The robust state of the US aircraft industrial base

Air & Space Power Journal,  Winter, 2006  by Michael J. Hicks

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In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist.

--Dwight David Eisenhower

RESEARCHERS OF ECONOMIC and national security issues have legitimate concerns about the ability of the US economy to securely provide for the manufacturing of key weapons systems and their components. Some of them call for thoughtful, informed, and analytically precise evaluations, both theoretical and empirical, of the defense industrial base. However, recommendations for active, interventionist policies toward domestic manufacturing industries exist only on the extreme fringes of the debate over international economic policy. Indeed, it is difficult to characterize the peripheral nature of the belief that considers directed demand-side intervention in industry an appropriate policy. As evidence of its marginal nature, only a few totalitarian and quasi-socialist states continue with overt demand-side support for domestic industry. Within this context, I was very surprised to read of a policy recommendation from a senior US Air Force program manager for direct policy intervention in the US aircraft industrial base ("The American Aircraft Industrial Base: On the Brink" by Lt Col David R. King, PhD, USAF, in the spring 2006 issue of this journal). The author bases this policy recommendation upon narrow and flawed analysis, a misreading of history, and unfortunate omissions of relevant data regarding the industry. Let me attempt to better explain the state of the US aircraft industrial base.

US Air and Space Power

Since the time preceding its formal establishment, the US Air Force has been the best in the world. As a counterfactual piece of alarmism, King notes the relative absence of leading-edge fighter technology at the outset of both world wars, arguing that the United States' reliance on European aircraft in World War I and the technological inferiority of its fighter aircraft at the outset of World War II have modern relevance. It seems curious to note these historical oddities in constructing an argument that supports demand-side intervention on the defense industrial base since in both instances that base is largely credited with providing war-winning technology and materiel. (1)

Further, little evidence exists that during the Cold War our Air Force chose substantially better aircraft-design characteristics than those of our leading enemy. In fact, the best available research suggests that avionics and aircrew training were likely the only substantive factors that differentiated the United States from its foes, from the Korean conflict to the present. (2) In the almost 40 years since the United States has lost a dogfight, we can attribute our victories to the pilots and supporting avionics--hardly evidence to justify intensive industrial policy for aircraft manufacturers. However, the key failures of King's analysis lie not in historical revisionism but in his examination of the causal impact of defense consolidation and the current state of the US aircraft industrial base.

Defense Consolidation

The recent consolidation of defense prime contractors represents the single starkest merger wave in US economic history. In retrospect the consolidation seems motivated largely by the urging of the Department of Defense (DOD) during the Clinton administration. During this period, the number of prime contractors dropped by more than 75 percent while revenues decreased no more than 15 percent in any given year--with no emergent trend in this decline--and the industry itself reported eight consecutive years of growth as of 2005. The apparent hope from the early 1990s was that these mergers would cut acquisition costs through increased efficiency, although I have yet to uncover an argument for these mergers based on economic analysis. (3) Importantly, the prime source of efficiency gains (and potential cost reductions) from these types of mergers would occur through achieving scale economies.

The DOD not only permitted but also promoted this merger wave despite clear and repeated violations of the Department of Justice's merger guidelines, established to protect competition (and, therefore, lower prices)--the goal of the DOD-supported consolidation. (4) The seemingly incompatible goals of higher concentration and lower prices never materialized. Indeed, in 1998 the General Accounting Office (GAO) (now the Government Accountability Office) offered a highly cautionary analysis of the recent consolidation, in effect warning the DOD of the potential for market-power-related price increases in subsequent purchases. (5) These fears proved warranted, and recent analysis suggests that defense consolidation played at least a modest causal role in cost overruns of the 1990s. (6)

In the end, my criticism of King's analysis does not reside in the potential impact of defense-sector consolidation, about which we largely concur. Rather, we differ in assessment of the cause. I do not view industry consolidation so much as a result of the declining fortunes of the defense sector--although that was a catalyst--but as a result of the 1990s' poor policy choices that permitted uneconomic, ultimately ineffectual, mergers. King goes further in identifying potential problems of mergers by offering specific concerns regarding product diversity, innovation, and competition. Like the authors of the GAO report, I believe that the biggest problem is likely the escalation in price due to market power from these firms. Again, King and I probably find ourselves in some agreement here. However, he writes that the US aircraft industrial base is "on the brink," deriving his chief examples from employment data from 1990 through 2005. (7) I believe that only a profound misreading of these data could lead to such a conclusion.