US Defense Firms Dodged the Budget Bullet

The United States defense industry is adjusting to the end of the cold war far more rapidly and far more effectively than was generally expected. Many of the changes to date have been painful, and the end of the adjustment process is not yet in sight. Nevertheless, the nation can hold considerable confidence in the continued presence of a strong defense industrial base.

The concern with the defense industrial base is far more than a matter of contract forms, cost controls, and business procedures. Fundamentally, we are dealing with the continued ability to possess an adequate arsenal of military power in a dangerous world and at a time of serious budget stringency.

Fallacy of forced 'conversion'

The United States military establishment is facing levels of funding for research, development, and procurement that, in real terms, are less than one-half of the 1985 numbers.

Compounding the loss of much of the traditional military market has been the challenge of fending off pressures to "convert" defense industry resources to civilian markets. This "second front" was opened in the mistaken belief that Congress will only approve substantial reductions in the military budget so long as defense industry jobs are maintained, albeit for civilian work.

Proposals included new government controls to force company managements to shift to civilian markets. This is a task that most of these companies have flubbed time and again. Such dissipation of their limited resources would have left them very much weakened financially.

Fortunately, the major defense companies followed a different approach. Facing a reduced number of major awards in the years ahead, key prime contractors merged with their rivals. Marriage partners included Lockheed and Martin, Northrop and Grumman, and soon, Boeing and McDonnell Douglas.

Many defense contractors eliminated large divisions that were not industry leaders. General Dynamics sold its space systems to Martin and its tactical aircraft business to Lockheed. General Motors's Hughes subsidiary sold its defense electronics activity to Raytheon. Ford's Aerospace and IBM's Federal Systems Division went to Loral (which was then absorbed by Lockheed Martin). Northrop Grumman acquired Vought Aircraft and Westinghouse defense work.

Some bemoan the prospect of declining competition for military contracts from a reduced number of competitors. However, that approach to the antitrust laws is pass. In the past two decades, the antitrust authorities allowed a host of mergers between active competitors in civilian markets.

Since 1980, many large banks, retail chains, communications companies, and manufacturers have merged quite successfully. We have not witnessed the price increases that might have been expected. Consumers are enjoying a benign inflation situation - coupled with high employment.

The new approach to antitrust reflects the changing nature of the marketplace. The most striking characteristic of defense procurement is that, even after the current mergers, production capability will far exceed procurement. Most important, the competition for new contracts remains intense.

Danger of antitrust measures

If the conventional antitrust approach had been applied to the recent wave of defense industry mergers and acquisitions, the result would have been a larger number of financially weak firms. Most of them would lack the critical mass required to maintain high levels of research and development. Along with the shareholders, the national security would have suffered from the erosion of defense technology.

Overall, the defense industry is in far better shape than might have been expected given the loss of so much of its basic market. Despite massive cutbacks in defense spending, no plea has been heard for taxpayer bailouts of faltering contractors.

Remember the famous Sherlock Holmes story where the key clue was that the dog did not bark? Similarly, the most important point in military-industry relationships in the post-cold war period has been the absence of crisis.

* Murray Weidenbaum is chairman of the Center for the Study of American Business at Washington University in St. Louis.