An Era of Limits

By Janice Castro

When defense-industry executives gather to talk about business these days, their cocktail of choice may be Maalox. As Congress debates how to cut the Pentagon budget, one outcome is virtually certain: programs will be abandoned and assembly lines shut down. Under pressure to cut the federal deficit, Congress and the Bush Administration are determined to shear billions of dollars from military outlays. As a result, anxious defense-industry + executives from New York's Long Island to Los Angeles are frantically lobbying to keep their weapons programs alive. Tens of thousands of jobs depend on the decisions now being made on Capitol Hill.

After the crackle and roar of the Reagan Administration's $2.4 trillion military buildup, defense spending is in a steady decline. The Pentagon budget is still staggering in size -- more than a quarter of annual federal outlays. But in fiscal 1990, for the fifth year in a row, defense spending will grow at a slower rate than inflation. Adjusted for inflation, the $295 billion spending request that Defense Secretary Richard Cheney has submitted for 1990 is 15% smaller than the 1985 budget.

Cheney has offered Congress a blueprint for cutting $10 billion from the $305 billion budget request submitted by President Reagan just before he left office last January. In his plan, Cheney hopes to spare major strategic weapons like the B-2 Stealth bomber by trimming smaller but costly programs, notably Grumman's F-14D jet fighter (saving: $2.4 billion) and the V-22 Osprey ($7.8 billion), an innovative tiltrotor aircraft made by Boeing and Bell Textron. The Defense Secretary worked the Capitol Hill corridors last week to make his case, while President Bush courted key Senators and Representatives over a series of White House breakfasts.

But at week's end the House handed the President a sharp defeat by approving a defense authorization bill that turned his priorities upside down. By a vote of 261 to 162, the House slashed spending for four major strategic weapons while reinstating the F-14D and the V-22. The House decided to restrict production of the controversial B-2 bomber to just four planes during the next two years, and to authorize those only if the Bush Administration agrees to scale back its $70 billion program. The House also chopped $1.8 billion from the Administration's $4.9 billion request for the Strategic Defense Initiative, cut $502 million out of Bush's $1.9 billion plan for a rail- launched MX missile, and completely eliminated $100 million for the Midgetman missile. Griped Bush: "Yesterday was not the House's most memorable moment." The Senate is expected to complete its own, equally tough spending prescriptions this week. Differences between the two versions will be resolved in a September conference.

If the 1990 Pentagon budget is tight, the years that follow promise even more bad news for hard-pressed defense firms. The General Accounting Office estimates that as much as $150 billion will have to be hacked out of defense plans over the next five years. One reason: giant, multi-year spending commitments in the early 1980s are still rolling through the budgets like a giant bow wave, pushing aside other priorities. One of the biggest is the Northrop B-2, which is now expected to cost $530 million per plane, making it the most expensive weapons system in history. Eliminating the plane would create huge savings, but the effect would be felt across the U.S., as 126 contractors in 46 states have a stake in the project.

The five-year slowdown in defense spending is already hitting military contractors hard. Since 1982, the number of U.S. companies turning out hardware for the Pentagon has plummeted from 120,000 to just 40,000. At most major defense firms, profits are down and payrolls are being slashed. Los Angeles-based Northrop, which lost $78 million in the second quarter, is cutting its work force by 3,000 workers, to 41,000. St. Louis-based McDonnell Douglas (1988 defense sales: $9.7 billion), the largest U.S. military contractor, reported a loss of $48 million during the same period. If Cheney sells his plan to end production of the company's AH-64 Apache helicopter in 1991, as many as 4,000 McDonnell Douglas workers in Mesa, Ariz., and Culver City, Calif., could lose their jobs.

Hughes Aircraft, the General Motors subsidiary that makes aircraft radar systems and missiles for the F-15 jet, has announced plans to lay off 6,000 of its 75,000 employees in Southern California. No new planes are being built at the Lockheed aircraft plant just north of Atlanta, which once produced such military mainstays as the C-130 and C-5 transports. Reduced to performing subcontracting jobs for Boeing and Northrop, the plant has chopped its 20,000- worker payroll in half.

