Table Of Content[Classification]
CRANFIELD UNIVERSITY
DEPARTMENT OF DEFENCE MANAGEMENT AND
SECURITY ANALYSIS
PhD
Academic Year 2007
Kogila Balakrishnan
Evaluating the Effectiveness of Offsets
as a Mechanism for Promoting Malaysian
Defence Industrial and Technological
Development
Supervisor Professor Ron Matthews
April 2007
“This thesis is submitted in partial fulfilment of the requirement for the Degree of PhD”
Cranfield University, 2007. All rights reserved. No part of this publication may be may be reproduced
without the written permission of the copyright holder.
This Page Is Intentionally Left Blank
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ABSTRACT
Offsets have taken centre stage in defence trade. To date, more than 78 countries around
the world practice offsets and outstanding offsets obligations run into billions of US
dollars However, why have offsets gained such a momentum? Increasingly, both sellers
and buyers in the arms trade view offsets as an efficient and effective economic
compensation tool to justify arms deals. Buyers, consider offsets as a catalyst for
industrial and technological development, employment, creation of value-added
activities and skills development. Sellers, on the other hand, perceive offsets as
providing product differentiation and competitive advantage in an already tough defence
market. The question, though is whether, do offsets really work as claimed? The
purpose of this dissertation is to empirically verify the above proposition by evaluating
the effectiveness of defence offsets in developing a defence industrial and technological
base, using Malaysia’s defence industry as a case study.
This study employs a Multi-Method or Triangulation Methodological approach
(comprising survey, archival sources and participatory observation) to gather data.
Fieldwork research employing questionnaires and interviews were undertaken as part of
a survey of Malaysian defence companies, international defence contractors and
relevant offsets-related government and non-governmental agencies. These data were
further substantiated and consolidated via archival sources, such as government and
company reports and also participatory observation.
Research analysis indicates that offsets have provided mixed results, in the case of
Malaysia. The successes have been mainly focused on technology capability-building
and human resource development, limited to through-life-support of the defence
equipment and the ancillary systems purchased. Morover, offsets have been
successfully used to diversify into civil sectors, mainly aerospace and electronics
sectors, leading to increased exports, jobs, backward linkages and technology
enhancement in these sectors. However, offsets have had minimal effect on creating
joint-production, collaborative activities and R&D programmes, requisites for the
process of Malaysianisation. Further, offsets have also been less than effective in
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increasing employment, and dual-use technology programmes that could provide long-
term impact on Malaysia’s economic growth.
Overall, Malaysia’s offsets policy has been pragmatic and flexible. The government has
played a vital role in ensuring that the offsets policy operates in tandem with Malaysia’s
national aspirations. Yet, offsets have had a limited impact on developing and
sustaining Malaysia’s defence industrial and technology base. The offsets policy aim
and objectives have not been clearly reflected in the offsets process and implementation.
As defence offsets will continue to be of an essence in Malaysia’s defence procurement
activity, initiatives should be taken to review the offsets policy and implementation
processes. The review should augment the effectiveness of offsets in developing
measurable and value-added programmes that build a sustainable and competitive
Malaysian defence industry. To this end, and based on the research findings of this
study, a number of important policy recommendations are advanced to raise the
effectiveness of Malaysia’s offsets policy.
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ACKNOWLEDGEMENTS
The research leading to the completion of this doctoral thesis would not have been
possible without the blessing and unstinting support of mentors, colleagues, close
friends and family. I have received support from so many individuals and organisations
in the completion of this thesis. My heartfelt thanks to all of them for their enormous
contribution. However, I will not be doing justice if I do not single-out a few who have
been particularly instrumental in standing by me.
First and foremost, a big thank you to my ever so patient coach-cum supervisor,
Professor Ron Matthews. He has also been my mentor and inspiration in pursuing this
field of study. One cannot find a better teacher of defence economics. I must stress that
this thesis could not have been completed without his commitment, trust and positive
feedback towards my research. My gratitude goes also to the British Council and the
Foreign and Commonwealth Office United Kingdom, for selecting and supporting my
memorable stay in the UK. These purposeful years through the Chevening scholarship
have not only broadened my knowledge and sharpened my skills, but have also enriched
my personal experience, something that I will surely cherish.
I would also like to record my appreciation to the Public Service Department, Malaysia
for granting me the study leave which allowed me to focus my time and energy ‘full-
time’ in undertaking this research. I am particularly indebted to two gentlemen from the
Ministry of Defence, Malaysia. Firstly, to the former Secretary General of the Ministry
of Defence, Malaysia, Tan Sri Subhan Jasmon (who retired in 2006), for his constant
motivation and encouragement in support of my decision to pursue PhD study.
