Introduction: The UAE pursues aggressive defence industrialization through imports with offset agreements

As a natural consequence of the government’s ambitions to affirm its rising regional status, to balance against the potential threat from Iran, as well as to modernize its society and to diversify its economy, the United Arab Emirates have been aggressively pursuing defense industrialization through imports from major global producers.This has led them to become the most promising of the Arab candidates seeking to attainthe status of an emerging arms producer[1]. Out of all enabling factors, it is unquestionably the country’s large and sophisticated offset program that hascontributed to the development of their indigenous defense capabilities, in the sectors, such as land and naval platforms. 

The defence industrial policy of the UAE: the role of imports through offset agreementsMeanwhile, it has to be emphasized that offsets are, in theory, trade restrictions imposed on exporters by importing states: in comparison with direct off-the-shelf purchases, they impose significant additional costs to customers, thus carrying a certain degree of inefficiency with themselves. With the UAE having applied the most extensive mandatory offset policy among MENA states [2], a question arises on whether this kind of trade restrictions efficiently address the defence industrial requirements of the country, especially during the period of declining oil revenues.

Via illustrating how procurement deals in different sectors have different effects on the domestic industry;this paper concludes by suggesting the UAE government to clearly define their concrete import goals, as Abu Dhabi’s decision on what to buy has a direct impact on what they wish to produce. Furthermore, this paper challenges the mandatory character of the government’s offset policies, – specifically concerning the fields, such as the aerospace industry and C4ISTAR (Command, Control, Communications, Computers, Information/Intelligence, Surveillance, Targeting Acquisition and Reconaissance), –while supportingthe idea of ‘variable offsets’ policywith respect to different sectors, as means to achieve a more efficient defence industrial strategy in the long term.

 

Offsets are the products of imperfectly competitive markets

When procuring goods in imperfectly competitive markets (which is characteristic for the defence industry), the price is typically set above costs. This provides an opportunity: i) for the government to use its bargaining power to extractsome of this surplus from sellers; and ii) for the supplier to offer a package of benefits in the form of an offset to the customer as means to attract the latter side [3]. Within the defence markets, these benefits:1) can either be directedat the development of the local defence industry of the purchasing country through the form of local subcontracting, technology transfer, co-production or trainings (direct offsets); 2) or can be aimed at the other sectors of the domestic economy through foreign direct investment, export assistance orprocurement of local goods and services that have a specified value in relation to the contract price (indirect offsets).

The defence industrial policy of the UAE: the role of imports through offset agreementsPolitical rationales for offsets invoke a range of objectives: they reduce the economic impact of expensive arms purchases on taxpayers, foreign exchange and balance of payments; they help guarantee, to a certain extent, the security of supply; they may be seen as a strategy for the modernization of national economies and for the creation of local employment; they may be sought as a means of linking local firms into the global defence supply chain. Having recognised these advantages, some governments tend to apply mandatory offset policies to all arms imports above a certain value. In the UAE, in turn, defence contractors hold the obligations equal to 60% of the supply contract value, given the cumulative contract value exceeds USD 10 million [4].

Ultimately, this heavy concentration on offsets leads procurement decisions to be based on criteria other than military capability needs, equipment quality and price.What this implies for the defence industry of a buyer such as the UAE will be discussed in the following paragraphs.

 

Positive perspective: offset agreements on naval and land platforms have helped create indigenous production in the UAE

As mentioned, offsets appear to provide industrial benefits for the buyers, in the form of jobs, technology transfer and support for the defence industrial base. Particularly, the UAE’s stringent offset policies, since the initiation of its Offset Program in 1992, have required the contractors to either transfer technology or establish joint ventures with local firms [5]. These obligations have contributed to significant growth in the domestic defence sector in the fields of shipbuilding, systems integration, naval logistics and MRO (maintenance, repair and operation) activities [6]. In case of land platforms, multiple joint ventures of local companies with various foreign actors, haveultimately led to the manufacture ofplatforms, such as 4x4 and 6x6 armored infantry fighting vehicles (AIFVs) with the help of Western technologies [7]. Adoption of the necessary technologies and ‘know-how’ further led to the creation of local joint ventures, such as Nimr Automotive in 2000, the products of which stand today as one of the most prominent “made in the UAE” successes. As a result, the country has not only achieved self-sufficiency in this area, but also has begun steadily developing its businesses to export trucks and armored vehicles to neighboring countries such as Algeria, Libya and Jordan. 

The defence industrial policy of the UAE: the role of imports through offset agreementsNaval shipbuilding is another clear example of rising intent and capability driven by offsets and local work share. The inauguration of the Abu Dhabi Ship Building (ADSB), which initially had to focus on naval repairs and refits, was the consequence of offset agreements signed by the government in the 1990s. ADSB gradually expanded its expertise to include building sophisticated war ships, as in 2012 ADSB launched its first-ever indigenously developed Ghannatha class missile patrol boat for the UAE Navy. Meanwhile, ADSB’s six-ship Baynunah Corvette program stands as the largest and most ambitious naval shipbuilding project in the Gulf. Having been developed by the French company CMN and built by ADSB, this program demonstrates the country’s large export perspectives for the medium term [8].

