Briefing: Licensed Production

What is it?

Licensed production is where a company's product is manufactured under contract by a company in another country. At its simplest, parts purchased from the vendor are assembled in the buyer country; at its most advanced, a weapon's design, along with the expertise of engineers, is purchased and the equipment built in its entirety in the buyer country.

Licensed production agreements are also often referred to as licensed manufacturing agreements, co-production agreements or technology transfer agreements, although there are technical differences between the terms 1 . We will be considering all of the above, and also the activities of company subsidiaries and any sale of production equipment. It is as well to be aware that the term "licensing" is used both for licensed production and the licensing required by governments for arms exports to take place.

Why is it important?

In the highly competitive global arms market, licensed production has become a common feature of deals. It is no longer an issue just of interest to "industrial studies" academics; it is a fundamental aspect of the arms trade - a basic tool used to win arms contracts. It is more than just a trend in itself, it is an integral part of the new "globalized" arms industry - the simple concept of an arms company is disappearing "into a labyrinth of licensed production, joint ventures, conglomerates, strategic partnerships, and Co-operative Armament Programmes".² This overall trend is unlikely to change so it is very probable that licensed production will continue to be an increasing factor in arms sales.

Buyer countries no longer expect merely to purchase equipment, they expect additional compensations, or sweeteners. There are a wide range of possible sweeteners (see "Offsets" box on back page), but licensed production by their own companies is a key one. Anticipated benefits for local industry and employment are leapt upon by the buying government to "sell" to their populations what might otherwise seem to be extravagant or wasteful weapons purchases.

Most of the largest arms importers are extremely active in seeking licensed production agreements, and Turkey, South Korea and India are particularly keen. The box opposite shows recent deals for India alone, indicating that it is having no trouble obtaining licensed production agreements for high-tech equipment. This is despite its conflict with Pakistan and a US arms embargo following its 1998 nuclear test.

A register of licensed production underway during 1996-2000, indicated that the UK had agreements with 11 countries including Algeria, Greece, India, Philippines, Poland, Saudi Arabia, Thailand and Turkey.3 The register covers only major conventional weapons. Information on agreements relating to small arms and ammunition is harder to come by. However, one analysis of relevant licensed production agreements from 1960- 1999, established that 14 countries, including the UK, had made such agreements with 46 other countries.¹
 

India - one country's recent deals

India has recently formalised closer military industry links with Russia, Israel and France. All of these envisage sizeable licensed production.

Deals with Russia:
a $3.3 billion contract for the licensed manufacture of 140 multirole fighter aircraft.⁴ the purchase of 310 Russian main battle tanks for an estimated $600-$700 million. 124 will be delivered complete and the rest assembled in India. The tank is expected to be eventually produced under licence.⁵ plans for a $1 billion air defence system which "includes licensed production of 2,000 155mm self propelled guns".⁶

with Israel: an accord between India and Israel was signed in July 2001. It allows for the transfer of Israeli technology to India and has a potential value to Israeli industry of $2 billion.⁷ It aims to establish "licensed production lines in India for the Indian Army, as well as for potential third-country exports".⁸

with France:
India and France have formed a "partnership of defense industries" and agreed transfers potentially worth $2 billion. These will comprise technology transfer, licensed production and arms purchases. "In the long run, France is looking to India as a hub for military hardware exports to Asia, especially Indonesia, Taiwan and Malaysia".⁹

with the UK:
In 2000, the UK issued export licences to India for production equipment &/or production technology for: combat aircraft, military aero-engines, frigate, naval radar and electronic warfare equipment.¹⁰ (These are not necessarily for licensed production.)

BAE Systems is bidding for a deal which would see its Hawk jets produced under licence in India. Until recently it was favourite for the contract, and it is still vigorously pursuing the deal - fresh pressure was applied by John Prescott during a recent visit to India.¹¹

 
Why is it a problem?

Most countries' export control regimes, including those of the UK, fail to adequately cover licensed production, leaving a gaping hole in their ability to control arms transfers.