Secondly, to my former boss, Dato’ Jesbil Singh, (the then Under Secretary at the
Defence Industry Division and now the Deputy Secretary General, MOD), for his wise
council and intellectual thoughts on my research and for introducing me to the world of
offsets. My profound thanks also to DESO, UK, and in particular, to Mr. Adrian Dalton,
for sharing his cutting-edge knowledge and hands-on experience of offsets. Equally
,important, I must thank BAE Systems and MBDA for sponsoring my fieldwork, and
agreeing to my attachment and interviews within both organisations. Many thanks also
to BAE Systems, MBDA, Boeing, Armaris, Navantia, Rolls Royce and Northrop
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Grumman for coming together to sponsor the successful 2005 ‘Offsets Workshop’ in
Kuala Lumpur, which immensely contributed to my field research. I am particularly
indebted to those that I have interviewed from the Malaysian defence industries, various
universities, international defence contractors, and the many government agencies,
including the Defence Industry Division, MOD, MIGHT, STRIDE, MOF, MITI and
EPU for their in-put and responses, which have provided the backbone to this thesis.
My gratitude also goes to Cranfield University for providing me with this wonderful
opportunity, and in particular, Dr. Laura Clearly and Professor Chris Bellamy, who
were on my PhD Research Committee. Both of these academics were always positively
engaged in my research and provided constructive criticisms, ensuring that the research
progressed in the right direction. Many thanks also to Professor Trevor Taylor and Dr.
John Robertson for having been extremely supportive of my overseas conference
participations. These international forums provided me with the rare opportunities of
meeting the great-minds. Also, my thanks to Dr. Terri McConville for her untiring
efforts in educating me on research methodology. I am also very grateful to Dr. Jordi
Molas Gallart and Dr. David Moore for agreeing to be my External and Internal
examiners, respectively, and for their painstaking efforts in going through this thesis.
Not forgetting my friends-cum staff at the Vincent Centre: Annie, Amanda and Kerry,
as well as Sandra Stonham and others in the Wellington Hall for their moral support and
typical British humour throughout my research period. I must also thank the Cranfield
DCMT librarians, particularly the Defence Management team, Wendy and Mandy, for
tolerating with, at times, my bizarre requests. The Defence Academy of the UK
provided the congenial milieu to my stay in the UK. Finally, I would like to thank
Hooshmand, my beloved husband, for tolerating with my frequent absenteeism from
home and unpredictable idiosyncrasies. Also, many hugs to my doting son Jai, for all
the missed weekends and for being so understanding and independent all these years.
Thank you to my parents and sisters for their belief in me and for supporting me
emotionally during this period of life. Most importantly, I would like to dedicate this
PhD thesis to my late mother-in-law, Mrs Kalaimmal Palany, who would have been
very proud to see me complete this research successfully.
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LIST OF CONTENTS
1. INTRODUCTION ................................................................................................ 19
1.1 The Rise of Offsets ................................................................................................ 19
1.2 Definition............................................................................................................... 22
1.3 Offsets: Opposing Schools of Thought ................................................................. 23
1.3.1 Pro-Offsets.............................................................................................. 24
1.3.1 Anti-Offsets ............................................................................................ 24
1.4 Offsets in Emerging Economies ............................................................................ 25
1.5 Research Problem.................................................................................................. 26
1.5.1 Study Aim............................................................................................... 29
1.5.2 Study Objectives..................................................................................... 30
1.6 Study Value: .......................................................................................................... 30
1.7 Techno-Vision ....................................................................................................... 33
1.8 Research Methodology.......................................................................................... 36
1.8.1 Foreword to Research Methodology ...................................................... 36
1.8.2 Research Philosophy .............................................................................. 37
1.8.3 Typology of the Research....................................................................... 39
1.9 Research Design .................................................................................................... 42
1.9.1 Multi-Method Strategy ........................................................................... 42
1.9.2 Archival Research................................................................................... 44
1.9.3 Survey..................................................................................................... 46
1.9.4 Participant Observation .......................................................................... 47
1.10 Research Plan ........................................................................................................ 49
1.10.1 Pilot Study .............................................................................................. 49
1.10.2 Fieldwork................................................................................................ 50
1.10.3 Data Access ............................................................................................ 54
1.11 Data Analysis......................................................................................................... 55
1.11.1 Quantitative Data.................................................................................... 55
1.11.2 Qualitative Research Analysis................................................................ 56
1.11.3 Research Reliability and Validity.......................................................... 59
1.11.4 Research Values ..................................................................................... 60
1.11.5 Research Ethics....................................................................................... 60
1.12 Research Limitations ............................................................................................. 61
1.13 Study Road Map .................................................................................................... 62
2. INDUSTRIAL AND TECHNOLOGICAL DEVELOPMENT IN
DEVELOPING COUNTRIES ........................................................................... 71
2.1 Introduction ........................................................................................................... 71
2.2 Nuts and Bolts of Development ............................................................................ 73
2.2.1 Development or Growth? ....................................................................... 73
2.2.2 Nature of Developing Countries............................................................. 75
