Industry Market Trends

For Manufacturers, Impact of Sequester Is Just Beginning

Jun 11, 2013

Sequestration spent a lot of time at the top of the news early this year. But most Americans haven't felt much effect yet. The economy is adding jobs, the stock market is at record levels, and the housing market is climbing. This has led to media speculation that fallout from the sequester, while occurring, is overblown.

When the sequester -- which cut $85.4 billion from the federal budget -- officially went into effect on the first of March, the White House was grave. "Now, what's important to understand is that not everyone will feel the pain of these cuts right away," said President Barack Obama. "The pain, though, will be real."

The real picture comes when you look at where the sequester hits hardest. Cuts are evenly split between domestic programs (the FBI, Medicare, housing assistance, and others) and military and defense programs. Of the $85.4 billion in reductions, $42.7 billion are to the defense industry in the form of delays or cancellation of aircraft purchases, reduced military operations budgets, and trimmed back military research.

The Congressional Budget Office (CBO) estimates the sequester will directly cause the loss of 750,000 jobs this year alone and lop 1.5 points off the U.S. GDP. The 750,000 figure is only direct jobs lost; this number rises to 2.1 million jobs when indirect jobs (suppliers) and induced jobs (waiters at a café near FBI headquarters, for example, let go because business is slow) are factored in.

Certainly, the most obvious job losses will be among federal and state employees and prime contractors, but the fallout will also be felt by companies all along the defense and aerospace supply chains. How deeply manufacturing companies will suffer depends on how much of their business comes from government contracts. Lockheed-Martin, for example, derives more than 90 percent of its business from the government.

The National Association of Manufacturers (NAM) published a report in 2012 that found the sequester would result in the loss of more than 130,000 manufacturing jobs in the coming years, peaking in 2014, and push the unemployment rate up 0.7 percent. These lost jobs will be dispersed over both large manufacturers and smaller companies along the supply chain. To those who believe the worst of the sequester is over, NAM has a message: This is just the beginning.

"Companies have been hit hard and are being hit hard," NAM spokesman Matthew LaVoie told IMT. "This is a long, drawn-out process. The effects began last year, and it's still hurting orders. The slowdown in hiring and decisions not to invest in equipment began months before the sequester started," said LaVoie, who noted that the pain will continue for the next several years.

The sequester is likely to have a ripple effect on manufacturing. Aside from direct and indirect jobs lost, orders cancelled and sales on the wane, the cuts will cause instability in the supply chain. If a company that makes products for both private and public sectors cuts back production and lays off workers to stay afloat, this could affect the availability of products to the private sector, as well. If smaller suppliers, particularly those making unique products that require skilled labor, close up shop, those laid-off workers would likely retrain for new jobs and result in permanent job losses.

"The brain drain is a real threat," said LaVoie. "This manufacturing isn't the kind of thing you can just stop and start up again. Innovation is the lifeblood of manufacturing, and it comes from the workforce."

For many companies with large government contracts, another problem has been guessing how the cuts will be administered. Aerospace company Pratt & Whitney told IMT that while the sequester was a "known risk" prior to March, the threat brought a great deal of uncertainty as the company awaited clarity on how specific programs would be affected.

"That uncertainty remains as we await specifics of how the Department of Defense will execute its plans," said Pratt & Whitney spokesman Ray Hernandez. "While we continue to assess the impact of sequestration on our business, we do know that the budget cuts mean the military will fly less hours, buy fewer spare parts, and move overhauls out in time. A decrease in flight hours will likely mean downward pressure on our aftermarket business," he said.

Tomorrow, IMT will examine how manufacturing companies are taking steps to avert "sequester disaster."