  Evading controls to the buyer country

Licensed production can negate controls on exports to the buyer country. Whereas government controls on exports can be adjusted to take account of a conflict situation or a worsening human rights record, this is not possible with licensed production. Once equipment and technology have been handed over, it is out of the hands of the selling country. Depending upon the arrangement, spare parts or technical help might continue to be useful, allowing the selling country some say over production, but this is by no means certain and the production capacity of the buyer would have been enhanced regardless.
Oxfam has suggested that "It is not uncommon for the licensed production agreement to start by establishing an assembly facility which over time is provided with the technology to produce full versions and finally to undertake development of variants".¹² The "GKN" example in the box opposite indicates how the production capability of the Filipino plant was steadily increased, moving it away from reliance on UK exports and hence controls.
Additionally, there is the problem of knowing when the contracted volumes have been produced. It is entirely possible for production to continue after the agreed volumes have been manufactured, whether it is for the domestic or export market.
A blatant loophole exists just in terms of setting up initial production. If a UK company signs a licensed production agreement but arranges for the production equipment to be shipped from another country, the UK government would have no say.

  Evading controls to third countries

Licensed production agreements can also circumvent export controls by facilitating exports from the buyer country to third countries. This can be an unintended consequence of licensing production, but can also be a motivation in itself (see "India" box on front page, especially with respect to France).
As the law stands, the UK government cannot stop a UK company arranging for its small arms, armoured vehicles or fighter aircraft to be manufactured overseas and then sold to a third country. Circumvention of export controls has occurred in relation to the UK, though it is not presently possible to establish the extent to which it has been deliberately arranged. Whether deliberate or unintentional, weapons are delivered to places disallowed under the originating country"s export controls. Ann Clwyd MP used the example of the assembly of GKN vehicles in the Philippines to illustrate the UK government"s position:

"I asked the President of the Board of Trade "what control she has over the transfer of (a) armoured vehicles and (b) armoured personnel carriers to (i) Indonesia and (ii) other countries from the GKN Defence licensed production facility in the Philippines."
The answer was:
"The control of exports from the Philippines is a matter for the Philippine Government..." That answer illustrates the fact that the inadequacy of UK licensed production agreements leads to the establishment of new centres of production of military/security equipment over which the UK Government have little or no control. We must introduce statutory powers to control licensed production overseas."¹³

Many countries that are producing under licence from European arms manufacturers appear to have few meaningful restrictions on who they will export to. South Africa is a prime example. A study in 2000 compared government export criteria with the countries actually exported to. It found that 57 of the 83 countries to which South Africa sold arms between 1996 & 1999 did not comply with the necessary criteria.¹⁷ But at least South Africa had criteria. Many countries do not. A Pakistani General reported that they had "no ban on selling arms to specific countries. "I don"t think we have a problem on that score. Maybe Israel we wouldn"t like to sell weapons to"".¹⁸
The US has one of the strongest export control regimes in the world, with legislation making the "diversion of technologies to unauthorized uses and prohibited third parties" illegal. Unfortunately, "inadequate enforcement" means that there are frequent abuses.¹⁹ Some of these are shown in the box to the left. While it is unfortunate that the US enforcement is not stronger, there is at least the possibility of legal action. It would be naive to imagine that a lack of controls, as is the situation in the UK, would do anything but facilitate a much greater level of "diversion".
 

US "diversion" examples

• Japan Aviation Electronics Industry was fined $10 million in 1992 for illegally selling US licensed weapons components to Iran.¹⁴
• South Korea planned to export landmines that, according to o Pentagon officials, illegally used US technology. The plans were terminated in May 2001 after threats to block purchases of advanced US weaponry.¹⁵
• South Korea violated the terms of its licence for M-16A1 assault rifles by over-producing and exporting them without US approval. They were not penalised as South Korea claimed it had exported a "Koreanised" version of the weapon.¹
• "Israel has repeatedly transferred US-licensed missile and radar technology to China in the 1980s and 1990s".¹⁴
• Israel "has been charged with illegally incorporating U.S. designs and technology into weapons exported to South Africa, Chile and Ethiopia".¹⁶
• Brazil transferred US technology to Iraq, where it was used to improve the targeting capability of Scud missiles".¹⁴
• A member of the US "Presidential Commission on Offsets in International Trade" reported that "In small arms, there are numberous examples of violations of licensing agreements".¹⁴
• "A 1989 study of 18 co-production agreements..., found five e cases of unauthorized transfers." ¹⁴

