Lifeline in Danger

Nov. 1, 1988

The US defense industry in 1988 bears little re­semblance to the “Arsenal of Democracy” that turned out tanks and airplanes in legendary numbers during World War II. American industry today cannot meet surge or wartime mobilization needs. It even has difficulty with peacetime defense requirements.

The armed forces depend increasingly on foreign sup­pliers for high-technology weapon system components. Overseas firms, often backed by strong support from their governments, are aggressively penetrating US markets. Domestic industry lags behind in manufactur­ing and productivity improvements. Although the United States is still ahead in the international balance of military trade, its relative advantage is slipping fast.

“Continuing on its present course, this nation faces the real possibility of becoming a second-rank manufac­turing and technology power,” the Air Force Association and the USNI Military Database concluded in a lengthy report on the defense industrial base published Septem­ber 20.

The two organizations called for the appointment of a White House commission—comparable to the Packard Commission on defense management and the Scowcroft Commission on strategic modernization—to devise a recovery plan. The problem affects and is affected by government, industry, labor, and educational systems at the high school and college levels, the report said, so any possible solutions will have to be national in scope.

The decline of the US semiconductor industry (see chart on next page) has attracted considerable public attention, but other segments of the defense industrial base are hurting, too.

Even in peacetime, for example, defense consumes a fourth of the output of the machine tool industry. A shortage of machine tools was the biggest barrier to expanding weapon production in the two World Wars and the Korean conflict. Twenty-five percent of the US machine toolmakers in business in 1983 have since closed, been bought out by other concerns, or moved their operations offshore. The foreign share of the US machine tool market, only seventeen percent so re­cently as 1977, had grown to nearly half by 1986.

If the United States could pull its act together on modernization of plants, equipment, and manufacturing processes and somehow manage to coordinate its team­work, an additional hitch would still remain: American schools and colleges do not produce enough technically prepared people to keep pace with the demand. Iron­ically, foreign students account for eighty-five percent of the recent growth in technical education at US graduate schools.

Reasons for the Decline

The report cites multiple and interlocking reasons for the decline of the defense industrial base. US military budgets, no longer so ample as they once were, fluctuate wildly from year to year. This creates instability and uncertainty for the supporting industry. Industry is re­luctant to commit long-range capital to improve produc­tivity.

Defense has become a rather small customer in the high-technology market, which is now driven by com­mercial product lines. Many of the firms that were doing defense business twenty years ago have either closed their doors or moved to other markets. The decline has been sharpest among small companies in the industrial subtiers that subcontract work and supply components to the prime defense contractors.

The strong trend in the world economy is toward internationalization. American industry, preoccupied with quarterly profits and insufficiently attentive to quality, no longer holds the uncontested leadership. More and more, hard-charging foreign competitors are on the heels of US industry and, in some cases, have overtaken it.

In addition, foreign firms are achieving roundabout penetration of US markets through “offset” concessions that their governments demand as a condition when they buy US military products. (See “You Scratch My Export and I’ll Scratch Yours,” p. 128, September ’88 issue.)

These are side arrangements, perhaps unrelated to the main sale, that require some industrial or commercial compensation as a part of the deal. In a typical instance, the offset will call for the US seller to purchase military components from firms in the customer’s country. One result of offsets is that American component makers lose business and grow weaker.

Whereas foreign firms usually have the enthusiastic support of their governments, US industry and govern­ment are squared off in a withering adversarial relation­ship. “American industry deserves better support than it has been getting from American government,” the re­port said. “It’s an open question whether the United States is ready for a Japanese-style Ministry of Interna­tional Trade and Industry or even a British-style De­fence Export Services Organization. Clearly, though, the US can do more than it does—and it should do more.”

The problem is compounded, the report said, by “a tangle of laws, regulations, and requirements that often work at cross-purposes . . . and frequently achieve re­sults opposite of those intended. There is no coherent relationship among tax laws, incentives and disincen­tives in the systems procurement process, environmental and trade policies, and other aspects of government regulation.”

Partners or Adversaries

The popular perception that arms makers and the Department of Defense are united in a powerful “mili­tary-industrial complex” is wrong, according to the re­port. In fact, government and industry too often behave as adversaries rather than as partners. The relationship has been strained to the limit in the past few years.

Part of the rift is about money. In the name of procure­ment reform—and to keep its own spending down—the Defense Department began requiring contractors to shoulder heavy R&D costs on high-risk developments, even though other contractors might get the production contracts or the systems might never be built. The gov­ernment also cut progress payments to contractors, stopped covering expenses that had been reimbursable before, and eliminated tax deferrals.

