Washington, D. C.—After many years of neglect and abuse, the defense industrial base has finally sunk to the point that the Administration and Congress can no longer ignore the problem. It emerged as a major issue recently when the realization set in that other countries are overtaking us in high-technology manufacturing, that domestic industry is losing defense business, and that the US is rapidly becoming dependent on foreign suppliers for critical military items.
"There is no doubt that we are today more dependent on foreign sources for critical components in our weapon systems than we have ever been before," says Sen. Jeff Bingaman (D-N.M.), whose Senate Armed Services subcommittee is investigating the defense industrial base and related trade policies. "That is largely the result of the increasing internationalization of high-technology and other defense-related industries over the past forty years."
In his FY '89 report to Congress, Secretary of Defense Frank C. Carlucci said that 'we are continuously assessing our vulnerability to foreign dependency for critical items. Through these efforts, we have identified problems in the machine tool and electronic areas and are highly concerned with the situations developing in the precision optics and bearings industries."
The Pentagon admits that the US advantage in military trade is dropping, but says that sales are still ahead of purchases. "Our declining defense trade balance is not attributable to increased defense imports but rather to a loss of international market share," Dr. Robert B. Costello, Under Secretary of Defense for Acquisition, told Congress March 29.
Senator Bingaman says that "foreign military sales by American companies have been halved from 1980 to 1986, going from $14.8 billion to $7.1 billion. Our defense trade balance with NATO has gone from a high of 4.8:1 down to 1.6:1 during the last five years, and those figures do not take into account nondefense offsets to which our firms must agree to gain market access."
The net export value of military sales is often negated by such "offset" agreements. These are side arrangements—perhaps unrelated to the main sale—that require some industrial or commercial compensation as part of the package deal.
"Offsets have increased in the last decade from fifty to 160 percent of the value of the sale," says Sen. Alan J. Dixon (D-Ill.). "I believe that setting up a marketing system for hams or foreign cars or promoting tourism for a foreign country has no place in the sale of weapons."
Far more serious, Senator Dixon says, is that "US firms have transferred technology to foreign governments used to develop critical defense systems as part of offset arrangements." Thus fortified, foreign suppliers are better able to compete against US companies in the world market.
"A number of our allies are now competing against us using technology developed in the US," Senator Dixon says.
Surge Capability Slim
These new aspects of the problem come on top of older ones that have worried the defense community for a long time. A steady parade of Pentagon reports, confirmed in 1980 by congressional inquiry, warned that US industry could not expand its production to meet a wartime mobilization in less than eighteen months. It is not possible to surge the output of even the most important weapons and war materiel much faster than that.
Gen. Robert T. Marsh, USAF (Ret.), Chairman of AFA's Science and Technology Committee, has participated in numerous surge studies conducted by the Air Force. In most cases, he says, the finding was "that all you could really do by way of surge was sort of empty the pipeline. You could push a little faster, up your rates a little bit for things that were already in the pipeline. Then came the big dip, twelve to twenty-four months while the lower-tier [supplier and subcontractor] surging took effect."
Moreover, General Marsh says, the surge studies typically have a built-in weakness. They examine only one weapon system at a time. "We never could figure the intersections," he says. "If you're surging AWACS radars and surging Phoenix missiles, we don't know the extent to which they're depending on the same guys for the same critical components."
The shortage of such suppliers has long been recognized as a major industrial-base deficiency. Half of the small specialty firms that once supplied high-technology parts to the prime systems contractors have either disappeared or left defense work. The chain of suppliers often reaches down for four or five levels. Neither the Defense Department nor the prime contractor know who all of the suppliers are how many of them are foreign.
According to a March 24 report by Tim Carrington in The Wall Street Journal, "Pentagon strategists recently discovered that if war broke out, Soviet bombers could gravely wound the [United States] simply by attacking a small German plant thirty miles west of the Czechoslovakian border.
"The plant makes all of the high-purity silicon the US buys for chips in thousands of missile guidance systems. Destruction of the plant would stall US missile production for months, crippling the West's capacity to resupply its forces with missiles."
In response to a query from AIR FORCE Magazine, the Defense Department confirmed Mr. Carrington's report, but said that steps are being taken now to correct the situation.
A task force of the Defense Science Board concluded last year that the next generation of advanced semiconductor chips will probably be made by Japan, not the US. If so, the United States in the 1990s will either buy foreign semiconductors or settle for second best in its weapon systems.
Thus the armed forces are not only unable to count on domestic industry for mobilization but are also becoming increasingly dependent on overseas sources to meet their needs in peacetime.
