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Military Offsets as a Tool for Development: Poland, A Case Study Military Offsets as a Tool for Development F-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 Military Offsets as a Tool for Development 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 • Result: • Less than reported value actually flows into buying country Military Offsets as a Tool for Development 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.) 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 Military Offsets as a Tool for Development 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 Back-up Military Offsets as a Tool for Development Offset Agreement for Procurement of Lockheed Martin F-16s Form of Offset Definition Countertrade Commitment to purchase goods & services from buyer country (from supplier himself, subcontractors, or third parties Coproduction Assembly, processing, manufacturing of components or equipment in buyer's country Technology Transfer of new techology to buyer's transfer 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 Subcontracting Investment Lockheed Martin & Other US Companies Offset Projects (partial list) Subcontracts to make commercial jet trainers Parts for business aircraft for export to the U.S. Agreement potentially worth $200 million with PZL Mielic, Poland's major aircraft manufacturer Industrial Memorandum of Agreement with PZL Swidnik (helicopters), WZL-2 military works facility, Radwar, Institute of Aviation A partnership with the University of Texas to start a technology accelerator at the University of Lodz Venture with Accenture for a new technology center in Lodz Manufacture of compatible components in Goodrich's plant in Krosno to produce landing buyer's country gear Funding of a joint company in buyer's Pratt & Whitney's PZL Rzeszow facility to country; Other direct investment assemble F100 engines $70 million technology venture capital fund in coordination with Sandia National Laboratories High technology ventures Investment in Polish steel mills and shipyards Environmental and water treatment projects with Polish unit of CH2M Hill Inc. Type of Compensation Indirect Indirect Direct Indirect Indirect Indirect Direct Direct Indirect Indirect Indirect Indirect Indirect General Motors to expand a car plant in Poland $540 million oil refinery for Polish Lotos oil company to be built by Halliburton, partially financed by Lockheed Martin Telecommunications technology Indirect Indirect Military Offsets as a Tool for Development Funding Offsets • Selling Company Allocates Small Budget • Typically 4 – 10% of selling cost • Program funding used • Typically charged back to buyer as part of overhead cost of purchased equipment • Partner Companies • Often through new or existing investments in the buying country • Offset Credit “Trading Account” • Seller’s own account • Purchased credits from other companies Exhibit 3. Boeing’s Offset Arrangement with South Korea Total Contract Offsets to South Korea US$ (Billion) $4.40 $3.30 Technology Transfer 30 projects, including design & development of portions of the plane, its instruments, & armament system $1.50 Parts Manufacturing 11 projects, including the wings and front fuselages of the plane $1.30 Maintenance Projects 2 projects involving sophisticated maintenance depots $0.50 Wayne, 2003 Polish Stats Exhibit 7. Foreign Exchange Rates: Zloty, Euro, & US$ 5.0 New Polish Zloty/euro 4.5 United States Dollar/euro New Polish Zloty/US$ 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Polish Stats Table 1. Key Economic Factors in Poland 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