The recent mega Saudi arms purchase agreements signed during President Trump’s visit to the Kingdom, reportedly around $110 billion, has renewed the debate on localizing part of the military expenditures in the Kingdom through manufacturing components of the military package, often referred to as an offset program.
Offset programs can be deemed to be special cases of foreign direct investment and transfer of technology, with offset, in essence, being one form of counter-trade whereby it refers to the requirements of an importing country that their purchase price be “offset” in some way by the selling nation.
Arms sellers may be required to source some of the production locally, to increase imports from the importing country or to transfer technology. The Kingdom has already taken the first step to ensure that there is an institutional capacity on the ground to manage this, and has established the Saudi Military Industries (SAMI), a Public Investment Fund owned entity, to oversee the project.
A Saudi Offset Program can be a powerful tool for domestic investments, for those seeking to enter the lucrative Saudi market. An Offset Program has been in existence since 1984, when Saudi Arabia was the first country in the Gulf Cooperation Council (GCC) to set up such a program.
To date though, despite some commendable efforts by some of the governments involved in arms sales to the Kingdom, notably Britain, the results have been disappointing and Saudi Crown Prince Mohammed bin Salman noted that only around 2 percent of all military purchase are produced in Kingdom.
What Crown Prince Mohammed bin Salman aims to do is now promote the direct offset mechanism as opposed to the largely symbolic indirect offset projects carried out under previous arms agreementsDr. Mohamed Ramady
Offset programs can be classified as “direct” or “indirect” offsets. Direct offsets are those by which the purchasing country joins the selling country to supplement elements of the underlying purchased product through co-production, technology licenses and other supply arrangements.
Indirect offset means the selling nation agrees to assist the importing country in its general development and investment strategy, unrelated to the principal contract item.
What Crown Prince Mohammed bin Salman aims to do is now promote the direct offset mechanism as opposed to the largely symbolic indirect offset projects that have been carried out under previous arms agreements.
There are many forms of offset models for the Kingdom to choose from. These include co-production overseas production, based on government-to-government or producer agreements that permit a foreign government to acquire the technical information and tooling to manufacture all or part of a defence contract, and this is the most advanced form of offset and localization but greatly dependent upon a high degree of local technology and R& D expertise.
The second is directed sub-contracting procurement of domestic-made components for incorporating or installation in items sold to that same nation under direct contracts, and this is the interim solution for Saudi Arabia’s SAMI. The third is technology transfers/licenced production assistance in establishing defence industry capabilities by providing valuable technology and manufacturing know-how.
This seems to be the initial model for Saudi Arabia as evidenced by the agreement with Lockheed Martin to assemble 150 Blackhawk military helicopters in the Kingdom, valued at $6 billion.
The Peace Shield programs
The Saudi offset program started with the Peace Shield programs with the US, the Al Sawary Program with France, and the larger Al Yamamah program with British Aerospace, and the hope was that the offset mechanism would generate many benefits to the Kingdom.
These would be in the areas of industrial development and economic diversification, spurred on by the inflow of new technologies in sectors such as aviation engineering, electronics, computer and information technology, as well as utilizing the Kingdom’s mineral resource base.
Other benefits would help with strategic self-sufficiency in crucial military or civilian sectors, such as defense systems, aircraft repair and modification. Employment of Saudis and human resource development was also a priority.
Finally it was hoped that a successful offset program would act as a major “drawing power” to attract other international companies to the Kingdom as a viable center for investment.
Many reasons have been put forward as to why the first generation Offset programs did not achieve their aim, ranging from the lack of progress in identifying “good” investment opportunities, or that foreign partners have been unable to obtain reliable local market data on potential local partners.
In the past, some complained about the multiple level of foreign, corporate and government administration they must deal with, but with the establishment of SAMI, there should now be no excuse from foreign arms suppliers.
The short-comings of the Offset Program in the past was due more to institutional, administrative and marketing constraints, rather than to financial or technological restrictions as evidenced by the number of successful non-defense related offset ventures pursued, especially by the UK Offset Program.
With determination and ensuring that all Saudi stakeholders are involved, whether in the private sector, leading academic and scientific research institutions and local manufacturing elements, as well as the appointment of Prince Mohammed bin Salman as Crown Prince and Minister of Defense, the prospects for a more successful localisation and Offset program is now brighter.
Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia.
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