U.S. GOVERNMENT PRINTING OFFICE

64–306 CC WASHINGTON : 2000

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

ONE HUNDRED SIXTH CONGRESS

FIRST SESSION

JUNE 29, 1999

Serial No. 106–114

Printed for the use of the Committee on Government Reform

(

Available via the World Wide Web: http://www.gpo.gov/congress/house

http://www.house.gov/reform

(II)

COMMITTEE ON GOVERNMENT REFORM

DAN BURTON, Indiana, Chairman

BENJAMIN A. GILMAN, New York

CONSTANCE A. MORELLA, Maryland

CHRISTOPHER SHAYS, Connecticut

ILEANA ROS-LEHTINEN, Florida

JOHN M. MCHUGH, New York

STEPHEN HORN, California

JOHN L. MICA, Florida

THOMAS M. DAVIS, Virginia

DAVID M. MCINTOSH, Indiana

MARK E. SOUDER, Indiana

JOE SCARBOROUGH, Florida

STEVEN C. LATOURETTE, Ohio

MARSHALL ‘‘MARK’’ SANFORD, South

Carolina

BOB BARR, Georgia

DAN MILLER, Florida

ASA HUTCHINSON, Arkansas

LEE TERRY, Nebraska

JUDY BIGGERT, Illinois

GREG WALDEN, Oregon

DOUG OSE, California

PAUL RYAN, Wisconsin

HELEN CHENOWETH, Idaho

DAVID VITTER, Louisiana

HENRY A. WAXMAN, California

TOM LANTOS, California

ROBERT E. WISE, JR., West Virginia

MAJOR R. OWENS, New York

EDOLPHUS TOWNS, New York

PAUL E. KANJORSKI, Pennsylvania

PATSY T. MINK, Hawaii

CAROLYN B. MALONEY, New York

ELEANOR HOLMES NORTON, Washington,

DC

CHAKA FATTAH, Pennsylvania

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

ROD R. BLAGOJEVICH, Illinois

DANNY K. DAVIS, Illinois

JOHN F. TIERNEY, Massachusetts

JIM TURNER, Texas

THOMAS H. ALLEN, Maine

HAROLD E. FORD, JR., Tennessee

JANICE D. SCHAKOWSKY, Illinois

———

BERNARD SANDERS, Vermont

(Independent)

KEVIN BINGER, Staff Director

DANIEL R. MOLL, Deputy Staff Director

DAVID A. KASS, Deputy Counsel and Parliamentarian

CARLA J. MARTIN, Chief Clerk

PHIL SCHILIRO, Minority Staff Director

SUBCOMMITTEE ON CRIMINAL JUSTICE, DRUG POLICY, AND HUMAN RESOURCES

JOHN L. MICA, Florida, Chairman

BOB BARR, Georgia

BENJAMIN A. GILMAN, New York

CHRISTOPHER SHAYS, Connecticut

ILEANA ROS-LEHTINEN, Florida

MARK E. SOUDER, Indiana

STEVEN C. LATOURETTE, Ohio

ASA HUTCHINSON, Arkansas

DOUG OSE, California

PATSY T. MINK, Hawaii

EDOLPHUS TOWNS, New York

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

ROD R. BLAGOJEVICH, Illinois

JOHN F. TIERNEY, Massachusetts

JIM TURNER, Texas

EX OFFICIO

DAN BURTON, Indiana HENRY A. WAXMAN, California

SHARON PINKERTON, Deputy Staff Director

MASON ALINGER, Professional Staff Member

ANDREW GREELEY, Clerk

DAVID RAPALLO, Minority Counsel

MICHEAL YEAGER, Minority Counsel

(III)

C O N T E N T S

Page

Hearing held on June 29, 1999 ............................................................................... 1

Statement of:

Feingold, Hon. Russell D., a U.S. Senator from the State of Wisconsin ...... 67

Johnson, Joel, vice president, International, Aerospace Industries International; Owen Herrnstadt, director, International Affairs, International Association of Machinists and Aerospace Workers; and Robert

Scott, International Economist, Economic Policy Institute ....................... 73

Majak, Roger, Assistant Secretary for Export Administration, U.S. Department of Commerce; and Alfred Volkman, Deputy Under Secretary

of Defense for Commercial and International Programs, U.S. Department of Defense ............................................................................................ 157

Letters, statements, et cetera, submitted for the record by:

Feingold, Hon. Russell D., a U.S. Senator from the State of Wisconsin,

prepared statement of ................................................................................... 70

Herrnstadt, Owen, director, International Affairs, International Association of Machinists and Aerospace Workers, prepared statement of ......... 122

Johnson, Joel, vice president, International, Aerospace Industries International, prepared statement of .................................................................. 76

Majak, Roger, Assistant Secretary for Export Administration, U.S. Department of Commerce, prepared statement of .......................................... 161

Mica, Hon. John L., a Representative in Congress from the State of

Florida, prepared statement of .................................................................... 3

Scott, Robert, International Economist, Economic Policy Institute, prepared statement of ........................................................................................ 85

Tierney, Hon. John F., a Representative in Congress from the State

of Massachusetts:

Letter dated April 26, 1999 ...................................................................... 52

Minority staff report ................................................................................. 7

Prepared statement of ............................................................................... 61

Volkman, Alfred, Deputy Under Secretary of Defense for Commercial

and International Programs, U.S. Department of Defense, prepared

statement of ................................................................................................... 172

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DEFENSE OFFSETS: ARE THEY TAKING AWAY

OUR JOBS?

TUESDAY, JUNE 29, 1999

HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CRIMINAL JUSTICE, DRUG POLICY, AND HUMAN RESOURCES, COMMITTEE ON GOVERNMENT REFORM, Washington, DC.

The subcommittee met, pursuant to notice, at 10 a.m., in room 2154, Rayburn House Office Building, Hon. John L. Mica (chairman of the subcommittee) presiding. Present: Representatives Mica, Gilman, Hutchinson, Ose,

Kucinich, and Tierney. Staff present: Sharon Pinkerton, deputy staff director; Steve Dilingham, special counsel; Mason Alinger, professional staff member; Andrew Greeley, clerk; David Rapallo and Michael Yeager, minority counsels; and Jean Gosa, minority staff assistant.

Mr. MICA. Good morning. We will call this meeting of the House Criminal Justice, Drug Policy, and Human Resources Subcommittee to order.

I will begin this morning with an opening statement and then

will yield. We have three panels today, we will recognize them as

soon as we finish our opening statements.

This morning the topic of our hearing is defense offsets, are we

giving away our jobs?

Over the past decade, both small and large businesses have increasingly relied on international trade for growth and job creation.

International factors must be considered when conducting business

for almost every company, from Ford Motor Co., with its roughly

350,000 employees worldwide, to a small software company in my

district in Florida.

Our focus today falls upon the U.S. aerospace industry, an industry particularly affected by globalization. Companies like McDonnell Douglas and Lockheed Martin have led the world in technological advancements in the defense and aerospace industries. Such

companies have made it possible for the U.S. aerospace industry to

enjoy a trade surplus exceeding $40 billion while the overall U.S.

economy faces a record trade deficit approaching $300 billion.

Recently, the worldwide demand for both defense and aerospace

products has escalated. Many foreign governments are now officially mandating offsets from U.S. companies to help alleviate the

impact on the foreign country’s economy of contracting out the

business to the United States. Offsets can range from foreign demands that an aerospace company produce at least part of the

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product in the foreign country, to obligating the aerospace company

to purchase its office furniture from a company in the foreign country.

Offsets have gained increasing attention in recent years because

of the controversial impact they may have on the U.S. economy.

More specifically, some labor interests charge that defense offsets

send American jobs overseas.

The argument has also been made that offsets adversely affect

industries completely unrelated to the defense and aerospace industries.

While on a case-by-case basis, the aerospace industry might

agree that some smaller companies have been injured, they would

also argue that offsets help to keep alive an industry faced with increasing international competition. By refusing to negotiate offsets,

U.S. companies run the risk of losing the contracts to international

competitors that are willing to accept the offset requirements.

We are here today to listen to the concerns raised about offsets

in the defense and aerospace industries, and to determine whether

Congress should modify its policy of limited involvement in offset

agreements.

After reading today’s testimony, it appears that none of the witnesses champion the practice of offsets in foreign military sales.

Rather, the issue seems to be whether Congress needs to change

our current policy to protect against the negative impacts of offset

agreements or whether the benefits of jobs created by the exports

outweigh the losses to other companies.

The panel of experts before us today will discuss whether offsets

adversely impact the U.S. economy, and, if so, what can be done

about it. Currently, the U.S. Government’s role regarding offsets is

simply to monitor the offset agreements and issue a yearly report.

Also, when technology transfers are involved, the necessary licenses are approved.

Several options have been suggested to help alleviate the impact

of offsets. We will hear some of those proposals today, and also

some of the difficulties in implementing those proposals.

Are offsets detrimental to the U.S. economy? Are American jobs

being sent overseas? Should Congress modify the current policy of

limited involvement? I look forward to hearing from the experts to

help answer some of these questions.

[The prepared statement of Hon. John L. Mica follows:]

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Mr. MICA. At this time I am very pleased to recognize the gentleman from Massachusetts, who requested this hearing, and I was

pleased to comply. I apologize for the delay. We have had a couple

of other national issues which take precedence, but I thank him for

his interest in the issue, and I would like to recognize him at this

time.

Mr. TIERNEY. Thank you, Chairman Mica. I thank you for holding this hearing on defense offsets. You have shown a great ability

to lead in a bipartisan way by acceding to having this hearing and

participating in it.

I also want to thank Senator Feingold for taking the time out to

share with us his experiences in the defense offsets of his home

State of Wisconsin, and I thank our other distinguished witnesses

who will be joining us from the administration, the defense industry and the labor community.

Most people are, in fact, not familiar with defense offsets, how

they work, why we have them and what they are intended to do,

although many businesses and employees are impacted, and many

are sometimes adversely impacted by their use. This phenomenon

takes place regardless of whether the business or the worker is actually in the defense industry, as you will see. For those people out

there who are not familiar with the topic, offsets are the conditions

sought by foreign governments in their negotiations for purchase of

U.S. defense equipment. More often than not, these stipulations require U.S. manufacturers, as a condition of doing business with

these foreign governments, to transfer taxpayer-funded defense

technologies, in some instances to make direct investments in foreign companies, to purchase foreign-made components or to provide

other forms of assistance. These offsets or sweeteners range from

direct offsets, such as exporting jobs overseas for subsequent contracting, to indirect offsets, such as buying furniture or some other

product from foreign manufacturers at higher prices than those offered by American companies.

I first became interested in defense offsets from listening to

small businesses and contract employees prior to my election in

1996. In November 1997, a defense contractor located in my district

won a foreign military sales contract to produce 104 military fighter engines for the Korean KTX–2 Advanced Trainer/Light-Fighter

aircraft. This contract was well received locally by me, the defense

contractor, and the men and women who would be doing the work.

However, just a few weeks later, it was related to me that the defense contractor revealed the other side of the story to the work

force. As a part of the offset agreement, only the first 25 of the 104

engines would be fully made in the United States. The next 10 engines would be made with United States parts, but 100 percent of

the engines would be assembled, inspected and tested in Korea.

The final 69 engines under the contract would consist of 70 percent

United States parts, 30 percent Korean parts, and would be completely assembled, inspected and tested in Korea.

The euphoria quickly faded and turned to disappointment as we

learned these facts. People simply could not understand why a defense contractor would allow this important engine work to be performed abroad with foreign components and foreign workers. But

we know now that despite making the finest military equipment in

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the world, U.S. defense contractors say they are forced to make

these offset deals with foreign governments or else run the risk of

losing the defense contract to another foreign country that is willing to agree to such an arrangement. As we looked into the issue,

we learned that some offset deals are more than 100 percent of the

total contract price.

To learn more about defense offsets, I requested the minority

staff of the Committee on Government Reform look into these

issues and offsets. The result was a report entitled Foreign Offset

Demands in Defense and Civil Aerospace Transactions. Chairman

Mica, at this time I would like to ask unanimous consent that that

report be entered into the record.

Mr. MICA. Without objection, so ordered.

[The information referred to follows:]

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Mr. TIERNEY. Thank you.

The report includes a number of findings and recommendations.

One finding was that the U.S. offset policy, a policy now of noninvolvement, is weak. The report recommended that the U.S. policy

be strengthened by establishing a high-level offsets commission

composed of representatives of government, affected industry sectors, labor, and academia to review current offset policy and to propose a plan for the reduction of the detrimental effects of offsets.

I have made available copies of the report.

In addition to the report, I was interested to learn the views of

the executive branch, including the agencies that are part of the

defense offset working groups. Toward that end I wrote to President Clinton, Secretary of Defense William Cohen, United States

Trade Representative Charlene Barshefsky, Secretary of Commerce

William Daley and Secretary of the Treasury Robert Rubin urging

them to establish, as a primary goal, international trade negotiations, the elimination of offsets imposed by foreign governments on

defense and civil aerospace contractors.

From the responses that I received, it seems apparent that there

is no consensus in the executive branch on the adverse effects of

defense offsets. A representative from the Department of Defense

wrote to me that although we agree that offsets are market-distorting, the net effect of offsets in trade is unclear. A response from

the Office of the U.S. Trade Representative indicated that although

these agreements have led to increased foreign participation in the

manufacture of U.S. defense equipment, such as aircraft engines,

they have also led to the sale of U.S. equipment to foreign military

agencies that would not otherwise have been purchased. Secretary

Daley and a representative from the Department of State wrote to

me in support of a reduction in the distorting influence of offsets

on trade. Finally, a representative from the White House informed

me of efforts to reach a domestic consensus on offsets.

Chairman Mica, I would like to request unanimous consent to

submit the agency responses to my letter.

Mr. MICA. Without objection, so ordered.

