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The Modernization of Bribery: The Arms Trade in the Arab Gulf

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The New York Hall of Science in Queens is currently showcasing “1,001 Inventions,” an exhibit documenting scientific advances made in the Islamic World while Europe was mired in the Dark Ages. The standards are all there – the advances in surgery, astronomy, and mathematics without which we might still be engaged in trepanation, the reading of animal entrails and addition by abacus. But there is another pioneering regional development not on display: the modernization of the ancient art of bribery.

Predictably, this innovation involves the global arms market, which by all accounts is the source of more bribes than any other sector. And although most actors in the global arms trade have abandoned briefcases of unmarked, nonconsecutive bills for the relative security of Foreign Sales Corporations and shell companies, corruption watchdogs are rarely more than a few steps behind – nipping at their perfidious heels. Thus the real trophy for crooked public officials and their private sector counterparts is not finding extralegal ways to hide corrupt transactions, but changing the law to make existing practices legal. 

Enter the Holy Grail of graft – “defense offsets.” Offsets are incentive contracts that defense manufacturers sign with procuring governments to facilitate weapons sales. They usually take the form of substantial investments in the importing country’s indigenous defense industry or some politically important commercial sector. And although offsets first appeared after WWII – when President Eisenhower required West Germany to purchase American-made defense material to “offset” the cost of stationing U.S. troops on the continent – the Gulf States have raised them to a veritable art form. The projects that result from offset investment vary enormously – from straightforward industrial projects to complex financial transactions. The increasing diversity of offsets has helped make them big business; according to industry estimates there were about $100 billion in outstanding offset obligations as of 2009, with an additional $150 billion forecast for arms sales concluded over the next five years.[1] Almost one-third of this figure is expected to come from Saudi Arabia and the UAE alone.[2]

The UAE has proven especially visionary in its pursuit of offsets – pioneering practices like “offset banking” – which allows multiple defense contractors with offset obligations to dump money into a fund designated by the government, as well as the increasingly popular “pre-performance” offset, in which companies make an investment in the procuring country before the bidding process even begins. So far at least three firms that set up businesses in the UAE in hopes of securing future contracts eventually lost out to competitors or saw the predicted deals disintegrate: McDonnell Douglas (now Boeing) set up a Berlitz Language School in the run-up to its (ultimately) failed bid to supply fighter jets; Newport News (now part of Northrop Grumman) created Abu Dhabi Ship Building in anticipation of subsequent deals for fast patrol vessels it likewise failed to secure; and British Aerospace (now BAE Systems) helped start the aircraft leasing company Waha, for yet another deal that never transpired.[3]  Perceptions of the success of the UAE’s program have been so compelling to the Emirates’ neighbors that Abu Dhabi’s annual conference on defense offsets is attended by leaders from almost every Arab state, even those who claim not to engage in offsets – usually because they rely on U.S. military aid which technically prohibits them from demanding offsets from U.S. firms. Efforts have also been made in the GCC to consolidate regional offset programs in order to leverage the members’ collective purchasing power and compel defense manufacturers to meet increasingly stringent offset requirements.

The Gulf has also proven fertile ground for the growth of offset “brokers” – intermediary firms that specialize in designing and implementing offset projects, as well as law firms and investment houses that offer legal counsel and creative financing options, including accounting tools that allow procuring governments to leverage projected offset dividends in order to support additional defense procurement. The most prominent such firm is Blenheim Capital Partners, which cut its corporate teeth brokering Middle East offsets. The firm’s CEO Grant Rogan was labeled “Mr. Fix-It” by the UAE newspaper The National, but the company also advises the governments of Libya and Kuwait, and has offices in Bahrain. Rogan’s father, Richard Grant Rogan was (allegedly) Northrop Grumman’s ‘handler’ for that firm’s dealings with Adnan Khashoggi, the infamous Arab intermediary who made billions in commissions for facilitating arms sales to Saudi Arabia in the 1980s.[4] 

