Presentation to Jane’s Cityforum Defense Conference
I have been asked to spend 15 minutes describing the “givens” of U.S. defense acquisition through 2012, meaning the things that we can assume with high confidence will happen.
I will divide my discussion of the givens into two parts…
— First, the processes that we can count on shaping demand for defense goods.
— Second, the programs that we can count on moving forward as planned.
I am sorry to say that the core processes shaping defense acquisition are likely to prove more durable than many of the major programs, and as a result the sector is facing considerable uncertainty concerning future revenues.
You will not get that impression from reading the reports of most sector analysts, because there is a strong bias in favor of the status quo in the way Wall Street looks at defense equities.
Wall Street tends to assume that the way things are is the way they will be — which is not the same thing as saying past is prologue, because analysts frequently ignore data that predate the most recent phase of the spending cycle.
Thus, when the sector is down, the analysts tend to assume it will stay down for many years to come, and when it is up they tend to assume it will stay up for many years to come.
So even when major events occur that look likely to reshape the sector, like the collapse of communism or the 9-11 attacks, analysts usually underestimate their impact on defense outlays.
With that in mind, I’d like to remind you of the worst disaster the defense industry has faced in my lifetime, the tenure of Dick Cheney as defense secretary from 1989 to 1992.
Dick Cheney is widely viewed today as a superhawk, a hardliner who never saw a weapon he didn’t like.
He was viewed that way before coming to the Pentagon in 1989, too.
But Cheney arrived as the Soviet Union was unraveling, and he inherited a newly minted arsenal that was able to crush the dominant military power in the Middle East in a matter of weeks.
So Dick Cheney, the fire-breathing hardliner, decided that the armed forces didn’t need many of the weapons they were buying.
And here’s what he did…
— He canceled further production of the F-14, F-15 and F-16 fighters.
— He terminated the stealthy A-12 attack plane and delayed the stealthy F-22 fighter.
— He cut the B-2 bomber program from 132 planes to 20, and the C-17 cargo plane from 210 to 120.
— He killed both of the Navy’s submarine programs, Trident and Seawolf.
— He killed both of the Army’s heavy armored vehicles, Abrams and Bradley.
— He killed the Army’s main attack helicopter, the Apache, and tried to kill the Marine Corp’s V-22 Osprey.
When the smoke cleared from Dick Cheney’s four-year reign of terror, the industry had lost a hundred major programs — including most of the key military systems from the Reagan defense buildup.
The moral of this story is that when it comes to programs, there are very few true “givens” in defense acquisition.
Changes in external threats or internal political alignments can obliterate the most carefully crafted investment agenda in a few fiscal quarters, producing consequences no analyst foresaw.
The reason analysts seldom anticipate the surges and collapses is because defense is the only sector of the U.S. economy where demand is driven mainly by non-economic forces.
The forces that drive demand for defense goods are intrinsically less predictable than economic trends, producing patterns that only become fully apparent ex post facto — after the fact.
Nonetheless, if we want some guidance as to where defense acquisition is headed over the next four years, we need to look to the non-economic processes that are the dominant factors in shaping the scale and composition of military outlays.
I detect four such processes.
First of all, the level of demand for defense goods is extremely sensitive to the scale and urgency of external threats that the nation faces.
This dynamic was especially apparent in the years before the Cold War, when peacetime defense spending typically claimed only one percent of gross domestic product.
Back then, it was typical for weapons outlays to spike upward by a thousand percent in a few years as the nation mobilized for war, and then to rapidly retreat back to previous levels once the danger had passed.
The volatility of weapons outlays became less pronounced during the Cold War, because the danger didn’t go away for 40 years, but even then it was common for weapons accounts to swell or contract by 50% in a few years depending on perceived changes in the threat.
With the communist threat now gone and the severity of the terrorist threat subject to debate, we may be gradually reverting to the more volatile demand dynamics of the pre-Cold War period.
There no longer is a bipartisan consensus concerning the security challenges the nation faces that can provide a cushion against wholesale declines in weapons spending.
Furthermore, the introduction of an all-volunteer force has removed the budgetary flexibility once afforded by conscription, so it is much easier today to cut weapons outlays than personnel accounts when defense spending heads downward.
A second process driving demand for defense goods is that the level of spending for military systems is closely related to which political party controls the White House and the Senate.
A 2006 study by Merrill Lynch of weapons outlays over the past 40 years found that 76% of the variation up or down during that period was traceable to which party controlled the government.
When Republicans were in control weapons outlays tended to increase, and when Democrats were in control weapons outlays tended to decrease.
The correlation between spending trends and partisan control was weak with regard to which party controlled the House of Representatives, but extremely strong in the case of the White House and Senate.
I confess that I was bemused when I first encountered these findings, because Republicans slashed weapons expenditures at the end of the Cold War and Democrats presided over most of the big military buildups of the last century.
But Merrill Lynch argues that a new political paradigm has emerged since the Vietnam conflict in which Republicans are persistent supporters of robust weapons outlays and Democrats are persistent critics, making partisan control of the government the most reliable predictor of where weapons spending is headed.