2.3 Road to Industrialisation........................................................................................ 75
2.3.1 Defining Industrialisation ....................................................................... 75
2.4 Why Do Developing Countries Need to Industrialise? ......................................... 80
2.4.1 Linear Stages of Growth Model (LSG) .................................................. 81
2.4.2 The Structuralist Model .......................................................................... 83
2.4.3 Dependency Theory................................................................................ 86
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2.4.4 The Post Washington Consensus (PWC) ............................................... 87
2.5 Industrialisation Strategies of Developing Countries............................................ 89
2.5.1 Import Substitution Industrialisation...................................................... 90
2.5.2 Export Oriented Industrialisation (EOI) ................................................. 91
2.6 Industrial Clusters.................................................................................................. 93
2.7 Technology and Development............................................................................... 94
2.7.1 Defining Technology.............................................................................. 94
2.7.2 Innovation versus Invention ................................................................... 97
2.7.3 Dual-Use Technology............................................................................. 98
2.7.4 High Technology .................................................................................... 99
2.8 Determinants of Innovation ................................................................................. 100
2.9 Technology Transfer Process .............................................................................. 101
2.10 Technology Development Paradigm ................................................................... 103
2.11 Objectives of Technology Transfer ..................................................................... 105
2.12 Theoretical Approaches to Technology Development ........................................ 106
2.12.1 Early Theories on Technology Development....................................... 106
2.12.2 Neo-Classical Growth Theory.............................................................. 106
2.12.3 Technology Gap Theory....................................................................... 107
2.12.4 Macroeconomic Theories of Market ‘Imperfections and Informational
Economics’ ........................................................................................... 107
2.12.5 Evolutionary Theory of Technology and Growth ................................ 107
2.12.6 Endogenous or New Growth Theory.................................................... 108
2.13 Issues in Technology Development..................................................................... 108
2.13.1 Technology Learning and Capability Building (TCB)......................... 108
2.13.2 The ‘Visible Hand’ Approach to Technology Development................ 111
2.13.3 Costs of Technology............................................................................. 113
2.13.4 Competitiveness and Technology Development .................................. 113
2.14 Technology Acquisition Modes........................................................................... 118
2.14.1 Off-the-Shelf Purchase ......................................................................... 119
2.14.2 Foreign Direct Investment (FDI).......................................................... 119
2.14.3 Turnkey Operations .............................................................................. 121
2.14.4 Licensing .............................................................................................. 122
2.14.5 Sub-Contracting.................................................................................... 123
2.14.6 Joint Ventures (JV)............................................................................... 125
2.14.7 Collaborative Technology Programmes ............................................... 126
2.15 Research and Development ................................................................................. 127
2.16 Offsets as a Tool for Technology Transfer.......................................................... 127
2.17 Summary.............................................................................................................. 133
3. OFFSETS AND DEFENCE INDUSTRIALISATION.................................... 153
3.1 Scene Setting ....................................................................................................... 153
3.2 Components Countertrade ................................................................................... 155
3.2.1 Barter .................................................................................................... 156
3.2.2 Counterpurchase ................................................................................... 157
3.2.3 Offsets................................................................................................... 157
3.2.4 Direct Offsets........................................................................................ 160
3.2.5 Indirect Offsets ..................................................................................... 163
3.3 Why Pursue Offsets? ........................................................................................... 163
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3.3.1 Defence Industrial Base........................................................................ 164
3.3.2 Leveraging for High-Technology......................................................... 168
3.3.3 Jobs ....................................................................................................... 168
3.3.4 Human Resouce Development ............................................................. 168
3.3.5 Hard Currency Savings......................................................................... 169
3.3.6 Marketing ............................................................................................. 169
3.3.7 Political Mileage................................................................................... 170
3.4 Overview of Offsets Policy and Management Process ....................................... 171
3.4.1 Offsets Strategy .................................................................................... 171
3.4.2 Offsets Management Process ............................................................... 173
3.4.3 Offsets Implementation ........................................................................ 176
3.5 Challenges to Offsets Policy, Process and Implementation ................................ 180
3.5.1 Non-Harmonisation of Offsets Practices.............................................. 180
3.5.2 Imposition of Penalties ......................................................................... 181
3.5.3 Codified versus Un-Codified Offsets Policy/Guideline ....................... 181
3.5.4 Issues of Causality and Additionality................................................... 182
3.5.5 Is Offsets Practice Transparent? ........................................................... 184
3.5.6 Increase in Price?.................................................................................. 184
3.6 Offsets Success Factors: Key Discriminators..................................................... 186