More recently, the Pentagon has backed away from rigid use of fixed-price contracts on risky ventures and no longer expects industry to pay so much of the cost on speculative developments. One reason for this change of heart is that contractors balked at bidding on jobs that looked like losing propositions.

The defense industry, citing its own figures and the findings of independent financial analysts, claims that its profits are comparable to or lower than those of commer­cial firms. As recently as a few months ago, the Pen­tagon was still contending that profits in the defense industry are equal to or higher than the US average. (AIR FORCE Magazine asked the Department of Defense for the data on which it based that conclusion, but was told that the information was not available for public re­lease.)

Another source of bad feeling has been the zealous campaign against “waste, fraud, and abuse” during the Reagan Administration. Since 1982, the Defense De­partment has increased its force of fraud investigators by 147 percent and its number of auditors by forty-six percent. It has installed fraud hotlines and told federal workers to be on the lookout for possible fraud. Suspen­sion and debarment actions against defense contractors have risen tenfold.

Contractors, the report said, “claim auditors are en­couraged to find problems and are seizing upon any irregularity, no matter how small, to make their ‘quota.’ In addition, contractors argue that they are denied due process of law by the government’s contract debarment procedures. . . . Federal law does not require the gov­ernment to tell contractors that they are being consid­ered for debarment until the decision has been made. Moreover, the government is not required to state specif­ically the evidence used against the contractor. Only alter the proceedings have run their course can the company argue its case before the agency, and then only under a set of rules established by the agency itself, in essence making it legislature, judge, and jury.”

The Department of Defense, having weighed the in­dustrial base problem for more than a year, said in July that the adversarial relationship has been a major cause of declining American industrial competitiveness and that DoD will put a high priority on forging better rela­tions with industry.

Solutions and Non-Solutions

With federal budgets that allocate less than six per­cent of GNP to defense, it is pointless to talk about rebuilding the Arsenal of Democracy, the report said. In any case, it concluded, “It would be a mistake for the United States to seek complete independence for its defense industrial base. For many reasons, led by finan­cial ones, this is impossible. This nation does not envi­sion a single-handed defense of either the European or Pacific theaters of operation. In any such conflict, it is committed to fighting alongside its allies. A reasonable degree of interdependence and interoperability is logical under those circumstances.

“At the same time, it would be foolish in the extreme for the United States to ignore critical vulnerabilities and foreign dependencies. Advanced semiconductors, pervasively used and pivotal in weapons quality, are an example of such a dependency. It would be irresponsible to rely on uncertain sources offshore for such items.”

The report also cautioned against hasty legislation aimed at correcting pieces of the problem without taking the entire problem into account. “We urge Congress to legislate with economy, and in all cases, to consider the impact of the laws it makes,” the report said. “It was hasty, ad hoc legislation that created the tangle [that presently exists].”

The two organizations said that the Defense Department should begin the difficult process of gathering cru­cial information that it does not have now: “It must identify, all the way to the end of the supplier and sub­contractor chain, the foreign dependencies involved for critical weapons and components. Thereafter, it must continue to monitor and report such dependencies. It must also discover the overlaps for sources, foreign and domestic, in surge production requirements for those critical weapons and components. This will be a major task and an expensive one, but until it is done, the nation is planning in the dark.”

Finding the Focus

“The defense industrial base is not just the prime contractors,” the report said. “Many of the shortfalls and critical problems are concentrated at the sub­contractor and supplier levels. As one of its major rec­ommendations, the study appealed to prime contractors to adopt, as a major initiative, the nurturing and shoring up of the supplier-subcontractor base.”

It also said that “the United States must think of commercial vendors as part of the defense industrial base, too. Such diverse groups as researchers in aca­demia and those who mine critical minerals are impor­tant as well.”

The report assessed the state of the defense industrial base in 1988 this way: “Some industries are doing well and look ahead to a bright future. Another group, not threatened at present, is concerned about the future. A third group, which is quite large, is just getting by and scrambling to stay in business. This final group consists [mainly] of the small subcontractors and suppliers who furnish specialty products to the prime defense con­tractors. Federal programs to assist these industries exist, but they are frequently insufficient and under­funded.”

For all of the bad news in their report, AFA and the USNI Military Database reached one upbeat conclu­sion.

“The United States should approach the problem with humility, but not be abject about it. We can and should learn from other nations, but should not always assume that the best answers inevitably lie abroad. We aren’t the underdog yet, although our relative advantage is declin­ing. The defense systems that set the standard for the world are American systems.”