Reagan's defense muscle building boosts economy for now. . .
Washington — When President Reagan was elected and announced his goal of 10 percent annual increases in real defense spending, there were gasps of dismay. Some economists said it would disrupt the economy - prompting another burst of grim inflation.
But so far that has not happened. With a deep recession occurring in 1981 and '82, there have been no serious capacity shortages. In fact, the economic consequences of Ronald Reagan's arms buildup, like so many other recent financial events, are going the President's way. The sharply higher defense spending has already been felt in higher demand for goods and services, and thus an improved employment and income picture. That has been welcome, both during the recession and in the early stage of the recovery this year.
The brunt of the potential negative results of higher defense spending - including higher inflation, bigger federal deficits, and lower industrial productivity - will probably not show up until after the 1984 election, if at all, experts say.
The general agreement among economists, at least about the short-term impact of the spending buildup, is in sharp contrast to a heated debate on the military and foreign policy consequences of the administration's defense spending program. These arguments have been fueled by the Soviet Union's withdrawal from European nuclear arms control talks and by ''The Day After'' television show, which beamed images of nuclear war into 100 million US homes.
''So far the impact on the overall economy has been positive,'' says Douglas Lee, manager of defense economic services at Data Resources Inc., an economic consulting firm. ''There is enough underutilized capacity in the economy right now that defense spending has not caused any problems'' with shortages of key goods like electronic components or forgings.
The concern over bottlenecks and shortages is ''not now (but) over the next couple of years,'' notes Gordon Adams, director of the Defense Budget Project at the Center on Budget and Policy Priorities, which is often critical of administration defense policies.
''I don't see any major (negative) impact and I don't expect one,'' says Theodore Crackel, a defense expert at the conservative Heritage Foundation. ''Congressional action to increase the (fiscal 1984) budget 4.5 percent is not going to make any drastic'' difference in the economy.
This year Congress chopped about in half the administration's request for a 10 percent gain in inflation-adjusted spending. When Mr. Reagan came to office, however, he got Congress to pass a midyear boost in the fiscal 1981 budget, which was already in progress. And Congress approved inflation-adjusted increases in outlays ''on the order of 8 percent'' in fiscal 1982 and '83, says Mr. Lee. The result is that outlays in fiscal 1984 are scheduled to be $233.2 billion, up 32.8 percent from fiscal 1980.
And figures for outlays, or dollars spent in a given year, understate the true economic impact of the defense buildup. Roughly one-third of the defense budget is going into procurement of equipment. In such purchases, spending in the first year is typically only 12.5 cents of the procurement dollar, with heavier outlays coming in subsequent years as production work progresses. So even if the President cannot persuade Congress to spring for new programs, those already in the pipeline will push up spending 3 to 5 percent on an inflation-adjusted basis for the next four to five years - ''without an act of political courage'' by Congress in killing some defense programs, Mr. Adams says.
Increased military spending has obviously boosted defense industry sales and profits, with the gains of an individual company depending both on the strength of nondefense sales and on how heavily it must invest to attract more military business.
In the aerospace sector, the higher defense budget has generated ''somewhat better revenue and earnings, but I don't think that there has been a dramatic increase in defense industry profits overall,'' says Wolfgang Demisch, a vice-president at First Boston Corporation, an investment banking firm. Lower commercial sales and changes in the tax rules applying to defense contracts have held down profits, he adds.
By contrast, in the electronics business, where private-sector sales are good , added defense contracts mean business is ''very strong, almost great,'' says Phillip Brannon, a Merrill Lynch vice-president.
The upsurge in outlays has not produced a major upheaval in the ranks of defense contractors. From fiscal year 1981 to 1982, for the most part there were only slight shifts in positions among the top 20 companies. The companies' entrenched position and the difficulty competitors would have in recruiting engineers were the main reasons, analysts say.
Still, the fuller federal defense trough has brought out some new subcontractors. That was one of the administration's hopes. ''Some companies are seeking subcontracting which were doing commercial business before the recession ,'' Mr. Adams notes.
Union officials say job-creating gains were smaller than they expected. ''We haven't seen any pickup in employment for our membership at any major defense contractors,'' with the exception of a General Electric aircraft engine plant, says Richard Greenwood, special assistant to the president of the International Association of Machinists and Aerospace Workers.
Although experts do not expect defense spending to pinch consumers' pocketbooks before the '84 election, they do reckon that the buildup's longer-term consequences involve several elements of risk.
The most widely cited risk is that suppliers will not be able to meet the demand for defense-related products, and supply bottlenecks will emerge, pushing up prices in both the defense sector and the overall economy.
In fact, before the recession, bottlenecks were developing in certain key industries at the ''lower-tier subcontractor level,'' in electronic components, forgings, and some machinery, says Harvey Gordon, assistant deputy undersecretary of defense for acquisition. And he sees ''some potential'' for renewed but less serious bottlenecks as the recovery progresses.
''If we have a very robust 1984, there may be problems in 1985 and 1986,'' says Mr. Lee at Data Resources.
The act of overcoming bottlenecks can push up prices elsewhere in the economy , asserts retired Rear Adm. Gene R. La Rocque, director of the Center for Defense Information. Defense contractors can ''ask for whatever price they think they need to hire people and overcome bottlenecks.''
A potentially negative impact on productivity is another longer-term risk in the defense buildup, economists say. Productivity measures how much a worker can produce in a given period of time. This argument holds that private demand for equipment to boost productivity may collide with heavy defense buying of capital goods and engineers' time. As Congressional Budget Office study noted in February, nondefense demands might lose out in this battle, ''resulting in lower private investment and R&D and, hence, lower productivity.''
Greater reliance on defense work may also harm a company's ability to compete in the commercial market with foreign producers, according to a Cato Institute study by a Hofstra University professor, John E. Ullmann. The reason: ''a combination of financial and technical profligacy, bloated payrolls, wasted motion, unwholesome relationships with government agencies, and technical concentration away from commercial products'' - factors he sees as connected to defense work.
Critics also argue that defense-related research and development has little application to civilian products. ''We'll end up being almost a generation behind where we might have been'' if government R&D funds were used differently, maintains Stanley A. Weiss, president of Business Executives for National Security.
But Mr. Crackel at the Heritage Foundation says most military R&D goes into electronics and related areas ''where there is a lot of transfer to civilian use.''
There is more agreement that Congress will face tough pressures if it intends to fund the defense programs it has already started - but has only begun to pay for - while trying to rein in large budget deficits.
Unless some weapon systems are dropped and efficiency is improved, ''we have probably got more things under development than we can afford to buy,'' warns Mr. Gordon at the Defense Department.
Next: Getting a bigger bang for the weapons-acquisition buck.