3.6.1 Recipient Government’s Offsets Strategy, Policy and Implementation
Process .................................................................................................. 187
3.6.2 OEMs’ Commitment to Offsets Obligations and Technology Recipients
.............................................................................................................. 191
3.6.3 Local Industrial Strategy and Human Resource Development ............ 193
3.6.4 Technology Development and the Strengthening of the Subcontractor
Base ...................................................................................................... 193
3.7 Offsets as a Tool for Defence Industrial Development: Myth or Reality?.......... 194
3.7.1 Technology Development .................................................................... 195
3.7.2 Employment ......................................................................................... 197
3.7.3 Skills Enhancement .............................................................................. 199
3.7.4 The Supply-Chain................................................................................. 199
3.7.5 Competition within Supplier Countries................................................ 200
3.7.6 Sustainability ........................................................................................ 201
3.8 Summary.............................................................................................................. 202
4. DEFENCE INDUSTRIALISATION IN MALAYSIA: DEVELOPMENT
CHALLENGES AND THE ROLE OF OFFSETS......................................... 213
4.1 Developing Nations: The ‘Need’ for Defence Industrialisation.......................... 213
4.2 Defining Defence Industrialisation (DIB) ........................................................... 216
4.3 Contextualising Malaysia’s Defence Industrial Push.......................................... 221
4.3.1 Armed Forces Structure, Budgetary Processes and Defence Inventory224
4.3.2 Defence Procurement Planning and Procurement Processes ............... 226
4.4 Malaysia’s Defence Industrial Policy: Congruence or Contradiction? ............... 227
4.5 Tracing Malaysia’s Defence Industry Origins..................................................... 231
4.6 Defence Industrialisation and the Role of the State ............................................ 234
4.7 Malaysia’s Defence Industry: Structure and Capabilities ................................... 238
4.8 Malaysia’s Defence Industry Development ........................................................ 241
4.8.1 Aerospace Sector .................................................................................. 241
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4.8.1.1 Design............................................................................................... 241
4.8.1.2 Manufacturing .................................................................................. 242
4.8.1.3 Maintenance, Repair and Overhaul (MRO) ..................................... 244
4.8.2 Weapons Sector .................................................................................... 246
4.8.3 Land Systems........................................................................................ 248
4.8.4 Maritime Sector .................................................................................... 250
4.8.5 Information Communications and Technology Sector......................... 252
4.8.6 Common-User Items Sector ................................................................. 253
4.9 Malaysia’s Defence Industrial Subcontracting Base ........................................... 253
4.10 Role of Defence Offsets in Malaysia’s Defence Industrialisation ...................... 254
4.11 Summary.............................................................................................................. 256
5. MALAYSIA: DO OFFSETS WORK? ............................................................. 269
5.1 Introduction ......................................................................................................... 269
5.2 Malaysia’s Offsets Policy.................................................................................... 271
5.2.1 Setting Malaysia’s Offsets Objectives.................................................. 271
5.3 Offsets Policy Formulation.................................................................................. 273
5.4 Offsets Management Process .............................................................................. 277
5.4.1 Planning................................................................................................ 277
5.4.2 Offsets Negotiation............................................................................... 282
5.4.3 Offsets Contractual Terms.................................................................... 283
5.5 Implementation and Monitoring of Offsets ......................................................... 287
5.6 Offsets Scope....................................................................................................... 291
5.6.1 Defence versus Non-Defence ............................................................... 291
5.6.2 Source of Offsets .................................................................................. 299
5.7 Role of the Malaysian Government in Sustaining a Defence Industrial Base..... 300
5.7.1 Government Initiatives Aimed at Raising Offsets Effectiveness ......... 301
5.7.2 Challenges Faced by Government and Offsets Implementation .......... 304
5.8 Impact of Offsets ................................................................................................. 305
5.8.1 Technology Absorption and Capability Development ......................... 305
5.8.2 Technology Learning and Capability Building .................................... 305
5.8.3 Technology Collaboration .................................................................... 308
5.8.4 R&D Strategy ....................................................................................... 313
5.8.5 Technology-Sharing Problems ............................................................. 317
5.8.4 Human Resource Development ............................................................ 319
5.9 Industrial Transformation through Offsets .......................................................... 323
5.9.1 Technology Innovation and Competitiveness ...................................... 323
5.5.2 Dual-Use Technology........................................................................... 328
5.9.3 Diversification ...................................................................................... 330
5.9.4 Market Penetration ............................................................................... 330
5.9.5 Defence Exports ................................................................................... 331
5.9.6 Job Creation.......................................................................................... 332
5.9.7 Skills Enhancement .............................................................................. 333
5.5.8 Sub-Contracting and the Promotion of Industrial Clusters .................. 334
5.10 Offsets and Transformational Costs .................................................................... 337
5.11 Challenges to Sustainable Partnerships ............................................................... 339
5.12 Summary.............................................................................................................. 341
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