Where Economists Meet Since 1968
The Impact of Globalization and Shifting Defense Priorities on the Defense Industrial Base
A Summary of Remarks by
Nayantara Hensel
Chief Economist, Department of the Navy
March 11, 2010
Defense spending in the United States makes up a significant portion of government expenditures and is distributed throughout various sectors and regions of the country. Thus, post-Cold War changes in the defense sector, demand for new types of weapons systems following September 11, and globalization leave a significant impact on the U.S. economy. Dr. Nayantara Hensel, the Navy’s Chief Economist, discussed the effects of current macroeconomic conditions and shifting defense priorities on the defense industry, the evolution of the sector in response to this shift in priorities, and the continuously globalizing nature of the defense marketplace in her presentation to the National Economists’ Club.
Dr. Hensel begins by pointing out that growth in US debt as a percentage of GDP has risen to historic levels. She also remarks that defense expenditures as a percentage of GDP decreased following the Cold War, but have begun to increase again due to the growing demands of the global war on terror. Budget concerns combined with the new focus on insurgent combat forces are reflected in the Obama administration’s FY2011 budget request of $708 billion for the Department of Defense. This budget demands greater funding for types of weapons systems that support irregular warfare, a reduction in high-tech weapons systems for conventional warfare, and places more emphasis on controlling cost growth.
Although 2009 defense spending was only 4.9% of GDP, Dr. Hensel points out that defense industry presence has strong spillover effects in local economies. This is the case in Charleston, North Carolina, where mine-resistant armored trucks are designed and outfitted with new technology. From 2000-2007, Charleston experienced 52 percent growth in IT employment and equipment, while growth in this sector on the national level was only 9 percent. A second example of the impact of defense spending on local economies is the impact that the 2008 bid of Northrop Grumman and EADS to supply the Air Force with a new fleet of aerial refueling tankers would have had on Mobile, Alabama. Their proposal would have resulted in the construction of a $600 million facility, and would have brought $360 million in economic activity and created 1500 jobs.*
Thus, considering the extreme growth in US unemployment over the past two years, members of Congress have grown concerned about the impact of cutbacks in certain defense programs on the regional labor markets. For example, the F-22 fighter jet program was terminated in 2009, as it was deemed no longer necessary for current combat needs in Iraq and Afghanistan, impacting contractors in 46 states. Additionally, the Pentagon intends to cut the C-17 transport aircraft program, which is produced across 43 states.
The shift toward irregular warfare and away from conventional warfare may cause certain aspects of the defense industrial base to wane, but possibly may lead to increased growth in other sectors. The largest spending increase in the FY2011 budget is in operations, due to the increase in special operations forces, which would be the biggest buildup since the Vietnam War. There has also been significant growth in IT equipment production and employment. These new subsectors have already experienced positive growth.
Yet, there are still concerns that subsectors affected by cutbacks will reduce the skill base for the next generation of defense programs. For example, reductions in the space program could attenuate the industrial base for large-body solid rocket monitors (SRMs). She points out that these programs are currently doing well, but if the Pentagon reduces demand in this sector, it might cause atrophy of the design teams. She emphasizes that this type of skill base takes awhile to develop; currently, most of the designers in the defense sector are from the baby boom era. Without demand for skills in this sector, it will be difficult to develop the next generation of defense programs.
Nevertheless, demand for new insurgent combat systems create a space for entry by smaller defense firms, such as in the areas of unmanned aerial vehicle units (UAVs)—a market which will be worth $62 billion over the next ten years. UAVs present lower barriers to entry and lower fixed costs, creating opportunities for smaller, more innovative firms. The traditional large defense contractors are just getting involved in UAV production, mainly by buying out these smaller companies.
Dr. Hensel also points out that the defense industrial base is growing increasingly global in scope. For instance, about three-quarters of the helicopters used for homeland security are built in Italy, Germany, or France, littoral combat ships are being built in Mobile, Alabama at a shipyard owned by an Australian company or in Marinette, Wisconsin at a shipyard owned by an Italian company, and 80 percent of mine-resistant vehicles were designed by foreign firms. While the bulk of major US defense contracts are awarded to US companies as the lead contractor, our defense industrial base is involving an increasing number of foreign companies in the supply chain. She predicts that trends toward developing global supply chains for the purposes of sharing innovation and risk and developing interoperable equipment will continue. For instance, the production of F-35 joint-strike fighter jets currently involves 600 suppliers from over 30 countries
Additionally, there is an increasing demand from overseas countries for conventional defense weaponry. Dr. Hensel cited the Middle East and India as examples. For instance, although India currently imports 70 percent of defense equipment, it aims to bring this figure down to 30 percent by increasing its own production. She argues that these foreign transactions help a country develop its own industrial base through knowledge-sharing, as most countries require that a certain portion of its order uses domestic suppliers.
Dr. Hensel concludes by stressing that defense spending will potentially be impacted by growing fiscal pressures in other areas of the budget, as well as by the shift in defense priorities toward irregular warfare in the post 9/ 11 period. Nevertheless, she emphasizes that demand for new types of weaponry will present opportunities for new firms to enter the industry and to develop new technologies. As the defense industrial base continues to expand globally, the US defense sector will continue to become more innovative, cost efficient, and effective.
Dr. Nayantara Hensel is the Chief Economist of the U.S. Department of the Navy. She has served as a Senior Manager at Ernst & Young, LLP and the Chief Economist for one of its units, was a Post-Doctoral Research Fellow at the National Bureau of Economic Research, and taught at Harvard University and the Stern School of Business at NYU. She earned her B.A., M.A., and Ph.D from Harvard University.
Rapporteur: Nicole Firment
National Economists Club
P.O. Box 19281
Washington, DC 20036
703-493-8824
info@national-economists.org
