White House Study of Defense Industrial Base Will Find a Decaying 'Arsenal of Democracy'
(Source: Forbes; issued Aug 17, 2017)
In 1940, following major victories by fascist military forces in Europe and Asia, President Franklin D. Roosevelt proposed to a national radio audience that America could assist embattled democracies without fighting by becoming a "great arsenal of democracy." The Japanese attack on Pearl Harbor a year later ended talk of staying out of the war, but Roosevelt's belief that U.S. industry could provide the foundation for defending democracy proved to be well-founded. America's industrial mobilization armed the allies and overwhelmed the enemy.

On July 21, President Trump signed an executive order in effect directing cabinet agencies to determine whether the arsenal of democracy still exists. The order mandated a comprehensive assessment of U.S. industrial capabilities relevant to national security, with an eye to identifying deficiencies and dependencies that might impede military effectiveness in wartime. The assessment will burrow down to the lower tiers of supply chains in key industries to analyze how resilient the domestic economy might be in a military emergency.

This is not just a study of the "defense industrial base," meaning the public and private entities involved in producing military items. It is a "whole-of-government" assessment of the entire manufacturing sector and related services that will involve a dozen federal agencies. So, in addition to reporting that the nation's sole surviving tank plant is turning out a mere dozen tanks per year and that only one company is building state-of-the-art tactical aircraft, it will raise broader questions about how industrial mobilization would fare in a protracted conflict.

The news will not be good. Under the banner of economic globalization, basic industries vital to a war effort have moved operations offshore or simply shut down. For instance, in 2000 the U.S. had 23 aluminum smelters; today it has five, and only two of those are operating at full capacity. The rest have been driven out of business by a glut of aluminum produced by subsidized Chinese smelters -- smelters that would not be competitive without government assistance. So, 40% of U.S. consumption is now met by imports, up from 14% in 2010.

Or consider the example of steel, which is as important in building warships and combat vehicles as aluminum is in building planes. When Beijing joined the World Trade Organization in 2001, the U.S. and China were both producing about 100 million tons of raw steel per year. Today, America produces 80 million tons and China produces 800 million tons. Chinese steel mills too are subsidized, as are those of other exporting nations. As a result, imports have captured a third of the U.S. market, and the domestic industry lacks the capacity to meet wartime levels of demand.

Not all of America's industrial disabilities can be blamed on China. For instance, construction of large oceangoing commercial vessels for international trade ended during the Reagan years, because the government wiped out construction subsidies without seeking reciprocal action from other shipbuilding nations. Prior to that move, the U.S. shipbuilding industry was turning out 20 large commercial vessels per year. Now the only such vessels it produces are those protected by the Jones Act, which requires use of U.S.-built ships in commerce between domestic ports.

In the case of commercial transports -- jetliners -- U.S. losses have been caused more by America's allies, specifically the European countries that have subsidized Airbus since its inception. The World Trade Organization has ruled that every plane Airbus ever brought to market was illegally subsidized -- so much so that Airbus might not even exist without a continuing pattern of flagrant trade violations. Nonetheless, two of the three U.S. makers of jetliners were forced out of the business, and survivor Boeing has seen its market share cut to about 50%.

Distortions in particular industrial sectors can be fixed with targeted remedies. However, there is a broader decay in the U.S. industrial economy that would preclude the kind of mobilization seen in past conflicts. In 1976, the nation's bicentennial year, industrial companies claimed 86% of total market capitalization in the S&P 500. Today, after four decades of waning manufacturing activity and the rise of financials as a major economic sector, industrials only represent 10% of the S&P's market capitalization.

It's true that during that same period, information technology and healthcare rose to claim bigger shares of the S&P 500 market cap -- 21% and 19%, respectively -- but those industries are mainly engaged in delivering services. To the extent they manufacture goods, that is done largely overseas (particularly in Asia). For instance, America remains the dominant factor in global semiconductor markets, but the trend in recent decades among U.S. companies has been to design in the U.S. and fabricate overseas.

Although the shale oil revolution has reduced the need for America to import fossil fuels, the U.S. trade deficit in goods has not improved much since oil was at $100 per barrel because so many manufactured items once made domestically now come from overseas. Last year's $753 billion trade deficit in goods was, in inflation-adjusted terms, nearly four times higher than the deficit when the Cold War ended. Rising export of services has helped the overall balance, but the goods number underscores how dependent America has become on offshore sources of supply.

