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Offset Contracts as an Insurance Device in Building the National Security

Author

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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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    References listed on IDEAS

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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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