Initially offsets may sound more like foreign investment than bribery (offset figures are even factored into official U.S. stats on FDI), or at least the culmination of efforts by developing countries to secure more beneficial terms of trade with rich countries. But, unlike FDI, offset investment is made to secure lucrative arms sales – not because the procuring country necessarily has a good environment for domestic investment. Nor do offset projects go to the most ‘deserving’ industry, sector or firm in the importing country – the offset recipient is designated by regime officials using the same authoritarian survival calculus that dictates other economic decisions. Also, because offsets sit squarely in the regulatory “sweetspot” of international trade they are not exposed to the same degree of monitoring or government oversight to which FDI and other forms of economic exchange are subject. Although economists are nearly unanimous in condemning offsets as trade-distorting, WTO rules do not apply because offsets fall under the national security exemption, and because U.S. firms successfully lobbied to have offset information classified as proprietary, the potential for oversight by defense watchdogs in the world’s largest arms exporter (the U.S.) is virtually nil. 

In addition to being opaque and unregulated, offsets also perform many of the same functions as bribes: they allow competing firms to sweeten their bids outside the ordinary channels of price and quality-competition, and offsets provide officials in the procuring country with opportunities to direct benefits to their domestic political allies. Lastly, like an unpaid bribe, suing a defense firm for non-fulfillment of an offset is (quite literally) unheard of. In a 1999 Congressional hearing on defense offsets, the head of the largest defense aerospace trade association stated, “Companies do have contractual legal arrangements which would involve financial penalties. But, in point of fact, I don’t know of any company that has ever paid one.” In Saudi Arabia, for instance, where contractors have been granted offset credit for “moral” offsets, “best endeavors,” and “encouraging” investment by third parties, target deadlines for program completion are routinely missed without penalty. The offset program implemented alongside the Al Yamamah (the dove) arms deal between the UK and Saudi Arabia remains ongoing, 25 years after it was signed. Tony Smith of the UK’s Ministry of Defense British Offset Office said that London and Riyadh, “have a gentleman’s agreement now that we are not going to talk about the value of offset credits,” associated with the deal.[5]

Despite their shortcomings in terms of transparency and accountability, industry advocates and procuring country officials routinely portray offsets as a tool of the developmental state – a method for the benign autocrat to steer foreign investment toward domestic industry in order to modernize and diversity the economy. Even the term “offset” is gradually being phased out in favor of phrases like “industrial participation” or “economic enhancement.” A recent paper published by the Asian Development Bank heralded offsets as an “alternative means of financing infrastructure.”[6] And indeed offsets could be a tool for economic development if procuring countries were not the ones actually paying for them. In reality, the cost of offsets is not borne by the firms, or even the governments where those firms are headquartered. Instead, as offset demands increased in the early 1990s – owing largely to the decline in developed country defense budgets that forced firms to seek new markets abroad – U.S. laws governing defense procurement were re-written to shift the financial burden away from defense manufacturers toward the arms customers themselves. Although the regulations in force during the 1980s and most of the 1990s only permitted defense manufacturers to recover “administrative costs” associated with offsets from the procuring country government, this was expanded in 1999 to provide for the recovery of all costs.[7] Likewise contracting officers within the U.S. Government are advised to treat all offset costs as “allowable” contract costs (ie, ones that could be charged to the procuring government) because, according to the Defense Security Cooperation Agency, “[t]o disallow such costs means that U.S. companies must absorb offset costs that are required by the foreign government as a condition of making the sale. It is only reasonable that foreign governments that require offsets should bear the costs of those offsets.”[8] A DOD list of procurement FAQs for international sales even cautions contractors against submitting paperwork that singles out offset costs or segregating them into individual contract line items due to concern that the “foreign government may refuse to pay for them.”[9]

Richard Aboulafia, a defense industry analyst, was even more blunt about the perverse economics of offsets in a Financial Times article, flatly stating, “[t]here seems to be a massive confusion about who pays for offsets. It’s the buyer, not the seller.”[10] There are also those in the U.S. Government who have recognized this inconsistency. Representative John F. Tierney (D-MA) – perhaps the most vocal opponent of offsets – told the NYTimes in 2003 that offsets are, “a very serious problem … we tried to move on this issue, but we got no traction. I don’t think the industry is as upset as it claims to be; otherwise there would be more done about it.”[11] The ambiguity surrounding who really pays for offsets has allowed firms to inflate their prices on the basis of the costs of projected offset projects (which rarely approach the dollar figures initially negotiated with procuring governments), while simultaneously trumpeting their offset commitments as important sources of investment and avoiding the potentially damaging impact to their stock price of listing these large commitments as liabilities. One former industry trade group executive remarked in a speech at a 2008 international offset conference that:

