Budget Cuts May Sting State’s Defense Firms : Trimming by Congress Expected to Hit Industry in 1987 or ‘88, Possibly Triggering Huge Layoffs
As Congress prepares to rein in the once-robust defense budget, California faces the prospect of large-scale layoffs in its aerospace and defense sector, the state’s largest industrial employer.
Although a $142.5-billion backlog in defense programs enacted during the Reagan Administration will forestall a precipitous decline in employment this year, the impact of tight defense budgets should hit California by next year and is likely to make itself felt fully by 1988.
Defense contractors are apprehensive. “We are looking at a flat market soon. I mean right away,” said Harry Biederman, chief economist at Lockheed. “From an employment point of view, it will be hard to sustain where we are now. We could have a cutback of 10,000 (jobs) or more in California.”
“Industry will be hard hit,” said Bastian (Buz) Hello, senior vice president at Rockwell International. “There is joy in building up--but a desperate pain in cutting back.”
A consensus in Congress has emerged in the last year to quickly bring Pentagon spending to at least a zero rate of growth, after adjusting for inflation. Even if the Gramm-Rudman deficit-reduction law is ruled unconstitutional, significant pressure on the defense budget is expected.
Variety of Scenarios
Under the most drastic Gramm-Rudman scenarios, defense spending would be slashed, triggering an aerospace industry recession. Even an optimistic outlook provides for a zero-growth budget. But such a plateau in weapons spending would still trigger employment cutbacks, industry experts say.
“The defense industry has been doing quite well, and it will continue to do well from orders that have been placed for the next two years . . . but there is nothing you can do in 1988 when the orders have run out,” William H. Taft IV, deputy secretary of defense, said in an interview.
The future will be painful and will “unquestionably produce economic dislocation of a significant level in California,” Sen. Pete Wilson (R-Calif.) said. “We are right to be concerned.”
Some skeptics believe these dire forecasts simply represent posturing in an effort to keep defense budgets as high as possible. But clearly there is a range of possible outcomes stretching from slow growth in the industry to widespread layoffs.
Layoffs are already occurring as some early Reagan programs pass their peak. Rockwell International recently began the first of 6,800 layoffs that it will make by October on the B-1 bomber program. The firm has been lobbying intensively to sell more B-1s to the government, but tight budgets make such a sale highly unlikely.
The pessimism in the industry comes after an almost euphoric run-up in weapons procurement during the past decade, in which the industry has quadrupled its profits and boosted its stock market prices 11-fold, according to industry analyst Wolfgang Demisch of the Wall Street firm of First Boston.
As in past cycles, the industry has played a key role in boosting the economies of half a dozen states heavily dependent on aerospace. Now, a downturn will have broad national economic implications.
During the past six years, the California economy has created 1.3 million new jobs, roughly 15% of all new jobs in the United States. It did that largely as a result of defense spending.
Aerospace Industry Jobs
An estimated one-third of all new jobs created in California between 1980 and 1986, the Reagan years, are attributable directly or indirectly to the aerospace industry, according to Larry J. Kimbell, director of the UCLA Business Forecasting Project.
The precise magnitude of any layoffs is difficult to estimate because they will depend on the overall size of the Pentagon budget and the proportion of the anticipated cutbacks that come from industry’s share of defense spending.
President Reagan has asked Congress for $320 billion in defense budget authority for fiscal 1987. The House Budget Committee has voted to provide only $285 billion, a reduction of $35 billion. The Senate Budget Committee has voted to provide $301 billion, a $19-billion cut.
Many key budget watchers, such as Washington lobbyists for the defense industry, are expecting a compromise to yield a cut of $25 billion, producing budget authority of about $295 billion. That would result in a decline--after adjusting for inflation--of about $6 billion to $12 billion from the previous fiscal year.
The reduction would hit the Pentagon hard because it has been counting on continuing budget increases to fund many programs that are just beginning to grow significantly, including major aircraft, missile and helicopter programs.
The Pentagon has projected that its budget needs over the next five years will soar by 25% to complete programs that largely are already under way.
How the Pentagon would fund big increases in specific weapons at a time when its overall budget is in decline is the key issue that will be fought over in coming months, as defense contractors attempt to preserve funding for their own “high-priority programs.”
‘Summer of Discontent’
“This is a summer of discontent,” Hello, the Rockwell executive, said.
Many defense contractors hope that defense cutbacks will come chiefly out of military operations, such as reducing the time that Navy ships spend steaming at sea or cutting back on the flight hours of Air Force jets.
But Taft, the deputy secretary of defense, insists that the Pentagon’s top priorities lie with maintaining operational funding and with the nuclear weapons modernization program. Thus, procurement of conventional weapons will be the main target of cutbacks.
“These are not reductions that the Administration thinks are wise in any degree,” Taft said.
In many cases, cutbacks will mean only that expected increases in programs will be forgone or stretched out into the future. But to get $25 billion out of the budget and to get most of it out of procurement will necessitate outright cancellation of some programs, many experts say.
“There are going to be a lot of programs that are just going to be eliminated,” Sen. Barry Goldwater (R-Ariz.), chairman of the Senate Armed Services Committee, said in an interview. “We have several programs that are going to have to take sizable cuts.
“If you ask me if I would rather cut production or operations--that’s a God-awful question. I have never in my long experience with the Armed Services Committee lived through such tough questions that have to be answered.”
Nowhere will the questions be tougher than in the Air Force, which wants to increase funding sharply on such programs as Northrop’s Stealth bomber, the McDonnell Douglas C-17 cargo plane, Hughes Aircraft’s advanced medium-range air-to-air missile and the Strategic Defense Initiative (“Star Wars”) missile defense system.