[The information referred to follows:]

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Mr. TIERNEY. Thank you. I also believe it would be useful for the

government to have more detailed information on the particulars of

offset agreements. Toward that end, I am pleased that H.R. 973,

the Security Assistance Act, which recently passed the House, contains additional reporting requirements. I know, in fact, that the

Senator has also made an effort in the Senate to have those reporting requirements put into law. Section 204 contains additional reporting requirements on offsets regarding government-to-government sales and commercial sales. Specifically, if known on the date

of transmittal of such certification, a description of the offset agreement may be included in the classified portion of such number certification. Thus the information would remain confidential and

would not jeopardize American business interests. This is a positive

step toward an effort to obtain additional information on the specifics of offset agreements.

Mr. Chairman, I strongly believe that we need a national consensus on offsets and that we should have a firm national offset policy

that allows our defense contractors to sell their equipment abroad,

particularly to our allies, while at the same time ensuring that

American defense workers and small businesses that do out-source

work from these people in the industry, the manufacturers, to

allow them, some of the best workers in the world, to make sure

that they are not sacrificed in the quest to make the sale and seal

the deal.

Again, I want to thank you, Chairman Mica, for examining further the issues of the offsets, and I want to commend you and the

staff of the subcommittee for holding this hearing today. Thank

you.

[The prepared statement of Hon. John F. Tierney follows:]

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Mr. MICA. I thank the gentleman from Massachusetts and am

pleased to proceed with our first panel. Our first panel consists of

our colleague and distinguished Senator Russell Feingold from Wisconsin. I believe he is on the Budget, Foreign Relations Committee,

Judiciary and Special Aging Committee in the Senate. We are so

pleased to have you come across and provide us with your testimony and comments on this important issue. Welcome, and you are

recognized, sir.

STATEMENT OF HON. RUSSELL D. FEINGOLD, A U.S. SENATOR

FROM THE STATE OF WISCONSIN

Senator FEINGOLD. Thank you, Mr. Chairman, for holding this

hearing on the subject, and I want to thank Representative Tierney

for his interest on this subject and his efforts to stimulate public

discussion. He is so devoted to this, when he and I were stuck on

an airplane waiting on the runway for several hours in Boston, he

pursued this subject with me, and we renewed our commitment to

doing this, although I did not make it to the vote that day. I stayed

on the runway for quite a few hours. I do admire very much how

quickly the Representative has become a major force on this issue,

and I thank him for asking me to be here today.

As you may know, I first became involved in the offsets issue in

February 1993, when I learned that a Wisconsin-based company,

the Beloit Corp., a subsidiary of Harnischfeger Industries, Inc., had

been negatively affected by an apparent indirect offset arrangement between an aerospace contractor, the Northrop Corp., and the

Government of Finland. Beloit was one of only three companies in

the world that produce this particular type of large papermaking

machine. In its efforts to sell one of these machines to the International Paper Co., Beloit became aware that Northrop had offered

International Paper an incentive payment to select, instead the

machine offered by a Finnish company, Valmet, not the Wisconsin

company. Northrop was promoting the purchase of the Valmet machinery as part of an agreement that would provide dollar-for-dollar offset credit on a deal with Finland to purchase 64 F–18 aircraft. This type of payment had the flavor of a kickback, distorted

the practice of free enterprise, and I think, threatened U.S. jobs.

By lowering its bid, and thereby only barely breaking even on the

contract, to take into account the incentive payment offered by Northrop, Beloit still did succeed in winning the contract. Nevertheless, for me, the incident demonstrated the potential for offset obligations to have an impact on apparently unrelated domestic industries, as the chairman mentioned. I became concerned that this

could happen anywhere, in any industry, in the future without

being recognized, much less remedied.

Mr. Chairman, one of the first things I did as a new Member of

the Senate in 1993 was to offer an amendment to the Arms Export

Control Act to prohibit incentive payments in the provision of an

offset credit. I wanted to clarify the congressional disapproval of an

activity that appeared to fall through the cracks of various existing

acts. Neither the Anti-Kickback Act nor the Foreign Corrupt Practices Act seemed clearly to address the payment being offered to

International Paper in the Beloit case. My provision, which was enacted into law in 1994, prohibits the use of third-party incentive

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payments to secure offset agreements in any sale that is subject to

the Arms Export Control Act. The measure also expanded the requirements for congressional notification of the existence and, to

the extent possible, the details of any offset agreement at the time

of notification of a pending arms sale under the Arms Export Control Act.

Recognizing, too, that not enough information was available, I

also initiated a request for a GAO review of the use of offsets in

defense trade. I believe all of the members of the subcommittee received a copy of the most recent of the GAO studies, which is entitled Defense Trade: U.S. Contractors Employ Diverse Activities to

Meet Offset Obligations. This was released in December 1998. Mr.

Chairman, I ask unanimous consent that the text of that study be

entered into the record following my remarks.

Mr. MICA. Without objection, so ordered.

Senator FEINGOLD. Thank you, Mr. Chairman.

Last year I offered additional language to expand further the

prohibition of incentive payments and enhance the reporting requirement on offsets to include a description of the offset with dollar amounts. While my provisions were incorporated in the Security Assistance Act of 1998 as passed by the Senate Foreign Relations Committee, the legislation never made it to the floor. I was

pleased, however, to see the House pass similar, if not identical,

language in H.R. 973, which is your version of the Security Assistance Act of 1999.

Unfortunately, Mr. Chairman, while Congress has tried to address specific problems encountered by companies in our States

and districts, efforts to date have barely scratched the surface of

the difficult subject of offsets. In fact, neither the legislative nor the

executive branches have a full grasp of the breadth and complexity

of the issue, but I know that all of us are deeply concerned about

the potential impact of the use of offsets.

I believe we have to focus on several broad issues related to the

current and potential consequences of offsets; first, the impact on

the domestic labor force and defense industrial base, particularly in

the aerospace industries, of the increasing role of overseas production in the defense industries; second, the unintended harm to domestic nondefense industrial sectors as experienced by the Beloit

Corp. of Wisconsin, when defense contractors engage in indirect offset obligations; third, the broad economic implications of the

globalization of the defense industry; and fourth, the national security ramifications of joint ventures and growing reliance on foreign

defense contractors, a concern, Mr. Chairman, that was recently

highlighted in the Cox report on China’s technology acquisition.

Mr. Chairman, we must tread carefully and seek a balance between the need for our defense industry to remain competitive in

world markets and the potential loss of jobs and industrial capacity

down the road due to the transfer of technology and the encouragement of overseas production capabilities. The perceived inevitability of globalization is not an excuse for us to avoid dealing with the

hard issues.

I have had the opportunity to review a number of thoughtful proposals that touch on my concerns about offsets. I think we all agree

that greater transparency and monitoring are essential to fully unVerDate 11-MAY-2000 10:04 Aug 21, 2000 Jkt 000000 PO 00000 Frm 00072 Fmt 6633 Sfmt 6633 C:\DOCS\64306.TXT HGOVREF1 PsN: HGOVREF1
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derstand the offsets issue. In that context, I believe that there are

three key elements to effective handling of offsets: first, information; second, discussion; and, third, international cooperation.

First, information. To fully understand the implications of offsets

and the breadth of their impact, we must have more information

on offset agreements, particularly the indirect offset obligations

that are otherwise invisible. Although I recognize the need to protect the genuine proprietary information of defense contractors, we

must seek greater transparency in the process through which contractors negotiate and fulfill offset obligations so that we may better analyze the possible downstream consequences. While many of

us can cite anecdotal evidence of companies harmed or jobs lost, we

have to develop a more effective mechanism to accurately quantify

the impact of offsets. Unfortunately, the work that has been done

so far is insufficient.

Second, discussion. There needs to be broader public awareness

and debate on the implications of offsets. I believe this hearing is

an important step in that direction. Beyond these efforts, I support

the concept of a national commission to analyze the implications for

our economy and national security and to recommend potential policy alternatives. A commission can galvanize concerned parties and

demonstrate our interest in achieving a broad and coherent strategy to combat the negative effect of offsets.

Finally, international cooperation. With international dialog and

coordination, we can arrive at multilateral standards for the use of

offsets in defense trade agreements. Whether you believe that offsets are merely an annoying, but standard business practice or you

hold the view that they pose a major long-term threat to our labor

force industries and national security, I believe it is possible to develop some common ground for business practices worldwide.

Through the Group of Eight, Wassenaar Arrangement, the World

Trade Organization and other organizations, we have established

multilateral venues designed specifically to deal with international

trade issues. Certainly, one of these venues could serve as a forum

for international cooperation to consider this global problem.

Mr. Chairman, let me conclude by thanking your subcommittee

for taking on this difficult subject. You have gathered some of the

premier experts in the field for today’s hearing, and I look forward

to studying their testimony. I regret that I cannot stay for the rest

of the hearing, but I believe all of our efforts today will contribute

to the promotion of greater information, discussion and cooperation

and help us tackle this difficult subject that may well be so critical

to the future of American industry, trade and national security. I

thank you very much for your courtesy.

[NOTE.—The report entitled, ‘‘Defense Trade, U.S. Contractors

Employ Diverse Activities to Meet Offset Obligations,’’ GAO/

NSIAD–99–35, may be found in subcommittee files.]

[The prepared statement of Senator Feingold follows:]

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Mr. MICA. Thank you. We appreciate your leadership on this important issue and also your efforts to work with our colleagues on

both sides of the Congress, the House and the Senate, to seek solutions and different approaches so we can have some of the things

that you mentioned in your closing, the disclosure, the discussion

and the international cooperation. We appreciate that. We realize

that you have a time constraint.

Mr. Tierney.

Mr. TIERNEY. I thank you. I know that you have a time constraint, and I appreciate very much your participating this morning.

Mr. Chairman, before I forget, Mr. Kucinich was just here and

asked that his remarks might be placed in the record.

Mr. MICA. Without objection, so ordered.

I am pleased that we have been joined by the gentleman from

New York, the chairman of our International Relations Committee.

Did you have an opening statement?

Mr. GILMAN. No, I just want to commend you, Mr. Chairman, for

conducting this hearing in a very timely manner, and I think it is

important that we take a good hard look at these considerations,

and you have got a great panel, and we look forward to hearing

from the panel.

Mr. MICA. I thank the gentleman.

I am pleased now to call our second panel. The second panel consists of Mr. Joel Johnson, vice president, International, Aerospace

Industries International; Mr. Owen Herrnstadt, director, International Affairs, International Association of Machinists and Aerospace Workers; and Dr. Scott, international economist with the

Economic Policy Institute. I am pleased to welcome all three of

these panelists.

If you would stand, please, to be sworn.

[Witnesses sworn.]

Mr. MICA. The witnesses have answered in the affirmative.

I might also tell you, since I don’t think that any of you have testified before our panel before, we run this timer. We give you 5

minutes and ask that your oral presentations be limited to that

amount of time. By unanimous consent request we will be pleased

to enter into the record any reports that you want to be part of the

record.

With those comments, let me now recognize Mr. Joel Johnson,

vice president, International, of the Aerospace Industries International. Welcome, and you are recognized.

STATEMENTS OF JOEL JOHNSON, VICE PRESIDENT, INTERNATIONAL, AEROSPACE INDUSTRIES INTERNATIONAL;

OWEN HERRNSTADT, DIRECTOR, INTERNATIONAL AFFAIRS,

INTERNATIONAL ASSOCIATION OF MACHINISTS AND AEROSPACE WORKERS; AND ROBERT SCOTT, INTERNATIONAL

ECONOMIST, ECONOMIC POLICY INSTITUTE

Mr. JOHNSON. Thank you. I gather that my mic is working. I will

speak rapidly and in incomplete sentences to keep under my 5 minutes here.

I am testifying this morning on behalf of the Aerospace Industries Association, which is the trade association that represents the

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producers of commercial and military aircraft, helicopters, missiles,

et cetera. A couple of notes about the aerospace industry. We produced about $140 billion worth of product in 1998, about 3 percent

of the U.S. industrial manufacturing activity. The industry currently employs about 860,000 Americans.

What is perhaps most remarkable about our industry is its continuous export performance. In 1998, we exported $64 billion worth

of product. Our imports were $23 billion. That gives us a net of $41

billion in exports. That is the largest of any manufacturing sector.

I should point out these exports are critical to our industry. Ten

years ago our total output was about what it was today in real

terms. At that time, the government accounted for 60 percent of

purchases of our production, and exports were about 24 percent.

Primarily because of the rapid drop-off in defense procurement,

today the government buys about 30 percent of our output; exports

are 40 percent. All of our growth is in the export arena. We depend

on those exports in order to keep our employment where it is today.

From an industry perspective, offsets are certainly a nuisance.

Most of us would prefer to compete on the basis of quality and

price of our primary product. That is what we do. We are not in

the consulting, technology transfer, risk capital or trading business.

However, just as in the commercial aerospace arena you have needed to find imaginative financing arrangements, in the military

arena you need to find imaginative offset arrangements.

These obviously are not a new invention, but another form of the

age-old practice of barter and countertrade. While they may be inefficient, I think one does need to step back and recognize that for

every export, someplace, sometime there will be an import, or you

are giving the stuff away, and when you have an import, somebody

in the U.S. economy will be negativity affected. Overall, however,

society benefits. Offsets don’t change basic math. What they do is

close the loop in a reasonably visible fashion.

I should note that offset requirements are not unique to dealing

with overseas customers. When government spends taxpayer revenue, they often want more than just the product. In this country,

our industries require domestic offsets, e.g., setasides, for small

businesses, setasides for minority businesses, and you tend to

spread the work around in as many districts and States as possible. Both informal and formal offset, in other words, is also true

in this country. Similarly, when foreign governments spend their

money, they want to see some jobs and a piece of the action in their

couintry, even when they spend it overseas for foreign military

products.

Let me jump forward perhaps to save time and note that there

are really five things that we would like to see in government policy. First and foremost, and I think most people agree with us, you

should not take unilateral measures through statute or regulation

to control offsets, would which simply transfer jobs to our foreign

competitors.

Second, direct offsets, we would agree, should not be allowed

when a purchase is wholly financed by U.S. assistance on grant

terms. Now, I should note that this is almost irrelevant. Today

there are only two countries that receive grant military assistance,

Israel and Egypt.

