COLUMN ONE : Rethinking Defense. Arming for the ‘90s : The Crisis Ahead for Aerospace : Southern California firms foresee a short-term buffer from deep spending cuts. The long-term outlook is cloudier and already having an impact.

The vast American arms industry, nurtured by the Cold War for nearly 40 years, is rapidly approaching a crisis that could permanently recast its size, organization and technology.

Although many weapons makers prefer to focus on the relatively “optimistic” short-term outlook for Pentagon spending--no more than a 2% decline after inflation next year--thousands of aerospace jobs still will be lost in Southern California and across the nation in 1990.

But not long after that, the real pain will begin. A second stage of defense cutbacks, which should evolve in the early 1990s, has the potential to bring large, even catastrophic, job losses in the region and a painful consolidation of surplus factory capacity.

Although the nation’s military spending has risen and fallen sharply with various conflicts since World War II, never before has the structure of communist and non-communist confrontation in Europe changed as dramatically as in recent months.

Industry leaders dismiss any notion that demobilization is coming or that they will experience a wholesale drop in their weapons trade. But their optimism is a nervous one, and some of them are hedging their bets by quickly laying plans to diversify out of weaponry.

“There has been very little time for sitting back and soberly contemplating where all this will head, because the events are happening too fast and furiously,” said Hughes Aircraft Chairman Malcolm R. Currie. “The thing we know for sure is that they will have an impact on the defense industry. How large and at what pace is the thing I can’t even speculate on.”

There is some breathing space. For the next two to three years, aerospace will be shielded from the worst effects of the budget squeeze, since big cuts are only in the discussion stage and massive changes in federal funding can take several years to be felt.

But at the same time, some companies will prosper, thanks to a boom in commercial aircraft production. And a rapidly increasing civilian space program will also shelter some aerospace firms and workers. A large space station or manned Mars mission would further offset the loss of weapons business.

The outlook beyond the short term, however, has never been more obscure or posed greater potential peril for the industry. The commercial aircraft boom will eventually peter out and the space program budget--less than 10% of weapons spending--is far too small to make up for all of the potential losses.

If talks with the Soviet Union on strategic and tactical arms limitations lead to treaties and if economic problems continue at home, then Pentagon spending is likely to decline every year into the next century. House Armed Services Committee Chairman Les Aspin (D-Wis.) has declared that military spending is now in a “free fall.”

The next step in cutbacks holds the real potential for a protracted aerospace recession and perhaps a permanent reduction in the size of the business.

“You mothball it, turn out the lights and close down square footage,” explained Ralph E. Hawes, General Dynamics executive vice president, when asked what the future holds for at least some defense plants.

So much industrial capacity was added during the Ronald Reagan Administration’s defense buildup in the early 1980s that some factories are virtually idle today. Nearly every major contractor expanded to handle the burst of business that occurred between 1979 and 1985.

General Dynamics, for example, opened a new factory in Rancho Cucamonga in the early 1980s to produce the successful Stinger anti-aircraft missile at a rate of 1,000 per month. But now it looks as though that is twice as much output as the company can expect in the future. “I have to get into less space,” Hawes said.

Major Losses

Even without Pentagon cutbacks, the health of prime contractors is deteriorating. Major firms have lost an estimated $8 billion on fixed-price weapons contracts and have taken on huge debt to offset increasingly stingy Pentagon accounting practices.

“We are dealing with an enormous, bloated, obsolete defense Establishment that will have to be pared down,” said Herbert L. Fenster, a leading defense industry attorney at the Los Angeles law firm of McKenna, Conner & Cuneo. “It is a very troubled time.”

Many defense companies, especially those in Southern California, have been laying off workers for several years, starting with El Segundo-based Rockwell International Corp.’s massive furlough of 22,000 B-1 bomber workers beginning in 1986. Many of them went to commercial aircraft jobs at Douglas Aircraft in Long Beach, a McDonnell Douglas subsidiary, and to the B-2 Stealth bomber program at Northrop Corp. plants in Pico Rivera and Palmdale. But workers laid off in the future are unlikely to land on their feet as easily.

Estimates of aerospace job losses in 1990 vary widely among different economic studies, ranging from 5,000 to 65,000 in California alone.

DRI/McGraw-Hill, an economic forecasting service, has projected that the aerospace industry will lose 620,000 jobs nationally by 1994 from the current 3.125 million, (based on a broad definition of aerospace employment). California would lose 110,000 of those jobs, according to this projection.