"Buy American" Lawsuit
In a lawsuit filed April 8, the National Council for Industrial Defense accuses the Pentagon of granting blanket waivers to the Buy American Act without fully considering the consequences. It says that in pushing offshore procurements, a staff of international advocates" in the Defense Department not only hurts domestic manufacturing and technological leadership but also leaves the US dependent on plants and facilities that are 'within easy bombing range of the Soviet Air Force."
This newly formed lobbying organization claims a membership of 5,200,000, mostly drawn from defense supplier and subcontractor firms and several AFL-CIO labor unions, but says it is "not anxious to reveal the names of member companies" for fear that reprisals might be taken against them.
In its aggressive and rather flamboyant attack, the Council charges that a "buy foreign" policy causes "a dangerous weakening of the US defense industrial base, particularly at the second- and third-tier subcontractor levels."
These are the levels that most frequently lose business because of offset concessions.
The main objective of the lawsuit is "to compel the Department of Defense to comply with those laws that are intended to preserve our industrial base by giving a preference to the procurement of American-made defense products."
How Much Independence?
Opinions differ about the extent to which the United States can or should aspire to independence in its defense industrial base. The question is one of degree. Virtually no one who has studied the problem thinks the US could afford to rebuild a World War II style "Arsenal of Democracy." Another consideration is allied cooperation.
A recurring complaint of the allies about arms standardization is that, traditionally, the US has always sold weapons to the Europeans but never bought anything much from them. They called for the establishment of a "two-way street" in military sales. Congress and the Defense Department have put special emphasis on cooperative research and development the past few years.
"Our national security needs cannot readily be met with US resources alone," Dr. Costello said in his statement to Congress. "We must cooperate with our allies to reduce wasteful duplication of development efforts, to promote commonality and interoperability among US and allied forces, and to achieve urgently needed economies of scale throughout the acquisition and logistics cycles. Our domestic industrial base is critically important, but we must not allow ourselves to use this issue as a shroud for protectionism."
Secretary Carlucci testified that "national weapons programs have led to the deployment of six types of main battle tanks, six types of fighter aircraft, and a plethora of antitank missiles and armored vehicles within NATO." He added that "we project our investment in cooperative programs will increase from the current three percent of research, development, test, and evaluation [RDT&E] resources to twenty-five percent by the year 2000."
Senator Bingaman acknowledges the value of allied cooperation and has supported collaborative development and production. He says, though, that "while such programs help us in making the best use of the Alliance's limited resources for defense, they inevitably increase our foreign dependency." He further points out that allied governments practice protectionism regularly.
The United States, Senator Bingaman contends, has not been "as vigorous in pursuing US economic interests as our allies have been in pursuing their own. Our allies seem better able to recognize that while we are political and military allies, we are also economic rivals."
How We Got Here
As the issue heats up, questions arise about how the US defense industrial base could have deteriorated to its present state. There is no single or simple answer. And the trouble has been developing for a long time.
First, there have been big changes in the makeup of industry, both in the United States and internationally. Heavy "smokestack" industries have declined in economic importance as high technology has moved to the forefront. The United States is no longer so dominant as it once was in the global business arena. More and more, commercial interests and interdependencies cross national boundaries. Technological advancement, especially in electronics, has created an enormous demand for high-technology consumer products. For example, the US armed forces, once the primary customers of the semiconductor industry, currently buy just three percent of the total quantity produced.
Commercial and consumer sales now drive the technical product market. Suppliers have followed the shift in the market. They also found that their commercial lines gave them better profits, more stability, and less trouble than defense work. Meanwhile, ironically, these widget makers were becoming more important to defense. Between 1950 and 1980, the share of defense work sublet by prime contractors increased from nine percent to forty-one percent. One of the most intense areas of subcontracting is electronics—which is also the main pillar of technical superiority in modern weapon systems.
According to the Defense Science Board, the growing Japanese advantage in semiconductors is chiefly a result of their better ability to produce these chips in large quantities at very low cost.
A number of people, General Marsh among them, believe that stunted productivity may be the most fundamental problem of all with the US defense industrial base. Defense contractors have not invested in capital improvements that would have made them more productive and efficient.
"The defense industry suffers from insufficient capital investment, resulting in excessive touch labor and hence less than desired quality and productivity," General Marsh said in testimony to a Senate subcommittee on March 30. "This in turn leads to unduly high costs and reduced international competitiveness. These weaknesses exist throughout the prime and lower tiers of the industry. A perplexing characteristic of the defense industrial base is an overcapacity in a number of areas at the prime supplier level but a shortage of qualified suppliers for many critical materials and components in the lower tiers."
Failure of defense industry to modernize is a problem with multiple roots of its own. Economists have been lecturing for years about the proclivity of American business in general to emphasize short-term profits over long-range development. In the semiconductor industry, stock is traded at a breakneck pace, the volume of turnover being equal to a complete exchange in ownership every six to nine months. Management is under pressure from investors who want their earnings quickly.
