PERSPECTIVE ON THE DEFENSE INDUSTRY : To Downsize, Reshape Antitrust : Now that the Cold War is over, America must speed up consolidation of its healthy defense companies.

Today our nation searches for the proper balance between military spending and national security requirements, an objective Dwight Eisenhower described as “safety with solvency.” During his presidency, the defense budget averaged 59% of federal spending and about 11% of gross national product. In 1993, the defense budget comprises about 20% of the federal budget and 5% of GNP.

It has been estimated that, by 1996, the military procurement plus research-and-development budgets will have declined by more than 40%, equal to the 1991 defense revenues of Northrop, McDonnell Douglas, General Dynamics, Lockheed, Grumman, Loral, Hughes, Raytheon and United Technologies combined.

We must ensure that our defense industrial base remains capable of supplying the hardware that will be needed by our nation’s fighting forces in the future. This is a complicated task in the era of the “come as you are war,” when geopolitical circumstances literally shift overnight but defense industrial bases are rebuilt only over decades.

One result of rapidly declining U.S. military procurement is an extraordinary degree of excess capacity. This ultimately will be resolved in one of two ways, through consolidation of healthy defense firms or eventual bankruptcy.

Consequently, the trend toward consolidation must accelerate. A recent study predicted that up to 80 of the top 100 defense companies will disappear by the end of this decade. The United States is likely, for example, to be left with only three or four producers of military aircraft, one builder of tanks and one--or none--of submarines.

Unfortunately, antitrust laws were never intended to cope with such a massive shakeout, nor are they attuned to the special characteristics of firms with regard to ensuring national security. Antitrust policy encourages competition by ensuring the existence of numerous suppliers. But Pentagon officials are today arguing--correctly, I believe--for a defense industry with far fewer, more solvent and more efficient participants.

One misconception about defense firms is that they operate within the free-enterprise system. In fact, they are in a monopsony market, where companies bid for the business of one buyer, the government, which has overwhelming power to control the market.

Should we, however, require that underutilized defense firms compete as if in a free-enterprise market, consuming resources until only one weakened survivor remains, and the assets of the loser, including its human and intellectual capital, are scattered? Or might there be a better way?

A combination of antitrust policy changes would help resolve this dilemma. First, the Defense Department must have a formal role in evaluating the antitrust and national-security consequences of significant defense-related mergers. The Justice Department and the Federal Trade Commission should abide by this position unless there is compelling evidence that doing so would not be in the national interest.

Next, the current review process should be expedited so that proposed mergers are not left in limbo for months at a time. Also, Justice and the FTC should adopt policies that take the unique features of the defense industry--including national security--into account when evaluating proposed mergers. Today’s guidelines assume competitive models in which manufacturers build products and decide where to sell them. They do not adequately weigh the unique power of the Defense Department as a monopsony buyer.

Finally, Justice, the FTC and Congress should implement economy-wide changes in antitrust policy to increase the competitiveness of all U.S. companies abroad and to further recognize that market boundaries, in commercial business, no longer coincide with geopolitical ones. Such actions would help defense-oriented firms to diversify.

Congress has just enacted legislation to encourage production joint ventures, and Justice has recently decided to expand the use of U.S. antitrust laws to protect the interests of U.S. exporters operating in foreign markets. These are welcome changes. But we should review the whole range of antitrust laws to determine whether they are retarding the competitiveness of U.S. firms--defense and commercial non-defense--in today’s global marketplace.

It is time to reshape our antitrust laws as they apply to firms engaged in national security. Ironically, it was the notion of perestroika in the former Soviet Union and Eastern Bloc that helped create the budget conditions challenging today’s U.S. defense industry. We must enact our own, much more limited, but still much needed, form of perestroika by introducing reforms that encourage consolidation of our defense industry and the preservation of this most critical national asset.