U.S. defense suppliers need to divert a lot of time and effort to managing "offset" programs aimed at bolstering Taiwan's industrial development.

"Offsets" - the requirement that the seller spend a specified amount of money in providing economic benefits to the buyer- are specifically outlawed for normal commercial transactions under the rules of the World Trade Organization. But offset requirements are common in international military sales, where WTO regulations do not apply. In Taiwan's case, its procurements from U.S. defense suppliers typically involve offset commitments equaling at least 40% of the contract value. The seller gains credits against those commitments through such actions as technology transfer, co-production, investment, or component purchases in Taiwan. Typically half the amount goes for "direct offset" programs - meaning defense products and services directly related to the sales agreement - while the remaining "indirect" portion covers altogether different types of industrial activities.

U.S. companies have grown increasingly disillusioned with the whole offset concept. The search for projects that can be used for offset purposes often forces them to get involved in areas far from their core expertise and to incur heavy overhead and personnel burdens in administering those programs. Besides the key professional relationships they have developed with the customer countries' defense ministries, they must also learn to accommodate the needs of government agencies with a quite different, economic agenda - in Taiwan, the Industrial Development Bureau (IDB) of the Ministry of Economic Affairs. Defense executives have frequently been led to wonder whether the host country's top priority in working with them is national defense or job-creation.

With Taiwan now considering a Special Military Budget of some US$18 billion to finance arms purchases from the United States, the issue takes on added relevance. Based on the 40% rule of thumb, US$7.2 billion would have to be spent or invested in Taiwan, and since the IDB recently implemented new regulations putting a cap of US$20 million on individual offset "industrial cooperation" projects, 360 different projects would have to be carried out - no mean challenge in terms of planning and management.

The problem could be even larger if the 40% figure no longer remains the standard. In the case of one recent transaction, the Taiwan government has informed the U.S. defense contractor that the offset requirement would be set at a minimum of 50%, and for another major weapons system the figure cited was 70%. The defense suppliers are uncertain whether enough meaningful projects can be devised to cover that level of offset requirement, or whether the result will be "make-work" programs that put people on a payroll but contribute relatively little to industrial development.

Since the cost of offsets must obviously be reflected in sales prices, growing budgetary pressure may eventually lead the Taiwan government to re-weigh the financial implications of these programs versus their actual benefits. At the very least, suggest industry sources, the government should look at how to streamline the increasingly stringent rules governing how offset is conducted - allowing the suppliers to concentrate more of their effort on their area of real expertise, the provision of state-of-the-art defense systems.