Taiwan’s industrial cooperation policy presents a complex interplay of challenges and opportunities that affect not just the defense sector but Taiwan’s broader strategic and economic landscape.
Taiwan has recently placed significant orders of U.S. defense systems, solidifying some of the largest arms deals in the history of their partnership. In October, the United States approved a substantial US$2 billion arms sale to Taiwan, followed by an additional US$385 million deal in November. These agreements are an important part of deepening defense ties between the two amid evolving regional security dynamics.
Amid these record orders of U.S. systems, Taiwan’s defense procurement strategy is undergoing dramatic change. Taiwan’s “industrial cooperation” policy – known in most markets as “offsets” – is designed to ensure that the technology transfers, local investments, and other benefits provided by foreign defense contractors align more closely with Taiwan’s strategic needs. This policy was updated last year, marking a significant shift in how defense procurement is handled, a development closely monitored and discussed by members of AmCham Taiwan’s defense comittee.
For years, Taiwan’s offset policy was clear-cut, requiring foreign defense contractors to reinvest 40% of their contract value back into the local economy. This approach fostered predictability and flexibility, striking a balance between direct and indirect investments. Now, with the introduction of a case-by-case offset requirement, contractors are left facing new levels of uncertainty and financial risk. The elimination of indirect offsets, coupled with demands for transparent pricing, has turned what was once a straightforward process into a complex maze.
A shift in strategy
Taiwan’s previous offset policy was structured around a well-defined offset obligation in which defense contractors awarded contracts in Taiwan were required to reinvest 40% of the contract value back into the local economy. Such investment could be achieved through either direct or indirect projects.
Direct offsets were explicitly linked to the defense systems being acquired, such as establishing maintenance capabilities like local facilities for defense equipment repair and upkeep or incorporating Taiwanese suppliers into the production chain, particularly in areas such as structural components or spare parts, where export controls do not pose significant barriers. Indirect offsets provided broader flexibility, including investments in sectors unrelated to defense, such as healthcare or renewable energy, thereby benefiting a wide array of industries across Taiwan’s economy.
The old policy provided contractors with clarity and predictability. With an established offset requirement, contractors could effectively strategize their bids and long-term business plans. The government, building on the consistency of a standardized framework, published a “wish list” of preferred offset projects, giving defense companies an insight into what areas would be considered acceptable to fulfill offset obligations and making the process more straightforward for all parties involved.
The new policy departs from these established norms. Instead of a fixed percentage obligation, offsets are now determined on a case-by-case basis, purportedly allowing defense contractors to propose projects that better serve Taiwan’s evolving priorities, such as enhancing self-reliance in critical defense technologies or developing local production capabilities.
This change, however, introduces significant uncertainty. Defense contractors are now required to commit to offset plans before receiving contract awards, which means taking on financial risks without guaranteed compensation. Moreover, the elimination of indirect offsets and the new requirement for transparent pricing in offset projects add layers of complexity that complicate procurement processes.
A recurring concern from defense contractors is the lack of clarity around the definition of “contract award.” In the context of Foreign Military Sales (FMS), Taiwan signs a Letter of Offer and Acceptance (LOA) with the U.S. government, which subsequently signs contracts with defense companies. This sequence often involves a gap of 12 to 36 months or longer. While the LOA signifies a formal commitment from Taiwan, the actual contracts with suppliers are managed and signed by the U.S. government at a later stage. If Taiwan defines “contract award” as the point when the U.S. government finalizes contracts with suppliers, contractors have a window of time to assess their likelihood of winning the contract and decide whether to sign an Industrial Cooperation Agreement (ICA).
However, Taiwan is increasingly requiring contractors to sign the ICA shortly after the LOA is executed, well before the U.S. government’s contracts are finalized. Since Taiwan rarely rescinds an LOA once signed, contractors question the necessity of committing to the ICA so early in the process, particularly when their chances of securing the contract are largely determined by U.S. government decisions still pending.
This unclarity creates a misalignment in incentives. Contractors see little benefit in signing an ICA before the contract award stage, as Taiwan has no control over how the U.S. government contracts with contractors. Export license restrictions often prevent U.S. companies from being able to provide Taiwan with its requested products. Furthermore, not signing an ICA does not disqualify contractors from bidding, resulting in a lack of incentive to sign early ICAs that subsequently undermines the policy’s objectives.
Another critical concern is the elimination of a fixed offset percentage. Different offset percentages across companies lead to varying cost burdens, potentially disadvantaging firms with higher commitments. This situation incentivizes contractors to negotiate lower percentages, contrary to the policy’s goal of fostering meaningful offsets. Additionally, the “getaway clause,” allowing for no offset obligations if parties cannot agree on a workable project, may discourage the active pursuit of innovative solutions.
Increased uncertainty and financial risk
One of the most notable changes in the new policy is the requirement for contractors to finalize an Industrial Cooperation Plan (ICP) before a contract is awarded. In practical terms, this means that contractors must invest resources in identifying and negotiating offset projects without any certainty that they will actually receive the main contract. This approach significantly increases the financial risk for contractors, as they must allocate funds and resources prematurely. The unpredictability of winning a contract makes it difficult for companies to justify these preliminary expenditures to their shareholders.
