[New York Times] February 16, 2003 Foreigners Exact Trade-Offs From U.S. Contractors By LESLIE WAYNE
WASHINGTON A DECADE ago, when the ruling sheiks in the United Arab Emirates decided to expand the local economy after the gulf war, they turned to American military contractors like Boeing, Northrop Grumman and Lockheed Martin for a helping hand. In return for buying military gear, the emirates pressed the contractors to spend millions of dollars to create jobs and to improve the lives of citizens in their desert outposts: financing a medical diagnostic center linked by satellite to the Mayo Clinic, building a shipyard that has created thousands of jobs, helping with oil-spill cleanups, starting a laser-printer recycling business and even bringing Berlitz schools to Abu Dhabi and Dubai. In another era, these gifts might be considered bribes. Now they are called offsets. Bribes were outlawed under the Foreign Corrupt Practices Act of 1977, which barred payments to foreign officials in exchange for business. But offsets, while little known, are a legal and, companies say, necessary part of the international arms trade not only in the emirates but around the globe. "Offsets are the equivalent of what we used to do when we bribed foreign officials," said Robert E. Scott, an economist at the Economic Policy Institute, a liberal research group in Washington. "It's a tragedy, and it's a race to the bottom. The best way to avoid these kinds of competitive and disruptive games is to outlaw the practice." Instead, offsets are growing. For American and European arms makers, lavish packages have become the key to closing deals. The Czech Republic, for one, has said that when it next buys fighter jets, the offsets will be more important than the jets' price or performance. "It's an essential part of doing business overseas," said Kent Kresa, chief executive of Northrop Grumman. "I'm not negative on it." Although the ramp-up to potential war with Iraq and President Bush's request for a record $380 billion Pentagon budget would suggest that military contractors have it easy, the contractors say they must scramble for overseas sales. The Pentagon has stockpiled so many F-18 and F-16 fighter jets and other weapons that it is only through overseas sales that many aging production lines are kept running. If the public knows little about this corner of the military industry, that is by design. Most contractors refuse to talk about offsets. They disclose little about them to shareholders or regulators and grumble privately that they are a "necessary evil." Yet they have done little to halt the practice. "One reason it is hard to get people to talk about this is that it encourages people to ask for more," said Pierre Chao, an industry analyst at Credit Suisse First Boston. Offsets can be any form of aid - direct investments, agreements to help countries export their goods, pacts to use more foreign components in the weapons sold, even transferring subassembly jobs overseas. American arms makers have helped the Dutch to export yarn and missile parts, the Finns to sell rail carriers and passenger ferries, the Swiss to sell machine tools and ball bearings, and the Norwegians to market power-generating equipment. Lockheed had to use British-made Rolls-Royce engines instead of ones made by General Electric to power Apache attack helicopters sold in Europe. And, in a sale of F-16's to Poland, Lockheed agreed to have the jets' engines built there. Military contractors say they have been brokers for imported figs, tomato paste and wine; for years, McDonnell Douglas, now part of Lockheed, provided Christmas hams to its employees under a fighter-jet offset deal with Denmark. THE whole system is mad," said Kevin L. Kearns, president of the United States Business and Industrial Council, which represents small businesses, many of them military subcontractors. "Everything about offsets is totally counter to a free-trade philosophy. If we have the world's best armaments, other countries should buy them free and clear. The mice here are in charge of the cheese." So complicated are offsets that most major contractors have entire departments to devise them and to twist the arms of suppliers into participating as well. Contractors usually agree to pay damages if they fail to deliver on a deal; in practice, though, offset agreements that run into trouble are often renegotiated. Officially, the federal government frowns on offsets as economically inefficient and bars the use of taxpayer dollars to finance them. They are negotiated directly by American contractors with foreign governments, though the Commerce Department keeps data on them. Those statistics show that more than 120 countries require offsets in military sales. In 1998, the last year of available figures, American contractors signed 41 agreements with 17 countries. From 1993 to 1998, they provided $21 billion in aid to foreign countries under 279 agreements. Lockheed has entered into more than 300 offset arrangements in more than 30 countries in the last two decades. New data, as yet unreleased, will show increases across the board, said Daniel O. Hill, director of the Commerce Department's office of strategic industries. Aside from obvious distortions they cause in global trade, offsets have cost the United States thousands of precious manufacturing jobs, unions say. A 2001 presidential commission on offsets found that they led to an annual loss of 4,200 manufacturing jobs in the 1990's, mostly among subcontractors. "The government does not know the full impact of these deals because there is such a lack of information," said Owen E. Herrnstadt, director of the international department of the International Association of Machinists and Aerospace Workers. "It's a puzzle that policy makers have yet to put together, and the threat is growing. Workers are being sacrificed." Contractors say privately that they are not happy, either. Many complain that they must spend a lot of time and money putting