July 7, 2004    Volume 11, No. 13

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'Buy American' Raises Its Head Once Again;
This Time In A Battle Over Defense 'Offsets'

The simmering debate over the complicated issue of defense offsets -- when foreign countries require U.S. companies to transfer technology or manufacturing capacity to their country in order to receive a contract -- is reaching the highest levels of Washington policy makers.

Rep. Duncan Hunter (R-Calif.), chairman of the House Armed Services Committee, has inserted language in the latest Defense Authorization bill that requires "defense trade reciprocity" with foreign nations buying American-made weapons. The language is causing heartburn among large defense contractors who must play the offset game in order to win overseas contracts. Hunter calls offsets a form of "economic bribery."

"It is the policy of the Congress that procurement regulations used in the conduct of trade in defense articles and defense services shall be based on the principle of fair trade and reciprocity consistent with United States national security, including the need to ensure comprehensive manufacturing capability in the United States defense industrial base for military system essential items," states the opening paragraph of the section (811) in the authorization bill addressing the issue of offsets.

The offset language in the House bill (HR-4200), which has no counterpart in the Senate version, requires the Secretary of Defense to develop an "acquisition trade policy" that creates incentives to eliminate offset agreements. The bill would prohibit the Defense Department to enter into a contract or to permit a subcontract with a foreign firm unless that company's home country agrees to have an offset policy similar to that of the United States. (The United States does not require offsets.)

The Secretary of Defense would have the authority to make an exception to the rule if done so in writing and published in the Federal Register. "The authority of the Secretary to apply the exception...may not be delegated to any officer or employee in a position at a lower level than the position of the Under Secretary of Defense for Acquisition, Technology and Logistics," says the House authorizing bill.

House and Senate staff members involved in the issue say Congress risks not having an authorization bill pass this year due to the offset language. "We're looking at a similar situation to last year," when Hunter's "Buy American" provisions were hotly contested for months before being dropped, said one Senate staffer. Hunter "is not going to let up," adds one aide on the House side. The health of the U.S. defense industrial base is a pressing, ongoing concern of Hunter's. "He's going to attack this from many different angles," said the staff member. Last year, it was a requirement that the Pentagon increase American-made content of weapons systems from 50 percent to 65 percent. "This year, it's offsets," says the aide.

On the Senate side, Sen. John Warner (R-Va.) has taken an aggressive stand against anything ringing of "Buy American." "He is willing to give up on [the authorization bill] if it means getting rid of the Hunter language," said one Senate aide. Added another Washington lobbyist: "This is going to be a very long conference."

Industry is weighing in on the debate. The Defense Trade Reciprocity provision "is nothing more than a poorly camouflaged attempt to institute some of the more onerous provisions of 'Buy America' Act legislation," said Dan Heinemeier, president of the Government Electronics & Information Technology Association. "If the House language prevails, we could see serious damage done to our relations with key allies, such as Great Britain. This could lead to retaliatory policies by our allies that bar our industry from the ability to compete for important contract opportunities abroad."

The Aerospace Industry Association opposes the inclusion of the offset provision in conference. "We don't support offsets as a concept, but it's a cost of doing business in a global marketplace," says AIA vice president of legislative affairs Jon Etherton. "We recognize the distorting effect offsets have on trade, the only issue is what are the mechanisms for dealing with them? We can't just drop out of the marketplace."

Hunter is holding hearings and admits that the issue is "a very complex problem that once was small but has now reached a level that demands that it be brought under control." The big defense contractors, must not be at a competitive disadvantage, but also should not be allowed "to leverage away someone else's market share in order to compete in the global defense trade," he said at a hearing held on June 17.

Small- and medium-sized defense manufacturing companies with little or no Washington lobbying skills are losing business to offset arrangements. They are becoming more vocal as large contractors are signing deals that often shift more than 100 percent of the cost of the contracts to overseas facilities. Hunter said Lockheed Martin's sale of 48 F-16 fighters to Poland for $3.5 billion carried with it offsets worth $9.7 billion, 2.6 times the value of the F-16s. "Any way you look at this sale, we gave away much more than the Polish government purchased," Hunter said.

Lockheed Martin lined up about 20 U.S. companies to be engaged in the Poland deal, even though some of them had nothing to do with the production of the F-16s. Pratt & Whitney purchased a Polish factory, modernized it and created a manufacturing line that made engine components for the F-16s. "These components and assemblies are then shipped back to the U.S. for assembly into the engine," Hunter pointed out. Polish companies were able to sell tooling for Cessnas, components for land-moving equipment to Caterpillar, "roll-on roll-off" ships from a Polish shipyard, aircraft and helicopter parts, automotive parts, pressure-cast aluminum parts and electronic parts.

Even the U.S. Chamber of Commerce was involved in Lockheed Martin's F-16 contract. As one offset provider, the Chamber worked with Sandia National Laboratories in a deal with Krajowa Izba Gospodarcza to create an "export support system for small-and medium-sized Polish businesses for exports to the United States," according to documents from the House Armed Services Committee. United Technologies Corp. created a Materials Research Center at Poland's Air Institute in a deal with Instytut Lotnictwa of Warsaw.

"The free-trade mantra is for free and open competition," said Hunter. "Does anyone really think that American shipyards had fair and open competition for the ships included in this deal?"

At the June 17 hearing on the issue (another is planned for July 8), Hunter heard sad stories of U.S. companies having to agree to shift manufacturing production as recently as weeks ago to Spain and Japan as a result of those governments' demands for offsets.

The Spanish government even has an agency "that enforces these requirements," said Rick Edger, president and CEO of Jared Industries, a company with 100 workers based in Brunswick, Ga. "The ultimate effect of offset requirements...is to shift manufacturing jobs out of the U.S.," Edger said. "For too long our government has simply watched our manufacturing businesses decline while our technology and our jobs are transferred to other countries, raising our defense costs here in the U.S. To some it may seem like an academic exercise, but to those of us who make up the defense industrial base it is both a critical business issue and a critical national security issue."

Senate aides working on offsets said they were expecting Sen. Chris Dodd (D-Conn.) to introduce a companion bill to Hunter's. But Sens. Warner and John McCain (R-Ariz.) are bulldogs on the issue, effectively defeating any variant of the "Buy American" provision being debated.

If an offset provision had been introduced and defeated in the Senate, then Hunter would have had no chance of negotiating his language into the final conference committee report. "It was well known that anything that has to do with Buy American this year was an attack on Warner and his ability to negotiate effectively with Hunter in conference," said one Senate aide.

Additional interest in the issue might pick up when the Commerce Department's Bureau of Industry and Security releases a report on offsets in August. That report should provide insight into how large the problem has become.

The Department of Defense also has its own study under way, due out next spring. That report, required in the FY 2004 Defense Appropriations bill, requires the Secretary of Defense to assess the impact offsets are having on the industrial base and report all of them to Congress.

"We're in the very beginning stages of where we are going to go on this," said one Senate aide.

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