“In most cases, those jobs will be picked up in other industries,” said DRI Vice President Pat Strauch. “Employment does not suffer that much.”

Future Shock

But suffering there will be: Just ask electrical engineer Tony Tropin. After 20 years at Hughes Aircraft, Tropin was laid off recently as part of a 6,000-worker belt-tightening exercise at the Los Angeles-based aerospace firm. Although he will receive good separation benefits, Tropin, 58, is not sure what the future holds.

“It is spinning your wheels to look for a job at other aerospace companies when they are already laying off their own engineers,” Tropin said. “It looks like I’ll do a career change--probably real estate.”

The ultimate severity of the hit taken by Southern California will hinge on how several big-ticket programs fare, most notably the B-2 bomber at Northrop, the C-17 cargo jet at McDonnell Douglas and the Advanced Tactical Fighter program at Lockheed and Northrop.

Early indications are that the B-2, which employs about 12,000 at Northrop, will not be on the Pentagon hit list and that the C-17, which employs about 8,000 at Douglas Aircraft, will be delayed but not killed. The ATF program now employs only about 1,600 workers at Lockheed and Northrop combined, but the $68-billion program has the potential to grow explosively.

More important, ATF will be needed to provide jobs for the huge Southern California work force that specializes in development programs, Northrop President Kent Kresa observed. That work force is occupied on the C-17 and B-2 but will be released from those tasks in coming years. Without ATF, there is no major program to absorb them, Kresa said.

Guarded Optimism

Despite the perils ahead, Kresa and other top aerospace executives remain upbeat. “I am optimistic,” were words that repeatedly came up in a series of recent interviews with industry leaders about their own firms’ outlooks.

“We are projecting moderate growth,” Lockheed Chairman Daniel M. Tellep said. “Now, what we haven’t factored into that is what you might call a disaster scenario where the defense budget gets cut to $200 billion. We don’t believe that is going to happen.”

Similarly, Northrop’s Kresa dismissed the suggestion that the current 1990 Pentagon budget of $291.3 billion could be cut by even 25% by the mid-1990s. “Those are enormous changes that there would be no precedent for,” he said.

Theodore W. J. Wong, president of Hughes Aircraft missile systems group, remarked: “If you took the defense budget down by 25%, you would see companies drop like flies.”

Stock market investors believe that such risks are very real. Defense stocks lost 10% of their value in a single day last month after Defense Secretary Dick Cheney raised the prospect of cutting defense spending by $180 billion between 1992 and 1994. The industry is operating with “unwarranted optimism,” said aerospace analyst Lawrence Harris at the investment firm of Bateman Eichler, Hill Richards in Los Angeles.

“The industry is so frightened that they cannot think of how to operate in any other way than they have always operated,” said Kosta Tsipis, a professor of nuclear physics at the Massachusetts Institute of Technology. “They cannot respond to this crisis that is coming because all their lives they have been in this protected environment.”

Easing the Pain

Some companies appear to be well positioned for big cuts. McDonnell Douglas and Seattle’s Boeing Co. have a combined backlog of $82-billion worth of commercial airliner work that will extend production at both companies beyond the turn of the century. Rockwell has already reduced defense work as a percentage of its sales to 28%.

Hughes Aircraft plans to double its non-defense work by the late 1990s, up to 50% of total sales, according to Currie, the chairman. The company is rapidly growing in such fields as commercial communications and air traffic control, Currie said.

But others, including Lockheed, General Dynamics and Northrop, are more or less committed to staking their fortunes on the future defense budget.

If the Pentagon budget continues to drop by 2% annually in real terms after inflation, a trend that started after the budget peaked in 1985, then the current $291.3-billion budget will be $295.3 billion by 1994.

That would gut a long list of major programs that were started on the unrealistic premise by the Reagan Administration that the defense budget would continue to grow significantly. Some experts say the budget would need to rise to $600 billion a year to pay for everything the Pentagon started during the Reagan years.

Shaking Out

The cancellation of major programs is likely to drive the industry to a consolidation, in which companies merge, divest themselves of some divisions or simply go out of business. That difficult process, for example, could cut the number of military aircraft producers in the United States from the current six to three or four within several years. The survivors would be better able to live off the remaining business.

Merger talks are already taking place. “There is a lot of daily turbulence--companies on the block,” Currie said.