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We certainly would support efforts by the United States to obtain

multilateral accords on disciplining offset practices. I must admit,

however, we are somewhat skeptical of the success of such efforts,

mainly because I am not sure what are will willing to lay on the

table ourselves. When we recently held a competition for a joint

primary training aircraft for the United States Navy and Air Force,

the winner was basically a Swiss aircraft. That aircraft will be

built almost entirely in the United States, assembled in Wichita,

probably 99 percent U.S. content. I suspect that had the Swiss Parliament said you can only buy that airplane if it is produced in

Switzerland, the United States Congress would have suggested

mildly where they could go with their demand, and we would wind

up with a United States alternative. That is the real world. If you

look at each of the U.S. DOD procurements, they are almost invariably all produced by a U.S. prime in the United States, not because

of formal requirements, but that is because the U.S. system works

for exactly the same reasons.

Fourth, in instances where the only competitors for our foreign

contracts are United States firms, the government might place

some useful role in arbitrating and limiting what our companies

offer, but you have got to be very careful that you don’t create foreign competitors or create domestic solutions to a country’s procurement or increase the value, the actual quality of the offset,

which is essentially what happened when the government stepped

in in Korea and limited United States companies’ offset offers.

What happened is the quality of the offset offered went up considerably.

Finally, let’s be very careful about how we collect and publish information on offsets. We don’t have a problem sharing information

with the U.S. Government on offsets. What we do have a problem

with is providing a cookbook to our foreign competitors and to our

customers as to what the best current offers are out there. The

largest readers, I suspect, of an annual Commerce Department report on offsets are foreign embassies in Washington, DC.

In general, we tend to think that offsets are highly overrated

issues. Let me note, for example, that DOD procurement went from

$100 billion a year to $42 billion a year. Were DOD procurement

at the same level today as it was 10 years ago, we would have

400,000 more workers. There is nothing in the offset realm that remotely touches on those kinds of numbers. That is the major impact, and we are not arguing that we ought to have a larger defense budget, we are arguing take a look at what is effective, the

subcontractor base and the prime base, it has very little to do with

offsets. It has to do with much larger trends.

In summary, I would say starting with offsets is probably the

wrong starting point. If there are subsectors of our economy that

are in trouble, we ought to find out what is wrong. My own guess

is that you will find it has to do with underinvestment; it has to

do with a variety of things of which offset may be a symptom, very

seldom will be the cause. Thank you very much, Mr. Chairman.

[The prepared statement of Mr. Johnson follows:]

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Mr. MICA. Mr. Scott, you are recognized.

Mr. SCOTT. Good morning, Mr. Chairman and members of the

committee. Thank you for inviting me to testify here today.

The future of the industry may differ significantly from the past,

particularly regarding employment. The debate over the impact of

offsets is contentious because of the interplay of several closely related questions that can be difficult to disentangle. Over the past

decade, this industry has gone through a massive downsizing,

which has been driven by declines in defense expenditures. In the

past, offsets were a relatively small contributor to the problem.

However, defense restructuring is over. In the future, trade, and

offsets in particular, are likely to be much bigger factors in employment loss than in the past.

I have prepared several reports on these subjects. The most recent was published by the National Research Council, and that is

appended to my statement as appendix A. We have updated several

figures from that report, statistical figures, for this hearing, and I

have attached as a separate exhibit B or appendix B, those updated

tables and figures, and I will refer to several of those by their original figures in my testimony here today.

Mr. MICA. Without objection we will make both of those a part

of the record.

Mr. SCOTT. Thank you very much.

Turning specifically to employment, the impacts of offsets, and in

particular total aerospace employment, peaked in 1989, as Mr.

Johnson mentioned. Approximately one-half million jobs were lost

between 1989 and 1995, which was the last trough in this industry.

Employment recovered for a few years, but it peaked in April 1998,

which I think it is important for us to note today. This is shown

in my new figure A, which is included in the text of the testimony

itself.

There are several major reasons why employment declined in the

past. Between 1989 and 1995, there were three major factors. Decline in defense sales accounted for about half of the job losses.

Outsourcing, which includes the effect of offsets and all other forms

of increasing import of parts and components, accounts for about

6 to 10 percent of job loss in that earlier period. And productivity

growth accounted for the rest.

In the past year, the Asian financial crisis has been a very significant cause of employment loss in the industry. Economy-wide,

we have lost over 440,000 jobs in manufacturing since April 1998.

In aerospace alone, we have lost 29,000 jobs in this period, as

shown in figure A in my testimony.

Offsets contribute to both commercial and military job losses in

the aerospace industry. One important measure of the impact of

outsourcing is the ratio of imported engines and parts to total aircraft sales. That is, commercial and military sales. This is shown

in figure 4 in my appendix, which you may want to look at briefly.

You will note that shows a very steadily rising trend of foreign

components essentially to U.S. aircraft sales. It has gone up almost

every year for the past decade. It has doubled in the last 10 years

or so, and this growth ratio has accelerated in the last 3 years.

This ratio essentially is a measure of the foreign content of U.S.

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aircraft. It is quite rough, but it is an approximation of that measure.

Now, in the NRC paper, I estimate the likely threats to future

employment in the industry. To save time, I will just note that we

are going to lose perhaps as many as 45,000 jobs in the next 15

years or so to outsourcing, perhaps twice that many to increased

foreign competition, principally from Airbus, for a total loss of

about 123,000 jobs, about 15 percent of employment in the industry.

Let me move quickly to my policy implications section to save

time for discussion.

Given these estimates of future job loss, I think that this industry is at great competitive risk. I think it is important for us to

craft a policy that includes offsets, but goes beyond to look at the

broader issues of industry competitiveness for the reasons explained in the NRC paper. Domestic and foreign producers are

caught in what economists refer to as a prisoners dilemma with respect to offset agreements in particular. When a foreign customer

demands an offset in exchange for a sale, firms feel they have to

comply or risk losing contracts. They are engaged in a desperate

race to the bottom that will accelerate the transfer of jobs and technology to foreign producers.

There are several ways to attack this problem. First, I think the

United States and European Union should, on a bilateral basis,

agree to restrict the use of offsets, perhaps through an extension

of something like the Foreign Corrupt Practices Act.

Second, I think the United States and the E.U. are raising the

stakes in the aerospace battle. We have seen a number of conflicts

in the last year in issues like aircraft noise, new subsidy programs

and so on. I think we may be approaching a time where we have

to consider something like a market share agreement with the E.U.

Finally, I think we have to expand the treatment of offsets in the

WTO. Currently, government offset requirements are prohibited. I

believe that we also have to restrict firm-to-firm offset requirements. It is private offset agreements, because the line between

public and private firms has become extremely blurred, in areas

like East Asia and China in particular, where we are dealing with

essentially government-owned companies. I will close at that point.

Thank you very much.

Mr. MICA. Thank you.

[The prepared statement of Mr. Scott follows:]

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Mr. MICA. We will now hear from Mr. Owen Herrnstadt, director

of international affairs, International Association of Machinists and

Aerospace Workers. Welcome, and you are recognized.

Mr. HERRNSTADT. Thank you very much, Mr. Chairman.

The International Association of Machinists and Aerospace

Workers represents workers in a variety of industries, obviously

aerospace and manufacturing playing a significant role in our

membership. Given the nature of these industries and the negative

effects that offsets are having and will continue to have on our

members in these and other industries, the IAM has, for several

years, been concerned about the use of offsets by U.S. industry. Accordingly, we are grateful, Mr. Chairman, for your invitation to appear before you today, and we are especially grateful for the excellent work that Congressman John Tierney has done in this area.

Offsets create a serious threat to workers throughout U.S. industry, particularly workers in the aerospace industry. Indeed, the

transfer of production and technology abroad has had and will continue to threaten U.S. workers as their jobs and the production

techniques they have developed as workers move to other countries.

While more information is needed regarding offsets, what we do

know about them is highly disturbing. Indeed, the little information that we have should raise alarms for anyone who is interested

in maintaining and expanding the success of the U.S. aerospace industry. Research clearly indicates that offsets dominate the defense

aerospace industry. Research also indicates that in attempts to satisfy offset demands, U.S. contractors are becoming more and more

creative. More and more jobs will be sacrificed in the future to offset demands by other countries. In addition, studies have concluded

that offsets have contributed to the ability of other countries to establish their own industries which in turn compete with U.S. companies, and this trend will become more problematic in the future.

Finally, in addition to employment issues, as Senator Feingold

mentioned at the outset, offsets also raise serious concerns about

our national security. Let me briefly explain some of these points.

First of all, as we all know, offsets are direct in nature, indirect

in nature, and I will add a third category, voluntary at times, as

more and more companies voluntarily look for marketing schemes.

They are extensive. The Bureau of Export Administration reports

that an overwhelming number of offsets involve aerospace products, and they are growing.

While we know that offsets are extensive, we also know that inadequate reporting requirements concerning offsets and all of their

variations prevent us from knowing exactly how widespread they

are.

Aerospace workers have suffered huge job losses over the past

several years. As reported many years ago, in work done by my colleague on this panel, Rob Scott, between 1989 and 1995, over

500,000 jobs were lost in the U.S. aerospace industry, and 1 million

jobs were lost in related industries. The AIA’s own statistics report

that in 1989, 153,500 workers were employed in the production of

aircraft engines and parts, but by 1998 the numbers of aerospace

workers in that category had dropped to 103,500.

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Estimates predict that over 200,000 jobs in the U.S. aerospace

and related industries will be lost in the future, with offsets accounting for several thousand of these jobs directly related. To

make matters worse, these estimates don’t reflect all of the indirect

offsets, all of the unrelated industries that Senator Feingold mentioned during his testimony, as well as all of the convoluted voluntary marketing schemes that are taking place.

Of course, there are many reasons for the job losses that have

occurred and will occur. However, given the importance of the U.S.

aerospace and related industries to the Nation’s economy, the staggering job losses that workers have suffered and the significant job

losses that economists predict they will suffer, any factor that could

prevent or mitigate these losses should be carefully examined. Offset policy is a key factor that could help limit losses and should be

made a priority.

Let me refer to my statement to refer to industries that have suffered a decline in offsets and ask the question, ‘‘will the U.S. aerospace industry follow suit?’’ Without a national comprehensive policy on this issue, that could happen, and that is why the IAM has

urged government, for several years now, to initiate a national

comprehensive policy on this issue; to establish a permanent review committee that would be made up of members of labor, academia, government and, of course, industry to discuss these issues,

to figure out ways we can look at outsourcing, subcontracting, tech

transfer, production transfers, licensing procurement, research and

development and, of course, information gathering; and also to advise on multilateral and bilateral negotiations regarding offsets,

particularly with the World Trade Organization and other international arenas.

Calling offsets a nuisance is unacceptable to the thousands of

U.S. workers, their families and the communities where they live

that have suffered from these losses. We need to take action now

as a government. It is government’s responsibility. Thank you.

Mr. MICA. Thank you for your testimony.

[The prepared statement of Mr. Herrnstadt follows:]

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Mr. MICA. I thank all of our panelists for their statements.

First I have a question for Mr. Johnson. What happens to a company that fails to fulfill its offset requirements, and how enforceable are offsets?

Mr. JOHNSON. Offset agreements will frequently have some financial penalty that will be imposed on a company for not completing its offsets. Quite frankly, I don’t know of any U.S. company

that has paid such liquidated damages. Generally, if there is a

problem fulfilling them, you normally renegotiate the offset agreement because the country is not interested in getting paid a financial penalty, they are really interested in obtaining some kind of

tech transfer or new capability they don’t have.

Companies do have contractual legal arrangements which would

involve financial penalties. But, in point of fact, I don’t know of any

company that has ever paid one.

Mr. MICA. We heard Senator Feingold talk about one of the

things that he helped institute legislatively, but what has been the

effect of prohibitions against the third-party incentive payments in

offset negotiations?

Mr. JOHNSON. Probably very little in that that was—in over a

decade of reporting, this is the only case of this sort of smoking gun

that I know of, and it happened in a very narrow market where

the buyers and sellers are extremely few. And we urge offset managers to avoid those situations when we have meetings of offset

managers because you like to see indirect offsets spread about, just

like you like to see normal trading relations.

If anything, it may have slightly increased real offsets. One of

the practices that had occurred in the past, there were several operators who would look at normal companies that imported a great

deal, a Pier One, for example, find out what they were importing

from a country like Thailand, and who had an offset obligation in

Thailand. You would go to the company and say, for 2 or 3 percent,

I can get you a large offset obligation liquidated. They would go to

Pier One and say, I can buy down what you are already doing for

1 percent, and basically nothing whatsoever would happen except

a company would get a lot of offset credit. Nothing changed in the

real world. The Feingold rule basically knocks those guys out of the

picture. So you probably have more real offset now than when he

passed his law, in point of fact. A law of unintended consequences.

Most offset doesn’t involve financial stimuli. It involves basically

the ability to bring a buyer and seller together. When you have

companies that do $20, $30, $40 billion a year with extensive networks around the world and a lot of offsets accomplished by offshore activity that never would have affected the United States at

all.

Mr. MICA. Additionally, we have had recent or offset reporting

requirements. Can you tell us how they have affected industry?

Mr. JOHNSON. As I said in my statement, we have no problem

sharing with the government information as to what we are doing.

What we do have problems with is sharing with a broader public

which basically, unfortunately, sets new thresholds. When the

Commerce Department comes out and says that the average European demand for offsets is 100 percent, it is hard for a country in

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Latin America or Southeast Asia to ask for less because the United

States Government is saying that is what the new minimum is.

I don’t know how you get around that. Part of the job of an offset

manager is to make an offset look as attractive as possible to the

foreign customer with as little effort as possible, but the percentages are going to look high, and they are going to tell everybody

else that is the percentage that you should be shooting for. In

terms of practices of the industry, probably very little. In terms of

raising offset demands, it probably has had some impact.