The impact of defense cutbacks is amplified as it ripples through the communities where plants and bases are located. Pentagon economists estimate that each dollar spent in contracts triggers $1.60 of spending in the local economy. Reductions have a roughly equal and opposite effect. On Long Island, for example, defense contractors have cut their work force of 60,000 by more than one-fifth since 1987. As a result, an estimated 26,000 other local workers, from pizza-parlor employees to department-store clerks, have lost their jobs.

Long Island-based Grumman, which has produced military jets since World War II, builds the Navy's F-14D, the highly maneuverable fighter featured in the 1986 film Top Gun. Because Congress has slowed annual production of the Tomcat to just twelve jets, Grumman is reducing its 19,000 work force by 3,100. If Cheney's proposal to cut production even further is carried out, many of the 5,600 Grumman workers who make Tomcats will be put in jeopardy.

As the industry contracts, many big companies are getting out of the business. More than 60 defense operations have been put on the block in the past two months. Other firms are building up cash reserves against an uncertain future by paring back their defense ventures. Minneapolis-based Honeywell, the leading supplier of lightweight torpedoes to the U.S. Navy, has sold three military electronics and communications subsidiaries since last August, and is seeking to shed a fourth. In what has become a military garage sale, bargains aplenty can be found. David Smith, a senior vice president at the Raymond James & Associates brokerage in St. Petersburg, estimates that the rush to bail out of the defense business has depressed the value of such firms as much as 25% since last October.

Traditionally, U.S. defense contractors have coped with periodic downturns in Pentagon spending by boosting their military exports. But that is no longer an easy market. Last year, according to the Stockholm International Peace Research Institute, global arms imports totaled $34 billion in constant 1985 dollars, a 14% decline from the previous year. Among the reasons: the winding down of regional conflicts like the Iran-Iraq war, reduced oil prices and fewer petrodollars for military customers in the Middle East, and a falloff in Third World purchasing power caused by high debt levels.

In addition, Western arms dealers face an increasingly stiff challenge from the developing countries. "All of God's children are producing military weapons," remarked a U.S. contractor, "so the competition is blistering." New arms exporters crowding into the market include Brazil, Argentina, South Korea, Taiwan, India, Singapore and South Africa. At last month's Paris Air Show, Brazil proudly displayed its new Embraer EMB-312 Tucano, a turboprop military trainer jet that has been ordered by Britain's Royal Air Force. As more countries step up production of military hardware, they are buying less from traditional suppliers. Tokyo's insistence earlier this year on participating in joint production of the FSX jet with the U.S. suggests that - Japan, the world's sixth largest importer of weapons, may be moving in that direction.

U.S. military manufacturers will have to learn to cope with keener foreign competition, just as consumer-products companies have done. Otherwise, according to a report by the Washington-based Center for Strategic and International Studies, "in place of the arsenal of democracy, the U.S. may find it has only the best pizza parlors in the world." Robert Costello, until recently the Assistant Secretary for Acquisition in the Pentagon, has urged American companies to enter into joint ventures with foreign manufacturers to capture more offshore business.

While cuts in the defense budget are undoubtedly necessary to shrink the country's deficits, the U.S. cannot afford to let its defense-industry base shrivel away. One harmful effect would be reduced domestic competition at every level, from small subcontractors to major suppliers, which would put upward pressure on procurement costs.

To cut costs and preserve programs, former CIA Deputy Director Bobby Inman maintains that defense procurement policies must be streamlined. Defense contractors complain, for example, that the Pentagon insists that parts and equipment be built to military specifications, when less costly, commercially produced gear would often be just as good.

Other military experts support the establishment of an industrial policy for defense. New York City Democrat Ted Weiss, a member of the House Foreign Affairs Committee, is among a growing school of defense experts proposing "dual-use" planning by military contractors to seek commercial as well as defense applications for their research and manufacturing efforts. Such planning might help ease the boom-and-bust cycles of defense procurement. Perhaps more important, it could help stimulate the development of new high- technology consumer products, strengthening U.S. economic security at the same time defense firms are bolstering national security.

With reporting by Dan Cray/Los Angeles and Bruce van Voorst/Washington