Consolidating the defense-industrial base in the post-Cold War era: budgetary priorities & procurement policies in the U.S. & Western Europe

Public Finance and Management, Summer, 2007 by David W. Thornton

Abstract

This paper examines the U.S. and West European experiences with and approaches to the policy challenges of defense industry restructuring in the 1990s. The policies adopted by the Americans and West Europeans in their efforts to maintain their respective defense-industrial base (DIB) following the end of the Cold War provide instructive points of comparison that reveal both similarities and contrasts in approach with respect to the role of governments in managing and directing economic and industrial change. Attention is devoted to several related aspects: budgetary developments and trends, procurement policies, the pattern of industry mergers and acquisitions, policies of government with respect to promoting consolidation, and the prospects for future transatlantic cooperation in defense procurement.

U.S. Budgetary and Procurement Policy Developments

Introduction

As a consequence of the accession to power in the USSR of Mikhail Gorbachev in March 1985, the resulting collapse of the East Bloc in 1989, the implosion of the USSR and dissolution of the Warsaw Pact in 1991, the Cold War as the definitive structural divide in international affairs was ended. As the most important security threat to the U.S. and its allies since WWII receded, American and West European governments faced increasing economic and political pressures to reduce spending on military forces and weaponry to realize a "peace dividend". As defense budgets on both sides of the Atlantic declined accordingly throughout the 1990s, those same governments confronted the challenge of maintaining industrial and technological capabilities in research, development and production of weaponry and other equipment adequate to meet whatever threats might arise in the coming years and decades. However, despite facing a common challenge, both the methods used and the results of the American and European approaches stand in sharp contrast. On the U.S. side, the executive branch--specifically the Department of Defense (DOD)--used its powers of procurement to orchestrate a rapid and thorough consolidation. Contracts were used not only to winnow the field of major suppliers of defense equipment, but also to ease the financial burden as firms consolidated and reorganized. However, the process proved politically controversial, raising as it did questions of policy transparency and executive accountability, while the promised cost savings proved elusive. But whatever its flaws, by the end of the 1990s the consolidation policy had yielded a American DIB dramatically more concentrated in terms of the number of prime contractors. On the European side, the initiative for consolidation came not from government but from the defense industry itself, as it leaders saw themselves dwarfed in scale and resources by their transatlantic counterparts. This latest manifestation of the defi amercain prompted a wave of consolidation both within and among the DIB of the respective European countries yielding much larger and more competent business units. However, this industrial restructuring has not yet been matched by effective collaboration in the political and institutional realms, especially with respect to procurement policy and budgeting, thus not allowing the European firms to realize their full potential.

Developments since 9-11-2001 have only extended this pattern and further widened the gap between the U.S. and Europe regarding defense budgets, weapons procurement and industrial consolidation. Even excluding the extraordinary expenditures for ongoing military operations in Afghanistan and Iraq, U.S. spending on defense has risen sharply and the trend shows no signs of abating, while European allocations have remained stagnant, barely keeping up with price inflation. Therefore, in overall defense spending the U.S. total is several times that of the major European countries combined, and the differential in expenditures on research and development and weapons procurement is even greater. To make matters worse for the Europeans, since 9-11 the Bush administrations have shown much less willingness than its predecessors to purchase defense equipment from foreign suppliers, or to have U.S. firms collaborate with foreign partners in development and procurement process. Unless these trends change soon and dramatically, the U.S. will inevitably translate its expanding quantitative gap in spending and procurement into an increasingly qualitative one, and emerge as the only entity with both the economic resources and political will adequate to sustain a competent and technically advanced DIB. By contrast, the Europeans will see continued erosion in defense-industrial capabilities, both in absolute and relative terms, and thus will cede their already fading claim to first-rank status among the world's military powers in the 21st century.

Trends in U.S. Defense Spending

Depending on the exact years and precise categories used, spending on overall defense by the U.S. fell on the order of 20-25% from the peak years of the mid1980s to the late 1990s. As the Cold War ended, U.S. defense spending fell from around $335 billion in 1991 to $275 billion (constant 1998 dollars), a drop of nearly 18% (SIPRI, 2004). As a percentage of the overall federal budget, spending on defense declined from about 28% in the mid-1980s to approximately 16% in 2000. (OMB, 2002: Historical Tables, Tables 4.1 and 4.2, pp. 70-80). Defense industry employment dropped even more precipitously, falling by about 45% during the period 1987-1998, falling from around 3.7 million to just over 2 million. (Markusen and Costigan, 1999: Table 15). Spending on weapons procurement also fell, but by less in relative terms, declining from a peak of $163 billion in 1985 to $128 billion by 1998. (DIOR, 2004: Procurement Trends, History Table). Expressed in constant 2001 dollars, the procurement budget as a percentage of DOD spending peaked in the mid-1980s at about one third, and had fallen to around 23% by 2000. (DOD, 2004, Annual Industrial Capabilities, Jan. 2001, p. 17, Figure 6). Prime contract awards in selected key procurement areas fell from over $97 billion in 1989 to around $70 billion in 1993, as expressed in constant 1996 dollars. (Bischak, 1999: p. 57, Table 2.2). A recent RAND report for the United States Air Force (USAF) outlines the especially dramatic reductions in procurement spending on aircraft, missiles and space vehicles, noting that during the period between 1988 and 1997, "the aircraft procurement budget declined by nearly 75 percent." (Lorell, 2002: Chapter 2, p.3)