Report Summary
This Quwa Premium report (now a freely accessible resource) examines the viability of commercial offsets (tied to big-ticket defence purchases) in Pakistan. In this report, we briefly review the checkered history of offset packages, especially in the developing world. However, in contrast to many economic discussions of offsets – which assessed viability of such deals against the buyer and seller’s claims of development and savings – we benchmark offsets against resource optimization.
Unlike many countries, Pakistan’s defence or security establishment seldom requires public approval (in the mainstream democratic sense) to push defence purchases, but rather, they are constrained by fiscal resources. In effect, the discussion of offsets would, at least partly, revolve on the subject of return-on-investment (ROI) in that the results of offsets – such as new manufacturing entities, supply-chain contracts, foreign direct investment (FDI) or partnerships – must, ideally, reverse those constraints.
In other words, the purported economic benefits of offsets would have to be realized in order to fulfill the Armed Forces of Pakistan’s own strategic objectives, i.e. to secure long-term funding mechanisms to support ongoing and future big-ticket procurement.
Introduction
In its simplest sense, an “offset” is a counterweight. In defence procurement, an ‘offset’ serves to counter the expenditure of fiscal resources by the buyer with fiscal resources from the seller. For example, a fighter aircraft deal could be priced at $10 billion US. Under an offset package of 50% the contract price, the seller of that fighter aircraft would in some form return $5 billion US to the buyer’s economy. This return could take the form of investment in the buyer’s economy, countertrade or bartering by buying goods from the buyer or the buyer’s marketplace or a mix of the aforementioned methods.
In defence procurement, there are two forms of offsets: direct offsets and indirect offsets. Direct offsets involve the inputs necessary to bring a defence contract to fruition. For example, under an offset package, the seller could subcontract 10% of the value of the deal to suppliers in the buying country. Indirect offsets are transfers unrelated to the original contract: for example, the seller could invest in a kitchen appliance manufacturer in the customer’s market. Indirect offsets need not be outside of the defence industry. For example, the seller could connect a defence manufacturer in the customer’s market to produce parts for a defence system that the customer did not procure. This would be a form of countertrade.
Offsets are a recurring topic, especially in relation to the defence procurement dynamics of developing or low-income states where there are both fiscal constraints and macro-economic pressures. On the surface, offsets promise to manage – if not improve – macro-economic pressures by enabling the customer-state to control its balance-of-payments (BoP) by countering costly arms imports with exports and FDI resulting or borne from the arms contract. For Pakistan, offsets could be viewed as a means to remediate its macro-economic challenges while also procuring new armaments. In this sense, Pakistan could optimize its fiscal resources to multiple objectives – i.e. procurement, productive macro-economic activity and potentially transfer-of-technology (ToT) – through commercial offsets integrated to its arms imports.
The Challenge with Assessing Offsets
Though the backers of offsets – generally the governments buying arms and their suppliers – purport the value of offsets in retaining foreign or hard-currency for BoP, facilitating ToT, supporting exports by linking domestic industries to foreign supply chains and other means of productive economic activity. However, offsets are a contentious issue, especially from the standpoint of the purported benefits. In general, those skeptical of offsets – notably economists – cite the inherently costly, inefficient and opaque nature of the national security space as cause for doubting the utility of offsets, at least as a rule.
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