Eliminating Excess Defense Production

Throughout history, each time our nation has ended a war we have cut back our weapons arsenals and smartly propped up R&D to prepare for future enemies. But since the Cold War’s end, we have done the exact opposite. We have propped up commercial contractors’ production lines and risked shortchanging experimentation.

The long Cold War did something no previous engagement had: It shifted the balance between public and private power in the defense establishment overwhelmingly to companies. These companies now lobby effectively to protect their economic interests, and politicians, in the face of declining defense budgets, work to protect employment in their districts. Defense has become a jobs program.

As a result, we are wasting billions of dollars each year to keep unneeded production lines open. We have, for example, thousands more tanks and war planes than we need. Continuing this production steals precious resources from R&D, the real lever to future battle readiness, as well as other government programs. It is time to restore a balanced system for research, development, and production. As a nation, we must bite the bullet: buy out the defense industry’s excess capacity and get on with preparing for the future.

You want tanks?

At the end of its wars, the United States has customarily demobilized. Civilian contractors, brought in to help produce desperately needed military equipment, shifted back to commercial production. The nurturing of unique military technologies, to the extent that it has occurred between wars, was mostly done in government-owned arsenals and shipyards. The pattern was short, sharp spikes in funding for wars followed by long periods of small budgets.

The Cold War was different. Although there were cycles in defense budgets, with peaks during Korea, Vietnam, and the Reagan buildup, the budget range was narrow, roughly between $250 and $400 billion (in FY 1995 dollars). With plenty of business, hardly any contractors were compelled to return to civilian production. Instead, during the cyclic downturns, the Pentagon closed arsenals, shifting more business to the politically more influential contractors.

A variety of rationales were offered for shifting weapons design and production to the private sector. Industry was said to be more responsive than the arsenals to the armed services; industrial workforces were believed to be more flexible than public workforces; and contractors could pay higher salaries than the civil service and thus attract top scientists and engineers. A number of government facilities were closed before the recent rounds of base closures. The current debate over what to do with government facilities really concerns only the residual of the government’s arsenal system: a few large laboratories, five or six aircraft repair depots, and a handful of public shipyards.

The established acquisition pattern that keeps private contractors willing to maintain the U.S. edge in military technology is the large production run of a weapon system. Contractors have never made much money on R&D work, and in some cases have lost a great deal. But even losing money on the fixed-price development contracts of the 1980s did not hurt the majority of firms, because they were making profits on the booming production side.

Now, however, weapons inventories are bulging. The United States has 7,500 frontline fighters, even though the Air Force fields only about 2,000. The country has 16,000 main battle tanks, including 8,000 M-1s; but the Army’s six heavy divisions each need no more than 300 tanks, and the Marines need another division’s worth, for a total of 2,100. Obviously, plenty of tanks are left over to supply the National Guard and reserves, to conduct various predeployment activities, and to replace those lost in battle. It makes no strategic sense to support U.S. armored vehicle manufacturers with additional production contracts.

The production-capacity overhang is huge for many types of military hardware. Seven lines are producing military aircraft, six private yards are building large warships, five helicopter companies are totally dependent on military purchases, and four companies are making missiles. What is most striking, however, is how little contractor employment has fallen. Despite major reductions in service personnel and civilian defense jobs since the Cold War’s end, contractor employment is almost 600,000 more than its 1976 Cold War low. This is where the restructuring most needs to occur.

Bogus argument

Some argue that the widely discussed mergers now taking place among defense firms have already reduced excess capacity and that the problem can be left to market forces. But the evidence is plain that this arguments is bogus. Lockheed and Martin Marietta recently merged and have since absorbed Loral, but the new firm still has all three original aircraft lines open in California, Texas, and Georgia. The number of employees related to its defense work has hardly changed. Lockheed Martin’s consolidation has come in the space business, where commercial buyers supplement government demand. On the defense side, the company’s strong position has relieved pressure to rationalize production. Furthermore, the much-discussed synergies between the electronics and platform components of the new conglomerate are blocked by an antitrust agreement that prevents full communication among its divisions.

The agglomeration of Northrop, Grumman, and Vought into one company also did not lead to much change in employment or production capacity. Before the merger, the three companies produced aerostructures in nine plants; all nine are still open. There have been layoffs, but most had been scheduled before the merger. Although Northrop Grumman had another opportunity to consolidate capacity in its electronics businesses when it subsequently acquired Westinghouse’s defense electronics business, little consolidation has been achieved.

Another recent merger offers additional insight. General Dynamics bought Bath Iron Works, but neither Bath nor General Dynamic’s Electric Boat division are slated to close. Because of the post-Cold War politics of warship production, Bath has essentially been guaranteed at least one destroyer contract to work on every year for years to come–an assured income stream. The acquisition price for the Bath yard was less than the present value of that income stream, so it was a low-risk, profitable venture for General Dynamics. Two weak shipyards, each dependent on a political subsidy to stay in business, have joined forces.

