Industry Market Trends

Threat of Sequestration Looms Large Over Manufacturing

Jan 15, 2013

The patchwork deal to prevent the U.S. from going over the so-called fiscal cliff included numerous policy changes and deals that will have a direct positive effect on manufacturing businesses, but manufacturers remain deeply concerned about lingering problems that will need to be addressed in coming months, particularly budget sequestration.

As we reported earlier, a mix of permanent and provisional reforms were part of the deal hashed out at the last minute to avoid plunging the economy off the fiscal cliff. Some of the temporary provisions will expire at the end of the year, others in six months, and some in less than two months.

Among the issues Congress and President Obama must settle by March 1 is sequestration. Sequestration is a series of mandatory, semi-blind cuts across nearly the entire federal budget. The cuts will take $1.2 trillion off the budget from fiscal year 2013 through 2021 in order to reduce the deficit. This amounts to $109 billion in cuts per year, half of which will come from the Department of Defense (DoD).

American manufacturers have been worried about sequestration since it was incorporated into the Budget Control Act of 2011. The act formed a "super committee" tasked with trimming the federal budget by $1.2 trillion. Sequestration was included as a backup plan in case the super committee failed to come to come to an agreement - which is exactly what happened.

The law requires the DoD to reduce its mandatory spending budget by 10 percent, and its discretionary spending by 9.4 percent. These will be the most devastating cuts, though other spending reductions are bound to impact U.S. manufacturers as well.

"We have been very concerned about sequestration," Dorothy Coleman, vice president of tax and domestic economic policy for the National Association of Manufacturers (NAM), told IMT. "This has already begun to have a negative impact on the whole defense supply chain. A lot of small manufacturers are part of the defense supply chain. They are not sure how these cuts will play out for their business."

Some of the policies implemented in the temporary fiscal cliff deal will have a positive impact on manufacturing businesses, including corporate and personal tax rate changes, estate tax changes and exemptions, and research and development tax credits. Still, Coleman estimates that the U.S. could lose as many as 1 million jobs, as well as see a 1 percent dip in the gross domestic product (GDP), as a result of the defense cuts alone.

In a charged statement to its members, Aerospace Industries Association CEO Marion C. Blakey put the number of potential job losses at 2 million. "Sequestration is a slow motion catastrophe for our military forces, our space program, and virtually every critical function of our government from air traffic control and border security to food inspection and more," she said.

Coleman's numbers come from a report issued by NAM in June 2012. The analysis states that the aerospace industry will lose 3.4 percent of its jobs by 2015, and by 2022, when the cuts expire, unemployment will remain down 2.3 percent. Ships and boats will take a similar hit, suffering a 3.3 percent loss in jobs in 2014. Proportional to its size, the search and navigation equipment industry will be hit hardest, shedding 9.3 percent of its employment in 2016.

The report also calculates approximate losses on a state-by-state basis. The most negative effects will occur in California, where 148,000 jobs will be lost. Virginia will suffer the second biggest loss at 115,000 jobs, followed by Texas with 109,000 jobs.

Should the cuts go through in March, the delay will make the situation worse than if sequestration had taken place in January, according to George Little, Pentagon press secretary, who noted that the DoD would have only seven months of the budget to absorb the cuts, not a full fiscal year. He also pointed out that the department's 2014 budget, due in February of this year, will be nearly impossible to submit.

That level of uncertainty is already being felt throughout supply chains. Unsure of whether they will lose major accounts or see orders shrink, manufacturers are unable to make their own capital investment and hiring plans, which will continue to ripple down the chain.

In a recent survey, the National Federation of Independent Businesses found that uncertainty about economic conditions was the second most pressing concern for small business owners across the country. Government action (or inaction) was the fourth highest concern.

"Businesses like to plan ahead," Coleman added. "Leaving [sequestration] hanging for the next two months is problematic."