Warnings of Defense Industry Decline Ignore Political, Economic Realities

By Sandra I. Erwin
Industry groups for years have sounded Cassandra-like warnings: The U.S. defense industrial base is waning, rapid consolidation is draining competition, experienced workers are exiting in droves, there are not enough new programs to keep critical suppliers in business. The list goes on.
In the early days of the Obama administration, industry insiders predicted the government would adopt a more interventionist role in “managing” the defense industrial base. Traditional military hardware suppliers, particularly, have called for the Pentagon to take action to prop up key sectors — by ensuring there would be enough work to keep facilities open and skilled workers employed.
But the Obama Pentagon is still just as conflicted about industrial policy as previous administrations, experts contend. Pentagon officials want the market to dictate who wins and who loses, but they also believe in drawing the line when they see behavior in industry that they don’t like.
Industry advocates have been disappointed by what they see as a lackadaisical attitude from the Pentagon leadership toward this issue. “Industry needs an industrial base strategy that will guide it as it makes long-term planning decisions about plant equipment, technology investment, work force and other issues that affect its core business,” saidMarion C. Blakey, president and CEO of the Aerospace Industries Association.
Pleas for an “industrial base strategy,” however, ignore reality, because they “assume that DOD actually knows what kind of industrial base capability capacity they need to have going forward,” said David Berteau, senior adviser and director of Defense-Industrial Initiatives Group at the Center for Strategic and International Studies.
“The reality is that neither [political] party has an industrial policy that focuses on analysis,” Berteau said March 29 during a panel discussion in Washington, D.C., hosted by the National Journal.
“It’s either one view that says we’re not going to have an industrial policy, the government shouldn’t be involved in the commercial market, or we can’t afford an industrial policy or we’ll wait until we’re in trouble and we’ll fix the things that fall off the cliff,” Berteau said.
This debate goes back 30 years and, to this day, the Pentagon does not have a clear definition of what the industrial base is. “I go far enough back to the days when we talked about the defense industrial base as something that was uniquely oriented towards the requirements of defense," he said. "What’s really happened over the last 30 to 40 years is that the industrial base has disappeared, leaving only five or six companies that do 75 to 100 percent of their business assembling final products for the Defense Department."
Another fallacy in the current debate is that it ignores a fundamental shift in the Pentagon’s supplier base — which mirrors a similar transformation in the larger U.S. economy — from industrial to service-based, Berteau said. Last year, 56 percent of everything the Pentagon bought was services, not products, he said. “The defense sector is changing to a service economy just like the U.S. economy is. And we have to think of the industrial base as including [a majority] of service [support contractors].”
These shifts in the industry require the government to “think differently” about the defense sector, he said. “All of our rules are written around buying widgets, not about buying services. We don’t even teach people about buying services.”
Industrial policy discussions also have sidestepped important questions about the globalization of the industry, Berteau said. “Every weapon system today has foreign parts in it. The world is globalized in technology and in industry.” Again, politics have often trumped rational thinking on this issue, he noted. “There are some areas where we can take advantage of foreign technology, building it here … to keep competition growing in the industrial base,” Berteau said. “There are many opportunities for us to think about the impact of globalization in positive, not negative ways, while we tend to instantly think of it as negative.”
Congress is the “leading trail indicator” on this issue. “They haven’t recognized that the world has globalized. … In many cases, foreign companies investing in the United States are putting an enormous amount of equity into the country, bringing a lot of their products over here to be built here by our work force.”
To revitalize its supplier base, the Pentagon should tap into the commercial sector’s vast reservoir of advanced technology, and encourage defense-unique contractors to diversify, Berteau suggested, even though that has been tried in the past, with failing results.
“The Chinese just published their industrial policy, and what they say they need to do is much more dual use,” Berteau said. “Integration of commercial and military … that’s what we should be doing because it makes so much sense. But we have created barriers to doing that.”
Case in point is export controls. Despite ongoing efforts by the Obama administration to reform export policies that restrict sales of dual-use technologies to foreign countries, change is still years away. “The current regime is predicated on the assumption that all new good technology will be developed first in America by defense,” Berteau said. “The reality is it’s not all being developed in America. Secondly, it’s not all being developed for defense. … And if we’re not careful, we end up with second-class capability that nobody else would want and we’ll not be able to get the [best] technology.”
Predictions that the industrial base will founder also do not stack up against projections of continued strong financial performance by the defense sector. "Most defense stocks continue to hold up well in the face of broader budget uncertainties and debate," wrote defense industry analyst Byron Callan, of Capital Alpha Partners LLC. Despite anticipated moderate cuts to defense spending plans, the outlook is positive overall, Callan said in a newsletter to investors last week. "With entitlement and other mandatory spending programs taking center stage in budget debates ... it removes risk that defense takes the brunt of future reductions."
It should be noted that, although industry wants change, its rhetoric is laden with nostalgia for the past — the post-World War II era when the United States was a weapons manufacturing colossus. The defense industrial base in the 1950s “was so capable and successful and the volume of production was so large, that for many years it was capable of providing whatever DOD needed whenever it was needed,” Blakey wrote in a recent editorial. Fast forward to 2011: “The most telling illustration of the true extent to which the defense industrial base is imperiled is captured succinctly by the fact that starting in 2010, for the first time in 100 years, there is no manned military or civilian aircraft in design in the United States. Forty-nine military aircraft programs were under way in the 1950s, seven in the 1980s, three in the 1990s. Now there are none,” she noted.
The Pentagon’s top procurement official, Ashton B. Carter, said his office is reviewing the industrial base “sector-by-sector … as we seek to sustain the health, vibrancy, and efficiency of the industrial base upon which our security depends.” In that same February speech to industry, Carter also said the Pentagon would oppose mergers among top contractors.
How’s that for mixed messages?

Topics: Business Trends

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