In the newly democratised South Africa, who could say no to an investment into our economy of between R104- and R110-billion, with the creation of 65 000 jobs? This was the promise of the Strategic Defence Procurement Package (SDPP or arms deal) offset agreements. At the time it would cost the country around R30-billion – excluding financing costs – to purchase the arms, but parliamentarians were swayed by the potential benefits of offsets, and the deal was finalised in 1999.
The use of offsets is used globally as a means to counter the cost of large-scale government procurement, particularly in the trade of arms. But what do offsets entail? What role do they play in South African procurement deals? And most importantly, what role did they play in the arms deal?
Offsets are a particular form of counter-trade used to lessen the burden of large procurement deals on the purchasing country’s economy. The use of counter-trade became popular in the 1970s when governments could not afford to pay cash for large procurement deals, and sought other ways of repaying their debt. Offsets thus entail offsetting the cost of the product being bought, with a contribution by the seller to the buyer’s economy, either by purchasing goods from the buyer’s country or by investing in industries within the buyer’s country.
Offsets can be direct or indirect. With direct offsets, the goods purchased or investments made into the buyer’s economy have a direct relationship with the goods being procured. In the arms deal, these involved local companies sub-contracted for part of the software needed to run some items of equipment. Indirect offsets happen when the investments are not related to the product being procured by the buyer. In the arms deal, they included investment in the gold mining industry, which would contribute to the economy as a whole.
Offsets to be used sparingly
The World Trade Organisation does not look favourably on offsets, and has set clear limits on the manner and industries in which they may be used. According to the government procurement agreement signed by a number of states in 1994, the general rule is that parties are forbidden to request offsets, with the exception of government procurement in developing countries, although the agreement states that they shall not be used as criteria for awarding contracts.
The agreement also exempts the procurement of goods that relate to matters of national security from the use of offsets. But as South Africa has not signed this agreement, it uses offsets or national industrial participation programmes (NIPPs) for all government procurement which involves imported content of over $10-million. According to the Department of Trade and Industry (DTI), these programmes aim to support the development of local industry by using government procurement as leverage for broader economic benefit. These NIPPs oblige the seller to invest at least 30% of the procurement value in South African industry, with the objective of boosting:
- Sustainable economic growth;
- Establishment of new trading partners;
- Foreign investment into South Africa;
- Exports of South African value added goods and services;
- Research and development collaboration in South Africa;
- Job creation;
- Human resource development;
- Technology transfer; and
- The economic advantages of previously disadvantaged communities.
Contracts are signed between the government and the seller – they contain a performance clause, which holds the seller liable for 5% of the contract value if there is non-performance. The DTI’s Industrial Participation Secretariat assists the seller in fulfilling these obligations. It negotiates, evaluates and approves industrial participation proposals, concludes contracts, and audits performance of the NIPPs.
Offsets for the local defence industry
South Africa also has industrial participation programmes that are specifically directed at the defence industry. These defence industrial participation programmes (DIPPs) have been used by Armscor, the government agency responsible for the procurement of arms for South Africa, since at least the 1980s, although testimony at the Seriti Commission confirms that Armscor had used them long before they were officially introduced. Their aim is to oblige the seller to invest in defence-related business in South Africa, thereby advancing military strategic and defence-related industrial imperatives. The seller must invest at least 50% of the procurement value in defence-related industries and this figure is usually split between indirect and direct offsets.
The applicability of DIPPs and NIPPs depends mainly on the value of the contract. Where defence procurement contract values are above $2-million but below $10-million, sellers are obliged to participate in DIPPs but not in NIPPs. Where the defence procurement contract exceeds $10-million, sellers are obliged to participate in both DIPPs and NIPPs.
In the arms deal, both DIPPs and NIPPs were used to offset the cost of the deal, and, combined, would amount to 100% of the contract value. Ronnie Kasrils, then deputy defence minister, stated that these offsets would ‘delight the minister of finance’ as they would ensure sustained economic growth and create numerous jobs in South Africa. Ultimately they would justify the large expenditure on arms. The Joint Investigations Report found that DIPPs as they relate to the arms deal included:
- local assembly of weapons;
- local development of weapons systems; and
- the use of local technology in systems.
The NIPPs included investment in:
- solar panels;
- upgrading furnaces;
- the manufacturing of medical waste containers and the provision of medical waste management services;
- the manufacturing of aluminium tubes for motor-car radiators;
- the production of pressed metal for sub-economic housing;
- gold mining;
- the tourism industry; and
Not living up to the promise
However, a report tabled in February 2014 by the DTI indicates that the fruits of these offsets have not materialised. The Strategic Defence Packages Performance Review Report audited 40 of the 121 offset deals signed. David Maynier of the DA notes: “The findings of the internal audit report are particularly devastating when it comes to job creation”. This happened because some of the contracts did not specify job creation as a deliverable, and baseline figures for employment were not provided at the start, making it impossible to ascertain the number of new jobs created versus the number of existing jobs sustained.
The report also indicated that other investments promised under the offset contracts have failed despite the companies being credited with the full amount promised. These include proposed investments of over $170-million in a medical waste plant, of which only $1.1-million was invested, and a complete failure to invest in carbon manufacturing projects, discovered during the audit.
The findings of this report validate what critics of the arms deal and its offsets have been saying for a long time: that offsets are, in the words of Andrew Feinstein, “economic nonsense” because economic investment does “not require the state to spend billions on weapons”.