Mr. MICA. Dr. Scott, you kind of linked offsets to job losses in

your testimony, and you have a significant number of charts and

data that you submitted, but isn’t it true that we have had job

losses in the aerospace and defense industry primarily from

downsizing; if you looked at where we are losing jobs, downsizing

in the defense industry, that is one. And then, two, you could probably trace most of the other job loss to Airbus, which has now become a big player and taken Boeing and some of the other aerospace business away from us.

Can you give us any hard numbers as to what offsets in both defense and commercial we could tie to lost jobs?

Mr. SCOTT. It is difficult to develop hard numbers because we

don’t have any hard statistics on the exact volume of offset transactions, particularly in the commercial sector. This is one reason

why in my various reports I have supported proposals to begin to

collect data on offsets in the commercial sectors. So, in the absence

of that kind of data, it is very hard. Thus I have developed estimates based primarily on this information in figure 4 that I discussed in my testimony which show the increase in the share of imports of parts and components relative to U.S. production of military and commercial aircraft. And in the absence of hard data, I

think that is the best proxy for measuring the effect of offsets and

other forms of outsourcing on employment in the United States.

Mr. MICA. I am not sure if it was Mr. Johnson or Dr. Scott who

said that they favored no statutory or other limits imposed by Congress. Who had the list? Was that you?

Mr. JOHNSON. I would—certainly we would oppose, but I think

what my colleagues——

Mr. MICA. Who wants to own up to that statement?

Mr. JOHNSON. We argued that there should be no unilateral effort by the U.S. Government in terms of imposing restraints on

U.S. industry which would not be imposed on our competitors, but

I think my colleagues probably agree with that to some degree.

Mr. MICA. I see some disagreement. It is very difficult sometimes

when they have purchase agreements or manufacturing agreements because you want to manufacture some of those goods in

their country, and in most cases it is their money. When it is our

money, it is a different story. When you get into the question—and

some of you raise the point about the technology transfer, sometimes they want technology transferred as part of the deal. Don’t

you think we have a responsibility, given, say, the China incident—

again, someone raised that—to impose some limits and to put some

restrictions on technology transfers? We will start with Mr. Johnson.

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Mr. JOHNSON. It should be pointed out, in the first place, that

any technology transfer that is of military significance must have

a license from the State Department. Companies cannot transfer

technology as part of an offset or as a straight commercial deal

without going through the Department, which is referred almost

invariably to the DOD. Any technology transfer from a security

perspective has been approved by the U.S. Government.

Mr. MICA. And there are adequate protections in place, you feel?

Mr. JOHNSON. We believe so.

Mr. MICA. Dr. Scott.

Mr. SCOTT. I would make two comments. First, I want to carefully distinguish restrictions on—unilateral restrictions on offset

agreements and multilateral restrictions. I would tend to agree

with Mr. Johnson. I think unilateral restrictions could be counterproductive, but I think multilateral restrictions where we both

agree not to engage in destructive behavior, say, the United States

and Europe, would be in our interest. That is the first point.

And I think that with respect to the question of technology, even

in the commercial sector, our European counterparts argue that

there are indirect benefits to commercial R&D that flow out of defense spending.

I think there certainly are some overlaps there. So I think even

in the commercial sector, where the commercial industry might

argue that it is their technology to give away, we have a national

interest in control of that technology, and I think we should be

looking carefully at that question.

Mr. HERRNSTADT. I think you have raised a very good point. I

think there are two questions when it comes to unilateral restrictions on offsets. One is, we don’t even know what we are talking

about yet in terms of the exact information and data, so we need

to start with that, before we can come to those hard-core conclusions.

Two, we need to know exactly what we are talking about in

terms of unilateral activities regarding this issue. Offsets have a

very broad definition. Some have included things like outsourcing,

subcontracting, licensing procurement, which has already been

mentioned, research and development, export sales and financing,

and many, many other topics. So each of those needs to be looked

at to find out what is best for the U.S. worker, at least from our

viewpoint, when it comes to those issues.

If I could be so bold just to make one response to the first question you asked about the job losses, one of the areas that is very

undercounted, is the effect that job losses have had from the

subtier producers. The Bureau of Export Administration has some

very fine anecdotal evidence regarding subcontractors who have

been very hard hit by offsets. Presumably when they are hard hit,

their work force is also hard hit. So when we are talking about job

losses, we need to look at the entire labor market and the labor

economy.

Mr. MICA. Mr. Herrnstadt, if you would permit me just a quick

followup, you wrote an article recently, the Role of the U.S. Government in Setting Offset Policy, and you pointed out that there is

a serious lack of current and accessible information on offsets; and

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then you go on to explain that information about offsets is also very

difficult to obtain.

How do we obtain the information? How do we get a basis to

make judgments on? Again, this goes back to—you just answered

the first question, but you left sort of a blank here about what we

do as far as laws and regulation in this area. And Mr. Tierney

wanted an answer to that, too.

I could go into more depth and, in fact, I will let him finish the

rest of the question, but we are here trying to see what we need

to do as far as Federal policy, and that is where we need your recommendations. So if you could elaborate, and then I will just recognize Mr. Tierney.

Mr. HERRNSTADT. OK. Would you like me to go ahead?

Mr. MICA. Yes. On his time.

Mr. HERRNSTADT. In my written statement, I point out that one

of the things a commission would do, one of the things Congress

could do is look at more detailed reporting requirements in terms

of Federal procurement. There could be more detailed reporting requirements for export sales and financing issues. Those are the

types of things that need to be looked at to compel prime contractors to report more specific data, not only in terms of offsets in

their broadest definition, but also in terms of how they affect the

subtier producers on that.

Mr. MICA. Mr. Tierney.

Mr. TIERNEY. Thank you. Tell me, what now is required to be reported to the Commerce Department with regard to these offsets?

Mr. HERRNSTADT. Well, Congressman, I think there is someone

from the Commerce Department that is testifying next, and they

will probably have more specific information about that. I am

aware of the information that the Bureau of Export Administration

has now put out, I believe for 3 years, which is a very good, but

obviously, it is very difficult to find out where the specific offset is,

how it has specifically affected workers and, also, how it specifically affected the entire network of not only subtier producers, but

also those that are in industries that normally one would think

would be unrelated to the actual aerospace activity.

Mr. TIERNEY. I would just make the comment that we have had

a number of subcontractors contact our office and tell us that they

are just horrified by the situation of losing contracts, but they are

also afraid to come forward, frankly, because they have to maintain

a relationship with people in the industry and they do not want to

lose what remaining work they have. So we are stuck, in a number

of cases, with anecdotal evidence of what is going on, and in fact,

in some instances where contracts have been stopped dead in their

tracks—a 3-year contract ended after 1 because a situation arose—

if they are going to keep any work at all, they can’t really complain

and come forward and testify here.

Mr. Johnson, right now, as I understand it, U.S. companies are

not required to provide copies of their transaction papers to the

Commerce Department. Is that accurate?

Mr. JOHNSON. What we provide to the Commerce Department on

an annual basis is a record of every transaction over $100,000 to

help implement an offset agreement.

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Mr. TIERNEY. But you needn’t provide copies of those transaction

papers; it is just whatever you say it is in the form that you want?

So that none of the sales contracts, none of the written offset agreements or the related paperwork ever goes to Commerce?

Mr. JOHNSON. That is correct.

Mr. TIERNEY. But they do go to the other government that you

are dealing with?

Mr. JOHNSON. The guy that has bought the product in the first

place, correct.

Mr. TIERNEY. They get all of that reporting. And the U.S. companies are not required to give the Commerce Department copies of

the reports that you prepare for the foreign purchaser either? You

have a particular form that you prepare for them in addition to the

documentation?

Mr. JOHNSON. Every offset agreement will require different reporting—some annual; some will run into the hundreds of pages of

print-out pages per quarter, and that is why we agreed with Commerce on a threshold so that we will be looking only at those transactions which at least had some dollar value of importance. I would

argue even a $100,000 transaction, if it were at all critical, we

should probably put the Marines at that installation because it is

the jugular of the United States. This is an industry of $140 billion,

so when we start getting down to the $100,000 transaction——

Mr. TIERNEY. But whatever limit you set to start reporting, it

seems to me that it would be worthwhile to have copies of the sales

contracts, the offset agreements and other related paperwork go to

the Commerce Department.

Mr. JOHNSON. Well, you could do that, but it won’t give you a

context to put those in.

Mr. TIERNEY. Well, then the report that you give to the other

country or the other customer, that would be helpful too.

Mr. JOHNSON. But what it doesn’t tell you, Congressman, is that

the F–16 line would be shut down altogether today if it weren’t for

exports, that the F–18CD line will shut down.

How do you put that in the context of what you are providing for

offsets? There would be no assembly line, no work for subcontractors whatsoever. That is not in those reports that we give to the

foreign businesses, so that you have to have some——

Mr. TIERNEY. Could I interrupt you for a second? It is your contention that there would be no work left for us if we didn’t do offsets?

Mr. JOHNSON. There are a number of lines that are open only because of exports. The U.S. Air Force only bought something like 12

airplanes last year, fighter aircraft.

Mr. TIERNEY. We have enough in the budget to buy a zillion.

Mr. JOHNSON. The point is, we would not exist without exports;

it is as simple as that.

Mr. TIERNEY. Exports that come with offsets?

Mr. JOHNSON. They almost all come with offsets, sir.

Mr. TIERNEY. So this thing has grown to the point where you

don’t make a foreign sale without having offsets involved?

Mr. JOHNSON. Generally, that is correct.

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Mr. TIERNEY. And we can’t really tell what effect it is having on

our economy unless we get more information, and you object to

more information being given?

Mr. JOHNSON. What we object to is publicizing it. We also argue

that it doesn’t make sense to have one kernel of information if you

don’t have a context to put it in.

Mr. TIERNEY. Why can’t Commerce put it in context? They are

capable people.

Mr. JOHNSON. We have spent 20 years. You can ask the DOD

guys when they come up——

Mr. TIERNEY. You mean the Commerce people?

Mr. JOHNSON. No, the Defense guys for years have tried to track

that, and indeed this shop in Commerce, you try to look at subsectors of the industrial base to see what is domestic content, what

is foreign, and it is almost impossible in today’s economy. It is just

too complicated.

Again, one’s guess, and I think my—is that offsets occur within

the $8 billion to $9 billion worth of military exports in the aerospace industry. They have held reasonably constant over the last

10 to 15 years, they are actually going up a bit this next couple

of years, I suspect, in a $140 billion industry.

It is very hard to wash out the $2 billion or so in offset obligations activity which Commerce reports each year. Basically, they

are reporting about $2 billion in offset obligations in a $140 billion

industry. Now, how you disaggregate what each subcontractor deal

might have in the overall nature of our industry, it would be very

hard without having some information other than just what is

going on with this $2 billion.

Mr. TIERNEY. Mr. Scott, what would you need?

Mr. SCOTT. Well, I think we need more case studies, actually. I

think that it is a complicated issue. I could recommend one to you

by Professor Watkins from Lehigh University that was included in

this NRC volume, that we all participated in, that was published

earlier this year.

Mr. TIERNEY. You are going to tell me now what you specifically

think ought to be reported to Commerce so that we can

determine——

Mr. SCOTT. Yes. Let me get right to the point. In addition to the

defense offset information, we ought to be collecting information

about commercial offices.

Mr. TIERNEY. What information should we collect and how

should we collect it?

Mr. SCOTT. I think, as Mr. Herrnstadt suggested, that any time

there is government financing involved, we ought to require that

any offset transactions ought to be at least reported, if not, as perhaps you suggest, have the actual documentation submitted as

well. So I think that would certainly advance our knowledge of the

issue.

Mr. TIERNEY. Mr. Herrnstadt, would that be enough for you?

Mr. HERRNSTADT. Well, I think that would be a good start. I

think ultimately what we would want to know is anything where

taxpayer money is used to fund any offset in any form, whether it

is defense-oriented or commercial-oriented, we would want to know

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the effect that has on the actual U.S. work force that is involved

in any way in that offset.

Now, in terms of putting that together, that package together,

that is something I think we need to think about in more comprehensive terms, and we need to get many more people together

to figure out exactly how we can do that. But that way we can get

a clear picture about exactly what is going on in this system that

is becoming wildly out of control, and we don’t know comprehensively where everything is going, what the impacts are on all different aspects.

Mr. TIERNEY. It seems that everybody agrees that most of the defense reduction job losses occurred between 1989 and 1995, and the

statement was also made that the foreign content now in many of

these aerospace products has doubled in the last decade or so. Is

that a fair indication that these offsets in outsourcing and work

like that are in some combination having a tremendous adverse effect on jobs?

Mr. SCOTT. I would certainly agree that, yes, the offsets in

outsourcing are having a tremendous impact and will have more so

in the future.

Mr. TIERNEY. And Mr. Herrnstadt, is that your impression? How

do you separate out the two, the outsourcing versus the offsets?

Mr. HERRNSTADT. I think they are very difficult to distinguish,

very difficult.

Mr. TIERNEY. Now, is there any concern—Mr. Johnson, I suspect

that you are not overly concerned about this from your testimony,

but is there any concern about the fact that the aerospace industrial base that we have around here may be sort of being dissipated

through this process, and that we have a national security interest

in trying to find out the adequate amount of information on that

angle, too?

Mr. JOHNSON. All I can do is point to the statistics that even

with the reduction of over—of 60 percent in defense procurement,

we are producing today in real dollars what we were producing 10

years ago, and exports have doubled as a percentage of what we

are producing. That is not a litmus of a sick industry or a litmus

of one that can’t hold its own competitively.

Yes, foreign content, we quibble over the percentages, I think because a lot of it has to do with Rolls Royce engines coming in and

going back out on Boeing airplanes, but the fact is that exports

have also doubled as a percentage of what we produce and, therefore, it is not entirely surprising that you would have an increase

in foreign content.

Mr. TIERNEY. So when I see folks at General Electric in Lynn,

who are some of the best workers in the world in this area, and

they are in fear of losing their jobs and they see things like that

Korean contract that I talked about, it is not to worry?