No matter how it is described, the defense business is not a market-based enterprise, even when commercial companies own the production capacity. Congress buys weapons in response to defense firms’ lobbying; unnecessary production facilities receive support in order to prop up district employment.

The defense conversion myth

Converting defense plants to commercial production is not the answer either. An important distinction must be made between the big final assembly plants of the prime contractors and the component plants of smaller defense companies. Many Cold War subcontractors always integrated defense with commercial business, or at least have redeployed their assets on that model in the past five years. These firms are taking care of themselves. Too small and too weak politically to remain dependent on the government, they have already moved into the post-Cold War era.

The prime contractors, on the other hand, followed a different Cold War business model, which has led them to a different post-Cold War response to reduced international tension. They dealt directly with the government on big projects that were long lived and very visible politically. Their influence was compounded by the concentration of employment in final assembly operations, often with 10,000 or more workers in a single facility. This was true in the Soviet Union, too. But since the end of the Cold War, large Russian defense facilities converted to production of milking machines, diapers, and other products needed to fill pent-up commercial demand. There are no comparable areas of shortage in the U.S. economy.

The commercial market potential for the largest defense companies looks truly bleak today. For example, in the military shipbuilding market that defense firms are accustomed to, unit prices are extremely high; nearly every ship costs a billion dollars or more. Although a market for commercial ships exists, it is for ships such as tankers, which cost $40 million each. Newport News is making a few commercial ships with a purchase-loan subsidy, but not nearly enough to replace the two $4-billion aircraft carriers now in its yard. Not surprisingly, then, Newport News continues to covet military contracts. In 1995, when the Navy decided to consolidate all submarine building at Electric Boat in Groton, Conn., Newport lobbied hard to preserve its submarine production. In 1996, Congress blessed Newport News with a new contract to build a nuclear attack submarine–over Navy objections.

Acquisition reform is the Clinton administration’s favorite alternative to defense-sector restructuring, and some acquisition changes are desirable. In fact, many acquisition rules were created to undermine Pentagon efficiency. During the 1980s, the Democrat-controlled Congress could not confront President Reagan directly over his popular defense buildup. Instead, it attempted to hobble the buildup through regulation that ostensibly would reduce waste, fraud, and abuse in defense contracting. This became the justification for dozens of laws requiring contract reviews, rewards for whistle-blowing, social engineering through contracting, financial audits, and then even more audits. It is appropriate for today’s Democratic administration and Republican Congress to recognize the burden these laws place on the government and to seek reform.

The big thrust in acquisition reform is the administration’s strong promotion of dual-use technology and the elimination of unique production standards that make defense purchases costly. But cutting cost at the margin will not change the overall defense budget much, if at all. The political will is not there. Support for acquisition reform from the military services and from defense contractors is premised on the expectation that lower unit costs for weapons will lead not to a reduction in the budget, but rather to an expansion of demand for weapons. At the very least, procurement supporters hope that the budget cutters will split the windfall with them. Because this is unlikely to happen, neither the military nor the contractors will be long-term advocates for these reforms.

Even in the short term, the acquisition-reform rhetoric has a pernicious outcome; it allows politicians to maintain the illusion that they are making a cost-effective investment in our future national security. The participation of the F-22 program office in the Air Force’s “Lean Aircraft Initiative,” which claims that acquisition reform and new manufacturing techniques will substantially reduce unit costs, is a leading example of the political cover that acquisition reform provides to some very expensive programs. It diverts attention from the real question, which is not how to cut costs for the F-22, but whether we need to build F-22s when the existing F-15s, F-16s, and F-18s are already better than anyone else’s fighters. Furthermore, we have learned that the promised savings of more efficient production are often lost when Congress, confronted with political uncertainty, reduces production rates and thus increases unit costs.

The other purported benefit of acquisition reform, speeding up the development cycle, makes even less sense. Some think that once politicians show an interest in a new weapons system, we need to build it before they change their minds. Unfortunately, it is physically impossible to build weapons systems faster than politicians can manipulate budget priorities. Worse, accelerating projects by compressing development times, trimming test schedules, and taking other short cuts is a formula for guaranteeing performance shortfalls and cost overruns. Instead of accelerating development cycles, we need to slow them down. Why rush when there is no imminent threat? The freedom to proceed more deliberately is one of the benefits of the end of the Cold War.

From pork to spam

If mergers are not helping, if conversion offers little hope, and if acquisition reform will only make matters worse, what are we to do? To begin with, we need to recognize the real source of the problem: the ongoing lobbying of contractors to keep production lines running, if only slowly. Extended production runs of mature systems are the cash cows of the defense industry. Politically, the lobbying efforts resonate, because the lines represent jobs. Indeed, in 1995 retired general Robert Gard Jr. told Financial World, “We’re not buying some of these major weapons systems because we need them. We’re buying them to keep up employment in states with influential members of Congress.”