Effect on Air Force Budget
Lt. Gen. Truman Spangrud, comptroller of the Air Force, said that if Congress cuts $25 billion out of the defense budget for 1987, it would trigger an $8-billion to $9-billion cutback in the Air Force budget.
“In any case, we will have some negative growth,” Spangrud said. “The bulk of the $8 billion will come out of research and development and procurement.
“The cuts will be very hard to make. There will have to be cuts in quantities. I don’t know about cancellations. We would never cancel the ATB (Stealth bomber). It is too critical to our national defense.”
Star Wars, however, is on the top of a lot of analysts’ hit lists. Although huge, the Star Wars missile defense program is spread so thinly through the industry that no single company considers it critical to its future. Similarly, management of Star Wars is shared throughout the military services and defense agencies, which tends to dilute the strength of military support for the program.
The Pentagon requested $4.8 billion in fiscal 1987 funding for the Strategic Defense Initiative, up from $2.7 billion in 1986. The chief defense lobbyist for one of the largest aerospace contractors said he expects $2 billion to be cut out of the request.
As an apparent symbol of the new mood on Capitol Hill, the Republican-controlled Senate Armed Services Committee voted 10 to 9 Friday to trim more than $1.3 billion from the request.
“There is a great willingness to savage SDI,” said Wilson, a member of the Senate Armed Service Committee. “That could result in the cancellation of certain projects and not going forward with certain work that would have occurred.”
The cumulative economic effect of a big cutback in the program would be significant, especially in California. The top five Star Wars contractors are in California.
Lawrence Livermore Laboratory has been the leading contractor, with cumulative awards of $725 million since the program was announced in 1983, according to the Federation of American Scientists. It is followed in order by Hughes Aircraft, Lockheed, TRW and McDonnell Douglas.
Cargo Plane Vulnerable
Similarly, many analysts see the $34.5-billion C-17 cargo plane program as particularly vulnerable to cutbacks and possible elimination this year. The C-17, which would employ 13,000 people in Long Beach and Torrance, is the largest single program up for a critical vote this year.
The Air Force is seeking $830 million for the C-17, which would include money to begin production. That is up from funding of $372 million last year.
“(The) C-17 I have strong doubt will get started, as much as I would love to have it started,” Goldwater said. Other observers give it a better chance, however, noting that a recent vote in a key Senate subcommittee provided funding to launch production.
A major cutback in these relatively young programs would exemplify why a level budget can cause layoffs.
In building up defense production, contractors must hire large staffs of engineers and scientists for research and development of weapons. In addition, early production is always inefficient because management has not gone through the “learning curve.” As production programs mature, a greater proportion of contract dollars go into materials and inventory.
“It takes fewer people to spend the same amount of money when a program matures,” explained Hello, the veteran aerospace executive at Rockwell.
When defense budgets stop growing, the relative age of programs tends to increase, because one of the easiest ways of cutting spending is to stop new programs and extend existing programs. “If you cut procurement, the net result is cutbacks in existing programs and no new starts,” Hello said.
Certain aerospace markets that have experienced explosive growth will come under pressure. For example, U.S. employment in the production of missiles and spacecraft soared 83% between April, 1977, and April, 1984, from 81,000 to 148,100, according to the U.S. Bureau of Labor Statistics.
Pressure on Overhead Costs
At the same time, however, sales--in terms of constant dollars--increased only 51%, according to the Aerospace Industries Assn., a trade group. Now, in a market that will grow more slowly, the pressure will be on manufacturers to cut overhead costs.
Almost every major aerospace manufacturer has established programs to trim overhead costs, which is especially critical in a period of declining markets when overhead has to be spread over a smaller business base. Hughes Aircraft, for instance, plans to cut 5% of its white-collar work force.
Hughes Aircraft President Donald White said he expects defense budgets to show no real growth in the next several years. Nonetheless, he said, his firm, headquartered in Culver City, will continue to post sales increases in future years with fewer workers.
“I see the potential to keep growing,” White said. “Our business is electronics, and that part of the budget will keep growing.”
But even the relatively insulated electronics portions of the defense budget are not immune. George Solomon, executive vice president of TRW’s electronics and defense sector, said recently that military purchases of so-called command, communications, control and intelligence equipment will drop from a growth rate of 19% in 1986 to 9% next year.
Despite such projections, not every analyst foresees a downturn in the California aerospace industry.
Kimbell, the UCLA forecaster, recently predicted that aerospace employment in California will grow from 759,000 in the first quarter of 1986 to 820,100 in the fourth quarter of 1988. The prediction was based on a computerized economic model, which assumed a “flat” defense budget and a robust general economy.
But aside from his computer projection, Kimbell acknowledged, “There is a significant possibility that it could get very bad.”
Another who doubts a defense industry downturn is Ernest Fitzgerald, an Air Force employee who has made a career of showing that the Pentagon is spending too much money.
‘Money Tucked Away’
“The Pentagon has so much money tucked away in the mattress right now for acquisition that they don’t know what to do with it,” Fitzgerald said.
But many experts are simply baffled by the economic outlook for the defense industry. “I have never felt less certain or more confused,” said Karl G. Harr, president of the Aerospace Industries Assn. “I just don’t know which way it is going to go. I don’t think the President knows. I don’t think (Defense) Secretary (Caspar W.) Weinberger knows.”
If layoffs do occur in the aerospace and defense industry, it will be a problem that the companies and the states involved will have to deal with. “I don’t feel any responsibility or concern to provide a certain level of jobs to the defense industry,” Taft said.
