Pentagon Plan to Slash Industry Payments Appears at Odds with Trump Strategy and Economic Philosophy (excerpt)
(Source: Forbes; issued Sept 24, 2018)
Being in the arms business is seldom a passport to popularity. The New York Times complained during the early days of the Civil War that the War Department's system for buying military supplies was 'a hotbed of wickedness and corruption.' After World War One, it became fashionable in some circles to refer to weapons makers as 'merchants of death.' At the height of the Cold War, President Eisenhower warned against the dangers posed by a 'military-industrial complex.'

The irony of these concerns is that the defense industry (as we now call it) is the most heavily regulated sector of the U.S. economy. Because government is the industry's only customer, Washington can shape the sector in whatever way it wishes. There are advantages for weapons makers in being insulated from the vagaries of the commercial business cycle, but the trade-off is that they are subject to arbitrary policies imposed by political masters who often have little grasp of how the sector operates.

The latest episode illustrating this dynamic is a Pentagon plan to cut progress payments for big military contractors from 80% to 50%. Progress payments are the costs incurred by companies as they work on a contract that get reimbursed by the government. Companies eventually are paid the full amount agreed to in a contract, but with some projects stretching over many years and expending billions of dollars, the rate at which suppliers are compensated during execution can have a huge impact on cashflow.

Like commercial companies, defense contractors can borrow money if they need working capital during the execution of a contract. Unlike in the commercial world, though, military contractors are not allowed to bill the government for the interest paid on such loans. Progress payments are thus an alternate form of financing for government contractors, and the rate at which payments are disbursed historically has been related to where interest rates stand in the broader economy.

However, nobody has ever before proposed cutting progress payments to a point where they only cover half of contractor costs. The defense department says that by meeting various performance criteria set forth in the rule change proposed in August, big arms makers can get back to the prevailing 80% rate, or go even higher. For instance, if a company can prove it consistently delivers on time, progress payments increase by 10%; if it can prove its business systems are not deficient, payments go up another 10%. (end of excerpt)

Click here for the full story, on the Forbes magazine website.


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