'Industrial Offsets' - a special form of countertrade

Table of Contents

TABLE OF  CONTENTS  2

1  INTRODUCTION  3

2  COUNTERTRADE -GENERAL BACKGROUND AND DEFINITIONS  4

3  MAJOR TYPES OF COUNTERTRADE  4

3.2  COMMERCIAL COUNTERTRADE  5

3.2.1  Barter  5

3.2.2  Counterpurchase  6

3.2.3  Advance Purchase  6

3.3  FINANCIAL COUNTERTRADE  6

3.3.1  Bilateral Clearing  7

3.3.2  Switch  7

3.3.3  Swaps (Debt-Equity Swap)  7

3.4  INDUSTRIAL COUNTERTRADE  8

3.4.1  Buy- back  8

4  INDUSTRIAL OFFSET  8

4.2  A DEFINITION  8

4.3  FIELD OF APPLICATION  9

4.4  OFFSET SUBCATEGORIES  10

4.5  TYPES OF OFFSET  10

4.5.1  Co-production  10

4.5.2  Licensed production  11

4.5.3  Subcontractor production  11

4.5.4  Overseas investment  11

4.6  OFFSET EXAMPLES  11

5  SUMMARY  14

6  CONCLUSION  14

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1 Introduction

“To barter is to exchange goods for other goods rather than money. This was common in early days. Presumably, however, the deal was not always fair. Barter is from the old French barater - to cheat!” Mike Atchinson

In a growing globalized world where cash flows and flows of funds are getting more complex one would expect businesses to be completed in seconds through electronic transactions, which most times is also the case. Nevertheless, the oldest form of trading and its numerous variations regain each day their importance in international trade. Countertrade has become an important element of the world economy, for all countries whether industrialized, emerging or developing since World War 2. Despite the importance the topic continues to gather, there is still no universally accepted definition of countertrade, neither on terminology, set procedures, documentation or volume of trade. Some say it amounts to as little as 5 percent of the world trade whereas others claim it represents as much as 35 percent and growing (Pavlos 1989:9 & Rowe, 1995: 141). The reason for this uncertainty is mainly due to the secrecy of MNCs and countries concerning this topic and to the lack of official statistics and specific national rules. Nevertheless, all authors agree about the importance of countertrade within the world trading system, with its share of the world market is steadily increasing and it becoming one important opportunity for doing international trade (Siegl, 1993). The aim of this paper is to first to lay down the most common variations and definitions of this type of trade and then to focus on a specific form - industrial offsets. In the end the specific field of application, the concerned specific industries and examples will be discussed.

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2 Countertrade -General Background and Definitions

Despite the lack of standardization, concerning the terminology and definitions of countertrade there is one common element present in all definitions: the concept of reciprocity. The idea behind reciprocity is that the transaction should create some economic activity in addition to that which would occur if it were a mere cash transaction (Hammond 1990:5). This leads us to another important characteristic of countertrade i.e. the total (partial) lack of use of cash in completing the business. In his work “International Countertrade”, C. M. Korth defines countertrade as “a general term covering all forms of trade whereby a seller or an assignee is required to accept goods or services from the buyer as either full or partial payment. Further concepts standing behind the idea are the notions of causality and addionality. ¹ The general understanding of causality means that there is a relationship between cause and effect, in our case a relationship between the exporter and importer. Addionality is then given when this year’s volume of imports is greater than last years.

3 Major types of Countertrade

Countertrade exists in various forms and it is difficult to draw a clear line between the variations of Countertrade. Countertrade is an “umbrella” term covering a multitude of different types of trade but no categorization is universally accepted. There is nevertheless the differentiation between commercial and industrial countertrade, firstly mentioned by UNs Economic Commision for Europe. (United Nations, 1979: 6) that draws a line between the duration of the business (Short-term/long-term) and the technical relationship between the goods. (Kunze 2005: 36). Over the years a further form was added to UN’s categorization in order to cover also business that exhibited a financial characteristic - financial countertrade. (Fantapie Altobelli, Jalloh, Verzariu quoted in Kunze, 2005: 36). A more detailed classification of countertrade may be categorized if a larger number of characteristics is taken in consideration. Examples of possible variables may be:

¹ BMWA:http://www.bmwa.gv.at/NR/exeres/9337859A-8240-4789-ACE5-80C9730FC8D4.htm, 26.06.2007

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- relative duration -form of payment -relation of countertrade goods -legal arrangements -value relations of deliveries -size of the deal

-technology transfer motive (Welt, 1984: 50).

Due to page limit and a focus on offsets only the most important forms of the three types of countertrade will be discussed in the following subchapters.

3.2 Commercial Countertrade

These forms of countertrade have the best resemblance to the classic export-import business: barter, counterpurchase and advance purchase, as there is no direct connection between the mutual flow of goods (Korth, 1987: 53).

3.2.1 Barter

Classical barter, the first type of trade, is the direct exchange of goods between two parties without any flow of cash taking place. In the simplest case, both parties function as buyers and sellers, with the flow of funds being covered by one contract. A pure barter deal is a one-shot transaction and no third parties are involved. The classical barter regained popularity after World War II, when many European currencies lacked strength. Furhtermore, this type of countertrade seems to be quite popular in the Ex-Sovietic Countries, e.g. like the Ukraine, where the proportion of barters was estimated to make 51% of the GDP in 1997 (Marin and Schnitzer , 2002; quoted in Kunze, 2005: 44).

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