Military Offsets as a Tool for Development:

Poland, A Case Study

 

Military Offsets as a Tool for DevelopmentF-16 Deal with Poland

• 1998: Poland admitted to NATO in 1998

• 2001: Poland’s Parliament approved $3.5 billion to upgrade its fighter planes

• 2002: US Congress approved 15-year, $3.8 billion loan to Poland• US Government’s Deal with Poland

• $3.8 billion Foreign Military Financing loan• Interest payment through 2010; Interest plus principal 2011 through 201• Advanced Medium- & short-range air-to-air missiles• Maverick air-to-ground missiles• Laser-guided and other bombs• Radio-frequency countermeasures• Potential for acquisition of new F-35

• 2003: Poland negotiated a $6 billion offset deal with Lockheed Martin

Offset Practices

• Reciprocity arrangements conditions on foreign suppliers • Designed to compensate the buyer for selecting a foreign supplier • Commit the seller to certain obligations• Up to 100%+ of purchase price• Used in reference to military & high-dollar-value civilian contracts

• Buying Country Stategies:• Hard currency generation to alleviate shortages of foreign exchange• Technology transfer to build competitiveness• Domestic content to promote locally manufactured goods• Marketing assistance• Economic stimulants forming part of a country’s economic recovery program

• Selling Country Strategies:• Competitive or commercial reasons • Standardization & interoperability reasons • Concern for job losses & distortion of world trade• Work to mutual advantage

• Low-cost suppliers• Transferring technology, but not creating competitors• Building customer relationships

Military Offsets as a Tool for Development

Offset Agreement for Procurement of Lockheed Martin F-16s

• $3.5 Billion Contract for 44 F-16• Improving NATO fleet interoperability and standardization

• $6 Billion Offset Arrangements• Responsibility lies with Lockheed Martin

• 47 Projects

• Some of the Companies & Organizations Involved:• Lockheed Martin• Pratt & Whitney• Goodrich• Halliburton• CH2M Hill• Sandia National Laboratories• University of Texas

Military Offsets as a Tool for Development

Offsets & Their Valuations: Creativity & Leverage

• Setting Offset Values• Buyer & Seller work together to identify projects & potential investment value• Multipliers applied in many countries

• Set by law• Dependent upon project type

Military Offsets as a Tool for Development

• Result:• Less than reported value actually flows into buying country

Benefits vs Cost

Pros:• FDI: Projects worth $6 billion• Alignment w/gov’t strategy• Countertrade

• US commercial aircraft parts• Improve competitiveness thru technology acquisition

• Joint ventures in high tech areas• Co-production• Aftermarket opportunities• Technology centers/institutes• Improved infrastructure

• Telecommunications• Increased foreign trade

• Establish markets in high tech areas• Venture funding• Training

• Joint ventures/mfg expertise• Business development

• Managerial• Quality

• Commercial investment• Oil refinery, steel mills, shipyards

Military Offsets as a Tool for Development

Benefits vs Cost (cont.)Military Offsets as a Tool for Development

Cons:• FDI: Multipliers result in less dollars flowing in• Use of scarce resources to buy military

equipment• $0.2 billion/yr (2004-2010)• $0.8 billion/yr (2011-2015)

• Joint ventures independent of offset req’ts• Necessary infrastructure improvements

neglected• Roads• Railroads• Health service• Agriculture

• Risk of losing EU funding• Selling companies

• Slow on meeting investment req’ts• Market distorting• Lack of openness• Limit on forces to improve business climate• Direct gov’t intervention in market

• Gov’t choices in industries

Summary

• Offsets Role• Major role in decision & contract negotiations

• Offset Function• Major role in economy of buying country

• Issues:• Offset valuation

• Offset multipliers• Developing countries spending resources on large military equipment• Alternate use of resources • Alternative FDI• Market distortions• Direct government intervention in markets

Military Offsets as a Tool for Development

Back-up

Offset Agreement for Procurement of Lockheed Martin F-16s

Military Offsets as a Tool for Development

Form of Offset DefinitionLockheed Martin & Other US Companies

Offset Projects (partial list)Type of

Compensation

Subcontracts to make commercial jet trainers Indirect

Parts for business aircraft for export to the U.S.Indirect

Coproduction Assembly, processing, manufacturing of components or equipment in buyer's country

Agreement potentially worth $200 million with PZL Mielic, Poland's major aircraft manufacturer

Direct

Industrial Memorandum of Agreement with PZL Swidnik (helicopters), WZL-2 military works facility, Radwar, Institute of Aviation

Indirect

A partnership with the University of Texas to start a technology accelerator at the University of Lodz

Indirect

Venture with Accenture for a new technology center in Lodz

Indirect

Subcontracting Manufacture of compatible components in buyer's country

Goodrich's plant in Krosno to produce landing gear

Direct

Pratt & Whitney's PZL Rzeszow facility to assemble F100 engines

Direct

$70 million technology venture capital fund in coordination with Sandia National Laboratories

Indirect

High technology ventures IndirectInvestment in Polish steel mills and shipyards IndirectEnvironmental and water treatment projects with Polish unit of CH2M Hill Inc.

Indirect

General Motors to expand a car plant in PolandIndirect

$540 million oil refinery for Polish Lotos oil company to be built by Halliburton, partially financed by Lockheed Martin

Indirect

Telecommunications technology Indirect

Funding of a joint company in buyer's country; Other direct investment

Investment

Commitment to purchase goods & services from buyer country (from supplier himself, subcontractors, or third parties

Transfer of new techology to buyer's country under direct contractual arrangements between supplier and buyer's country; may take the following forms: research and development, technical assistance, or other activities under direct commercial arrangement

Countertrade

Technology transfer

Funding Offsets

• Selling Company Allocates Small Budget• Typically 4 – 10% of selling cost• Program funding used• Typically charged back to buyer as part of overhead cost of purchased equipment

• Partner Companies• Often through new or existing investments in the buying country

• Offset Credit “Trading Account”• Seller’s own account• Purchased credits from other companies

Military Offsets as a Tool for Development

Exhibit 3. Boeing’s Offset Arrangement with South Korea

US$ (Billion)Total Contract $4.40Offsets to South Korea $3.30

Technology Transfer $1.5030 projects, including design & development of portions of the plane, its instruments, & armament system

Parts Manufacturing $1.3011 projects, including the wings and front fuselages of the plane

Maintenance Projects $0.502 projects involving sophisticated maintenance depots

Wayne, 2003

Polish Stats

Exhibit 7. Foreign Exchange Rates: Zloty, Euro, & US$

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

New Polish Zloty/euro

United States Dollar/euro

New Polish Zloty/US$

Polish Stats

1995 1996 1997 1998 1999 2000 2001 2002

GDP (nominal, bnUSD) 127.05 143.85 144.04 159.28 155.06 164.15 183.3 189.28

GDP (% real change) 7.1 6.0 6.9 4.9 4.0 4.0 1.0 1.4

Inflation Rate (%) 28.0 19.8 15.1 11.7 7.3 10.2 5.5 1.9

Interest rates (%) 25.0 22.0 24.5 18.2 19.0 21.5 14.0 7.5

Capital Investment/GDP (%)

18.6 20.7 23.5 25.1 25.5 23.9 20.9 19.1

Foreign direct investments (bn USD)

3.7 4.5 4.9 6.4 7.3 9.3 5.7 6.1

Unemployment (%) 15.2 13.2 10.5 10.4 13.0 13.9 16.2 17.8

PAIZ, 2003; Political Risk Services, 2003; Annual economic indicators, 2003

Table 1. Key Economic Factors in Poland