In late August, the U.S. and Israeli governments appeared to have settled on a grand strategy to advance Middle East peace, one that traded a tougher U.S. stance on Iran for freezing Israeli settlement construction in the West Bank. But subsequent reports on plans for additional Israeli settlement construction and announcements by Tehran outlining its terms for talks at a September 9th, meeting of the P5+1 (that’s the five permanent members of the Security Council plus Germany) working group, indicate that the specific details of a bargain are still far from settled.

As negotiations on Israeli settlements commence in this environment of uncertainty, the Obama administration will need all the bargaining chips it can marshal. The key is to find a form of leverage that is costly enough to impact Israeli behavior without threatening their security and is also relatively cheap for the administration to apply. Defense “offsets” — incentives granted by private companies to facilitate the purchase of military goods — satisfy all these conditions, and may be especially effective in the struggle for Middle East peace.

Like most industrialized nations, U.S. defense manufacturers routinely grant offsets to purchasing governments, usually in the form of agreements to co-produce specific weapons or invest in commercial enterprises. It has long been U.S. practice not to allow offsets on products and services purchased with U.S. military assistance funds — except when it comes to Egypt and Israel. The billions of dollars in additional defense assistance that Israel has secured through this legislative loophole may prove to be a significant source of leverage in the Middle East peace process.

For example, Israel is hoping to pen a deal for $20 billion worth of U.S.-built F-35s that could include offsets of nearly $10 billion — that’s in accordance with Israeli policy requiring offsets of 48% of the overall contract value. These offsets would accrue mostly to the Israeli defense department, possibly via agreements that Lockheed Martin would purchase Israeli-built computer components for the assembled planes. Israeli press reports suggest the offset provisions are holding up the deal, signaling Israel’s continued pursuit of offsets even in its most strategic procurement decisions. These funds represent a significant tool the Obama administration should use to press Israel on the settlement issue.

There is precedent for trying security assistance to Israeli settlement policy. In the 1990s Congress frequently reduced multi-billion dollar loan guarantee programs by the amount the Israeli government spent on settlements in the occupied territories. This logic applies to offsets as well, since they may indirectly finance projects that support settlements by providing Israel with financial flexibility to commit additional resources to build more settlements or by funneling the profits from offsets into acquiring controversial crowd-control devices and other materials that many countries (including the United States) refuse to export to Israel.

Egypt’s offset history may also represent a bargaining chip in negotiations with Israel. Although official Egyptian policy is not to request offsets from the U.S., partly due to major cost overruns and inefficiencies in previous offset agreements, industry trade groups such as Epicos report that Egyptian authorities regularly demand “discounts” and “concessions.” If Israeli offsets are threatened, officials may demand that similar reforms be implemented with regard to Egyptian procurement processes, hoping to make the process too politically costly for the United States to implement.

This presents the administration with a win-win situation. Slashing offsets does not restrict the principle funds promised to Israel after Camp David, and it represents a reform to the defense procurement process that would prevent the controversial transfer of U.S. defense jobs to the Israeli defense sector. If the Israelis express willingness to move on the settlement issue rather than forego offset benefits, a more viable peace strategy will result. If, on the other hand, the Israelis will not revise their settlement policy, the United States can simply end these subsidies to their defense industry. Under this latter scenario the U.S. would also restrain “concessions” granted to the Egyptian defense establishment, in keeping with the equilibrium established under Camp David. The Egyptian military is a powerful political player implicated in a wide spectrum of abuses — weakening their institutional power would hardly be a difficult sell.

The U.S. has important and legally binding relationships with both Israel and Egypt. Offsets, however, are neither mandated by treaties nor are they justifiable on security or economic grounds. Israel’s acute desire to obtain the F-35 and its refusal to accept settlement restrictions gives the U.S. significant space for negotiation that might not emerge again in the foreseeable future. In the normally labyrinthine world of Middle East politics, obscure contract details may in fact provide a clear source of leverage in the struggle to secure progress toward peace.

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