The Committee commends the government’s steadfast commitment to strengthening national defense amid rising regional security challenges. President Lai Ching-te’s pledge to raise defense spending to over 3% of GDP is a pragmatic response to escalating cross-Strait tensions and demonstrates strategic foresight. While recent U.S. calls for even higher defense spending highlight the urgency of deterrence, both government leaders and independent experts recognize that such increases must be balanced against budgetary and social priorities.

Taiwan’s defense strategy has evolved notably in recent years, marked by significant arms procurements, targeted policy reforms, and an increased focus on co-development with international partners. In 2024, the United States approved a US$2 billion arms sale in October, followed by an additional US$385 million agreement in November. Together, they represent the largest arms packages in the history of the bilateral security relationship. These procurements, alongside expanded co-development initiatives, underscore Taiwan’s clear commitment to reinforcing its defense posture and advancing its indigenous defense industry.

The Committee strongly supports Taiwan’s pursuit of advanced indigenous capabilities, particularly through the co-development of technologies such as drones and next-generation submarines. We believe these investments are vital not only to strengthening Taiwan’s self-defense but also to contributing to broader regional stability.

To ensure a robust procurement and manufacturing environment that supports both Taiwan’s security and economic prosperity, the Committee offers the following recommendations:

Suggestion 1: Revise the Industrial Cooperation Policy to support national security and economic development.

A critical component of Taiwan’s defense industry regulations is the Industrial Cooperation Policy (commonly known as the offset policy), which aims to leverage foreign defense procurement to stimulate local industry development, technology transfer, and economic growth.

Taiwan’s evolving military offset policy is undergoing significant transformation, impacting both international defense contractors and Taiwan’s broader defense strategy. The new policy replaces the previous fixed offset obligation of 40% of contract value with a discretionary, case-by-case model. It also eliminates indirect offsets and introduces new transparency requirements for cost disclosure. While these revisions aim to better align offset investments with Taiwan’s strategic priorities, they have introduced significant uncertainty, financial risk, and procedural complexity for international defense contractors.

The Committee supports the government’s objectives to enhance self-reliance in critical defense technologies and develop local defense manufacturing capabilities. However, the new offset policy presents several challenges that risk undermining Taiwan’s attractiveness as a defense market, potentially slowing the procurement process and weakening the incentive for international contractors to invest meaningfully in Taiwan.

The shift away from a fixed offset percentage to a case-by-case model has created an unpredictable and opaque policy environment. Defense contractors must now commit to offset plans before receiving contract awards, requiring them to assume financial risk without any assurance of securing the primary contract. This requirement complicates contractors’ internal approval processes and reduces the commercial viability of participating in Taiwan’s defense market, particularly given U.S. export restrictions on defense technologies.

The new policy requires contractors to finalize offset agreements shortly after Taiwan signs a Letter of Offer and Acceptance (LOA) under the U.S. Foreign Military Sales (FMS) framework. However, the actual contracts between the U.S. government and defense suppliers are finalized months or even years later. This misalignment forces contractors to commit to offset plans without certainty regarding their contractual position, diminishing the effectiveness of the policy and deterring early engagement.

Meanwhile, the policy’s prohibition on indirect offsets eliminates opportunities for broader investments in Taiwan’s economy, such as in renewable energy, healthcare, or education. Given the constraints imposed by U.S. export controls, which limit the transfer of sensitive defense technologies, the exclusion of indirect offsets further restricts contractors’ ability to fulfill offset obligations.

The absence of a standardized offset percentage has resulted in varying financial burdens across contractors, creating an uneven playing field. Contractors may be incentivized to negotiate lower commitments rather than pursue projects that maximize strategic value for Taiwan. A “getaway clause” allowing for no offsets if no agreement is reached further reduces enforcement. Moreover, the requirement for detailed disclosure of offset project costs diverges from international best practices. Such transparency exposes commercially sensitive information, potentially placing contractors at a competitive disadvantage and deterring participation in Taiwan’s defense procurement market.

While the policy aims to enhance Taiwan’s self-reliance in critical defense technologies, its implementation must carefully balance strategic priorities with contractor incentives to help Taiwan maintain competitiveness and attract investment. To ensure that Taiwan’s Industrial Cooperation Policy effectively supports both national security and economic development while maintaining an attractive environment for international defense contractors, the Committee offers the following recommendations:

1. Enhance stakeholder engagement. Establish formal consultation mechanisms involving defense contractors, industry experts, and allied governments to facilitate ongoing dialogue on the development and implementation of the offset policy.
2. Reinstate a minimum offset percentage to improve predictability. Introduce a hybrid offset model that includes a standardized minimum offset percentage (such as 20% to 30% of contract value), while retaining case-by-case flexibility to align with Taiwan’s strategic priorities.
3. Realign offset agreement timing with FMS contract milestones. Define “contract award” as the point when the U.S. government finalizes contracts with defense suppliers under the FMS framework. Allow contractors to finalize Industrial Cooperation Agreements only after this contract award milestone to reduce financial risk and encourage timely participation.
4. Implement confidentiality safeguards for offset project cost disclosures. Protect commercial data by establishing a confidential review mechanism for Industrial Cooperation Plan cost assessments that protects sensitive commercial information while ensuring compliance with policy objectives.
5. Align with global best practices. Reintroduce limited indirect offsets to enhance Taiwan’s attractiveness while maintaining its strategic defense objectives.

