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Offset Contracts as an Insurance Device in Building the National Security

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  • Vesa Kanniainen
  • Juha-Matti Lehtonen

Abstract

A dynamic multi-stage decision-theoretic approach is introduced to establish the optimal offset and its incidence, the contract price arising from bargaining, and the scale of the acquisition. A new rationale is suggested for offsets in terms of their role as an insurance devise. Results are derived for the pricing of delivery contracts subject to offset claims and their national security implications. It is shown that the national security is strictly convex in the offset transaction. As to the incidence of the offset, the offset claim is shown to be capitalised in the delivery price. The bargaining price is shown to depend on the value of the product to be delivered for the national security, the relative negotiation power of the contracting partners and the social cost of public funds. The analysis highlights the expectation effects of offsets on the bargaining price and the scale of delivery. The results aid in explaining why offsets are widely used in procurement contracts for defence materiel. As they contribute to the national security, they should be allowed to survive and not be denied under competition laws.

Suggested Citation

  • Vesa Kanniainen & Juha-Matti Lehtonen, 2017. "Offset Contracts as an Insurance Device in Building the National Security," CESifo Working Paper Series 6445, CESifo.
    • Handle: RePEc:ces:ceswps:_6445
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    File URL: https://www.cesifo.org/DocDL/cesifo1_wp6445.pdf
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    References listed on IDEAS

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    1. Nash, John, 1953. "Two-Person Cooperative Games," Econometrica, Econometric Society, vol. 21(1), pages 128-140, April.
    2. Caves, Richard E & Marin, Dalia, 1992. "Countertrade Transactions: Theory and Evidence," Economic Journal, Royal Economic Society, vol. 102(414), pages 1171-1183, September.
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    4. Jurgen Brauer & John Paul Dunne, 2011. "Arms Trade Offsets: What Do We Know?," Chapters, in: Christopher J. Coyne & Rachel L. Mathers (ed.), The Handbook on the Political Economy of War, chapter 13, Edward Elgar Publishing.
    5. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
    6. Hennart, Jean-Francois & Anderson, Erin, 1993. "Countertrade and the Minimization of Transaction Costs: An Empirical Examination," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 9(2), pages 290-313, October.
    7. Rolf Mirus & Bernard Yeung, 1986. "Economic Incentives for Countertrade," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 17(3), pages 27-39, September.
    8. Carol Petersen, 2011. "Defense and Commercial Trade Offsets: Impacts on the U.S. Industrial Base Raise Economic and National Security Concerns," Journal of Economic Issues, Taylor & Francis Journals, vol. 45(2), pages 485-492.
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    Cited by:

    1. Stephen Kelly & Daniel Chicksand, 2024. "A Critical Exploration of Bargaining in Purchasing and Supply Management: A Systematic Literature Review," Group Decision and Negotiation, Springer, vol. 33(3), pages 617-646, June.

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    More about this item

    Keywords

    offsets; national security; defence material; insurance;
    All these keywords.

    JEL classification:

    • H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management
    • H56 - Public Economics - - National Government Expenditures and Related Policies - - - National Security and War

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