South America Initiates Sophisticated Offset Barter In Defense Purchases

By Gary Pacific

Industrial participation programs, known as �offsets�, have started to flourish in South America. In essence, these economic benefits programs are nothing more than high-tech barter. They are a result of large defense sales of aircraft and other arms systems starting to take a hold in Brazil, Chile and Colombia.

Foreign purveyors of sophisticated aircraft, who often are in a fierce battle over highly competitive situations, must use offsets to gain favor from the ultimate government buyer.

Some South American countries are following the advice of their European counterparts. Thus, they are incorporating and imposing difficult requirements on those defense contractors.

Counter-trade has a long history in facilitating the sales of arms and defense programs in Argentina and Brazil as a means of converting soft currencies. Now the latest offset programs are stressing local fabrication, technology transfers and economic benefits.

It is only recently that Chile mandated the imposition of offset guidelines on its F-16 aircraft procurement from Lockheed Martin. The offset part of the sale of the modern F-16�s to Chile is being managed by the Chilean governmental economic development agency called CORFO.

Brazil has a similar program for the potential procurement of the French Mirage 2000-5, or the Lockheed F-16 being contemplated. Only in the last few months has the Lula administration decided to temporarily suspend the procurement.

Colombia is under a lot of pressure to continue the modernization of its Air Force (Fuerza Aero de Colombia) with a purchase of 22 aircraft. Included in the recent tender is a very extensive offset guideline.

It is obviously patterned after the Spanish FA-18 guidelines imposed on McDonnell Douglas over twenty years ago. A high official from the Colombian Ministry of Defense was in Spain for a month being trained by ISDEFE, the Spanish offset Czar�s office.

Hugo Chavez, the populist Venezuelan President, is having his administration negotiate with the Russians to purchase 50 of the highly sophisticated Mig 29�s. Stories coming from Venezuela indicate that they are seeking local fabrication of these aircraft near Caracas. This co-production technology is a typical offset function and would result in a new aerospace industry not currently in Venezuela.

The economic impact would result in a new aerospace industry and provide for highly technical jobs. There are even rumors that the Brazilians are offering to assemble turbo-prop Tucanos, or perhaps a more modern jet aircraft called the AMX.

Where is all of this headed?

The purchases of major defense items are extremely costly to these Latin American countries, especially when most governments in this hemisphere are under political pressure to provide infrastructure projects. Perhaps, with the need for sophisticated defense equipment comes the need for advanced counter-trade barter programs as well.

In the case of Colombia, the estimated value of the 22 aircraft is $234 million dollars. The value of the offset compensation is $234 million dollars as well.

Currently, there are over ten foreign defense contractors bidding on aircraft to the Colombian Air Force (FAC). However, it is well known that the specification was originally prepared for the Brazilian Embraer Tucano 321, to cover the contractors limited capabilities.

The Tucano, which is now in the FAC�s inventory, is basically a turbo prop aircraft. Most of the foreign competitors are offering jet turbine fighters with modern avionics and weapons delivery systems.

The Colombian offset program requires that the defense contractor provide a mix of 60% aircraft oriented projects and 40% social oriented programs. They are given 5 years to complete the offset obligation in a separate contract to that of the aircraft.

A stiff liquidated damages penalty is also tied to the offset performance if the defense contractor cannot complete their program within the milestones and schedule as negotiated within the offset contract.

The Chilean program has a committee of resourceful executives from a cross section of the many governmental agencies. In this way each governmental agency or ministry can help guide the offset programs to the objectives and goals that they administer for the total benefit of the government.

In the Colombia program the management of the offset program follows the Spanish model of keeping the offset compensation under the purview of the Colombian Minister of Defense. Unfortunately, this all but eliminates an exchange of industrial and economic benefits across the full governmental spectrum.

Also, typical of the Spanish program is a staid management style, which under the McDonnell Douglas FA-18 program resulted in a dogmatic philosophy of, �do it this way, or else� attitude.

Some economists might say that these offset programs being forced upon the defense firms are nothing more than economic warfare, since in essence they eliminate badly needed aerospace work needed in the home country. This has always been a case for the Washington core of machinist unions and anti-outsourcing lobbyists.

Gary Pacific has an extensive background in the countertrade industry covering over 25 years with various Fortune 500 companies. He has experience working in Turkey, UAE, Taiwan, Brunei, Peru and Venezuela.

(This article was provided to BarterNews magazine January, 2006.)