With the Cold War over, it is easier and easier for members of Congress, Republicans or Democrats, to ignore the plans and preferences of DOD and the armed services. With each political maneuver to protect current production lines, the opportunity to do new things, to prepare for the wars of the future, and to keep our technological edge disappears. Production funding threatens to crowd R&D out of the defense budget. Adding up the already promised spending on production of major weapons systems in the next decade leaves no room for research under the DOD’s projected budget.

The defense drawdown following the Cold War has been gentler than any drawdown this century. And yet, even as Congress and the president debate what social program to cut to help balance the federal budget, no one in Washington has found the courage to point to defense cuts as a significant potential contributor. Instead, we are debating increasing the procurement budget to $60 billion by FY1998.

The United States needs to recognize and accept the full implications of the end of the Cold War. It needs a plan for future force structure and research. What is needed is the kind of planning that Gary Weir, a historian at the U.S. Naval Historical Center, describes the Navy’s submarine program doing after the World War I. The submariners built no new boats for 10 years but they kept developing technology. They forced the closure of the Lake Boat Company in order to keep Electric Boat alive, because Electric Boat had the better facility. Then, in order to keep Electric Boat focused, they developed submarine construction capacity at Portsmouth, a public yard. During the 1920s and early 1930s, submariners brought in foreign component technology and worked on their offensive doctrine and new submarine designs. What came out of this work was the effective fleet boat of the World War II and the strategy that helped defeat Japan.

Time to pay the bill

The United States should devote resources to an ambitious R&D program. The political obstacles that the services face in the absence of a strong overseas threat work against them, but they have the responsibility for maintaining national security. The new missions being offered the military won’t generate sufficient support to sustain vital technologies. To preserve resources for design teams, the Pentagon will have to eliminate unneeded production capacity.

The United States should restore a balanced system for research, development, and production by adopting a two-step strategy. First, pay the bill. It is time to buy out the excess capacity and get on with the task of preparing for the future. Demand for military products is down, so producers should downsize. Not even the free market proponents can deny this simple logic. It happens in commercial industries every day. The government should buy out unneeded companies, their employees, and their surrounding communities. Sure, this would be expensive. But Congress will spend the same amount of money keeping plants open. The difference is that a buyout is a one-time charge. Artificially sustaining companies goes on and on.

Unfortunately,this proposal faces formidable political opposition. Congress narrowly rejected language attached to the FY1997 appropriations bill that would have ended the DOD’s ability to pay restructuring costs for merged companies that close plants. The present political environment would certainly block a major government restructuring payment. Defense policy is back to the Bush administration’s practice of verbally encouraging mergers but “letting the market decide” the ultimate configuration of the industry. The fallacy with this policy is that the defense industry is not governed by normal, competitive market forces. Plants that would otherwise be forced to close, either due to bankruptcy or a postmerger consolidation, can be kept open by aggressive lobbying.

A simple, properly designed subsidy to plant-level restructuring would provide a ready solution to this market failure. Somehow, though, the idea of paying an exit subsidy to defense contractors has been politically branded as a cash handout to influential companies–a form of corporate welfare. The real welfare going on, however, is the continuation of unnecessary production contracts, which are much more expensive in the long run because production requires the purchase of materials and the sustainment of high overhead on substantial overcapacity.

The political demise of the Clinton administration’s merger policy is due to its failure to do enough for workers and communities. The few payments for restructuring charges have thus far gone mostly to company coffers, leaving workers and local officials with an incentive to lobby against plant closings and against the policy. The government already pays military personnel and civilian DOD workers to leave the federal payroll; it is time to pay civilian defense workers and their communities to leave as well.

Fortunately, our experience with the size of the payments required to encourage civilian defense workers to leave their government jobs suggests that the bill for paying off workers need not be large. We have recent experience in negotiating the value of defense-related property through the Base Realignment and Closure Commission process. Civil DOD personnel have been given $25,000 to leave, and some officers have agreed to early separation for $30,000. Even if the government had to agree to pay workers their full salaries for a long or indefinite period of time, a true worst-case scenario, savings would accrue to the defense budget due to reductions in materials, manufacturing, and overhead costs.

The second major step that we propose for defense procurement is to try to build the equivalent of a public arsenal system, even while defense firms remain nominally private. The system that makes defense work profitable only with long production runs should be replaced by one in which technological experimentation is financially worthwhile for private firms. There is no need for a continuous re-outfitting of the entire U.S. military, but there is a need for continuous research and prototyping. A new institutional design, appropriate for a “private arsenal system” in the post-Cold War world, would award contractors with fair rates of return on R&D alone. Follow-on, large-scale production contracts would be the exception rather than the expectation.