 
Examples involving the UK

Heckler & Koch
Heckler & Koch (H&K) is a small arms multinational company. It became a subsidiary of Royal Ordnance, of the UK, in 1991, which is in turn owned by BAE Systems. H&K has licensed small arms production in 14 countries, including Burma, Iran, Mexico, Pakistan and Saudi Arabia and Turkey.¹ Oxfam lists 60 countries using H&K"s G3 rifle and 53 countries using the MP5 sub-machine gun.¹²

From the UK to Bosnia and Serbia
Even before 1991, the UK was a H&K licensed producer, manufacturing weapons in London and Nottingham. Prior to the UN embargo on Yugoslavia it was illegal for Germany, but not the UK, to export weapons there. When H&K sub-machine guns were identified as being used in Bosnia and Serbia, H&K stated that the weapons in question were made in London.¹

From Turkey to Indonesia
MKEK of Turkey also produces H&K weapons under licence, and has been doing so since the 1970s. Not only is this production questionable due to the human rights abuses carried out by the Turkish military and police, but it sells its licensed products around the globe. In September 1999, at the height of the referendum massacres in East Timor, MKEK was reported to have shipped 500 H&K sub-machine guns to Indonesia. This was only a few months after the UK government had refused export licences for the export of similar weapons to Indonesia.¹

Land Rover
In 1994, Otokar, a Turkish company, began production of the Scorpion light reconnaissance vehicle. The Scorpion is comprised 70 per cent of Land Rover parts which are assembled in Turkey and to which machine guns and night vision surveillance cameras are added. The Land Rover parts are exported from the UK but are listed as civilian transfers and so do not require an export licence. "Ottokar in the past have exported such armoured personnel vehicles to Pakistan and also to Algeria".²⁰

GKN
GKN Defence Ltd set up a licensed production agreement with a company in the Philippines to produce Simba Armoured Personnel Carriers. A total of 150 vehicles were ordered, the vast majority to be assembled at the plant of the Filipino company. The company started with the assembly of kits, progressed to importing some parts and manufacturing others, and finished up producing the whole vehicle. (Also see Ann Clwyd quote on opposite page.)

Rolls-Royce
"Abdul Minty of Anti-Apartheid gave evidence to the UN Security Council in 1977 how sanctions were bypassed when British-designed equipment was made under licence in a third country and sold on to South Africa. "The most flagrant example in this area involves Rolls-Royce engines," he claimed".²¹

 
Why is it being ignored by the UK government?

How are we to interpret new legislation to control arms exports which has an omission that allows it to be systematically by-passed?
Maybe the UK government hasn't caught up with changes in the international arms industry? Maybe it has faith in the end-use controls of the countries it sells to? Maybe it believes that licensed production won't by-pass its export controls? Or maybe it knows licensed production can circumvent its controls but doesn't mind! It is difficult to avoid the latter conclusion.
In trying to understand the failure to adequately address licensed production, it is useful to consider who gains. In the proposed export control legislation, the only serious loophole closed is brokering. While this is a valuable tightening of controls, it is the one loophole that will not affect the workings of the major arms companies. Indeed, controls on brokering, where the deal is organised from the UK but transfers are between other countries, may well be favoured by the large arms companies as the practice brings unwanted negative attention to arms trading. In addition to licensed production, end-use monitoring and the prior scrutiny of export licence applications were missing from the legislation. (Unlike licensed production, the other two aspects could be addressed in secondary legislation. However, there is presently no reason to believe that they will.) Each of these could seriously affect major arms deals.
The question being asked by the UK government appears to be not, "Could licensed production undermine UK export controls?" but, "Will controlling licensed production affect our exporting arms companies?"

What is needed to regulate it?

The government needs to set the same standards for goods produced under licence as it does for direct exports.
Contracts for licensed production need to specify the quantity of military equipment to be produced and the duration of the contract. There must be a clause in the contract that provides that the finished product will not be exported to third countries unless an export licence is obtained from the UK government. The licensed production contract needs to be approved by government before it is finalised and should be turned down:

• if a direct weapons transfer would be refused
• where the buyer country cannot demonstrate sufficient accountability in terms of end-use control
• to states that have a record of violating international arms embargoes.²²

It is not complicated to set up contracts that restrict exports. Pharmaceutical companies and football manufacturers, among many others, have them. But will arms companies countenance anything that may hinder their ability to make deals? And, if not, will the government have the integrity to close the loopholes regardless?
 