My industry probably has billions of dollars of offset obligations. They don’t show anywhere on our balance sheets because no auditor knows what to do with an offset. When you start asking us for performance bonds and penalty clauses, that’s going to show, and that makes people very nervous. I am aware of some recent cases where companies simply weren’t willing to put that on their books.[12]

This ambiguity is reproduced in most media and government reports on defense offsets, and there is almost no scholarly work that examines offsets as a potential source of corruption or rent-seeking in authoritarian regimes.[13] This is despite the fact that there are currently no requirements on due diligence regarding offset agreements, no monitoring of the projects themselves, and no audits conducted – unless this is done by the firms themselves at the behest of procuring governments eager to display the benefits to their domestic constituencies.[14] Needless to say, such reports seldom reflect objective reality. U.S. figures provided to Saudi Arabia promised 75,000 jobs in connection with one major offset program in the mid-1980s, while an independent figure compiled by the Janes Defense group listed only 3,500 jobs created by U.S. offsets in the kingdom as of 2009.[15]

So, have defense firms collectively ‘hoodwinked’ their customers into financing their own bribes? Although the question is an economic one, the answer is political.  While the cost of offsets is borne collectively by the importing country’s public – whose tax dollars or natural resource endowments finance defense procurement, the benefit of offsets is targeted specifically to actors and institutions designated by the procuring country government. This makes offsets an excellent way for governments to conceal the delivery of public subsidies to interest groups. This is especially true in the current atmosphere of economic liberalization and government austerity, where such subsidies are almost universally condemned as inefficient and economically counterproductive. The fact that procuring governments pay for offsets is irrelevant to the political calculations of regime officials, which frequently center on maintaining political power rather than pursuing economically beneficial policies. Although offsets provide defense firms with a cheaper and more palatable alternative to traditional bribes, they also provide procuring governments with something they do not get from old-fashioned kick-backs: the illusion of a thriving private sector investment climate untainted by allegations of cronyism and politically-motivated subsidies. 

This is reflected in the U.S. Department of Defense’s procurement and acquisition policy (DPAP), which justifies the non-inclusion of offset information in Letters of Agreement (LOAs) and other government-to-government paperwork because, “foreign governments as a rule do not want offset costs isolated/highlighted.”[16] As a result, the only parties to the offset agreement are the defense firm and a select group of officials within the procuring government. Withholding this information allows officials in the procuring government to cite unrealistic economic benefits from arms purchases, justify the approval of higher-cost contracts on the basis of vague offset provisions, disguise the funneling of investment to domestic firms with high-level political connections, and otherwise transfer what should be public money into the coffers of regime allies. This is further illustrated by a survey conducted by the U.S. Bureau of Industry and Security, which consulted “foreign and domestic entities” and concluded that “subsidizing interest groups” was primary among the rationales for offsets.[17] 

Just as the colonial powers of Europe slowly transformed their methods of imperial rule from vulgar resource extraction to the more “evolved” power exercised through international institutions, corruption and bribery in the global arms market has also been transformed into something more sophisticated and less crude. The states of the Arab Gulf, flush with capital but short on legitimacy, have been at the forefront of this effort. Although traditional kickbacks no doubt persist, deposits to numbered Swiss accounts are likely to elicit scrutiny from international watchdogs, who have access to a growing number of statutes and legal fora to pursue violators. Of course, bribery – like the tango – requires two parties. Defense manufacturers have cultivated offsets to resolve not only the problem of legal culpability, but also to address the financial burden of the bribes themselves. Because offsets are accepted as legitimate (if inefficient) aspects of the arms trade and framed in a developmentalist discourse, they are not obvious targets for corruption watchdogs. And because offset projects must be viable – that is, the designated domestic recipients must have access to the requisite capital, equipment and/or labor to take advantage of a partnership with the obligor firm – it is almost assured that offset investment will go to powerful economic actors and influential sectors allied with the ruling elite. This is also the case with traditional bribery: individuals only receive substantial bribes if they can demonstrate to defense firm personnel that they have the capacity to derail pending arms sales – and the only individuals able to issue such a credible threat are those with direct access to decision makers. Like engineered elections and less overt techniques of surveillance, defense offsets provide a patina of legitimacy to what is fundamentally a tool of regime maintenance. And – just as Western governments have promoted a truncated form of democracy based on hollow elections, and dispensed the technologies that facilitate less conspicuous forms of repression – they are also complicit in providing defense firms and foreign dictators with the legal and regulatory tools necessary to find and exploit new resources to add to their authoritarian arsenals.

