with requirements of the Arms

Export Control Act, the Department of Defense collects data potentially related to

offsets. Through its Office of Foreign Contracting, the Department collects

information from U.S. contractors on the extent of foreign participation in its

contracts.7

 The information is collected to assess matters related to defense trade

balances and domestic industrial base capabilities. Prior to 1995, companies were

required to state whether the subcontract would apply toward fulfillment of an offset

agreement and to what program or offset agreement it was related. DOD officials

told us that the requirement for this information was discontinued because many

companies did not correctly report the information and it generally was not used in

DOD’s analyses. The information the Office of Foreign Contracting collects is

included in enclosure II.

FEDERAL AGENCY COORDINATION EFFORTS RELATED TO OFFSETS

Federal agencies generally have not coordinated defense offset data collection

efforts. This lack of coordination, however, may not be significant because the data

being collected by each of the reporting agencies differs or the required reporting

time period differs. However, agencies have coordinated on reporting and some

policy issues. Coordination has included (1) Commerce’s annual report to the

Congress on offsets and (2) policy changes incorporated into the Defense Federal

Acquisition Regulation Supplement concerning cost recovery for implementing

offsets.

As stated above, Commerce collects specific information on transactions that have

taken place in relation to a specific effort. For example, companies report to

Commerce the name of the entity fulfilling the offset transaction and the dollar value

of the offset both with and without any multipliers. State and Defense, on the other

hand, have historically reported the existence of a proposed offset connected to the

sale of a defense item or service but not the specific transaction undertaken to fulfill

the offset requirement. Further, the time periods covered by the reporting differ.

Commerce data covers the prior year, whereas State and Defense report prospective

offsets without a specific time frame. For example, companies were required to

report offsets activities that occurred during calendar year 1998 to Commerce by

June 15, 1999, for inclusion in its annual report.

The Department of Commerce is required by section 309 of the Defense Production

Act to coordinate its report with other federal agencies, namely the Secretaries of

State, Defense, and Treasury, and the United States Trade Representative. In

practice, the report is also coordinated through the Office of Management and Budget

with the Department of Labor and with several other agencies. Commerce

Department officials told us that most agencies perform only a cursory review of the

report and provide limited comments. However, some agencies, particularly the

Department of Defense, perform a detailed review.

 

7

 We reported on problems with this database in Defense Trade: Weaknesses Exist in DOD Foreign

Subcontract Data, (GAO/NSIAD-99-8, Nov. 13, 1998).
Page 5 GAO-01-83R Defense Trade

Recent clarifications to the Defense Federal Acquisition Regulation Supplement

(DFARS) also involved coordination among the relevant defense agencies. Section

225.7303 of the DFARS permits U.S. companies to recover all costs associated with

implementing offset agreements. However, U.S. companies and the individual

military services have interpreted the new section in various ways. These differing

interpretations have resulted in confusion over what costs could be charged and how

they should be charged. In September 1999, the language in the DFARS was revised

to provide clarification that a U.S. defense contractor may recover all costs incurred

for implementing offset agreements with a foreign government. This revision was

coordinated among various defense agencies and military services.

Federal agencies also have the opportunity to coordinate on policies pertaining to

offsets through the Interagency Offset Steering Committee chaired by the

Department of Defense. In 1992, Public Law 102-558 directed the Secretary of

Defense to lead an interagency team to consult with foreign nations on limiting the

adverse effects of offsets. As of September 1, 2000, the interagency committee has

met with representatives of the governments of Canada, France, Great Britain, and

the Netherlands. They also have sent letters to other nations with which the U.S.

government has memoranda of understanding requesting meetings to discuss offsets.

The committee recently has also begun to consult with industry.

The Defense Offsets Disclosure Act of 1999 established a National Commission on

the Use of Offsets in Defense Trade. The law directs the President to appoint

commission members by the end of March 2000 to study the effects of offsets and

report back to the Congress one year later. The Commission is to be comprised of

members from government as well as industry and academia, and the Office of

Management and Budget is to chair the commission. As of September 22, 2000, the

commission has not met. However, potential members have been identified subject

to congressional approval. This body, once it is established, may provide an impetus

to greater coordination of U. S. government data collection and policy efforts

concerning offsets.

AGENCY COMMENTS

We requested comments on a draft of this letter from the Departments of Commerce,

Defense, and State. The Department of Defense provided technical comments, which

were incorporated as appropriate. The Departments of Commerce and State did not

provide comments.

SCOPE AND METHODOLOGY

To identify which federal agencies collect data on offsets, we reviewed legislation

pertaining to offsets to identify those agencies that have a legislative requirement to

collect offset related data. In addition, we contacted various agencies to determine

whether they were involved in collecting information on offsets. We also interviewed

officials at defense contractors that have offset obligations to determine what kind of

data on offsets they are required to submit to federal agencies, as well as to identify

the data collecting agencies.
Page 6 GAO-01-83R Defense Trade

To determine the extent of coordination among federal agencies, we reviewed

legislation to determine what coordination is required, interviewed officials at the

relevant agencies, and reviewed data on coordination efforts provided by those

agencies.

We conducted our work from February through September 2000 in accordance with

generally accepted government auditing standards.

*** *** ***

We are sending copies of this letter to the Honorable Norman Y. Mineta, Secretary of

Commerce; the Honorable William S. Cohen, Secretary of Defense; the Honorable

Madeleine K. Albright, Secretary of State; and the Honorable Jacob J. Lew, Director,

Office of Management and Budget. We will also make copies available to others upon

request.

Please contact me on (202) 512-4841 if you or your staff have any questions

concerning this letter. Major contributors to this letter were Thomas J. Denomme,

Paula J. Haurilesko, Lauri A. Kay, and Richard Burrell.

Sincerely yours,

Katherine V. Schinasi

Director

Acquisition and Sourcing Management
Page 7 GAO-01-83R Defense Trade

Enclosure I Enclosure I

Information Pertaining to Offsets that Industry

Reports to the Commerce Department

For offset transactions completed during the previous year:

• Name of country or entity purchasing the weapon system, defense item or service

subject to offset requirement

• Name or description of weapon system, defense item or service subject to offset

requirement

• Name of entity fulfilling the offset transaction

• Name of entity receiving benefits from the offset transaction

• Dollar value of offset credit claimed by entity fulfilling the offset transaction,

including any intangible factors or multipliers

• Actual dollar value of offset transaction without any intangible factors or

multipliers

• Description of the type of offset (e.g., co-production, technology transfer,

subcontract activity, etc.)

• Broad classification of the industry in which the offset transaction was fulfilled

(e.g., aerospace, electronics, chemicals, etc.)

• Direct or indirect offset

• Name of country in which the offset was fulfilled.

For offset agreements entered into during the previous year:

• Name of country or entity purchasing the weapon system, defense item or service

subject to offset requirement

• Name or description of weapon system, defense item or service subject to offset

requirement

• Names and titles of the signatories to the offset agreement

• Approximate value of the export sale subject to offset requirement

• Total value of offset agreement

• Term of offset agreement (in months)

• Description of performance measures (e.g., “best efforts,” liquidated damages)
Page 8 GAO-01-83R Defense Trade

Enclosure II Enclosure II

Information Collected by the Defense

Department’s Office of Foreign Contracting

• Prime contract number

• Program identification

• Name and division of prime contractor

• Address of prime contractor

• Name of subcontractor or foreign division of prime contractor

• Address of subcontractor or foreign division of prime contractor

• Value of effort performed outside the United States

• Country of origin of actual producer or service provider

• Description of supplies or services obtained outside the United States

• Name of company submitting report

(707447)