Friday, June 23, 2006

Defense Procurement: Great Comments

Taiwan Focus was once again the source of a great post from shimk83, on defense procurement. There's plenty here I'd like to comment on but why spoil something good? Enjoy!


Taiwan relies on Foreign Military Sales (FMS) channels as a proportion of its force modernization and follow-on support, perhaps more than any other country in the world. The one exception is Saudi Arabia.

There are two rationales given for this type of reliance. One is the lack of a professional acquisition corps. There is a view that management of complex public projects, such as weapons acquisition, either domestic or foreign, is complex. The uniformed military focuses on warfighting, and assignments to positions responsible for acquisition tend to be temporary "touch and go's." Countries such as the U.S., Japan, Australia, UK, France, etc, tend to rely on a cadre of civil servants.

Secondly, there is risk averse culture in Taiwan's defense establishment, especially in the wake of the Lafayette scandal. Having high cost programs managed by the U.S. government, including selection of the prime contractor, relieves the military of having to take responsibility for the decision. No one wants to open themselves up to charges of corruption.

And there is the view that weapon systems that the US, or other foreign countries, produce are of higher quality than those which could be developed indigenously. Perhaps more important, however, is that arms sales from the U.S. imply a linkage with the U.S. that carries with it a political symbology in the political struggle with China. It shows that Taiwan is not isolated, and that it has a powerful benefactor. This is a good thing, and has value for Taiwan, at least up to a certain limit.

This is not to say that Taiwan doesn't have an indigenous defense industry. In the 1980s, AIDC working in partnership with General Dynamics (now Lockheed Aeronautics in Ft Worth), produced the IDF. This fighter is often disparaged (i.e., called "I Don't Fly"), but the problem is not with the quality of the aircraft -- AIDC has some very talented engineers. It was with the restrictions that the US government put on the design of both the engine and fire control system. God forbid if it were ever used to defend the island by hitting PLA staging areas as the Gomers (a term for the PLA based on their Gomer Pyle-style uniforms and a play on the Beijing term for "pengyou" -- Gummer) prepared to attack Taiwan.

CSBC, working in partnership with Lockheed Martin, played a key role in the joint development and production of the PFG-2s, a program which many believe to have been one of the most successful and smoothly managed U.S-Taiwan program in history. CSIST and Lockheed also worked together in the 1980s on the Tienkung program, which uses a variant of the AEGIS radar (in Taiwan, known as the ADAR or Changbai radar). Also in
the 1980s, there was the General Dynamics joint development program with ORDC on the M48 Hybrid Tank.

Today, Taiwan's defense industry has a number of indigenous programs, such as the Hsiungfeng 2E, which has become famous recently (it's been going on for six years), the TC-2A (modified version of the TC-2 air-to-air missile), the Tienlei multiple launched rocket system (MLRS), the CM-32 light armored vehicle (LAV), and the PRC-37 tactical radio. All of these programs are almost all indigenous, with the US and other foreign industries serving only as sources of components. No systems engineering, program management, or other significant role as one saw in the 1980s. And most programs have been criticized by the customer (i.e., Taiwan Army, Navy, and Air Force) for not meeting requirements.

Nevertheless, Taiwan dedicates at least 75% of its annual force modernization and follow-on support budget on foreign acquisition, mostly through FMS (government to government) channels. There are costs for doing this. First, DoD charges an administrative fee of 2.5% for managing FMS programs. This is going up to 3.7% in the very near future. So, in the case of a US $1 billion program, Taiwan taxpayers pay an additional US $25 million (US $37 million in the future) for US government management of a program. A US $10 billion program, such as submarines, would involve an extra fee of US $250 million (or US $370 million in the near future). But there's more. The US program manager within the Army, Navy, or Air Force, charges an additional amount, often about the same, so the cost charged to the Taiwan government goes up even more. So administration fees for using the FMS channel charged to Taiwan taxpayers adds at least 5-10% on top of the actual cost of a weapons system.

There's more though. For all foreign procurements above US $20 million, the Taiwan government requires an "offset" obligation. This is similar to a rebate in some ways, in which the US company is obligated to transfer technology or some other service valued at an amount as much as 40-70% of the program value. In other words, a US $1 billion program would have an offset obligation of at least US $400 million. The Ministry of Economic Affairs (MOEA) Industrial Development Bureau (IDB), however, assesses each proposal that a US company forwards to satisfy parts of this 40-70% offset obligation for each program. MOEA/IDB evaluates the proposal and assigns a multiplier of anywhere between less than one all the way to 10 or even 20 (only rumors about this much). The offset programs are usually indirect in sense that they have nothing to do with what the military is buying. They could for a US company to provide technology for motorcycles, or washing machines. MND nornally stays out of it, even though it is associated with their

In terms of real dollars, offset obligations cost the US company, which is contracting with the U.S. government (which in turn contracts with the Taiwan government), roughly 10% (sometimes more, sometimes less) of the overall value of the program -- in a US $1 billion program, this means about an additional US $100 million. The US company is not going to take this out of its profit margin, which is limited in accordance with US federal acquisition regulations. It adds the costs of offsets into its contract with the US government, a move that is permitted under US regulations. Offsets aren't free, so the US government, because it is billed by the US company for the offsets, adds an additional 10% on top of the standard administration fees associated with FMS, and passes this additional cost back on to the Taiwan taxpayer, through the Taiwan government.

It doesn't stop here. Commissions that US companies pay to sales representatives in Taiwan are also added into the bill sent to the US government. Under FMS rules, there are certain limits to the amount US companies are allowed to bill. But this isn't transparent. As an aside, commissions, which can run anywhere from 1% to 15% of the total value of a program, tend to be a major factor in tempting officials in Taiwan toward unethical behavior -- kickbacks or success fees in the event a program actually goes through. There often is an assumption that there are no commissions on arms sales today, especially if a program is managed through FMS channels. Not true at all -- just means the commission is less.

