Defense Watch

November 2006

Industry Fortune Tellers See a Mix of Boom and Bust

By Sandra I. Erwin

For the defense industry, depending on whom you talk to, these are the best of times, and the worst of times.

Soaring profits, thriving military spending and a healthy aerospace global market offer undeniable evidence that the nation’s security industrial complex so far seems safe from the evils of cyclical downturns.

But it also can be argued that these ebullient forecasts ignore irrefutable signs that defense is headed down the same path that has led to the demise of major manufacturing sectors in the United States, such as commercial shipbuilding, consumer electronics and automobiles.

In other words, the industry should enjoy the spoils of war while it can, because they will not last.

Loren B. Thompson, a defense analyst at the Lexington Institute, says it is impossible to ignore the ominous trends that portend trouble for the industry. One is the Bush administration’s disinterest in the subject. The president, himself, turned “industrial” into a dirty word by complaining in a 2000 speech the military was organized for “industrial age” operations rather than for the information age. Ever since, he says, “Policy makers under the spell of transformation have turned industrial into a retrograde and irrelevant word.”

“Transformation” has become a pervasive catchword that conveniently captures the mood of the administration, but neglects to take into account the economic foundation of defense industry. “Based on what we’ve seen under Rumsfeld’s watch, if he had his way, every major production line would be closed in the next decade,” Thompson says. “They don’t seem to care.”

Defense contractors clearly have benefited from increased spending in Iraq, but it is not certain what will happen beyond this conflict. Pentagon officials often express their distaste for protectionist policies and their preference to rely on the free market to shape the industry. The problem with that reasoning, says Thompson, is that the nation’s manufacturing capacity is withering away. “Manufacturing share of the U.S. economy has gone from 22 percent in 1976 to 11 percent today.” By the end of the decade, the U.S. trade deficit will be a trillion dollars. Under the Bush administration, 43,000 manufacturing jobs have been lost every month. The “de-industrialization” of the United States, combined with the administration’s indifference to the issue, should be cause for worries about how the nation would mobilize for a prolonged conflict, says Thompson.

A case in point: It took two years for the Defense Department to ramp up the production of truck and body armor to supply troops in Iraq.

The industry’s best chance for continued stimulus is, unfortunately, a protracted war on terrorism. “Despite of all the talk of a long war, we don’t know how long the threat will last,” Thompson says. “Who knows if we can maintain the political will for military modernization?”

This glum outlook, however compelling, ignores the prosperous forecasts for the aerospace industry, which does not entirely depend on Pentagon spending for its survival, says John Douglass, president of the Aerospace Industries Association. Commercial aviation and space sales, he says, will keep U.S. industry booming for years to come, regardless of what happens with military budgets.

“Our view is somewhat counterintuitive to what you might hear,” he says. “We are looking at a period of seven to eight years of steady growth.” Companies that only rely on Pentagon sales may have a tough time in the future, but those that also sell commercial products globally will thrive. The aerospace industry’s current annual sales of $185 billion are projected to soar to $250 billion by 2011. “Even with a disastrous decline in military spending, industry won’t go below $200 billion.”

The Pentagon actually could reap some of the industry’s financial windfalls if it chose to heed its own rhetoric, Douglass says. “The military is going to have to realize that Boeing and Airbus are going to build as many as 25,000 jets in the next decade or two. That’s way more than the Defense Department buys.”

Profit margins have risen from 3 to 8 percent in the past five years. “I don’t see drastic cuts in military spending in the next four to five years,” says Douglass. “Other parts of the economy have suffered under globalization. That is not true for aerospace and defense. We are the largest importer by far of military systems. The situation doesn’t look that bad.”

The flaw in this argument, Thompson says, is that the military buys a lot more than aircraft and satellites. Production of advanced electronics and software largely is being outsourced, which should alarm a Defense Department that is basing its future on high technology. “What happens when the manufacturing capabilities are gone? We cannot sustain our economy on the trends we see unfold today.”

The Government Accountability Office agrees. An aging aerospace industry work force and an increasingly competitive global market, says a GAO report, “may threaten the U.S. industry’s traditional leadership in aerospace manufacturing.”

These widely diverging views of where the industry is headed add up to a rather confusing picture.

But Pentagon suppliers can at least rest assured that even if manufacturing takes a dive, service contracts — which run the gamut from weapons maintenance to providing security at military bases to administrative work — likely will make up for downturns in manufacturing. Under the current administration, outsourcing of jobs to the private sector shows no signs of slowing down. In 2005, the Pentagon spent more than one-third of its procurement dollars on services.

Please email your comments to SErwin@ndia.org

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