Why Savings on Defense May Not Help the Economy

The drive to cut defense spending is turning into a politician’s free-for-all, and President Bush is expected to join the crowd in his State of the Union message by lopping $10 billion or so from defense budget requests.

But don’t look for a quick boost to the economy. Bush’s $10-billion cut would be from budget estimates for fiscal 1993, which begins in October. Like most other defense cuts being talked about these days, it’s not real money but a cancellation of future planned expenditures in hopes that spending can rise for other programs. That’s a chancy assumption in a time of continuing budget deficits.

Meanwhile, defense cuts will eliminate jobs in some communities--notably weapons-producing states such as California, Missouri, Texas and New York. On the other hand, expenditures on military research should continue relatively undisturbed, benefiting states such as New Mexico, Virginia and the New England area--as well as California and Texas.

The outlook is confused because the Bush Administration and Congress, for all their talk of peace dividends, seem to have no coherent plan for the post-Cold War economy. And that lack of thought will mean a lot in the coming years--for business, employment and investment. We should understand what’s ahead and what it means.

The urge now is simply to cut or mothball military programs and deal with consequences later. Thus, the Marines’ V-22 short-takeoff and landing plane may be canceled or cut back even though the Gulf War demonstrated a need for such maneuverable small aircraft.

The brand-new F-22 fighter program, awarded to Lockheed last year after the expenditure of roughly $15 billion in government and private research and development funds, will be reduced to perhaps 300 planes from the 648 stipulated in the contract.

If such a cut occurs, the economics will be curious: The cost per fighter will skyrocket to almost $200 million, but there will be less work for Lockheed’s Marietta, Ga., factories and hundreds of subcontractors all over the country. Meanwhile, the question the F-22 was designed to answer--what kind of fighter plane the United States will need early in the next century--will remain open.

Overall defense expenditures by the end of this decade may total $200 billion a year in today’s dollars--a 30% reduction from current levels, says Gordon Adams, director of the Defense Budget Project, a Washington research organization. That will support full-time armed forces of 1.3 million, down from today’s 2 million, with fewer Army divisions, Air Force wings and naval carrier task forces.

The trend favors high technology. “Training is a costly activity in peacetime,” notes Michael Rich, vice president of RAND Corp., a Santa Monica firm specializing in Pentagon research. So there will be a call for computerized training systems to simulate combat and cut costs of maintaining forces in the United States rather than overseas.

Surveillance and electronics technology will continue in great demand because it’s still a dangerous world, with half a dozen countries vying for nuclear weaponry and the separating republics of the Soviet Union harboring military ambitions. Pentagon research budgets may stay close to current levels of $40 billion a year.

That’s why Wall Street analysts are high on defense companies with a niche, such as E-Systems, a Dallas-based electronics firm specializing in surveillance and reconnaissance.

Overall, however, defense companies face declining revenues. Thus defense stocks sell at low prices in a booming stock market--although that could change for an odd reason, says analyst Michael Lauer of Kidder Peabody. Just because they have little new military work to invest in, defense companies will pile up cash from past programs and become attractive for their potential to pay special dividends or buy back stock.

“Look at General Dynamics,” Lauer says. The St. Louis firm’s Trident submarine and F-16 fighter contracts face cutbacks, but its stock rebounded last year because it piled up more than $600 million in cash. And professional investors anticipate a payout from the “cash cow” if the firm, in effect, decides to liquidate its business.

It would be better for employment, for the company and the nation as a whole if General Dynamics and other defense companies invested their now-surplus cash in new and diverse civilian industries. That way a real peace dividend could be realized in the transfer to new business of military skills and technology.

But for that to happen, the government would have to find a way to encourage new industry as it has encouraged defense with trillions of public dollars in the last half a century. And that’s unlikely because “the Administration has no policy for it to happen, no technology policy of any kind,” says Lawrence Korb, an assistant secretary of defense in the Reagan Administration and now a research fellow at Brookings Institution.

The prospect is for defense to serve as an election year “cash cow,” as politicians compete to see who can cut more from tomorrow’s defense budgets in order to fund today’s campaign promises. The real state of the union is careless.