In short, use of FMS channels, when one adds in all the administrative fees, projected costs of offsets, commissions, etc, adds to the cost of a program by as much as 20%. So when you hear pan-Blues bitching about overpriced weapons, "sucker" arms deals (kaize de jungou), etc, this is in large part is what they're talking about.

But the costs are more than just a straight dollar figure. One also has to deal with inefficiencies inherent in a large bureaucracy, such as the US security assistance community. The US government is in effect serving as a middle man, or broker, between the manufacturer and the customer. In relying on the US government to facilitate spare parts supply for programs it is managing, Taiwan's military units can wait for as long as six months or a year to get what it needs!

But there may be a calculation that the additional costs are worth it. It saves by not having to worry about managing complex programs -- the US government (Army, Navy, or Air Force acquistion units) does all the program management. And it helps to avoid the impression of impropriety (this is somewhat of an illusion since commissions are still allowed, but normally less than in a direct commercial sale). And there is the political value of the linkages with the U.S. government.

But the key issue is this. Those funds used to procure weaponry from the US, as good as US weapons are in terms of quality, have very little direct positive impact on Taiwan's economy. Indirectly, it does by providing for defense of the island. And there are supposed to be offsets -- rebates of a sort -- that are intended to help Taiwan's overall economic development. However, almost every other country in the world views investments made in defense as not just buying metal and electronics -- those public expenditures are also intended to create jobs, money to circulate in the economy, and technology spin-offs.

So when the the DPP asks the LY to appropriate US $15 billion for three FMS programs, one could imagine scenario in which pan-Blues ask three questions -- what's in it for me (i.e., money in the pocket). Probably nothing. Second question would be -- does it create jobs in my district so that I can get elected again (only applies to those LY members who are elected by their local constituencies and not at large representatives appointed by the party).

If neither of the first two is in the affirmative, then it leads to the last question -- how could I use this to bash my political opponent, in this case the DPP? Of course, there are other rationales, but these likely are less important than sheer politics. If there's no personal gain, either money in the pocket or getting re-elected, then why not use it as a political football? Plus, if there is any inkling that the DPP would use the opportunity of a single package, rolled together at a huge amount, such as US $15 billion, for either personal gain (i.e., in
the pocket) or for political campaign funding (i.e., skimming off US $100 million or so, which is almost unnoticable when a US $15 billion package is bundled together), then opposition would be even greater.

The U.S. Congress is not that much different. But at least in the US, the second question -- jobs, income, and technology spin offs -- is critical. Having a defense industry, spread through the US in almost every state, that creates jobs and income, is a major reason why the US Congress, and the Executive Branch, is able to garner so much public support for high levels of defense spending. Without the pork barrel benefits (this is a reality and not a criticism) that creates jobs and income for constituents, there would not be so much support.

Taiwan is no different. If one wants to create incentives for the KMT/PFP (or DPP later -- there's a good chance that if it loses in 2008, it would do the same as the KMT/PFP is doing now) to increase defense spending, then create jobs and income for constituents. Do it in a fair way that brings in the foreign assistance for systems engineering expertise, creates an equitable distribution of jobs and income in the US and Taiwan, and get a good weapon system on top of it. And cut 20-25% additional charges from having to go through FMS channels (locally produced products incur no offset obligation).

It would take one key move though -- transparency in procurement. There are legitimate reasons to keep a certain portion classified, especially for intelligence and "black" programs. But right now, 16% of Taiwan's defense budget is classified. It's almost all the funds used for weapons acquistion, with most of it being from the US. There is little, if any, public accounting for how those funds would be used, line item by line item. Most other countries do this -- why not Taiwan? Taxpayers, who ultimately are paying for Taiwan's defense, have a right to know how their money is being used (or misused).

If one had a transparent system for use of public funds, then corruption becomes much more difficult and ethical standards would likely rise (Transparency International has lots of background on this). And the military could manage programs without fear of being accused of corruption. And it could recruit a talented corps of civilian acquisitions specialists to manage complex programs. And there would be less fear within Taiwan's private sector of having to deal with those politicians of questionable integrity.

Last point, then I'll cease and desist. Today, there are alot of charges being slung around against the DPP. But why are few, if any, prescribing solutions to fix the system? Ma Ying-jeou, or Chen Shui-bian or others in the DPP, could gain huge brownie points by actually striking at the heart of corruption at its source. This includes transparency in procurement, a viable judiciary, and encouraging a responsible, but watchful media.

The current political crisis carries with it the seeds or opportunity for advancing Taiwan's system of governance. Transparency, effective enforcement of laws, and a fair, unbiased media are critical elements to moving toward a mature democracy -- Taiwan's is still in its nascent stages of democratic development. To me, one of the best things the US could do would be to offer positive suggestions on how to enhance the quality of democracy. If, of course, it really believes what it says, and stands by the principles upon which it was founded.

Enough rambling! That's it for now....


Kerim Friedman said...

"And there is the political value of the linkages with the U.S. government"

Why pretend that it is anything other than bribery? The senators in the states with large arms manufacturers continually support Taiwan.

Transparency? Did you know that US has over a trillion dollars of taxpayer money that has been unaccounted for by the military!? And every year Congress votes to let the military off the hook for having to account for these funds!?

Red A said...

I once watched a talk show here with the pan-blues bitching about the cost of the of them wanted to buy arms from China instead and the other complained that the USA should sell arms "at cost" to Taiwan.

My impression was that these guys were ungrateful pricks.