Industry Market Trends

Small and Midsize Manufacturers to be Hit by Defense Spending Cuts

Nov 13, 2012

Upcoming cuts in federal military spending are poised to significantly reduce business activity among defense contractors and manufacturers that supply the defense industry. Moreover, unless the looming "fiscal cliff" issue is resolved in time, even deeper budget reductions will hamstring military funding for years to come. Small and medium-sized manufacturers are particularly at risk from the potential cuts.

President Barack Obama's re-election means that reductions in military spending favored by the administration will continue to move forward, with an estimated $487 billion in cuts by 2023, according to National Defense Magazine. These reductions will be accomplished by ending the war in Afghanistan in 2014, shifting military resources to the Asia-Pacific region and increasing the focus on cyber warfare, drone warfare and special operations forces.

The cost-cutting trend is already in place and affecting many manufacturers. But that's not the only concern. Unless Congress and the president take action, United States government spending will plunge off a "fiscal cliff" in less than two months. Under the Budget Control Act of 2011 (BCA) passed in August 2011, automatic federal spending cuts -- an "automatic sequester" -- of $1.2 trillion dollars over 10 years will go into effect Jan. 2, 2013, with half of the cuts coming from the military budget.

The impact on the U.S. economy, including manufacturers, would be enormous, says the National Association of Manufacturers (NAM) in its report "Defense Spending Cuts: The Impact on Economic Activity and Jobs." For 2014, NAM projects that budget caps and across-the-board cuts in defense spending would result in:

  • The loss of over 1 million jobs in the private sector, including 130,000 manufacturing jobs;
  • A 1 percent drop in gross domestic product (GDP);
  • A 0.7 percent increase in the national unemployment rate; and
  • The loss of 3.4 percent of aerospace jobs, 3.3 percent of jobs in the ship and boat industry and 9.3 percent of jobs in the search and navigation industry.

The projected loss of over a million jobs involves a "multiplier effect," says NAM, "since the job losses, including workers in the defense manufacturing supply chain and those employed in the military and as defense contractors, will result in lower disposable income and reduced consumer demand -- creating a ripple effect across the entire economy."

The report concludes that "it is critically important that policymakers understand that deep cuts in defense expenditures will impair our national security, cripple a vital part of the manufacturing sector and have far-reaching negative effects on a broad spectrum of the U.S. economy."

Defense contractors across the country have been voicing their concerns about the threat of spending reductions. The risk is especially acute for small and medium-sized manufacturers.

Larger defense manufacturers are more likely to be able to weather the storm by diversifying into other sectors, but smaller suppliers tend to be less adaptable and often have to respond to such cuts by simply withdrawing from the market altogether, according to Reuters.

Some companies are more worried about conditions for their lower tier suppliers, rather than top tier suppliers. "It's when we start to see a broader backing off from the defense supply chain that concerns me because then you take the slack out of the system," Wes Bush, CEO of Northrop Grumman, told Reuters.

Joseph J. Murphy, chairman of Ferco Aerospace Group, a small manufacturer of engine parts in Franklin, Ohio, told the Cleveland Plain Dealer that "supply chain companies like Ferco tend to be the rule, not the exception" in the defense business.

"About 70 cents of each military purchasing dollar goes to supplier firms, which are home to three-quarters of defense manufacturing jobs in the United States," Murphy explains. "When people talk about the 'defense industrial base,' they are talking about a network of thousands of small and midsize businesses spread across all 50 states."

This means that the damage from these potential spending cuts will be felt mostly by small and midsize supplier firms across the country. If smaller players continue to exit the business, key manufacturing expertise could be permanently lost. Brett Lambert, deputy assistant secretary of manufacturing and industrial base policy at the Department of Defense, gives an example: "A master welder who takes 12 or 13 years to get that status is essential for the Department of Defense. Those are the individuals that, once lost, would be very difficult to recover."

Christina Chaplain, director of acquisition and sourcing management at the Government Accountability Office (GAO), echoes that observation: "It's hard to reconstitute certain kinds of knowledge."

The Obama administration asserts that the $1.2 trillion automatic sequester creates "a strong incentive" for Republicans and Democrats to work together to strike a budget deal.

"If the fiscal committee took no action, the deal would automatically add nearly $500 billion in defense cuts on top of cuts already made, and, at the same time, it would cut critical programs like infrastructure or education," the White House explains. "That outcome would be unacceptable to many Republicans and Democrats alike -- creating pressure for a bipartisan agreement without requiring the threat of a default with unthinkable consequences for our economy."