Mr. JOHNSON. I can sympathize with the chaps at Lynn, but I

would also note that were it not for those exports, a lot more of

them would be on the streets. They primarily make military engines up there.

Mr. TIERNEY. Unless, of course, we did something about this offset business, we might get back to where we want to be.

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Mr. JOHNSON. If you could wave a magic wand and make other

parliaments not concerned about spending their taxpayers’ money

on imports, there wouldn’t be a problem.

Mr. TIERNEY. We have a situation where—you take the European

people, this is a jobs thing for them. They need a product that we

make and they don’t make in a lot of instances, so the deal is, they

want to buy it from us. But they want to be able to tell the folks

back home the reason they had to buy a superior product from the

United States was so that they could have jobs; and they spin it

that way.

You mean to tell me that we can’t deal with that issue? I mean,

it seems to me we are making a superior product and we ought not

to have to bargain where we give them jobs, and technology to boot

on top of that. It should be quality, price, and drive the bargain.

Mr. JOHNSON. That would be wonderful in an ideal world, if they

were private consumers, but just as I don’t think you can identify

a single major DOD purchase from offshore that has not had a U.S.

prime and been produced in the United States——

Mr. TIERNEY. The difference being that we have a product that

they need, and they don’t have anything comparable in many of

these instances. They would like to have that kind of leverage.

Mr. Herrnstadt, I see you are nodding over there. We have that

kind of leverage where we make the superior product that they

need, so why are we also giving them jobs in technology in this

thing?

Mr. HERRNSTADT. I think you have asked a very poignant question. I think—there are two comments that come to mind. One is,

we do not know that if it weren’t for the offset, we would not make

the sale. After all, the things that we make in the aerospace industry here in the United States are quality. They are the best in the

world. That is why the U.S. aerospace and related industries have

become the success, the world leaders that they are.

The second is, the whole issue of engaging in both bilateral and

multilateral negotiations regarding offsets. There are a limited

number of engine makers and airframe makers throughout the

world. There are world trade organizations in the world that do put

restrictions on different types of trade requirements. Those also

need to be focused on, so that we can take care of what some people call a nuisance, others call a real threat.

Mr. TIERNEY. Now, the comment was made, too, that if we are

going to do that, if we are going to start addressing this, we might

be in a bad position because we have requirements like Buy American and things of that nature. What is your impression of that?

Are we going to have to put something on the table and walk away

from some other policies in order to try to have these multilateral

and bilateral agreements that address offsets and hopefully eliminate or reduce the impact?

Mr. HERRNSTADT. I think the first thing we need to do before we

even get to that question is to look seriously at the offset issue in

terms of a multilateral negotiating stance. I mean, I have here a

copy of the country reports on economic policy and trade practices

from March 1997, talking about the Netherlands, and there is an

actual subsection for offsets for defense contracts where there are

well-defined policies in other countries which specifically, specifiVerDate 11-MAY-2000 10:04 Aug 21, 2000 Jkt 000000 PO 00000 Frm 00154 Fmt 6633 Sfmt 6633 C:\DOCS\64306.TXT HGOVREF1 PsN: HGOVREF1
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cally look at offsets. That is where we need to start. That is what

we need to start looking at first.

Mr. TIERNEY. Thank you. I am going to defer to Mr. Gilman, who

is very patient.

Thank you for your patience.

Mr. MICA. Thank you. We will get back to you, Mr. Tierney.

The gentleman from New York, Mr. Gilman, you are recognized.

Mr. GILMAN. Thank you, Mr. Chairman.

I ask all the panelists, what would you say if we outlawed offsets?

Mr. JOHNSON. I take it if you outlawed offsets—and this perhaps

gets back to one of the points Mr. Tierney made. The Europeans,

who are the largest demanders of offsets, particularly in terms of

military; this is a region with 12 percent unemployment, which has

also had a shrinking defense industry.

They have two other choices than buying American with offsets:

One, they produce it themselves even if the quality might not be

as good; and second, they have the alternative of not buying anything.

As we noted in Kosovo, one of the reasons we had to take 80 percent of the burden is because the Europeans don’t buy very much.

They cut their defense budgets more rapidly than we did. They

don’t have to buy American. They have two other alternatives. In

the case of the Apache helicopter to the U.K. or to the Netherlands,

the alternatives were buying the German-French attack helicopter

or not buying an attack helicopter. And I think what you would

find, Congressman, if we were to outlaw offsets, you would see our

defense exports drop by 40, 50 percent, and you would see our European allies even less prepared to work with us in the next combat.

Mr. GILMAN. So you are willing to live with the offset problem?

Mr. JOHNSON. Absolutely, as a better alternative than any other

alternative we can come up with.

Mr. GILMAN. Mr. Scott.

Mr. SCOTT. I am not willing to again unilaterally outlaw offsets.

I think that could have negative consequences for U.S. trade, U.S.

exports. But I think a multilateral restriction on offsets would certainly help producers in both the United States and Europe, both

in terms of employment and technology.

Mr. GILMAN. Dr. Herrnstadt.

Mr. HERRNSTADT. We need to do much more work on offsets to

find out exactly what they are before we think about the topic you

are talking about. Exactly what are the offsets? We need to know

the impact on them, and then we need to know what it is we need

to do as a Nation. We need to develop a comprehensive national

policy on this issue.

Mr. GILMAN. What sort of a policy do you recommend?

Mr. HERRNSTADT. Well, I think we need to look at whether or not

offsets in all of their many forms—commercial, defense-oriented, direct, indirect, voluntary marketing schemes—how they actually affect the U.S. work force; and we need to figure out what works and

what doesn’t, what will maintain the U.S. work force and expand

the U.S. work force and expand the success of an industry like the

U.S. aerospace and related industries.

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Mr. GILMAN. Well, assume that you find it affects the work force.

What kind of a recommendation would you make?

Mr. HERRNSTADT. Oh, I think then we need to figure out exactly

what it is we need to do to resolve the issue, and I think——

Mr. GILMAN. That is what we are asking. How do we resolve the

issue?

Mr. HERRNSTADT. That’s right. And that is why we have urged

this high-level commission where we can get everyone together, to

get all of the information that is possible, to look at all of the nuances, all of the different aspects of offsets on this. When offsets

end up sacrificing U.S. jobs and technology overseas, then we need

to do something about that, to curtail that.

Mr. GILMAN. Assume we do apply some restrictions on offsets, if

you find it affects jobs, and we get the EU and other nations to

agree, how do we enforce that kind of a restriction?

Mr. HERRNSTADT. Well, I am no expert on the World Trade Organization, but one suggestion would be to look at the remedies or enforcement provisions of the WTO and other international trade bodies.

Mr. GILMAN. Dr. Scott, do you have any suggestions, assuming

there is an agreement on restricting offsets? How would you

enforce——

Mr. SCOTT. In addition to working through the WTO, I think we

could also rely on—to some extent on self-enforcement. The Foreign

Corrupt Practices Act has been in place for a number of years. It

has, I believe, successfully reduced bribery in international transactions.

I think in the same way, if the United States and Europe agreed

to outlaw offset agreements, or to restrict them in some very specific way, that each country or region could be relied on to enforce

its own agreements in its own region.

Mr. GILMAN. Mr. Johnson, why are you objecting to publishing

an offset agreement?

Mr. JOHNSON. Simply because you are providing a cookbook to

every other guy that is out there wanting offsets. As I have said,

we don’t have a problem working with the government and sharing

with our own government that information. What we dislike is

sharing that information with 80 other governments who demand

offsets.

Mr. GILMAN. Essentially, you don’t like offsets; is that correct?

Mr. JOHNSON. We don’t like having the U.S. Government help escalate the demands of offsets around the world by providing every

demander the best practices of demanders for offsets, which is essentially what publishing this kind of information does. It provides

every other finance ministry, economics ministry and defense ministry a look at what is the most people have extracted out of the

United States, and that is our new bottom line where we start

from. That is the problem. Just as we don’t want to publish our

proprietary manufacturing data for every competitor to look at, we

don’t have much interest in publishing our offset data for every

consumer to look at.

Mr. GILMAN. Well, Mr. Johnson, would the industry prefer to restrict offsets rather than keep escalating the offset problem?

153

Mr. JOHNSON. No. We just don’t want the U.S. Government to

help in that escalation process. This is one of those cases where industry will take care of itself, I think, for lack of any other alternative.

Mr. GILMAN. But the industry hasn’t taken care of itself apparently, and with all of the projections of job losses, it would seem

to me, the industry would be more interested in finding a solution

rather than just keeping from publishing.

Mr. JOHNSON. All I can say is, we are still the single largest net

exporter in the United States of any industry. That is not the sign

of an industry that has self-destructed. Any other industry in this

country would envy our record.

Mr. GILMAN. Just one concluding statement from each of you.

What should the U.S. Government do about offsets?

Mr. Johnson, what should we do? Apparently you are saying,

nothing.

Mr. JOHNSON. Certainly, we can continue private discussions

with our government. You are only talking about 40, 45 companies

that are involved in the bulk of international trade in defense products, which is where most of the offsets are. We do some of that

now. We could do more of that, sitting down with our government

and talking about what our practices are. They could tell us a bit

about what sectors they are particularly worried about. We have

asked for 10 years for that kind of information from the U.S. Government and never received it.

Tell us where you think the problems are and we will try to

avoid doing offsets in those sub sectors. No one has ever given us

any of that kind of information. Start at the bottom up rather than

the offset down. Certainly, you can jaw-bone our allies and try to

put some kind of lid on offset demands. But as long as we, by and

large, demand that everything we buy from offshore in the military

arena be produced in the United States, it is going to be very hard

to convince the Europeans that offsets are a bad thing.

Mr. GILMAN. Dr. Scott.

Mr. SCOTT. I believe that we need to create a national aerospace

commission, or executive council within the National Economic

Council, that is responsible for monitoring this problem and also

for monitoring the broader competitiveness of the U.S. aerospace

industry.

I think we have to recognize that there is a difference between

a national interest in jobs and technology and the interests of

many of the producers of these aircraft systems. I think we have

to be aware of that when we develop policy. It may be in the interests of the aerospace industry to export jobs and to engage in

outsourcing, in part because it increases their leverage with some

of the labor unions or some of their suppliers. But this may not be

in the national interest, so I think we have to be aware of that

when we develop policy.

Mr. GILMAN. Mr. Herrnstadt, what is your recommendation?

Mr. HERRNSTADT. We can no longer relegate to private parties

the issue of offset policy. This is a job for government. Government

has the resources, government has the responsibility and the obligation to closely scrutinize this matter and come up, finally, with

154

a comprehensive national policy for an issue that affects so many

workers now and will affect so many more workers in the future.

Mr. GILMAN. I thank our panelists.

Thank you, Mr. Chairman.

Mr. MICA. Thank you. I recognize Mr. Ose, the gentleman from

California.

Mr. OSE. Thank you, Mr. Chairman.

I am curious about something with respect to the offsets. The information that is going to be compiled and reconciled and analyzed

and digitized and all that sort of stuff, who is going to collect that?

Mr. SCOTT. I believe that information is currently being collected

by Commerce and by the Department of Defense. I think that it

needs to be channeled up to an organization like the National Economic Council in the White House. I believe that we need to have

that information coordinated at a much higher level in the government so that it can be used for policy purposes.

Mr. HERRNSTADT. I agree. I think it is being collected currently

in the Department of Commerce and elsewhere throughout government, but there needs to be more coordination through all of the

Federal agencies, whether it is the Labor Department, Commerce,

Defense Department, a clearinghouse, if you will, that can collect

all of the information and sift it out and coordinate it.

Mr. OSE. Did I understand, Mr. Herrnstadt, from your comment

that you think we need to expand it beyond the current arena to

include all transactions, both of a government-private and a private-private nature?

Mr. HERRNSTADT. I believe Dr. Scott had mentioned that.

Mr. OSE. How big of an agency do you think we are going to create to compile and reconcile and analyze this data?

Mr. SCOTT. Well, it is relatively simple. We have essentially one

aerospace prime in a commercial site and we could ask that one

company simply to supply to the appropriate government office the

reports and agreements that it is already making with foreign

firms and foreign governments.

So basically this requires a copy machine in the appropriate departments at Boeing and a few of the other major suppliers.

Mr. OSE. What about the subtier companies, for instance? Do

they not also have to—I think my point is that if you expand it beyond, say, Boeing to private-to-private transactions, I mean, you

are going to open a huge area for data collection, if nothing else,

which probably dwarfs even the—I can’t even conceive of the agency, the Labor Department, perhaps.

Mr. Johnson, I would appreciate any comments you have on this.

You referenced 45 companies being involved in these kinds of

transactions where there is government involvement of one nature

or another in the defense business, but what if we go outside, say,

defense and do lumber or automobiles or oil or computers?

Mr. JOHNSON. You would have a matrix that would make MIT

blanch. I mean, suppose you get credit for moving X number of

wicker chairs from Thailand to Pier One. Then, are we going to examine the entire worldwide wicker chair industry to find out what

impact you had on the wicker chair people? That is the problem.

When you get into direct offsets in general, what you find, even

when Commerce looked at three areas that they thought might be

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heavily impacted offset transactions, is that offset activity amounted to less than 1 percent of the total activity of any of those three

subsector industries in the United States.

Even with the narrow confines of the defense industry, suppose

you get credit for buying X number of fasteners from Germany for

aircraft. There are hundreds of distributors in the United States.

They, in turn, draw from fastener manufacturers around the world,

including the United States. How do you figure out what impact

that had on all of the fastener activity in the world? You would

have a matrix that MIT can’t handle with supercomputers.

Mr. OSE. The question that comes into my mind, when I was

building houses and I had partners in the deal, some of those partners also provided subcontracting services, and while I was sensitive to their needs, I didn’t let them jab me for an extra 3 percent

just because they were my partners. If it was a lumber guy and his

bid was the equivalent, well, then, I gave him the benefit of the

doubt. But if he was 3 or 5 or 2 or 1 or anything over what the

market was, I mean, it was a ‘‘tough’’ kind of thing.