Replacing the fixed 40% offset obligation with a discretionary, case-by-case system creates further ambiguity. Contractors are left guessing about the scale of their obligations until well into the procurement process, complicating their ability to calculate their costs and plan effectively. This uncertainty can cause longer procurement timelines as companies are forced to navigate the complexities of each contract on an ad hoc basis.
In addition, by eliminating indirect offsets the new policy focuses entirely on projects directly related to the specific defense systems being procured. While this change aims to ensure that all investments contribute directly to Taiwan’s defense capabilities, it also removes the flexibility that indirect offsets provide through investing in non-defense-related sectors that bring broader economic benefits.
The absence of indirect offsets is especially problematic given the constraints of stringent U.S. export controls. Those policies strictly limit what advanced defense technologies can be transferred to other countries or used in domestic production abroad. Without an indirect offset option, contractors may struggle to identify enough feasible projects that both meet Taiwan’s needs and comply with U.S. regulations. This could result in delays or even a failure to meet offset obligations, ultimately slowing down Taiwan’s defense procurement process.
The push for transparency in ICP pricing adds yet another layer of difficulty. Traditionally, the costs associated with offset projects were embedded within the overall contract pricing, allowing companies to allocate these expenses across various elements of the contract. Taiwan’s new policy requires that these costs be clearly itemized. This requirement diverges from standard practices in other markets and adds a level of scrutiny that could increase costs for contractors. Moreover, such transparency could expose sensitive commercial information, potentially putting companies at a competitive disadvantage.
The first rule of offsets, as described humorously by one defense contractor in a reference to the rule in the movie Fight Club, is “You do not talk about the cost of offsets.” This secrecy has traditionally been maintained to protect the competitive strategies of defense companies and to avoid potential disputes over cost allocations. Requiring full disclosure not only disrupts these practices but could also make Taiwan a less attractive market for defense contractors compared to countries with better structured or lenient offset requirements.
Opportunities within the new framework
Despite the challenges, the new offset policy does offer potential opportunities for Taiwan. By focusing exclusively on direct offsets, Taiwan can ensure that investments by foreign contractors align closely with the strategic needs of its defense sector. For instance, past agreements have included contractor-led training programs to develop advanced defense system operation skills and technology transfers for critical defense components, fostering the rapid development of specialized capabilities. Such focus could help reduce the country’s reliance on foreign technologies and bolster its self-sufficiency in critical defense areas.
Additionally, the new policy could lead to the creation of a more sophisticated defense industrial base. By requiring contractors to invest directly in defense-related capabilities, Taiwan might accelerate the development of niche sectors within its defense industry, such as uncrewed aerial vehicles or precision guidance technologies, fostering local expertise and establishing Taiwan as a competitive player in the regional defense market. The insistence on transparency could also, if managed correctly, reduce corruption risks and ensure that the Taiwanese government gets maximum value from its defense contracts.
To make the new offset policy workable and advantageous, industry experts suggest several strategic measures:
1. Industry consultation and stakeholder engagement: One of the biggest criticisms of the new policy is the lack of stakeholder engagement during its development. Engaging with defense contractors, industry experts, and allied governments is essential for refining the policy to make it commercially viable while also serving Taiwan’s strategic needs. Creating a formal consultation mechanism could help identify potential issues early and allow for a more collaborative approach to resolving them.
2. Balancing flexibility and predictability: The shift away from a fixed offset requirement has introduced unpredictability that complicates planning for contractors. Taiwan should consider adopting a hybrid model that restores some of the predictability of the old system, such as a minimum offset percentage, while retaining elements of strategic alignment from the new case-by-case approach. This balance could provide greater clarity for contractors while still meeting Taiwan’s defense priorities.
3. Enhanced transparency with safeguards: While transparency in ICP pricing is a laudable goal, it should be implemented with safeguards to protect commercially sensitive information. One possible solution is to establish a government body that reviews offset costs confidentially, ensuring that projects meet their strategic objectives and that contractors comply with offset obligations – without compromising competitive advantages.
4. Global alignment and competitive positioning: Taiwan needs to align its offset practices with international norms to remain competitive as a partner in global defense procurement. Many countries, including those with robust defense sectors, still allow indirect offsets and offer more flexible arrangements for contractors. Adopting a hybrid model that reintroduces some flexibility could enhance Taiwan’s appeal in the market while maintaining alignment with its strategic priorities.
Taiwan’s revised offset policy represents both a bold opportunity and a considerable risk. On the one hand, it aims to align foreign investments more closely with the country’s strategic defense needs, potentially accelerating the development of critical defense capabilities. On the other hand, the increased financial risks for contractors, the elimination of indirect offsets, and the demand for pricing transparency introduce challenges that could slow down procurement processes and make Taiwan a less attractive market for international defense contractors.
By refining its approach to balance strategic alignment with market competitiveness, Taiwan can strengthen its defense capabilities and industrial base, fostering long-term resilience and promoting innovation across the defense sector.
The Ministry of National Defense was approached for comments, but did not immediately respond to the request.
