Japan has yet to harness the potential of offsets to reduce defense costs

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Security threats in East Asia are increasing as China builds larger and more sophisticated weapon systems and North Korea advances its missile development program. While Japan’s defense spending has slowly increased, there is a limit to what the country can spend. Former Defense Minister Nakatani Gen says offsets – widely used overseas but not by Japan – are an option worth considering.

What are offsets?

TO INTERVIEW The defense budget for fiscal 2021 is expected to climb to 5.34 trillion yen, the highest on record. How much of this will be used to buy arms, supplies and equipment abroad?

NAKATANI GEN The share claimed by imports is increasing year by year. This is especially true of items covered by the Foreign Military Sales Program, in which Washington provides defense items and services to its allies. The budget request for FY2021 includes imports of 3.7 trillion yen under the FMS, of which 3.1 trillion yen will be for items used in Japan and 500 billion yen overseas.

TO INTERVIEW Japan’s economy has been decimated over the past year due to the COVID-19 outbreak, but purchases of weapons and equipment from foreign sources are expected to increase in order to counter developments in China and China. North Korea. Can the Japanese government do anything to overcome this dilemma?

NAKATANI One option would be to introduce compensation obligations in our military purchases. Such agreements are common in countries around the world, and Japan is one of the exceptions to the absence of such a mechanism. It is essentially a barter agreement where the sales of the exporting country are conditional on the purchase of items from the importing country. For example, Japan may agree to purchase fighter jets if the exporter purchases Japanese armored amphibious vehicles or allows a Japanese manufacturer to assemble them in the domestic market. Under some arrangements, non-military compensation is offered, such as investments in unrelated factories or even purchases of agricultural products. Japan has never engaged in the latter type of transaction.

TO INTERVIEW Can you give us some examples of how offsets work?

NAKATANI When Brazil bought Gripen jet fighters from Swedish company Saab, it negotiated to allow production to be licensed to a domestic manufacturer. And when Britain’s BAE Systems sold fighters to Saudi Arabia, it agreed to invest in building sugar, pharmaceutical and petrochemical refining plants in the country.

TO INTERVIEW If agricultural products were offered as payment for military equipment, could Japan trade rice for fighter jets?

NAKATANI Yes it’s possible. Thailand, for example, offered compensation offering frozen chicken to pay for its purchase of F-16 fighters. This never materialized because the Thai government was ousted by a coup, but Japan could in theory offer rice, wagyū beef, or fruits under a similar cleared exchange agreement.

Nakatani Gen discusses the benefits of offsets. (© Takayama Hirokazu)

Why use offsets?

TO INTERVIEW Why do you think Japan should seek compensation?

NAKATANI In the past, when purchasing military equipment from the United States, Japan entered into agreements for licensed production, domestic assembly or joint development by American and Japanese companies. This contributed to the development of the Japanese defense industry and helped consolidate the country’s defense industrial base. But these arrangements have become quite rare in recent years, as the rules for protecting sensitive technologies have become stricter. In addition, the price of military equipment is generally not negotiable, so Japan could pay an unreasonably high sum for its imports. Compensation agreements require the seller to buy an equivalent amount from the buyer, so they function as a deterrent to higher prices. This gives Japan a chance to compensate for its weak trading position in a short market.

TO INTERVIEW Are there any rules on how much or what percentage can be paid by bartenders?

NAKATANI India has institutionalized compensation whereby any military purchase worth more than $ 30 million requires compensation of at least 30%, with most deals calling for around 50%. In some European countries, however, the percentage may be 100% or even more. Each country has its own rules.

TO INTERVIEW I understand that when France bought three AWACS [Airborne Warning and Control System] US reconnaissance aircraft in the late 1980s for $ 800 million, compensatory provisions included an agreement for the United States to purchase jet engines from France worth 130 percent of the price purchase of AWACS.

NAKATANI Yes, it’s true. Many countries develop their own unique armaments and military equipment, which are often protected as defense secrets. In this regard, the acquisition by the United States of French expertise in the field of engine technology has not been without merit. The deal may have been costly for Paris, but it was a godsend for the national defense industry, so I would say it was a win-win.

TO INTERVIEW Concretely, what should Japan do to introduce compensation?

NAKATANI Trade is under the jurisdiction of the Ministry of Economy, Trade and Industry, so the Ministry of Defense should work with METI to formulate clear rules and guidelines. And the transfer of defense materiel to foreign countries would have to be approved on a case-by-case basis as some restrictions on arms exports are still in place. But if the government has the will, it is possible to find ways to enter into compensation agreements.

The need for political commitment

TO INTERVIEW Then all that would be needed would be a green light from Prime Minister Suga Yoshihide.

NAKATANI There is no question of negotiating a compensation deal at this time, but before anything can happen, the prime minister is expected to announce that Japan is open to such arrangements. Only then can we start the preparatory work to establish procedures and the like.

TO INTERVIEW Given Prime Minister Suga’s enthusiasm for lowering cellphone rates and NHK viewing fees, I’m sure he would appreciate any ideas on how to get more for the money spent on defense. . Did you have the opportunity to speak to him directly or with Minister of Defense Kishi Nobuo?

NAKATANI I raised the issue in my questions to the Diet, as well as at a meeting of the House Security Committee in November 2020.

TO INTERVIEW The FY2021 draft budget allocates about 600 million yen to “the appropriate transfer of defense equipment abroad” to promote exports of competitive products developed in Japan. Any thoughts on this?

NAKATANI I think this will not only help strengthen Japan’s defense industrial base, but also facilitate coordination with our partners in joint exercises if we use the same equipment. It can also strengthen the reputation of our defense industry if these products help increase the capacity of the procuring country.

TO INTERVIEW Offsets could also come into play when Japan is the exporting country, if the importing government seeks to enter into a countertrade agreement.

NAKATANI It will depend on that country’s negotiating position. India, as I mentioned, requires offsets as a rule, and the United States could seek such arrangements as well. We’ll have to see. One thing that currently hinders Japanese exports is the need for every item to be METI cleared. Most manufacturers are not willing to risk building products that they might not be able to sell overseas. And if they are unable to make a profit, there is no point in doing so. The government must provide some kind of insurance to encourage the development of the Japanese defense industry.

TO INTERVIEW Do you think Japan will resort to offsets in FY2021?

NAKATANI I am doing what I can to promote the idea, but the outlook is not bright. Before the Three Principles of Arms Exports were replaced in 2014 by the Three Principles on Transfer of Defense Equipment and Technology, there was a de facto ban on all military exports. Although the restrictions have been relaxed somewhat, any time Japan tries to sell defense equipment it becomes a political hot potato. The administration must therefore follow a very fine line on this issue. Having said that, it is something that deserves serious consideration; given the growing tensions in East Asia, we will need to strengthen our security in areas such as missile defense and space operations without overburdening our strained public finances.

(Originally published in Japanese on January 28, 2021. Banner photo: The Thai government has already proposed a chicken compensation deal [© Kyōdō] for F-16 combat aircraft [courtesy the US Indo-Pacific Command].)

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