What The Last Defense Downturn Tells Us About Military Spending In The Current One
Many experts believe that the Pentagon has entered a prolonged period of declining budgets. If that proves true, it will only be the third major downturn in military demand since the modern defense industry emerged during the 1950s in response to the security challenge posed by the Soviet Union. The previous downturns occurred after the Vietnam War, when the buying power of the Pentagon's budget declined by 30% over eight years, and at the end of the Cold War, when the after-inflation value of the top-line declined 33% over a dozen years.
As Byron Callan of Capital Alpha Partners has repeatedly pointed out, there is nothing mechanistically inevitable about defense-spending cycles. Just as the purchasing power of Bush-era defense budgets rose above the highest levels of the Cold-War era, so today's impending decline could be deeper or shallower than those of the past. It all depends on what threats the nation faces and how the political system sets spending priorities. However, the past provides our best insight into what the future holds, so with that in mind it's worth considering what spending trends in the last big defense downturn might signal for the years ahead.
The Reagan defense buildup during the last decade of the Cold War peaked in fiscal 1986 at $574 billion in today's dollars. Few people today remember that the Future Years Defense Plan Reagan proposed for the period from 1986 to 1990 would have increased U.S. annual military expenditures to over $800 billion in today's dollars. But of course that didn't happen: military spending began falling after 1986 and went into a tailspin once the Soviet Union collapsed. What's interesting about the decline is how differently the major categories of military spending fared.
Although the buying power of the entire defense budget fell by 33%, military procurement fell at a much higher rate -- about 66% between the mid-eighties and the mid-nineties. Meanwhile, R&D fell by a mere 18%, while spending on military personnel fell 23%, roughly in line with a 25% decrease in active-duty headcount. Operations and Maintenance, the catchall category that includes sustainment, training, military healthcare and civilian pay, fell by a moderate 11%. This pattern persisted by and large through the end of the Clinton years, with procurement down 61% between 1985 and 2000, military personnel down 31%, R&D down 24% and O&M down 11%.
Although it is still early in the current downturn -- spending peaked in 2010 -- there is already plenty of evidence that past may be prologue in terms of how the major categories of military spending make out in the years ahead. The Obama Administration noted in its fiscal 2013 defense request that most of the Pentagon savings realized during its first term of office came from weapons spending, as programs like the F-22 fighter and Future Combat System were canceled. Meanwhile, the political system is showing little inclination to cut the pay and benefits that each soldier and sailor receives, suggesting that personnel costs will only decline as headcount does.
As for Operations and Maintenance, that will probably hold up well once we get past the first year of sequestration. When threats recede and money gets tight, it's usually easier to maintain and upgrade old weapons than to buy new ones. The military services may be willing to cut readiness to keep other types of spending on track, but past experience suggests that Congress won't go along with that approach. The first time a combatant commander utters the phrase "hollow force," O&M will be increased even if it means cutting more weapons programs. At least, that's what happened the last time around.