A third process shaping demand for military goods is the close relationship between the composition of demand and the constellation of domestic political and bureaucratic constituencies.
What I mean by this is that although threats and partisan control determine the size of weapons accounts, local and institutional bureaucracies play a key role is how that money is allocated among specific programs.
Consider, for example, the top modernization priorities of the military departments as the nation prosecutes what the White House calls the “global war on terror”…
— The Air Force plans to buy 2,000 stealthy fighters.
— The Navy plans to modernize every type of warship.
— The Army plans to network a new generation of armored vehicles.
None of these initiatives has much to do with winning the global war on terror.
However, they are closely connected to the prevailing constellation of political, bureaucratic and industrial constituencies associated with military production.
All of the officers who run the military today rose to the top of their command structures by operating the signature weapons systems of their services.
And all of the legislators who serve on defense panels represent constituencies with a stake in weapons programs tracing their origins back to the Cold War.
So when Donald Rumsfeld propounded the view that many of these systems are not well-suited to a world of unconventional threats, he got little support from Congress or the military bureaucracy.
All of which serves to underscore the point that the main customer for future military production is a political system that insists on sustaining specific constituencies even as it seeks to address external threats to the nation’s security.
The fourth process that can be treated as a “given” of the acquisition system going forward is a corollary of the previous one.
Because political and bureaucratic constituencies are so central to the allocation of military investment dollars, the system is only willing to entertain fundamentally new approaches to equipping the force when it is under extreme threat or the needs of core constituencies have already been served.
These conditions tend to coincide, because rising external dangers generate a surge in weapons spending that exceeds the productive capacity of established suppliers.
Thus, there is a temporary excess of demand that permits the system to accommodate new players, at least until the capacity of traditional suppliers to address emerging needs increases.
We have seen some of that openness to new sources and new ideas during this decade, in response to the counter-terror campaign launched after 9-11 and the subsequent difficulties in suppressing Iraqi militants…
But we should not confuse these recent developments with a secular trend: eventually, threats will recede, the Democrats will return to power, and demand will decline.
At that point, traditional suppliers will begin pressuring the political system to allocate a larger share of the shrinking budget to them.
And the system will be highly responsive to their pleas, because in the end the allocation of defense dollars is a political process.
So my fourth process-related “given” of the defense acquisition system over the next several years is that in the absence of timely market stimulus from Al Qaeda or Iran, many of the new players in the sector will be forced out or absorbed by traditional suppliers.
Let’s turn now, briefly, to the second part of my presentation — the outlook for key programs — and ask how the processes I have described will shape demand for specific systems.
The current military investment program rests on three pillars: transformation, counter-terrorism, and recapitalization of the Cold War arsenal.
The need to fund all three activities simultaneously during the Bush years has resulted in a doubling of investment outlays since the Clinton era.
But if we look at the military and political demand drivers I described earlier that made this surge in spending possible, it is clear the landscape is changing quickly.
The severe sense of danger that followed 9-11 has dissipated, and countries once said to constitute an axis of evil are of less concern…
— Iraq has been occupied, turning its potential for violence inward.
— Iran has ceased pursuing nuclear weapons, at least according to our intelligence community.
— And North Korea has become more conciliatory about its own nuclear program.
The sense of danger is receding, replaced among many voters by a feeling that the occupation of Iraq was a mistake and economic troubles deserve more attention.
These trends have weakened Republican control of the government, and increased the likelihood of Democratic control in both Congress and the Executive Branch.
The Democrats have ambitious plans for new domestic initiatives that can only be funded within their pay-as-you-go framework by cutting defense outlays.
Even if Senator McCain manages to win the presidential race, he will face a Democratic Congress with little enthusiasm for weapons expenditures.
So the outlook for the three components of military investment is as follows…
— Every major transformation program is in trouble.
— Spending on counter-terror initiatives is headed downward unless Al Qaeda strikes America again.
— And recapitalization of Cold War systems is beset by doubts about its relevance to future threats.
The reason transformation is doomed is because few experts see it as useful in combating current dangers, and it threatens the interests of entrenched political and military constituencies.
The reason counter-terrorism has lost political momentum is because Al Qaeda has proven to be a weak foe, and voters fear further involvement in the Middle East quagmire.
However, recapitalization of Cold War systems (despite its questionable relevance) connects well with existing political and military constituencies, so it will be hit less hard by the downdraft in weapons outlays.
— The F-22 fighter will not cease production as the Bush Administrations wants.
— The C-17 cargo plane will continue to be funded by Congress.
— And the DDG-1000 destroyer program will not terminate after two vessels.
Each of these programs has strong support from legislative, institutional and industrial constituencies that will protect them, even as more revolutionary ideas like Space Radar die.
So the closest thing to a “given” in the program realm over the next several years is that after a decade of traumas and new ideas, the system is reverting back to its former priorities.
Transformation and counter-terrorism will persist at the margins, but the heartland of defense acquisition will remain the recapitalization of Cold War weapons.
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