Now, the question I have is, I am the guy writing the check on

these things. If I am buying it, don’t I have the right to buy it from

the person that I want to buy it from? I mean, if I am France buying X, Y or Z, don’t I have the right to say, well, a component of

X is going to be this?

Mr. SCOTT. I think there are two answers to that. One, part of

what they are buying was, in part, paid for by the U.S. Government, and that is the party who doesn’t sit at the table in many

of these transactions. We are talking about technology developed

with government funding.

And I think, No. 2, often parties from different countries play by

different rules. I think we have the European governments intervening informally behind the scenes in the purchases made by private companies.

For example, we saw a huge share in Airbus shipments to European producers, and the United States share there plummeted, I

think, much more rapidly than those exchanges happened in the

United States. I think that does reflect a national interest as well

as the search for the best deal. So, I think that we have to recognize that when we get into international trade, the rules are different, and we need different policies to respond.

Mr. OSE. Mr. Chairman, I see the red light is on and I am

crushed. I yield back.

Mr. MICA. Thank you.

Mr. Tierney, did you have any additional questions?

Mr. TIERNEY. I do, and I thank you for that.

First of all, Mr. Johnson, I need to go at this one more time with

you, because I am still puzzled.

You are fearful, I guess, or the industry is fearful that if we provide Commerce with the information that might be necessary to

sort of monitor or police what is going on, that offsets will escalate.

How can that possibly happen? I mean, already exports, you have

indicated, in this area has an offset agreement attached to it. I

have been to conferences where the room is packed with people

whose sole responsibility for the corporation is to devise seemingly

new ways to surreptitiously, and I think unseemingly to go around

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and find ways to do offsets, the most creative things that many

people have ever seen. So what are you afraid of?

Mr. JOHNSON. Let me say one more time, we do not object to

sharing some information with Commerce. Our concern is, when

you publish it, you create a best practices for every other offset demander in the world.

Mr. TIERNEY. They are already——

Mr. JOHNSON. The other issue, I would say, as discussed with the

gentleman from California, is that if you provided Commerce with

wheelbarrows full of offset data, it doesn’t give them a context to

look at it in.

Mr. TIERNEY. You want to say that the only people that can give

the context is the industry?

Mr. JOHNSON. No. I am just saying you have to come at it from

the other direction. I sympathize. If you look at the trend across

the board in industry, for example, one trend in automotive and

aerospace, et cetera, is to slash the number of subcontractors as an

efficiency means. How do you differentiate that overwhelming

trend from some guys who think they were affected by offsets unless you know what the general trend is?

All I am saying is that you are taking information which is a

teeny part of our industry without having a context in which to put

it. I don’t see how Commerce can do that if—that is why I think

it is much more sensible to start at the bottom up.

Mr. TIERNEY. We are acting like we haven’t already had a great

deal of agreement on this, that offsets are not good. The agreement

on government procurement already makes, I think, a pretty clear

statement that offsets are not something that we think are great,

it is market distorting, it is not favored. In fact, article 16.1: Entities shall not—shall not consider, seek or consider offsets.

Basically, the problem with that is, we then go ahead and exclude it on defense. Basically we say, well, you can do it in defense

if you say it is for your national security. But you and I both know,

Mr. Johnson, this has nothing to do with national security; it is to

explain it to the people somewhere in the European Union that

they spent dollars on American goods and the dollars didn’t go to

them.

We are fussing around with this a little bit and if we can prohibit

offsets for virtually every other industry and just leave this loophole for defense, it seems to me that you could take another step.

And if we have the information, we find out what we need to know

about the statistics, and we go ahead and do it.

We have 45 companies; presumably they have some patriotism in

their blood. Why don’t they get together and come up with some

standards in a joint effort about what they are going to do with

this issue, which they say is a prisoners’ dilemma—it seems to me

like a lot of unwillingness on their part—and then maybe work on

the national government to set a policy and start applying it to

some of these multilateral and bilateral agreements in coming

down on that to prohibit it, as we have for virtually every other industry, and I don’t see them falling by the wayside or going out of

business.

Mr. Herrnstadt, what do you say to that?

Mr. HERRNSTADT. I think you make a lot of sense.

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Mr. TIERNEY. That is why I asked you.

Mr. HERRNSTADT. I will even turn on my microphone.

Mr. TIERNEY. I was going to ask Mr. Scott to turn his off.

Mr. HERRNSTADT. No, I think what you stated makes an awful

lot of sense. Other countries have, as I mentioned before, well-developed offset policies. It is time we develop our own. It is also time

that we stop considering this as a mere inconvenience or as a nuisance and look at it as the real threat it is. We need to be able to

start with the data issues that you have talked about and formulate the comprehensive policy I have referred to before.

Mr. TIERNEY. Mr. Chairman, I will stop with that. It just seems

to me when something is an inconvenience, seldom do you see people hire entire staffs and fill ballrooms full of people that deal with

this inconvenience in more creative ways rather than just find out

how to work the system, as opposed to doing something constructive about it.

Thank you.

Mr. MICA. I thank the gentleman. I want to thank this panel for

their contribution and also for their willingness to participate with

us and answer questions in helping us seek some solutions to the

problem of offsets.

There are no further questions of the panel at this time, so you

will be excused, and thank you again for your participation.

Our third panel I would like to welcome, consists of the Honorable Roger Majak, Assistant Secretary for Export Administration in

the Department of Commerce; and the Honorable Alfred Volkman,

Acting Deputy Under Secretary of Defense for Commercial and

International Programs with the Department of Defense.

Gentlemen, as I mentioned to our first panel, I don’t think you

have been here before either. This is an Investigations and Oversight Subcommittee of Congress. If you would stand and be sworn,

please.

[Witnesses sworn.]

Mr. MICA. Let the record reflect that the panelists answered in

the affirmative.

Welcome, gentlemen, representatives of the administration, to

help us address the questions and problems surrounding defense

offsets. As I mentioned to our previous panelists, we try to limit

the oral presentations to about 5 minutes; as the red light goes on,

you get about a minute to conclude. We do welcome any lengthy

documentation or statements within reason, they will be made a

part of the record by unanimous consent.

So, with that, you are recognized, first the Honorable Roger

Majak, Assistant Secretary for Export Administration with the Department of Commerce.

Welcome, sir. You are recognized.

STATEMENTS OF ROGER MAJAK, ASSISTANT SECRETARY FOR

EXPORT ADMINISTRATION, U.S. DEPARTMENT OF COMMERCE; AND ALFRED VOLKMAN, DEPUTY UNDER SECRETARY OF DEFENSE FOR COMMERCIAL AND INTERNATIONAL PROGRAMS, U.S. DEPARTMENT OF DEFENSE

Mr. MAJAK. Thank you, Mr. Chairman. I appreciate the opportunity to inform the subcommittee regarding the Commerce DeVerDate 11-MAY-2000 10:04 Aug 21, 2000 Jkt 000000 PO 00000 Frm 00161 Fmt 6633 Sfmt 6633 C:\DOCS\64306.TXT HGOVREF1 PsN: HGOVREF1
158

partment’s involvement in the issues surrounding offsets in defense

trade.

As you know, the Defense Production Act directs the administration to prepare annual reports to Congress on defense tradeoffsets

and also codifies the current policy, which was initiated by President Bush, of nonintervention in offset transactions by the Federal

Government. Within Commerce, the responsibility for monitoring

offsets has been delegated to the Bureau of Export Administration,

with which I am associated.

We are presently working on our fourth report to the Congress,

which will be submitted later this summer. We coordinate the collection of this data and the issuance of these reports with the Departments of Defense, Labor, State and Treasury, and the Office of

the U.S. Trade Representative.

To help you better understand the scope of the offset issue, let

me review just a few of the findings from our 1998 report to Congress.

New offset agreements from 1993 to 1996 total about $15 billion.

That is about 52 percent of the value of the defense exports involved, which were about $29 billion. So in order to secure $29 billion in exports, we had to give back, in a sense, $15 billion in offsets.

Preliminary figures for 1997—you should keep in mind that our

data are a couple of years behind in this area—our figures, preliminarily, for 1997 indicate that the average offset as a percentage of

export value will be approaching 80 percent, and discussions with

U.S. prime contractors indicate that number is continuing to go up,

gradually approaching 100 percent. So we could be looking in the

future at a situation where we are asked for $1 in offsets for every

$1 in defense exports.

We also measure actual transactions under these offset agreements. Transactions reached $9.2 billion between 1993 and 1996;

38 percent were direct offsets, 58 percent were indirect offsets, and

the rest were unspecified. About three-quarters of those transactions appeared to displace U.S. subcontracting work, and certainly it has been a consistent finding of our studies that the subcontractor base is most seriously and directly affected by offset requirements.

Three-fourths of all of the offset transactions we have tracked involve three industry sectors: Transportation, which includes aircraft and aircraft parts, that is about 48 percent of these transactions; electronic and electrical equipment, which is about 16 percent; and industrial machinery account for about 9 percent.

Between 1993 and 1996, over 90 percent of new offset agreements and transactions were triggered by U.S. aerospace deals, although nearly half of those offset requirements were actually fulfilled with nonaerospace products. Ship-building is an industry

which appears to have been particularly hard hit by offsets. The

machine tool industry has also been heavily affected, according to

our figures, in the period 1993 to 1996. In total, more than 40

major U.S. industries, from food and food products to apparel,

printing, stone-cutting even, have been hit by offsets, despite the

fact that those industries have little or nothing to do with defense

trade.

159

While virtually all governments engage in offsets to one extent

or another, five countries account for about 72 percent of new offset

requirements, by value—the United Kingdom, the Netherlands,

Switzerland, Saudi Arabia, and Taiwan. In the period that I have

mentioned, 1993 to 1996, European countries demanded 94 new

offset agreements worth about $10 billion in return for $11.3 billion

in defense purchases. That is about a 90 percent offset rate.

The United Kingdom, I would note, has one of the most aggressive offset programs. Not only does Britain demand nearly 100 percent offsets against their United States military purchases, but the

British Government also has established a program to assist their

companies meet offset requirements demanded by other countries.

Canada’s offset program is also quite aggressive, and is designed

to enhance its general economic development, rather than its national security or defense industries in particular. Again, Canada

tends to require 100 percent offsets, most of them indirect. It does

so despite the fact that we offer special access to Canadian firms

in our markets.

Is there a better way of sharing the benefits of defense trade

than resorting to these offsets? Probably. The development and production of extensive weapons systems through international partnerships would be a better approach, in our view, for example.

Our allies have been reluctant to discuss and negotiate limits on

offsets for a variety of reasons. I think some of them regard offsets

as an economic win; others are responding to political factors; overcapacity and excess employment in the European defense industries have increased pressure for offsets in order to keep European

defense facilities operating.

So where do we go from here, Mr. Chairman and members of the

subcommittee? Official U.S. Government policy, as has been noted,

is to avoid government involvement in offsets and to actively consult with friends and allies to limit the adverse affects of offsets in

defense procurement. We have had discussions over the last few

years with officials of the Dutch Government and the Canadian

Government. It is particularly important, I think, to make progress

with the Canadians, because they are a part of our North American

industrial base, and they are our closest neighbor, of course, and

largest trading partner.

Our objective remains to reduce and restrict offsets where possible. It will be difficult to stifle the demand for offsets, at least in

the short term. It is a buyer’s market for defense systems. We are

unlikely to restrain or eliminate offsets by just complaining about

them. We certainly will not eliminate them by unilaterally restricting our own defense contractors.

If we are serious about further constraining offsets, I think we

need to consider ways to increase our leverage, including the following.

We need to continue our efforts at international negotiations on

offset rules, both on transatlantic trade with our European allies

and on Third Country markets where we compete with European

manufacturers. As I have mentioned, recent discussions have indicated some receptivity to our ideas in this area. We need to collect

accurate information on all foreign sourcing of parts and components and weapons systems down to the subcontractor level.

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Finally, Mr. Chairman, we may need to take a closer look at the

British program. I mentioned, in passing, that the British Government actually assists its companies in responding to offset requirements in order to make them more competitive and to bring the demanders of offsets to the negotiating table. That’s fighting fire with

fire, which we may need to consider under these circumstances.

That summarizes my statement, and I thank you for your patience on the time.

[The prepared statement of Mr. Majak follows:]

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Mr. MICA. Thank you for your testimony. We will withhold questions until we have heard from the Honorable Alfred Volkman, who

is the Acting Deputy Under Secretary of Defense for Commercial

and International Programs with the Department of Defense.

Welcome, sir. You are recognized.

Mr. VOLKMAN. Good morning, Mr. Chairman, members of the

subcommittee. I appreciate this opportunity to participate in these

discussions on the subject of offsets in international trade.

As almost all of our panelists have noted this morning, there is

no consensus on the subject of offsets. Government agencies have

a range of views on the topic, and industry opinion on the matter

is also divided. There is no definitive evidence of the effect of offsets on the U.S. economy. Views on their effect are generally divided between those who accept offsets as an unavoidable cost of

doing business overseas and those who believe that offsets negatively affect the defense industrial base and other U.S. interests.

It is difficult to accurately measure the impact of offsets on the

overall U.S. economy and on specific industry sectors that are critical to defense. The GAO reports that U.S. defense companies advised them that without offsets, most export sales would not be

made and the positive effects on the U.S. economy and defense industrial base would be lost. In addition, company officials indicated

that export sales provided employment for the defense industry

and orders for larger production runs, thus reducing unit costs to

the U.S. military. They also noted that many offset deals created

new profitable business opportunities for themselves and other

U.S. companies.

Critics, however, charge that offsets have effects that limit or negate the economic and defense industrial base benefits that claim

to be associated with defense export sales.

In response to concerns raised by the impact of offsets, the President issued a policy statement in 1990 that reaffirmed DOD’s longstanding policy of not encouraging or participating directly in offset

arrangements. This policy statement also recognizes that certain

offsets are economically inefficient, and directed that an interagency team led my DOD, in coordination with the Department of

State, consult with foreign nations on limiting adverse effects of

offsets in defense procurement.

