Defense Industry Outlines "Doomsday" Budget Cuts

January 31, 2012

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The Pentagon plans to cut at least $480 billion from its budget over the next decade, and even more if Congress follows through on plans for deeper reductions. Needless to say, the defense industry is piqued.

Nobody likes having their budget cut. It's irritating, inconvenient and puts the financial health of a company in peril. Organizations often need to find alternative channels to fill the holes. What happens, though, if you can't do that? Imagine that you're one of the many companies that supply the U.S. Department of Defense (DOD), and the Pentagon has threatened to cut your budget.

It's not like you can make up for it by signing a contract with Target to sell discount guided missile destroyers.

But cutting the budget is what the Pentagon plans to do: some $480 billion over the next decade (2013-2022), up to a $1 trillion sequestration that would take effect if Congress does not enact a major budget reduction plan before January 2013. The military ultimately plans to eliminate about 80,000 jobs; skip future troop-intensive counterinsurgency campaigns in Iraq and Afghanistan; downsize the nuclear arsenal; trim the fat on future retirement and healthcare benefits; draw down on warships and delay the purchase of Lockheed Martin's famed but troubled F-35 Lightning II jets.

As such, a consortium calling itself the Defense Industrial Base Task Force — comprised of the Aerospace Industries Association (AIA), the National Defense Industrial Association (NDIA) and the Professional Services Council (PSC) — recently sent a joint letter to U.S. Secretary of Defense Leon Panetta to outline what the wider impact of budget cuts might be.

The consortium's forecasts, if true, are stark: Cuts beyond $480 billion, which most company executives expect in future budget requests even if sequestration is avoided, "would render major segments of the defense industry unable to produce critical products and components."

The letter and accompanying report represent a softening of projections made last fall, which were based in part on an AIA-commissioned study that measured the economic impact of DOD spending cuts on equipment such as small arms, ordnance, communications, aircraft, guided missiles, ships and armored vehicles and tanks. It concluded that for each job lost by the DOD's prime contractors, three more jobs would be lost in the U.S. economy as a whole.

The first $45 billion cut in spending on military equipment would cause losses throughout the supply chain that could cost the economy more than $164 billion. Essentially, for each $1 in military spending cuts, the broader economy would lose $2.64 in sales thanks to the ripple effect. Job losses from the cuts could exceed 1 million in both direct and indirect jobs.

But it won't stop there, the Task Force says. The proposed spending cuts would decrease the U.S. gross domestic product (GDP) by more than $86 billion, dropping the projected annual increase in GDP for 2013 by 25 percent and shaving the U.S. economic growth rate from a projected 2.3 percent to 1.7 percent.

Although the Task Force has backed away from some of the earlier projections of the AIA study, the new Defense Industrial Base Task Force report does point out even more catastrophic consequences should further cuts — the $1 trillion "doomsday" scenario — be enacted by default.

While some of the scenarios sound decidedly hyperbolic, the defense industry does have some unique characteristics not shared by other industries. Companies that rely almost entirely on DOD spending can hardly drum up new business, and the closing of manufacturing facilities could be catastrophic if the U.S. military suddenly has an urgent, unexpected need.

For companies that do have civilian business, the cuts might lead them to shutter their military production lines, leading to breaks in supply chains that could be filled abroad — not a great idea for a variety of reasons, alienating investors not the least of them. The squeeze could ultimately lead to a reduction in U.S. military technological innovation. On the flip side, maintaining a supply chain to a size that is no longer needed is a bit like the old buggy whip argument: Is it wise to continue paying for goods and services that are no longer needed, particularly when U.S. taxpayers are forking over the cash?

While the DOD has responded to the Task Force's letter and assured the industry it will continue to work with it to alleviate consequences of budget cuts, the DOD says the industry needs to "be reasonable." In turn, the defense industry has said it acknowledges that the current economic environment has led to the necessity of budget cuts. It seems likely that negotiations will continue through the year, and come to a peak prior to Election Day in November.

Resources

AIA, NDIA, PSC Release Joint Industrial Base Report Aerospace Industries Association, National Defense Industrial Association and Professional Services Council, Jan. 6, 2012

Defense Industrial Base Task Force Letter to Leon Panetta Aerospace Industries Association, National Defense Industrial Association and Professional Services Council, Nov. 11, 2011

...Budget Cuts: Not Just How Much, but How Defense Industry Daily, Jan. 9, 2012

DOD Official Seeks to Reassure Industry Over Cuts by Amber Corrin Defense Systems, Jan 6, 2012

The U. S. Economic Impact of Approved and Projected DOD Spending Reductions on Equipment in 2013 by Stephen S. Fuller Second to None, Oct. 24, 2011

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