Subcontractors will be even harder hit, according to Hamilton W. Jenkins, who runs the defense consulting business on the West Coast for the accounting firm of Peat Marwick Main & Co. As major prime contractors suffer, they will award fewer subcontracts and will pull more work in-house, steepening the decline in business for smaller firms.

“The number of subcontractors has already been cut down by 50% over the last four or five years,” Jenkins said. “The ones who are left are pretty hardy individuals and now they are going to get even more competitive.”

Still, some small companies will prosper. Aluminum Precision Products, a precision forge in Santa Ana, has 335 employees, up 65 in the last two years. Thomas R. Newell, vice president for sales, projects a sales increase of 18% next year on the strength of commercial orders.

Basic Needs

Another small production company, Anaheim-based Sonfarrel, has witnessed its high-technology machining business explode in the last two years, said President Frank Power. “I don’t see any slowdown in our segment,” Power said. “The soldier in the field is still going to need a rifle and a grenade, and that’s the market we serve.”

The thawing of the Cold War will prompt major changes in defense strategies, leading to new weapons and technology. But even with defense cutbacks, Pentagon and industry executives dismiss out of hand any suggestion that the United States is about to relinquish its role as “the catalyst for the whole defense structure of the free world,” as Hughes’ Currie put it.

“I don’t know whether basic human nature and the basic nature of nations has changed that much,” he added. “If you look over history, there have been very few periods in which there haven’t been tremendous instabilities and regional conflicts.

“You know it is going to happen, but not where and to whom and what role we will play. Well, we are going to play a role in it, and we are not going to relinquish it, and it will be played largely with technology rather than sheer numbers of people like in World War I and World War II.”

In the same vein, Rockwell Chairman Donald R. Beall asserted: “Let’s face it. It is not a perfect world. The requirement for all new weapons systems is not going to go away. As you have less physical quantities, you’d better have much more capable systems. And that means development.”

Research Effort

Assuming that the Pentagon withdraws forces from around the world and cuts manpower, as expected, by a quarter of a million troops, the smaller remaining forces will still require the best weapons money can buy, the industry insists. High-technology weapons mean big research programs.

DRI/McGraw-Hill goes so far as to predict that defense research and development will be maintained at the current spending level of about $39 billion annually. That would probably mean a boost for California contractors, which received a disproportionately large amount of research funding. In 1988, they were awarded $9.1 billion in research contracts versus $11.7 billion in production contracts, according to a recent study by the California Commission on State Finance.

But other experts consider that to be a fantasy, because much of that $39 billion is more for development and testing of specific weapons programs than for research. If those programs are killed, it is not clear how the money could even be spent.

One major element of the so-called peace dividend resulting from lower Pentagon spending would be diversion of defense research to commercial projects.

An estimated one-third of U.S. engineers and scientists work on defense, and they are among the best technical minds in the nation, according to Albert Wheelon, former chairman of Hughes Aircraft and a government official who is working with a group from the Massachusetts Institute of Technology to develop a strategy to redeploy scientists to civilian pursuits.

Facing Reality

“Everybody thinks the blade isn’t going to nick them,” Wheelon said in a recent interview. “The danger is that these people will be lost and end up selling real estate. It will be a terrible loss to the nation.”

Wheelon, among other experts, believes that the defense industry is not responding quickly enough to accept and position itself for the major defense spending drops that are coming.

Denying that demobilization is on the way also ignores history, according to William Kaufman, a defense analyst who wrote a detailed Brookings Institution report on how to cut the defense budget in half.

After World War I, Kaufman said, the United States cut annual defense spending to just $10 billion (stated in 1990 dollars), or less than 1% of the gross national product--contrasted with about 6% now. And by 1940, the U.S. Army was no larger than Portugal’s. Although such Draconian cuts seem unlikely today, it is not clear what threat the United States faces that requires the current level of spending, Kaufman said.

“Our supremacy depends on a healthy economy and much less foreign borrowing,” Kaufman said. “I have nightmares that we will buy B-2s at $500 million apiece and then a bulldozer will show up and roll over them under an arms treaty.

“People forget that under INF (intermediate-range nuclear forces treaty) we are destroying $6 billion worth of missiles. I am not criticizing the treaty, but that is money down the drain.”

Staff writer Melissa Healy in Washington contributed to this story.

See related stories in Business.