[1] Blenheim Capital Partners (offset broker/services firm) brochure.

[2] “Gulf states seek to cash in on arms buys.” 25 June 2010. UPI (Saudi Arabia).

[3] Ivan Gale. 13 June 2010. “Offshoots from arms contracts.” The National (UAE).

[4] Author Robert Kessler documents a 1971 meeting between Khashoggi and the elder Rogan at the Mayfair Hotel in London during which Khashoggi advised Rogan to mislead a bribe-seeking (but low ranking) member of the Saudi royal family that Northrop was getting annoyed with Khashoggi’s demands. Since this family member’s request for a ‘cut’ would have to go through Khashoggi, who would later dispense payments from his single commission via a vast network of front companies, this was an indirect way of ensuring that more of the bribe money stayed in Khashoggi’s hands instead of trickling down through the vast Royal Family hierarchy. Ronald Kessler. 1986. The Richest Man in the World: The Story of Adnan Khashoggi. New York: Warner Books, p76.

[5] CTO Newsletter. 9 April 2007. 25(7).

[6] Of course the authors do not pose this in contradistinction to any conventional method, which in such a case would be to take the money directly from the government budget and commit it to infrastructure projects as opposed to recycling it (and most likely losing a sizeable chunk) through the arms procurement process.

[7] GAO. Defense Trade: US Contractors Employ Diverse Activities to Meet Offset Obligations. (GAO/NSIAD-99-35, December 18, 1998), p2-3.

[8] DSCA memorandum, “Inclusion of Offset Costs in Letters of Offer and Acceptance.” 19 January 2000.

[9] DPAP Offsets of Foreign Military Sales. FMS Offsets and Other Issues Affecting FMS Procurements Frequently Asked Questions.

[10] Sylvia Pfeifer. 10 June, 2010. “Overseas defence clients get tougher.” Financial Times.

[11] Leslie Wayne. “A Well-Kept Military Secret.” NYTimes. 16 February 2003.

[12] CTO Newsletter 28. May 2008. 26(10).

[13] One exception is Travis Taylor. 2003. “Modeling offset policy in government procurement.” Journal of Policy Modeling. 25: 985-998, as well as the work by scholars Jurgen Brauer and J. Paul Dunne.

[14] Transparency International (UK). April 2010. “Defence Offsets: Addressing the Risks of Corruption & Raising Transparency.” See also Transparency International (UK). April 2002. “Corruption in the Official Arms Trade.” Policy Research Paper 001.

[15] Sylvia Pfeifer. 19 July 2010. “Foreign contracts: New offset deals face greater scrutiny.” Financial Times. Even Mohamad A. Ramady, a Saudi professor and vocal proponent of offsets, admits that figures for offset-generated job creation are dismal. (2005). The Saudi Arabian Economy: Policies, Achievements and Challenges. 

[16] DPAP Offsets of Foreign Military Sales. FMS Offsets and Other Issues Affecting FMS Procurements Frequently Asked Questions.

[17] BIS Offsets, 11th Annual Report. P182 (3-3). I take the term ‘interest groups’ to be synonymous with ‘political coalition’ or ‘elite network,’ expressed in the peculiar language of public choice scholarship in the American tradition.

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1 comment for "The Modernization of Bribery: The Arms Trade in the Arab Gulf"


indeed, this is an illuminating and revealing piece of investigative reporting on modern customized techniques, veiling the ancient art of bribery!

zilzal azizi wrote on January 07, 2011 at 05:19 PM

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