Defense spending in the United States is likely to grow in the
long term, officials said, regardless of the length or the outcome
of the war in Afghanistan. The expected boost in Pentagon budgets
is good news for the defense industry, even though experts believe
that companies will have to adapt to a new way of doing business.
The surge in requirements for new equipment and weapons that ensued
from the terrorist attacks of September 11, on the one hand, will
result in significant new business for many companies. On the other
hand, the nature of the conflict in Afghanistan is driving Defense
Department officials to rethink buying priorities. The so-called
"transformation" of the U.S. military, officials said,
means that increases in spending will not necessarily be allocated
to traditional military hardware, but rather to "transformational"
technologies.
Deputy Undersecretary of Defense for Industrial Policy Suzanne
Patrick recently told National Defense that she is confident that
the defense industry will be able to adjust to the changing environment,
which is "a natural by-product of the transformation we find
ourselves in."
Recent developments in the world, she said, show that "we
are veritably at the watershed between the more known, conventional
forms of warfare and new ways of pursuing warfare that will undoubtedly
be less platform and more network-centric.
"So it should not be surprising that as we advance this new
kind of warfare, we will have a dwindling supplier base of the old-style
platforms and systems." At the same time, Patrick said, "it
is important to adequately fund the futuristic systems that will
take us to this new form of warfare without exposing ourselves to
imprudent risks relative to current requirements."
Patrick said that specific programs would benefit as a result of
the current conflict. The Pentagon, she said, will "accelerate
into production a number of the transformational technologies so
important to Secretary Rumsfeld as he took office."
Defense contractors, she said, should be flexible, "in order
to pursue new opportunities as they continue to produce current
platforms." A case in point is an initiative by Boeing to pursue
future contracts for unmanned aircraft. "We were particularly
pleased to see Boeing stand up its Unmanned Vehicles business unit
in order to go after some of these new opportunities with many members
of the fine team they assembled to compete for the Joint Strike
Fighter program."
Operation Enduring Freedom and homeland defense efforts will result
in the infusion of significant funding for "key programs in
the defense industry," Patrick said. "And even after the
current conflict ends, there should be considerable additional funding
allocated for the replenishment of defense hardware and consumables
expended."
In the United States, she said, "We are very fortunate …
to have a strong, resilient and responsive industrial base."
Patrick’s office is part of a newly-established Defense Department
task force aimed to ensure that the industry can produce the needed
equipment and that the available funds are prioritized to meet the
most urgent needs. Patrick is working with the Joint Staff, the
Defense Contracting and Management Agency, and the services, in
a group called the Priority Allocation of Industrial Resources Task
Force. The task force, she said, "will ensure the smooth and
equitable allocation of key warfare requirements among multiple
programs."
This organization will monitor the industrial capabilities and
assign "production priority to key systems and subsystems,"
she said. "These measures should allow for the most efficient
and expedient provision of needed hardware to the war fighter."
One important consideration for the Defense Department is whether
is the industry is robust enough to meet changing requirements,
said Jeffrey Bialos, senior fellow at the John F. Kennedy school
of government at Harvard University and former deputy undersecretary
of defense for industrial policy. "The nature of warfare has
changed," he said in an interview. "The concept of surge
capacity is fairly outmoded." The Defense Department should
ask: "do we have sufficiently robust defense companies to meet
our national security needs?"
A short-term boost in defense spending surely will benefit defense
companies, said Bialos, "Some $20 billion of the $40
billion emergency funding already appropriated by Congress will
go to defense for such things as increased operations, upgrades
to electronic reconnaissance aircraft, situational awareness, acceleration
of unmanned air vehicle (UAV) programs such as the RQ-4A Global
Hawk and munitions purchases," said Bialos.
"Most people agree that what we can’t scrimp on right
now is defense," said Andrew Krepinevich, president of the
Center for Strategic and Budgetary Assessments. This makes the
defense industry "recession-proof," he stressed.
Despite significant boosts in defense spending, a skittish stock
market and an uncertain U.S. civilian economy have prompted analysts
to worry about a market downturn in the long run.
Changing Requirements
Byron Callan, a defense and aerospace analyst at Merrill Lynch,
said it takes time for the defense dollars to trickle down to the
broader economy. "There is an expectation that there will be
more money for defense, but we won’t see that money for at
least six months on the commercial side," he said. "What
was so significant about September 11 was that it suddenly made
defense a growth market, where there had not been growth before.
I expect that there will be a lot of commercial companies looking
to do business now with the Defense Department, to the benefit of
the entire defense sector," Callan said.
"Unless you want to make the case that we’re going to
have rolling terrorist attacks, this could be an opportunity for
the Defense Department to get some things done," Callan said.
Aggressive investment in defense modernization may be one way to
"get things done," said Dov Zakheim, the Defense Department’s
comptroller. Zakheim made the case that the Pentagon should spearhead
an economic stimulus package.
"What better way is there to kill multiple birds with one
stone than by accelerating the modernization of facilities, really
building, that will give the construction industry real work and
puts a lot of people to work right now?" Zakheim said during
a breakfast with reporters. "We have for years, seriously neglected
the modernization of our facilities, housing and other facilities.
What we’ve done is create a situation where we try to get
the best people to serve in the military and then we treat them
like dirt because they live in substandard housing and work in horrible
office environments."
Wolfgang Demisch, managing director of Dresdner Kleinwort Wasserstein,
had a less optimistic view. "We have come to a frustrating
impasse in defense. There is an expectation that various programs
currently in the pipeline, such as the fighter programs, will be
put on hold. People thought that funding for modernization would
be curtailed to pay for the fighters, but now all that funding is
going toward the war effort."
Defense stocks, he said, experienced a 25-30 percent gain in the
weeks immediately after September 11. "But the counterpoint
is that commercial stocks have experienced a blow, the worst since
the energy crisis of the 1970s," Demisch said. "We are
looking at a worldwide financial crisis for the air transport industry,
and as a result, its entire supplier base is in enormous distress."
Companies that make products used by both commercial and military
aviation, such as precision cast parts and turbines, he said, have
seen their stocks "whacked painfully." The expectation
is that air traffic will continue to shrink, and the government’s
security procedures are "being applied in a typical bureaucratic
fashion—making air travel significantly less convenient and
more expensive," Demisch said.
"It is not clear that the people determining the security
regulations are very conscious of the financial crisis of the air
transport system," he added. "Defense companies that have
a substantial commercial presence in air transport will be hurt
by current conditions."
Krepinevich noted: "One could argue that the recession could
spur the government to provide support to the commercial and aerospace
sector." He said that the Pentagon is looking for ways to help
bail out certain companies. "Boeing, a defense company heavily
involved in the commercial airline business, is at risk because
so much of their business is commercial. The Defense Department
is now talking about buying C-17s, which Boeing makes, to help bring
Boeing out of its crisis," he said.
However, Demisch added that defense and aerospace products are
not made or acquired overnight, so the sector will lose huge amounts
of money while it waits for direction from the government.
Ben Bernanke, a member of the Business Cycle Dating Committee of
the National Bureau of Economic Research, said that based on historical
data from previous post-war recessions, the U.S. economy is likely
to begin a recovery by July 2002.