Suggestion 2: Strengthen supply chain integrity by addressing made-in-China risks in defense articles.

Taiwan maintains strict prohibitions on the use of Chinese-made components, software, and systems in its defense articles and critical infrastructure, driven by national security concerns over espionage, cybersecurity risks, and supply chain vulnerabilities. Under policies enforced by the Ministry of National Defense and regulations such as the Cyber Security Management Act, defense procurement contracts explicitly ban PRC-origin hardware and software, require supplier vetting, and mandate third-party certification to ensure compliance.

Taiwan’s concerns are driven by considerations of security risks, supply chain vulnerabilities, and potential dependence on a geopolitical rival. These concerns are particularly significant in defense-related contracts, where the integrity and reliability of hardware and software are essential to ensuring operational security and national defense readiness.

Cybersecurity and espionage risks represent significant concerns associated with the use of Chinese-made components, particularly in the fields of electronics and communications. Such components may contain backdoors or other vulnerabilities that could be exploited for cyberattacks or intelligence gathering, posing a direct threat to national security. The potential for malicious actors to infiltrate defense systems through compromised hardware or software highlights the need for rigorous cybersecurity measures and comprehensive supplier vetting processes to safeguard critical infrastructure and defense capabilities.

Another major concern is overdependence on Chinese-manufactured parts, which could result in supply chain disruptions during periods of heightened tension or conflict. A heavy reliance on China exposes Taiwan to the risk of restricted access to essential components, potentially jeopardizing defense readiness. Diversifying suppliers and securing alternative production sources are crucial steps toward preventing this vulnerability.

The integrity of components and the risk of counterfeit or substandard parts infiltrating defense supply chains further complicate the security landscape. Counterfeit parts not only undermine the reliability of military equipment but also pose operational hazards that could compromise mission effectiveness. Ensuring rigorous quality control and verification processes is vital to safeguarding defense systems from potentially defective or compromised components.

Legal and regulatory compliance is another critical factor. Like the United States, Taiwan has introduced stricter regulations to prevent the use of Chinese-origin components in defense applications. However, enforcing these regulations requires robust oversight mechanisms and close coordination among government agencies, defense contractors, and international partners. Strengthening compliance frameworks and enhancing monitoring efforts will be essential to mitigating the risks associated with the use of foreign-made components in Taiwan’s defense sector.

Ambiguity in the definition of “made in China” also presents compliance challenges, particularly in defense and critical infrastructure sectors. A primary concern is whether regulatory restrictions apply solely to the location of final assembly or whether they extend to subcomponents and raw materials. Given the complexity of global supply chains, products assembled outside China may still contain critical Chinese-made elements, raising concerns over potential security vulnerabilities and regulatory loopholes.

Moreover, the treatment of multinational companies with subsidiaries or joint ventures in China complicates enforcement. Many global corporations maintain significant operations in China, either through direct ownership or partnerships. Determining whether their products should be classified as Chinese-made introduces added complexity, particularly regarding ownership structure, operational control, or manufacturing location.

Components manufactured outside of China but using Chinese-sourced materials or intellectual property further blur the lines of compliance. If critical materials, technologies, or proprietary designs originate from China, they could still pose security risks, even if final production occurs elsewhere. Policymakers and regulatory authorities must establish clear guidelines on how these factors are weighed in determining whether a product is considered Chinese-made, ensuring that national security measures remain effective without unduly disrupting global supply chains.

The Committee offers the following recommendations:

1. Adopt a tiered classification system. The tiered classification system could be arranged as follows:

   ．Tier 1 (Prohibited): Components manufactured, assembled, or designed by Chinese companies, including subsidiaries and state-linked entities.
   ．Tier 2 (Restricted): Components made outside of China but containing critical Chinese subcomponents.
   ．Tier 3 (Allowable with disclosure): Components produced in non-Chinese facilities by non-Chinese companies but using some Chinese raw materials.

2. Implement supply chain traceability and certification. Require defense contractors to map their entire supply chain, down to subcomponents, and disclose Chinese-origin materials, and implement third-party verification mechanisms for high-risk components.
3. Enhance contractual language. Defense contracts should include clear and explicit definitions of prohibited and restricted sources. Suppliers should be required to provide formal certification confirming that their products and components do not originate from Chinese sources.
4. Align with U.S. regulations. Taiwan should consider aligning its policies with relevant U.S. regulations, such as the National Defense Authorization Act and the Federal Acquisition Regulation, to ensure consistency, interoperability, and compliance in joint defense programs.