GAO Report: Offshoring/Foreign Direct Investment - Risks to the Defense Supplier Base?

Under the FY 2018 NDAA, House and Senate Committee Reports called for GAO to examine the effects of Offshoring (OS) and Foreign Direct Investment (FDI) on the Defense Supplier Base. GAO reviewed the available public data and convened a panel of experts from academia, industry, and government to address the issues.  It submitted a lengthy report to Congress on September 5, 2019, and we provide a brief summary below.

There was no consensus on the definition of OS. Broadly defined, it refers to the shifting of domestic production to a facility abroad, the expansion of a US corporation overseas without a change to domestic production, and the overseas sourcing of products and materials.  FDI, per the definition of the Department of Commerce’s “Bureau of Economic Activity,” involves an investment transaction by a foreign entity with a US business equivalent to 10% or more of voting ownership.

GAO noted that the lack of comprehensive data precluded a full understanding of the extent and magnitude of OS activities on the Defense Supplier Base. Nevertheless, panelists were able to distill certain general benefits, risks, and recommended strategies.

OS/FDI Benefits, Risks, Recommendations

Overseas production may bring lower labor cost, which can be passed through to the government. FDI provides domestic businesses with access to additional, critical financial resources. On the risk side — OS and DFI can lead to the transfer of critical technologies to our adversaries. This includes “dual-use” technologies, i.e., those which have a present commercial use but have the potential for military application. The panelists also noted the risk of technology transfer from “defense trade offset agreements,” where a foreign country that purchases a weapon system insists that a portion of the production be performed in the purchasing country.

The panelists recommended the implementation – via rulemaking–of recent legislative initiatives in the area. One such statute was the “Foreign Investment Risk Review Modernization Act of 2018” which increased the types of foreign investment transactions subject to review by the multi-agency Committee on Foreign Investment in the United States.  Another statute was the “Export Control Reform Act of 2018,” which expanded the definition of the technologies that are subject to export control. The panelists also recommended the need to increase private sector awareness of technology transfer risk, and the need to work with our allies to minimize illicit technology transfers.

The Global Supply Chain: Benefits, Risks, Recommendations

DOD benefits when it can turn to foreign sources to obtain needed parts and materials that are unavailable domestically. However, increased reliance on these sources has reduced visibility into the supply chain. This reduced visibility has inhibited DOD’s ability to identify high-risk suppliers that can introduce counterfeit or compromised parts into the supply chain, affecting the production of secure weapon systems. Panelists recommended that supply chain risks and security be addressed in the acquisition process, i.e., in acquisition planning and source selection; that greater responsibility to secure the supply chain be shifted to contractors; and that DOD increase coordination and communication with the private sector to facilitate a better understanding of the overall risks.

 Growing the Capacity and Capability of the Defense Supplier Base (DSB)

The panelists discussed the growing threat of a US workforce deficient in science, technology, engineering, and math (STEM) to meet the future capacity and capability demands of the DSB (the “skills gap”). Panelists suggested increasing government support of programs to incentivize students to pursue STEM careers; leveraging the STEM skills of foreign workers and students living here; and encouraging more tech-based domestic companies to do business with the government.