The Department of Defense fully supports the policies articulated

by the Congress and the administration concerning the need to negotiate with friendly and allied governments to eliminate the harmful effects of offsets in defense trade. My office has been actively

engaged in discussing offsets with key allies during our regular

meetings on reciprocal defense procurement activities. In addition,

we have cosponsored seminars, organized by independent organizations such as the National Research Council, to better understand

and deal with the complex and growing world of offset demands in

international trade.

More recently, we initiated action to lead an interagency team,

including representatives from the Department of State, Department of Commerce, Department of Labor, and the Office of the U.S.

Trade Representative that has met bilaterally with officials from

Canada and the Netherlands on the subject of the harmful effects

of offset demands in defense trade.

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Our allies consistently tell us that they need offsets because they

perceive that the U.S. defense market is not open to them due, at

least in part, to protectionist legislation. In particular, they cite

congressional reluctance to change Buy America and small business preference legislation. We believe that offsets should be considered as one, among many, practices that distort defense trade,

and consequently, negotiating the offset issue by itself does not

give the United States a strong bargaining position.

Furthermore, officials from the defense industry have expressed

concern about any unilateral action by the U.S. Government that

would limit the use of offsets, stating that such action, as Mr.

Johnson said earlier, would place U.S. exporters at a competitive

disadvantage in winning overseas defense contracts.

The Department of Defense is prepared to continue to work with

other Federal agencies, our allies, and the defense industry to monitor the employment and effect of offsets in international trade, to

ensure that U.S. Government policies of action or inaction do not

compromise broader U.S. national interests. The DOD will continue

to support U.S. industry interests when they are forced to comply

with foreign government-mandated offsets, while working to discourage our foreign friends and allies from requiring offsets. However, the Department would be very concerned over any U.S. Government actions that would diminish the competitiveness of the

U.S. defense industry or harm the Department’s efforts to achieve

military interoperability with our allies.

Mr. Chairman, thank you very much for this opportunity. I am

prepared to answer any questions you may have. Thank you.

[The prepared statement of Mr. Volkman follows:]

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Mr. MICA. Thank you. We do have a couple of questions.

It appears from the testimony that we had from Secretary Majak

that you have a pretty good handle on what is happening, of

course, with defense offsets; and it appears that that is going to

jump from 80 to 100 percent. Is that your prediction?

Mr. MAJAK. It seems the trend is in that direction, Mr. Chairman.

Mr. MICA. Is there anything in that area that we should explore

as far as legislative limits, in your opinion, or is this something

that is just bound to happen?

Mr. MAJAK. Well, we share the skepticism of industry in setting

limits by legislation in this area. I think our preference is to use

negotiation and have flexibility to both respond to offset requirements and to attempt, at the same time, to negotiate them away,

both on a government-to-government level and on an industry-toindustry level. So I don’t see a legislative mandate as a direction

we would want to go, although, of course, that is the prerogative

of this body, and it would depend a lot on what the provisions of

such legislation might be.

Mr. MICA. Well, you have pretty good data, and of course there

have been some requirements on reporting. I am wondering if

sometimes the collection of aggregate information regarding offsets

hasn’t actually provided information to countries—it is openly

available to other manufacturers to require this. I mean, everybody

else is getting a piece of the action. Why shouldn’t they? Are these

reporting requirements now fostering this increased offset requirement?

Mr. MAJAK. I seriously doubt that they are, Mr. Chairman. As

you say, they are only aggregate data.

I have no doubt that other governments may from time to time,

hold up a copy of the Commerce Department report and refer to

the numbers there, but my own experience with the aerospace community is that they are tough and very capable negotiators. I suspect that they have good answers to those tactics on the part of the

governments or customers they are negotiating with. I think the report and the data that we provide may provide some rhetorical ammunition for these other governments, but I hardly think that it

would be a decisive factor.

Mr. MICA. Another question is that if you get into the commercial

arena, we heard the gentleman, Mr. Herrnstadt, say we need more

information, I guess Senator Feingold said we need more information, data collection. But then I think we also heard testimony that

said how difficult it is or at least a paper Mr. Herrnstadt published

said how difficult it is to collect that information.

From a Department of Commerce standpoint who is responsible

for collecting commercial data? Is that possible and would it be

helpful and how would you go about that?

Mr. MAJAK. Well, I would say, first of all, Mr. Chairman, we of

course would prefer strongly not to impose major new burdens on

industry, whether the defense industry or industry generally, for

data reporting to the Commerce Department. That is a principle

that we try to adhere to, and it is a principle set forth in a number

of pieces of legislation set forth by the Congress. So we tread carefully into new areas of data collection.

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Is it feasible? I would have to say, yes, it probably is feasible.

We have one other example in my own bureau of collecting that

kind of data. As you know, there is legislation prohibiting and restricting the compliance of companies with foreign boycotts, and we

collect data from all companies who may be approached by any foreign party to participate in such a foreign boycott, and they are required to report to us. It is a major undertaking. We have to have

computers and people and facilities to handle that kind of data.

Could it be done? It could. It certainly is feasible. I think, however, at the same time, we have a good and adequate base of information right now based upon what the 30 or 40 prime defense contractors provide us. I think we have a pretty good picture, at least

of what is going on in the defense sector. If you need or want to

expand that to all commercial transactions, it would be a rather

large data base, and so we would have to weigh the benefits of

doing that.

Mr. MICA. How many people do you currently have at the Department of Commerce that work on the offset issue?

Mr. MAJAK. Three or four.

Mr. MICA. Would it require a substantial increase in personnel

to expand——

Mr. MAJAK. I think almost certainly it would, although we would

hope to take advantage of economies of scale with other data collection facilities that we have. I think we would try to use some of

the existing resources that we have for other kinds of data collection as best we could. But certainly it would require more than the

three or four people we presently have working on this issue.

Mr. MICA. In addition to manufacturing offsets, it is very popular, particularly in the defense area, were technology transfers to

be made part of the deal. Currently, the Department of Commerce,

the Department of State, the Department of Defense are all involved in some way, or get involved, in the question of export controls and technology transfers.

Is the current system adequate in this offset transfer process?

Are there gaps or things that we should be looking at? Is there

something that we should be doing that is different? Are we going

to have another embarrassment in this area, or are we adequately

covered? And we will go to Mr. Volkman first, and Mr. Majak, you

can be the clean-up hitter.

Mr. VOLKMAN. I think that the export license control process is

very well established. I think it is generally effective in protecting

the transfer of U.S. technology outside of the United States. Obviously, any——

Mr. MICA. As it works with offsets and again some of these requirements that are being imposed; and it looks like we are going

to even higher percentage. Do you think that everything is in place

and working well?

Mr. VOLKMAN. In order to export the technology, an export license is required. If it is a military item, a request would be submitted to the Department of State, who then consults with the Department of Defense before an export license is granted. It is my

understanding that it is a very thorough process. If there is a deficiency in the process, it is that it takes too long.

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Mr. MICA. One of the problems that you saw even in the China

missile technology transfer is that tremendous amount of pressure

from the private sector—we have to do the deal, we have to provide

this technology transfer. And with an offset, you run into the same

situation—pressure from the vendor to do the deal, get the technology transferred—and you see the little lobbying efforts that go

on to move this technology.

Do you feel pretty comfortable that we have enough protections

in place, even though there is going to be even more pressure on

vendors to transfer this technology, to do the deal?

Mr. VOLKMAN. Well, I think there is always pressure when a

firm wants to make a sale, whether it is a foreign military or commercial sale, that the export license be granted. I think there is an

integrity in the process that permits the U.S. Government to withstand those pressures.

Certainly, that is true of the munitions license process, which involves the Department of State and the Department of Defense. I

would defer to my colleague as to whether the Department of Commerce can withstand the pressures.

Mr. MICA. No further disclosure information should be revealed

in the process to shed any light on this—on what is taking place?

Mr. VOLKMAN. I don’t believe that we are making any improper

disclosures of information because of offsets.

Mr. MICA. I am talking about disclosure where you have an offset

involved, any further disclosure; do you think that is adequate?

Mr. VOLKMAN. Not that I am aware of. I don’t know of any pressures for further disclosure as a result of an offset agreement.

Mr. MICA. No? That we should impose any further?

Mr. VOLKMAN. No, sir, I don’t believe so.

Mr. MICA. OK.

Mr. MAJAK. I would agree with Mr. Volkman. The Commerce Department administers the export licensing process for so-called

dual-use items, those that have both commercial and military applications; and we have a very thorough process. Whether the

transfer is based upon an offset arrangement or not would be more

or less immaterial to us. If the transfer of a technology is to be

made and that technology requires a license, then we require and

review those licenses. So it really wouldn’t matter what the source

of the transfer was, whether it was an offset arrangement or otherwise.

We do see license applications in our process which involve

transfers of technology under offset agreements. But as I said, we

analyze those with the same scrutiny for national security as we

do any other transfer. And I think that process is generally working well and reliably.

Mr. MICA. Thank you.

Mr. Tierney.

Mr. TIERNEY. Thank you, Mr. Chairman.

Mr. Volkman, your department within the Department of Defense is not the primary department dealing with offset policy for

the Department, is it?

Mr. VOLKMAN. Well, there is probably not a primary office. Within the Department of Defense, the responsibility for discussions

with foreign nations over limiting the adverse effects of offsets is

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shared between my office and the Office of the Director for Defense

Procurement that has a director of foreign contracting.

Mr. TIERNEY. They wrote to us and told us that they were the

ones within the Department of Defense, the procurement people,

with the primary responsibility for offset policy within the Department. Is that accurate?

Mr. VOLKMAN. I would say that we share that responsibility. We

both work for the same under secretary.

Mr. TIERNEY. You have to share that with them then; they don’t

know that, just reading this, ‘‘My office has the lead for Department of Defense in these matters.’’ That is by Dave Oliver, the

principal deputy of procurement.

Mr. VOLKMAN. That is my boss. That is correct.

Mr. TIERNEY. Other industries survive quite well with offsets

being restricted under international multilateral agreements. Is it

your opinion that the defense industry could not survive in similar

atmospheres?

Mr. VOLKMAN. I don’t know the answer to that. I would echo the

comments made previously, that it would be a dangerous thing to

try to impose that kind of restriction unilaterally. Obviously, if it

is going to be effective, it has to be agreed to by all of the participants, all of the nations that participate.

Mr. TIERNEY. It has been agreed to in other industries through

multilateral agreements that it would be restricted and eliminated.

Do you see any reason that we couldn’t do that in Defense if we

came to a multilateral/bilateral agreement to restrict or eliminate

the use of offsets?

Mr. VOLKMAN. I would welcome that. I would just hasten to say

that I expect that it would be a very difficult multilateral agreement to achieve.

Mr. TIERNEY. It wasn’t difficult, apparently, in other industries.

Why do you think that it would be difficult to achieve it in the defense industry?

Mr. VOLKMAN. My impression is that parliaments, like our Congress, want to see the large expenditures that are made on national

defense spent within the borders of their country.

Mr. TIERNEY. You would agree with me that there are harmful

effects to offsets?

Mr. VOLKMAN. Yes, sir.

Mr. TIERNEY. Mr. Majak, you also have come to that conclusion?

Mr. MAJAK. Very much so.

Mr. TIERNEY. Tell us about the economic inefficiencies that result

from offsets.

Mr. MAJAK. Well, there are a number of them. I think probably—

duplication of facilities, manufacturing facilities, is probably one of

the more blatant ones.

Obviously, in defense industries, like any other industry, you

want plenty of competition for both finished systems and for components, but you don’t want overcapacity. That creates inefficiency.

And I think foreign governments, in their eagerness to have some

of these dollars spent within their own borders, probably do not

take a very good look at what the global market for whatever item

they are wishing to produce within their country might be.

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Furthermore, many of them do not have the resources to sustain

a broad military base. So to pick one item or another item to manufacture, even with assistance from the outside, is not always an

economically efficient way to proceed. That is why we feel that

international cooperation agreements are a more rational process

by which to determine who should produce what, who should invest

in what facilities. That would not eliminate offsets completely, but

it would make them more economically rational.

Mr. TIERNEY. Do you have enough information in your department to give us an opinion whether or not offsets have an adverse

effect on the labor market?

Mr. MAJAK. We do not specifically analyze labor impact. Perhaps

we should work more closely with the Labor Department on that.

We do share our data with the Labor Department, and I would look

to them to make those kinds of projections.

Really, our data are confined to aggregate figures on both the

number and the dollar value of offset agreements and the dollar

value of implementing transactions. I mean, we can use some crude

measures of what that might translate into in jobs. Personally I

think those crude formulas are not very accurate, so I would look

to the Labor Department to make those kinds of projections.

Mr. TIERNEY. Tell me for what reason you do collect the data

that you do collect.

Mr. MAJAK. Well, I think, under the congressional mandate, we

collect this data to develop a gross measure of the magnitude of the

offset requirements in defense trade. That kind of data is not designed and doesn’t give us the capacity to make very fine analysis

of the details of these offset requirements except as we might find

them out on an anecdotal basis. We are confined to dollar value of

the country to which the offset is provided and that kind of basic

information.

Mr. TIERNEY. Toward what end?

Mr. MAJAK. Toward the end of understanding the impact on

trade and the impact on defense and moving toward restraining

these activities which we have concluded are not economically efficient.

Mr. TIERNEY. What was the foundation of your conclusion that

these are not economically efficient, that you want to somehow

limit them or terminate them? What information did you get? Was

it the aggregate figures, these numbers; it is a bad thing?

Mr. MAJAK. Well, I think both aggregate data and the anecdotal

data that we do obtain enables us to evaluate the impact on particular industries. We are able to break these numbers down by industry and to distinguish the impact on subcontractors versus

prime contractors. So we do some economic analysis of the data,

and we have reached those conclusions from that economic analysis.