together offset deals - an activity far from their core skills. Some fear that as American contractors send jobs and technology overseas, they are undercutting their own future. Under a $3.3 billion agreement for the sale of 40 F-15K Strike Eagle jets to South Korea, Boeing will transfer jobs and skills to South Korea that will enable it to produce its own fighter jet by 2015. Korea will be given avionic, software and design technology that Boeing values at $1.5 billion, and while the plane's final assembly will be done by Boeing in St. Louis, the wings and front fuselage will be made in Korea. Contractors say the leaders of many countries, particularly those in developing economies, need offsets as political cover to justify the billions spent on military goods. "From a general industry perspective, while we'd prefer that offsets did not exist, most companies would say that we are pretty good at them," said Michael Messina, chairman of the Defense Industry Offset Association, a group of military contractors. "If U.S. companies did not provide offsets, we would not have the business in the first place. Half a loaf is better than none." In a survey of eight large contractors, the 2001 commission found that seven estimated that they would lose 50 to 90 percent of foreign sales without offsets, while one said eliminating them would have little or no effect. While no contractor contacted for this article would comment, one leading arms maker did allow a senior vice president to be interviewed as long as neither he nor the company was identified. The executive, who oversees foreign sales, said the end of offsets would force many contractors to shut production lines; he specifically cited lines for the F-18 and F-15 jets (made by Boeing) and the C-130J transport aircraft (made by Lockheed). "If and when there is a multilateral agreement so that offsets would go away, we would be delighted," he said. "But until that day, let's not take the risk." In Congress, Representative John F. Tierney, Democrat of Massachusetts, has tried for years to curb offsets. "This is a very serious problem," he said. "We tried to move on this issue, but we got no traction. I don't think the industry is as upset as it claims to be; otherwise there would be more done about it." Some in the industry say as much. "We have the world's largest defense industry, companies and economy," said Joel J. Johnson, vice president at the Aerospace Industries Association. "We can do offsets no sweat and better than anyone. I'm not sure we want to get rid of them when we have a competitive advantage." Offsets began after World War II, based on the theory that co-production agreements were needed to help European countries rebuild military-industrial bases and resist communism. Communism died, and European arms makers were back on their feet - but offsets stayed. "Once the genie was let out of the bottle," said Mr. Chao, of Credit Suisse, "it was impossible to put it back in as nations figured out how they could use the offsets game." According to government data, the biggest recipients of offsets are among the most sophisticated countries: Finland, Britain, Israel, Switzerland and the Netherlands. Switzerland's presence on the list irks some critics, who say that the country is so rich that it needs little help and that its policy of neutrality means no American security interests are at play. Israel, too, raises eyebrows. It is one of two countries - Egypt is the other - that receive direct American military aid to buy American-made weaponry; but unlike Egypt, Israel insists on offsets. In 1999, according to the Commerce Department, the United States gave Israel $1.86 billion in military aid, with the requirement that the bulk be spent on American goods. With this money, Israel has pitted American contractors against one another. Lockheed and McDonnell Douglas were once in an offset competition for a $2 billion fighter jet deal. Because of the technology it gained through these offsets, Israel has developed its own weapons systems and competes against American contractors for orders. Critics have called Israel's actions double dipping, and the Commerce Department asked Congress to halt it in 1998, but the proposal had no political support. THE United Arab Emirates, a federation the size of Maine at the entrance to the Persian Gulf, has one of the most sophisticated programs for offsets, important to its economic development. Since the country set up an office to attract offsets in 1992, it has received offsets totaling $680 million. Millions more are expected now that it has announced a $7 billion purchase of 80 F-16's from Lockheed. The French have also established a big presence in the emirates, pumping money into everything from a fish farm to a nursery with four million roses to a date-palm cloning operation. The French are also financing a huge air-conditioning project to cool the country's shopping malls and office towers. To make life easier for the contractors, the emirates have even set up a $20 million venture capital fund, the Chescor Capital Offset fund. "We've come up with a pretty aggressive offset program," said Nasri Tehini, a partner in Chesco Capital. "Our country has been put on the map, and one of the reasons is offsets." One centerpiece of the emirates' program is Abu Dhabi Ship Building, which makes warships and commercial vessels; Northrop Grummman owned 30 percent of the company before selling it in late 2002. So eager was Northrop to make inroads there that it made this investment as a "pre offset" for future ship orders that never materialized. Northrop declined to comment, but American shipbuilders are fuming. "We view this as tantamount to war," said Cynthia Brown, president of the American Shipbuilding Association, a trade group. "The U.S. government should be insisting that foreign governments cease offset policies. They are killing our industry. It's like Pac-Man. It breeds industry cannibalism to the detriment of the U.S. taxpayer."