 

Negative perspective: UAE’s mandatory offset deals on high-technology systems purchases are costly and have no significant utility for the local defence industry

Besides the fact that the costs of the offsets are included in the premiums that the customers have to pay, the mandatory character of offsets also prevent the customers’ability to negotiate price discounts instead of offset conditions, - even in purchases related to the sectors where the domestic self-sufficiency is either not a priority for the government, or not within its capacities.The UAE, for instance, acknowledges that it is not likely to achieve self-sufficiency in sophisticated platforms, such as the aerospace or C4ISTAR capabilities, at least for two reasons: i) the R&D costs are prohibitively expensive, while UAE’s R&D spendings (0.47% of GDP) are well below the OECD average (2.2% of GDP) [9]; ii) the limited number of native population and high-skilled workers creates a structural roadblock for this purpose. Furthermore, while offsets can appear to offer substantial work shares, it is unlikely that they will provide much high technology work, as offsets are for the purchase of existing defense equipment where all the major development work has been completed [10].

Consequently, in relation to the incurred expenses, imports of sophisticated weapons through offset agreements seem to have only minor effects on the domestic industry of the UAE. In fact, the primary motivations behind the huge amount of spendings by the government on ‘glamour’ sophisticated systems, such as C4ISTAR, appear to be the regional arms race and the country’s pursuit of prestige, rather than the utility to the local defence industry. 

This raises the question whether mandatory offsets are the most efficient means for the importation of these kinds of products. According to Markowski and Hall, if the customer has the necessary market power, it should be able to use its market power effectively for a more advantageous procurement deal with or without offset obligations and can negotiate price discounts as easily as package enhancements [11]. Considering that the UAE’s market power is indeed sufficiently high (due to its expanding market [12] and increasing rivalry between multiple global actors such as the U.S. and Russia for its market share [13]), then why does the country persist with mandatory, broadly targeted offsets rather than negotiating specific ones on a case-by-case basis when advantageous? The following policy recommendations will address this question

 

How to increase the utility of UAE’s arms imports for the development of the local defence industry?

1. Formulating clear defence production policy: While the UAE’s defence industrial aspirations are undoubtedly strong, the country lacks an official production policy. Significantly large amount of procurement plans and decisions are based on threat scenarios primarily driven by the Iranian military potential, making procurement procedures exclusively reactive or prestige-oriented. Indeed, defence industrial ambitions of the country are only presented on the documents related to purchase deals and no comprehensive strategy or policy has been adopted on this issue [14]. Consequently, clear defence production policy is needed to be introduced, in order to concisely and transparently articulate the country’s agenda for supporting a domestic defence industrial base.

2. Applying ‘variable offsets’ policy: As Taylor suggests, gradually removing mandatory offset policies and giving procurement officers the choice between attaching an offset to the government purchase or negotiating price discounts in markets, can be an effective measure in getting rid of the abovementioned costly offset deals that have no significant effect on the development of the local defence industry. Providing the negotiators with the opportunity to compare the net benefits of a price margin exchange with an offset for the particular economic setting, would reduce the probability of the UAE’s approval of the offset proposals that result in production diseconomies. Instead, various flexible offset deals can be devised dependent on the sector, for instance: joint ventures mayremain prioritized on naval platform purchases; whereas in case of abovementioned high technology systems purchases (aerospace, C4ISTAR etc), the government mayeither opt for direct less-costly off-the-shelf purchases, or introduce offset agreements that require investing in the R&D sector of the countryby the suppliers. While ongoing joint ventures and technology transfers through mandatory offsets have secured the UAE’s inefficient and unsustainable low-tier level local participation in the production of those high-tech systems, investments in the R&D sector would more effectively contribute tothe country’s defence industrial baseby boosting its competitiveness in its already established sectors.

 

 

References:

1. Osborne T., ‘UAE Industry Builds Capability’, Aviation Week & Space Technology, 2013.

2. Jovovic A., ‘Opportunity amid uncertainty: defense procurement in the Middle East & North Africa’, Avascent White Paper, 2014

3. Taylor K.T., ‘Countertrade offsets in international procurement: theory and evidence’, New Horizons in Public Procurement (2011), PrAcademics Press, Florida USA

4. ‘The Program’, Tawazun Economic Council, https://tec.tawazun.ae/the-program/

5. ‘The UAE Defense Industry – market opportunities, entry strategies, analyses and forecasts to 2016’, ICD Research, 2016.

6. ‘UAE leads Gulf Arab push to build up domestic defence industry’, Reuters, 2013, http://www.reuters.com/article/uae-defence-idUSL6N0BJ73020130219

7. GaubF., Stanley-Lockman Z., ‘Defence industries in Arab states: players and strategies’, ISSUE Chaillot Paper № 141, 2017.

8. ‘Abu Dhabi establishing itself as a key regional player in defence and security’, Oxford Business Group, 2017.

9. OECD, 2016 Research and Development Statistics: Government budget appropriations or outlays for RD, OECD Science, Technology and R&D Statistics (database). 

10. Hartley K., Sandler T., Handbook of Defense Economics, Vol. I, pg. 481-483, 1995.

11. Markowski S., Wylie R., Hall P., ‘Defence Procurement and Industry Policy: a small country perspective’, Routledge Studies in Defence and Peace Economics, 2010, pg.153-185.

12. ‘Global economic rebound boosting Middle East growth prospects’, IHS Markit News, 2014. http://news.ihsmarkit.com/press-release/aerospace-defense-security/middle-east-presents-huge-growth-opportunities-defense-chem

13. Bilal Y. Saab, The Gulf Rising: defense industrialization in Saudi Arabia and the UAE, Atlantic Council, 2014.

14. Taylor K. T., The Proper use of offsets in international procurement, Journal of Public Procurement, Volume 3, 2003, pg. 338-356.

 

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