Mr. TIERNEY. Nevertheless, you don’t feel that any other collection of data in any form at all would be helpful?

Mr. MAJAK. I wouldn’t go so far as to say that. Certainly we

would like to have more accurate and complete information, perhaps at the subcontractor level, more complete information with respect to the inclusion of foreign components in major defense systems. Some of that data is collected already by the Department of

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Defense and we have access to it. I would like to have more thorough information, but without imposing major burdens on industry

to provide that data.

Mr. TIERNEY. What would you need to get the information that

you say that you need?

Mr. MAJAK. Well, initially perhaps, more data from the subcontractor level on their experience with offsets, the impact that it

has upon them. At the present time, we do that only on a spot

basis; we could do that on a more thorough basis.

Mr. TIERNEY. Would you get written information from them?

Mr. MAJAK. Yes. Our authority is based in terms of our ability

to conduct surveys of industry, so we would do it through a survey,

presumably. I am not talking here about the documents.

Mr. TIERNEY. Is there anything prohibiting you from doing that

now?

Mr. MAJAK. Only time and resources. I think we have the authority to do that now.

Mr. TIERNEY. What kind of resources are you saying would be

needed to do that?

Mr. MAJAK. This is primarily people resources, personnel.

Mr. TIERNEY. Significant—I know that Mr. Ose is going to be

very concerned if it means hiring more people.

Mr. MAJAK. We collect a lot of data and do a lot of analysis now

with three or four people. I couldn’t put a number on how many

more people. It would not be a large number unless we expanded

the data collection beyond the defense export sector into all commercial activities. That would be a major expansion.

Mr. TIERNEY. Do you see any benefit of your department getting

copies of the sales contracts and related documents and reports

from the industries to foreign countries?

Mr. MAJAK. Well, that would obviously provide us with more detailed information with which to work. So, yes, there would be advantages to having that kind of information in terms of our detailed understanding of these transactions.

Mr. TIERNEY. Do either of you gentlemen have an opinion as to

the wisdom in requiring, as a condition of entry into the WTO, that

China agree to no offsets in defense procurement agreements?

Mr. MAJAK. Well, I think that question is more appropriately directed at the Department of State. Certainly, it is our view in the

Commerce Department that the WTO requirements represent an

important discipline on trade barriers and distorting trade practices of this kind, and we would expect China to conform to those

requirements along with all of the other WTO members.

Mr. TIERNEY. Mr. Volkman, when you negotiate or discuss this

with other allies in Europe or elsewhere, what is your opinion that

results from those discussions as to what we would have to use for

leverage? What do we have for leverage to get them to agree not

to have offsets factor into contracts?

Mr. VOLKMAN. As I said, when we discuss the adverse effects of

offsets in our defense relationship with other countries, their reaction invariably is that the U.S. defense market is essentially closed

to foreign competition and that the way in which they compensate

for that is to demand offset, or like the United Kingdom, industrial

participation requirements.

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Mr. TIERNEY. We know that is smoke, because fairly often we

read in these reports that their real motivation for doing these

things is, they are just trying to kick their economy up, right?

Mr. VOLKMAN. But if they were to agree to eliminate demands

for offset, they would expect to have a clear entry for their defense

industry into the U.S. defense market, which they view as closed,

and I think perhaps with some justice because of protectionist legislation, small business set-asides. In fact, in the past when the

U.S.—on the rare occasions that we do buy an item of major defense equipment outside of the United States, we have required

that the item be produced in the United States. So we don’t call

it an offset, but in fact one of the conditions of the purchase was

that there be assembly to a large extent, manufacture of equipment

like the AV–8B Harrier aircraft, Beretta pistols purchased from

Italy, that had to be assembled in the United States, trainer aircraft that was of foreign origin that has to be manufactured in the

United States. So they see the United States as imposing requirements that limit their ability to manufacture in their country, or

they would view them as tantamount to offsets.

Mr. TIERNEY. Mr. Volkman, do you or your colleagues have any

concerns at all about the defense industrial base being dissipated

in this country as a result of offsets?

Mr. VOLKMAN. We are concerned about maintaining a viable defense industrial base. So, to the extent that offsets would diminish

that viable defense industrial base, obviously we would be concerned.

Mr. TIERNEY. I have no further questions right now.

Thank you.

Thank you, gentlemen.

Mr. MICA. Mr. Ose, you are recognized.

Mr. OSE. Thank you, Mr. Chairman.

Do end-user inspections fall within the offset dialog?

Mr. MAJAK. They do not as such. As I indicated in response to

an earlier question, whenever a militarily sensitive technology is

exported, we license that. We require a license for it. We review it.

One of the mechanisms we use to evaluate those licenses is both

a pre-license check to see where the product is going and how it

is going to be used and sometimes a post-license check to make

sure that it got where it is going and is being used as indicated.

We control those technologies, however, based on the technology,

not on the basis of whether it is an offset or any other kind of arrangement.

Mr. OSE. Your trading partners, when we require an end-user inspection, do they take that as negotiating something subject to negotiation and ask for a countervailing concession?

Mr. MAJAK. Not usually. They may complain about the burden

of having to provide us with access in order to conduct those inspections, but it normally does not become a subject of commercial

dispute.

Mr. OSE. What happens when the trading partner—that is not

within the jurisdiction of the discussion. Never mind.

Mr. Volkman, you have a comment in your testimony on page 7

about various studies and evidence showing no clear or significant

impact on some sectors or subsectors of the U.S. economy. ReferVerDate 11-MAY-2000 10:04 Aug 21, 2000 Jkt 000000 PO 00000 Frm 00190 Fmt 6633 Sfmt 6633 C:\DOCS\64306.TXT HGOVREF1 PsN: HGOVREF1
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ring to these studies, they have produced no clear evidence that offsets have a significant impact on specific sectors or subsectors of

the U.S. economy, including sectors important for defense production. Congressional hearings on the subject have also presented inconclusive testimony on the negative economic effects of offsets.

That is your position in your testimony.

I just want to—this is the Department’s position?

Mr. VOLKMAN. I think we were recounting the results. In this

case, we were recounting the results of the studies which show the

ambiguity of this issue, that we are unclear as to the effect offsets

have on various sectors of the defense industrial base.

Mr. OSE. When there is a defense product that is sold, presumably the buyer is buying American because of the quality or the

price or the quantity or lack of availability elsewhere. In the case

where it is a very specialized piece of equipment, such as an airplane, and it is not available elsewhere—say, the country of France

wants to buy 117—what happens if we refuse their offsets?

Mr. VOLKMAN. Well, if it is not available elsewhere, as Mr. Johnson said earlier, their alternative is not to buy at all.

Mr. OSE. Does that occur?

Mr. VOLKMAN. I suppose it could occur that there would be a decision that absent the economic benefits to, let’s say, the French

economy in your example, that would result from offsets, that they

would choose not to make the investment in the piece of defense

equipment. If that were the case and if it were a necessary piece

of defense equipment, then I think that the alliance or those who

are likely to fight together in the future—and certainly in the recent past France has been a loyal participant with us in most of

the conflicts that we have engaged in—that we would all be at a

disadvantage as a result of the French making that decision.

Mr. OSE. What is the consequence when there is an alternative

elsewhere in the world, in other words, a cargo plane?

Mr. VOLKMAN. My observation, and I would hasten to add that

I am hardly an expert in this, my observation is that offsets are

demanded and offsets are granted and that, in effect, one of the

major items in the decision is the adequacy of the offset package.

So U.S. industry is competing with foreign industry to come up

with the best offset package.

Mr. OSE. Going back to our hypothetical with France being the

buyer, they have the opportunity to buy from us or any number of

other suppliers; and if we don’t grant the offsets, they will not

make the deal because they will get the offset package elsewhere?

Mr. VOLKMAN. If there is a competing European supplier for a

piece of defense equipment, one of the issues that will be considered in making the selection, whether to buy from the U.S. manufacturer or the foreign manufacturer, is the adequacy of the offset

package. If we decided not to offer an offset package, that would

obviously be a factor in the source selection.

Mr. OSE. These products that are transacted, whether they be

cargo planes or what have you, in these instances where there is

a transaction, how often or in what percentage of such transactions

is there a choice being made by the buyer? In other words, in what

percentage of the transactions are we not the only supplier of a

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product—in other words, you have a choice of buying this one or

that one?

Mr. VOLKMAN. I don’t really know the answer to that. There is

adequate foreign competition in most defense sales.

My staff tells me that it is about 70 percent. Apparently there

is anecdotal evidence that suggests in about 70 percent of the cases

there is a foreign competitor.

Mr. OSE. So in 70 percent of the transactions, if we were to adopt

a policy mandating no offsets, we would, in effect, be chasing the

transaction to some other country?

Mr. VOLKMAN. Yes, sir.

Mr. OSE. And losing the jobs that would otherwise be here for

assembly?

Mr. VOLKMAN. We would be taking the risk that that would be

the case.

Mr. OSE. You are a far better wordsmith than I am, but I will

learn.

Thank you, Mr. Chairman.

Mr. MICA. I thank the gentleman.

In this GAO report, that was done last December, I believe, one

of the statements on page 2 says,

in the past, contractors had to absorb the cost of offset implementation against

their negotiated profit margins.

In 1992, DOD recognized that contractors incurred such costs by allowing their

recovery under FMS contracts. Today U.S. Defense contractors may recover administrative costs incurred to implement their offset agreements under certain circumstances by charging such cost of purchasing of foreign governments through

FMS sales contracts.

It seems that is also—well, there are not too many ways to get

a handle on offsets, particularly in this defense arena.

Should we go back and revisit this, Mr. Volkman? Would it make

any difference?

Mr. VOLKMAN. I am sorry, would you repeat that, sir.

Mr. MICA. The contractors have had to absorb the cost of offset

implementation against their negotiated profits in the past. We

changed that policy in 1992. I am wondering, if we didn’t provide

an incentive to these folks not to do anything, would we need to

go back and change this policy, would it help any, or is it a legitimate cost?

Mr. VOLKMAN. Change the policy so that they would have to bear

the costs?

Mr. MICA. Right. Again, we are trying to find some ways to discourage offsets, and if you have a vendor getting to write off—we

changed the policy in 1992, letting them absorb the cost of offset

implementation against their negotiated profit margins. Maybe we

should go back and change this to the way it was.

Mr. VOLKMAN. My reaction to that would be——

Mr. MICA. We have several contractors squirming in the audience.

Mr. VOLKMAN. You would be placing defense contractors in a

tough situation where they would have—in order to be competitive,

they would have to meet offset demands, but couldn’t pass on the

costs of fulfilling those offset demands to the foreign customer who

is, in effect, imposing the demands.

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Essentially what we do is, we recognize that when a foreign customer requires that there be an offset commitment, that there are

costs associated with demands for that offset commitment and that

it is fair for U.S. contractors to pass those costs on to the foreign

customer, the foreign government.

So I think it would be a bad idea to do what you have suggested.

Mr. MICA. So we, through our policy, help promote offsets?

Mr. VOLKMAN. No, I wouldn’t say that. What the policy does is,

when a contractor agrees to an offset commitment, we are treating

U.S. contractors fairly by letting them recover the necessary costs

associated with that. I think the reason that they enter into offset

commitments, it is the price of making the sale.

Mr. MICA. And we help them write off the costs of implementing

the offset.

Mr. VOLKMAN. At the expense of the foreign government; not at

the expense of the U.S. Government, but at the expense of the foreign government.

Mr. MICA. Mr. Majak, did you want to respond?

Mr. MAJAK. I have nothing further to add to that difficult question.

Mr. MICA. Well, I just like to stir things up every once in awhile.

Mr. Tierney, do you have any final questions?

Mr. TIERNEY. I do. Thank you.

Are you aware of an administration attempt to put together an

advisory group or panel to look into this issue and help us revisit

national policy on offsets?

Mr. MAJAK. I am aware only of the interagency group headed by

the Defense Department, which is mandated by the Defense Production Act.

Mr. VOLKMAN. I would say that we have the basis of a good

interagency group that has been formed as a result of this cooperative relationship that we have developed.

Mr. TIERNEY. How active are we in terms of pursuing some remedy of this offset situation through bilateral or multilateral negotiations?

Mr. MAJAK. Well, in my full statement, I articulate and list the

recent discussions that we had with the Dutch, the Canadians. In

addition to that, we participate in many multilateral official and

unofficial conferences, and attempt to convey our concerns about

offsets at every opportunity within the limits of our time and personnel.

Mr. TIERNEY. Are you getting any response?

Mr. MAJAK. Yes. I think there is a receptivity in many of these

discussions, which I think we need to take advantage of by intensifying these discussions. We are continuing with Defense to schedule additional ones.

There is receptivity to restraints on offsets if we can mutually

find a way out of the current practices; and that is the difficult

part. But, yes, I think generally, we find there is more interest in

restraints than one would suppose from looking at the volume of

demands.

Mr. TIERNEY. Mr. Volkman, do you know roughly what the percentage of people in the Department of Defense procurement division is that formerly worked within the defense private industry?

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Mr. VOLKMAN. No, I don’t know the answer to that. I would suspect that it is not very large.

Mr. TIERNEY. Why do you suspect that?

Mr. VOLKMAN. Mainly because I know people who are in civilian

procurement for the Department of Defense, and it is not noticeable that many of them come from the defense industry to government, at least at the working level. It may happen on occasion that

someone will come from an industry position to a government position, perhaps at the executive level, but the bulk of the work force

does not have industry experience.

Mr. TIERNEY. Thank you, Mr. Chairman. I thank the witnesses

also.

Mr. MICA. Mr. Ose.

Mr. OSE. No further questions.

Mr. MICA. There being no further questions of this panel, I would

like to thank Mr. Majak and Mr. Volkman for their participation

in representing the Department of Commerce and the Department

of Defense at the hearing today. We will keep the record open for

1 week, without objection, so we can receive additional testimony

or statements from members.

There being no further business to come before the subcommittee

this afternoon, this meeting is adjourned.

[Whereupon, at 12:35 p.m., the subcommittee was adjourned.]

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