Harsh Policies Hurt
Part of the fault, however, lies in the way the government has structured incentives and disincentives for business. The defense industry—unpopular with the public and perceived widely as a threatening "military-industrial complex—has been treated more harshly than most.
A February 1988 study published on behalf of the Aerospace Industries Association, the Electronic Industries Association, and the National Security Industrial Association examines the effect of policy changes from 1984 to 1987 on capital formation in defense industry.
"Business is fundamentally about risks and returns," the study says. "As essentially the only purchaser of highly specialized defense equipment, DoD controls both sides of the risk/return balance (at least for major systems procurement). In the period we have examined, DoD and Congress decided to adjust what was viewed as an imbalanced risk-return relationship. Unfortunately, it reduced rewards and increased risks simultaneously, with not one but multiple uncoordinated adjustments. At the same time, Congress significantly increased the industry's capital requirements (by reducing progress payments and deferred tax financing).
"While some in DoD now claim industry is much more like commercial industry, Wall Street is saying it will not provide it with capital at the same rate as commercial industry. Wall Street might provide the capital if it saw the opportunity for high returns (as it does for biotechnical companies, for example); the industry might live with the low profits if the government provided more of the financing and did away with cost-sharing, fixed-price development, and other unreasonable risks. But, as matters currently stand, the government has stepped out, Wall Street is unwilling to step in, and the industry is unable to."
It is not only the large prime contractors who feel the government has been clumsy in its use of carrots and sticks. Dennis M. Biety testified to the Senate Armed Services Committee on March 30 for Pneumo Abex Corp., a first-tier supplier of hydraulic subsystems. He said that his firm, which does about half of its business in military sales, is typical of the subcontractor base.
Mr. Biety said that suppliers and contractors see DoD as chasing short-term savings with policies that would be counterproductive in the long run. He said that firms at his tier are finding it "increasingly inadvisable to invest in the development of advanced technology or manufacturing capability for defense systems."
Proposals and Solutions
The Pentagon, Congress, and industry are all hacking away at parts of the problem.
Centerpiece of the effort to regain US competitiveness in semiconductors is Sematech, an industry consortium that just opened its permanent headquarters in Austin, Tex. It will work on improved equipment, materials, and techniques for semiconductor manufacturing, not on the design of chips. It was production ability that enabled Japan to overtake the United States in the semiconductor market in the early 1980s.
Sematech will not emphasize military applications in its research, pointing out that defense consumption of semiconductors is a small share of the total. The Defense Department says that its role in Sematech has not been decided yet. The guiding idea at Sematech seems to be that the proper way to help defense is to restore the domestic semiconductor industry to a strong position in the commercial market.
Target financing for Sematech is $1.5 billion over six years, with $600 million of that coming from the federal government and member companies paying most of the remainder.
The Pentagon's own Manufacturing Technology (ManTech) and Industrial Modernization Incentives Program (IMIP) are older and broader initiatives that share with industry the cost of upgrading the defense production base. There have been some successes, notably in assembly, castings, forgings, and factory automation. The Air Force is the only service that has shown real interest in ManTech, though. Funding has been modest, and industry has been reluctant to make capital investments to improve productivity.
Legislative actions are also pending. Senators Bingaman and Dixon, along with Sen. Phil Gramm (R-Tex.) and Sen. Timothy Wirth (D-Colo.), are sponsoring the Defense Industry and Technology Act of 1988. It would re-weight the balance among risk, reward, and profit in defense procurement in a way that is more favorable to industry.
The Defense Department has already backed away from the use of fixed-priced contracts on development programs for which the outcome is but dimly foreseen. Acquisition officials have also seen their error in forcing contractors to pay big portions of the R&D cost on high-risk developments even though the production award might go to a different contractor or the product might never be built. Part of this was a realization that the policy was unfair. Perhaps more motivating, though, was the discovery that contractors were refusing to bid on losing propositions.
In April, Senator Dixon introduced an amended version of his Defense Industrial Base Preservation Act, which he says "would eventually eliminate the growing number of offset arrangements." He concedes that "earlier drafts were protectionist in nature," but claims the revision "does not close the door to our friends and allies overseas."
At best, these measures might ameliorate the defense industrial base problem. They would not solve it. Even if all of the proposals were adopted immediately, the United States would still lack the capacity for wartime mobilization and surge. It would still depend—to an unknown extent—on foreign suppliers. Commercial demand would continue to drive the high-technology market.
The most encouraging sign is that concern about the defense industrial base is spreading. If the public, Congress, and Administration officials stay worried enough for long enough, the United States may slowly work out of the hole it has dug itself into.
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