Defense Sector Post-Election: Caution Sets In
Investors’ euphoria about rising Pentagon budgets and a lessening of regulations in a Donald Trump administration is giving way to realism and caution.
Defense watchers overwhelmingly agree that military spending will go up under Trump, but warn of caveats. Republican control of the executive and legislative branches of government almost ensures that the current caps on discretionary federal spending will be lifted.
Doubts are growing, however, over whether the administration and Congress will be able to come together around a defense budget plan in the long term. Whereas congressional defense hawks will seek to immediately pour money into areas like equipment modernization and force readiness, Trump has been adamant that any defense boost would have to be offset by reductions in overhead, bureaucratic bloat, fraud and waste in Pentagon programs.
“It’s incumbent on the administration and the Department of Defense to come up with a sensible plan that can be executed,” says Jack Deschauer, a partner at the Washington, D.C. office of Squire Patton Boggs, a lobbying firm.
The Trump White House’s first order of business will be the fiscal year 2017 budget that Congress is unlikely to pass during the lame duck session. Republicans want an $18 billion increase for defense and President Obama has vowed to veto such a measure unless the money is split evenly between defense and nondefense agencies.
“I don’t see any reason why Republicans would compromise on that,” says Deschauer. Since the Republicans do not have the 60 votes to roll over Senate Democrats, the minority will have a say in the process, he notes. But without the threat of a presidential veto, they will not be able to prevent defense budget increases of some magnitude. He predicts the full $18 billion boost for defense will be enacted after Trump takes office.
The Bipartisan Budget Act of 2015 canceled the automatic reductions in discretionary spending for 2016 and 2017. Defense spending was capped at $551.1 billion for 2017. Current law limits defense spending to $549 billion in 2018.
Looking farther ahead, if and when the Budget Control Act spending restrictions are lifted, the Pentagon is going to have to present a reasonable funding plan that addresses “readiness and recapitalization the right way,” he says.
The Pentagon will be pressed to restore credibility with Congress on fiscal responsibility. Over the past decade, it has relied on war budgets known as “overseas contingency operations” accounts to fund basic needs like personnel and weapon systems. “That shows that there hasn’t been any budget discipline in the Department of Defense in a long time,” says Deschauer.
The Pentagon over the years has used so-called budget gimmicks to claim cost savings that never materialized. One of the Obama budget proposals, for instance, included $60 billion in “efficiencies” such as contracting reforms and reductions in administrative overhead. These phantom savings may no longer be acceptable. “It will be the administration’s responsibility to hold the military accountable,” Deschauer says. With a single party in control, it should be easier to reach a compromise, he says, although the White House and the Pentagon will have to “show budget discipline and demonstrate how funding increases contribute to defense.”
On the issue of federal regulations in military procurements, there has been much speculation that Trump might repeal measures that the defense industry claims add unnecessary cost and delays to Pentagon programs. While there may be a push to reconsider Obama’s labor-related executive orders, nobody should expect any sweeping deregulation, says Deschauer. “I don’t think there’ll be any rolling back of defense acquisition policies.”
With Sen. John McCain still at the helm of the Senate Armed Services Committee, there will be continuing pressure to crack down on contractors. “I don’t think they’re going to suddenly give defense contractors free rein or a blank check,” he says. “That’s not going to happen at all.”
Potentially of more significance to Pentagon weapon buyers and defense contractors is whether Trump delivers on campaign promises to withdraw the United States from international trade treaties and adopt protectionist policies. Any anti-trade measures, or even just fears of such actions, would be detrimental to the defense and aerospace business, analysts warn.
“This is a complicated area,” says Luigi Peluso, managing director in the aerospace and defense practice at AlixPartners. The aerospace and space sectors are truly global markets, he says. “They have global customers, global suppliers. They are very intertwined.” If trade relationships fracture in any way, “there are potentially significant risks.”
Aerospace and defense are sectors of the U.S. economy that have thrived in the global market. According to the Aerospace Industries Association, U.S. aerospace and defense companies generated a record $142 billion in exports in 2015. Over the past five years, exports have grown by 62 percent, from $88 billion in 2010. Aerospace and defense accounted for 9 percent of all U.S. exports in domestic goods and is the nation’s third largest exporting industry. This sector generated a trade surplus of $81 billion in 2015. Over the past five years, the industry’s trade surplus has grown by an annualized growth rate of 8.2 percent.
A trade war with China, for instance, could be devastating to aerospace exports as China might retaliate by directing its airlines to buy aircraft from Airbus rather than Boeing, Peluso says. Before the United States initiates a trade dispute, he says, “caution is warranted.”
Could defense companies do business in an anti-trade climate? “It would be very difficult,” he says. “It’s easy to see how you could do a lot of damage on the supplier and customer sides.”
Arms sales, additionally, are a key component of U.S. foreign policy. “We want compatible technology. And it creates U.S. jobs,” says Peluso. He speculates Trump will soften his campaign trade stance as it becomes apparent that it could backfire.
Deschauer points out that every major defense contractor is pursuing international sales. Companies also have to worry about Trump’s pledge to shift security burdens to U.S. allies in Europe and Asia. “If the administration increases allies’ responsibility to pay for their own defense, that could have an effect on how much money they will have to buy American-made equipment.”