Offsets and Public Procurement

Abstract

Major government or public procurements directly and indirectly impact a country’s economy, infrastructure, industry base and even security. Foreign competition has the potential of reducing governments’ procuring costs. However, this will hurt local industries and employment. Hence, governments impose offset requirements: a form of contractual obligation such that a portion of what a foreign firm supplies must be produced locally. Offsets are prevalent in key areas of public infrastructure such as energy, communications and transportation, and especially in defense and security. Using the defense industry as a leading example, we develop a model where two governments seek to minimize their Net Defense Costs (NDC). Using a standard definition for NDC, we find that governments — when they act independently — will set full offset requirements. However, coordination of offset policy requirements could achieve lower NDCs for governments. In this case we find that offset are eliminated. Taking a broader definition for NDC that also accounts for gravitation of production from one country to the other, governments may set partial, rather than full, offset requirements, whereas joint decision is always full offset.