Offsets

Offsets are essentially sweeteners used to secure deals with buyer countries. Clauses are included in the arms contract whereby the vendor country or company makes such promises as:

• To invest in the buyer country's domestic companies (not necessarily arms industry). This often suits the vendor company as it can use this to acquire arms companies in the buyer country and hence open new markets
• To buy an agreed quantity of the buyer country's produce. For example, US company McDonnell Douglas agreed to accept frozen chickens as part payment from Thailand for 8 F-18 fighter aircraft.²³
• To buy back used military equipment from the buyer country
• To accept the buyer country's produce in barter as part paymentt (illegal for non-military industry under WTO rules). An example of this is the payment in oil negotiated between the UK and Saudi Arabia under the massive Al Yamamah deal.
• To source components for the deal from buyer country companies
• To set up production lines in the buyer country
• To provide the technical know-how and design for the buyer country to produce the equipment themselves.

Offsets of 100% of the value of the deal appear to be becoming commonplace, i.e. the selling country or company is required to compensate the buyer country to the full level of the deal. In some cases, such as the South African deal of 1999, much higher offsets are agreed. In the South African case they were approaching 400% of the cost of the armaments.
However, offsets have a poor record in terms of delivering on agreements. The above Al Yamamah deal was supposed to create 75,000 jobs in Saudi Arabia. Only 1,600 jobs were actually created, with just 300 of those being filled by Saudis.²⁴

 
References

1. Abel, Pete, "Manufacturing Trends: Globalising the Source", in Lora Lumpe (Ed.), "Running Guns: The Global Black Market in Small Arms", Zed Books Ltd, London, 2000
2. Wrigley, Christopher, "The Arms Industry", CAAT, London, March 2001
3. SIPRI, "Register of the transfers and licensed production of major conventional weapons. Background material for Conference on Public Transparency and Arms Trade, May 5 2001, Nykoping, Sweden", SIPRI Arms Transfers Project, 10 April 2001
4. Flight International 9-15 January 2001
5. Jane's Defence Weekly 21 February 2001
6. Defense News 11-17 June 2001
7. Jane's Defence Weekly 25 July 01
8. Defense News 23-29 July 2001
9. Defense News 6-12 Aug 2001
10. Foreign and Commonwealth Office, "Strategic Export Controls Annual Report 2000", The Stationery Office, Norwich, 2001
11. Air Forces Monthly September 2001
12. Oxfam, "Out of Control: The loopholes in UK controls of the arms trade", December 1998
13. Hansard, 9 July 2001
14. Markusen, Ann, "Appendix H of Status Report of the Presidential Commission on Offsets in International Trade", www.offsets.brtrc.net, 2001
15. Defense News 4-10 June 2001
16. Lumpe, Lora, 1994, referenced in Ann Markusen, "The Arms Trade as Illiberal Trade", paper for presentation at the the First Annual Research Conference on Defence and Peace Economics, Rutgers University-Newark, May 10-11, 2001
17. Ceasefire Campaign, "Report on the Human Rights Situation in Recipient Countries of South African Arms", Johnnesburg, May 2000
18. The Guardian 7 November 2000
19. Markusen, Ann, "The Arms Trade as Illiberal Trade", paper for presentation at the the First Annual Research Conference on Defence and Peace Economics, Rutgers University-Newark, May 10-11, 2001
20. Crowley, Michael, in Quadripartite Committee "Draft Export Control and Non-Proliferation Bill. Report, together with the Proceedings of the Committees", The Stationery Office Limited, Norwich, 1 May 2001
21. The Guardian 9 May 2001
22. UK Working Group on Arms submission in Quadripartite Committee "Draft Export Control and Non-Proliferation Bill. Report, together with the Proceedings of the Committees", The Stationery Office Limited, Norwich, 1 May 2001
23. The Guardian 21 August 1996, quoted in Mark Phythian, "The Politics of British Arms Sales since 1964", Manchester University Press, 2000
24. Matthews, Ron, 1999, referenced in Terry Crawford-Browne, "South Africa's R30 billion Weapons Procurement Programme", ECAAR, 26 May 2000

August 2001