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ABSTRACT
Mandatory offsets are policy instruments to leverage defence procurement projects to conduct industrial policy. The prime contractor commits to generate new business in mutually acceptable sectors equivalent to a large percentage of the project value. Offset multipliers “relax” this constraint by discounting the prime contractor’s offset obligations if investments flow to sectors prioritized by the purchasing country’s industrial policy objectives. This endogenizes the relationship between the original project and the offset contracts. This paper provides a new theoretical analysis of the following three questions that have gone unaddressed in the literature. First, the efficiency of such policies depends on the absorption capacity of a targeted industry. If this capacity is low, import substitution is expensive and the prime contractor may rather choose to invest elsewhere in the economy to satisfy the overall mandatory offset constraint thereby thwarting the original objective. Second, whereas a uniform relaxation of offsets through multipliers can reduce distortions introduced by mandated offsets, multipliers may enhance distortions as an unintended consequence. Third, the prime contractor’s response to offset credit incentives may be weak due to transaction costs arising from having to find new domestic partners to satisfy the offset requirements and manage the contracts.
Disclosure Statement
No potential conflict of interest was reported by the author(s).
Notes
1. Germany, Greece, Italy, Netherlands, Norway, Poland, Turkey, UK, South Africa, Australia, India, Indonesia, South Korea, Singapore, Taiwan, Brazil, Chile, Colombia, Saudi Arabia and UAE (Kimla Citation2013; El Hajami and Chinoperekweyi Citation2019).
2. Direct offsets themselves can perhaps be split into offsets towards the same project they derive from and offsets towards other defence sectors (Palavenis Citation2021; Yedvav, Kordova, and Fridkin Citation2022). Although a direct offset is normally defined as business activity related to the original project subject to the offsets agreement, the prime contractor can still produce items directly related to the equipment or platform in question without being part of the original project and hence count towards indirect offsets.
4. In a similar, but smaller country, Norway, two-thirds of defence acquisitions are off-the-shelf OTS). Whereas ‘the three most commonly mentioned advantages are reduced procurement costs, reduced technological risk and a faster acquisition process. … ’ (Berg, Presterud, and Øhrn Citation2019]), there are two disadvantages. First, the product may not be precisely tailored to defence requirements, and as expectedly, OTS may be more suitable to consumables.