Exhibit A in this story is the bilateral imbalance with China. In 2001, the year Beijing joined the WTO, the U.S. had a negative trade balance in goods of $83 billion. Last year, the imbalance favoring China was $347 billion -- nearly a billion dollars per day. And the flow of imports from China consists almost entirely of manufactured goods, such as flat-screen displays that were originally invented by U.S. companies such as Philco and Westinghouse. Those companies, once leading producers of electronic systems, have largely ceased to exist.

The most worrisome sign of America's faltering competitiveness in manufacturing is trade in advanced technology products. That category of merchandise consists of items like smart phones, laptops, and tablets that I see my 20-year-old twins using constantly. The year they were born, 1997, America had a trade surplus of $32 billion in advanced technology products. Today, the surplus has turned into a deficit of over $80 billion annually. Manufacture of sophisticated electronic devices, the heartland of global innovation, has moved offshore.

If you want to understand why the U.S. economy is growing at only 2% annually compared with its historic average of 3%, you need look no further than the trade deficit in manufactured goods, which has cut the annualized growth rate by over one percentage point in recent years. Candidate Trump had it right on the campaign trail last year when he traced many of America's woes to waning manufacturing activity. This trend has major implications for national security, not just in a wartime mobilization, but also in being able to sustain a peacetime military posture.

The question for the White House will be what to do about it. Free market principles won't help much in a world where many of the biggest trading nations behave like mercantilists. Even as Intel is planning to spend $7 billion on the world's most advanced semiconductor plant in Arizona, China is looking to spend $150 billion on developing its own semiconductor sector. The biggest semiconductor plant being built in China, by government-influenced Tsinghua Unigroup, will cost $30 billion -- over four times the investment in Intel's plant.

Meanwhile, China's government has targeted its artificial intelligence sector for expansion to $59 billion in sales by 2025, and is working to increase its share of lithium-ion battery production (used in smart phones and laptops) from 55% of global output today to 65% by 2021. U.S. producers have a 10% market share. These moves are not unlike the decision of Chinese provincial governments to target antibiotics production, which resulted in closure of the last U.S. plant making precursor materials for penicillin a decade ago.

If the United States is to sustain a robust industrial base capable of coping with the full range of national-security contingencies, its government will have to do a whole lot more than it has been lately to bolster domestic manufacturers. Paring regulations and reducing taxes is a good start, but the government needs to facilitate much higher levels of domestic investment in advanced manufacturing, and take the handcuffs off its export credit agency so the playing field with other trading nations is leveled.

One step that is indispensable in rebuilding the U.S. base is to penalize nations for violating trade treaties. The Obama Administration did a reasonably good job of punishing China, South Korea and other transgressors for dumping steel products in the U.S., but nothing concrete has been done to penalize European countries for their illegal subsidies of Airbus. Those subsidies have cost America tens of thousands of aerospace jobs and shrunk the industrial base available for defense production.

Decisive action is needed, and soon.

(EDITOR’S NOTE: The conclusion that European subsidies to Airbus have cost “tens of thousands of aerospace jobs and shrunk the industrial base available for defense production” is laughable, and not only because it ignores the fact that the World Trade Organisation has found that illegal US subsidies to Boeing allowed the company to finance its latest aircraft and to survive.

The decline of the US defense industrial base is due, first of all, to President Ronald Reagan’s fantasy that markets will always find the most efficient solution, and thus require no supervision.

In this case, it led to major US companies merging, moving operations offshore or simply shutting down unprofitable operations so as to move into more profitable markets.

The second reason is the famous “Last Supper,” when the CEOs of America’s largest defense companies were told by then Defense Secretary William Perry that there would not be enough business for all of them, and encouraged them to reconfigure for lower defense budgets and a more competitive market.

Again, this led to a wave of mergers, foreign outsourcing and re-focusing that, again, caused a downsizing of the defense industrial base. This is how it was described by the New York Times in 2011:

“The year was 1993. Bill Clinton was the new president, and Les Aspin was his defense secretary. As recounted later by Norman R. Augustine, then the chief executive of Martin Marietta, Mr. Aspin called together about 15 C.E.O.s of the prime military contractors for a dinner at the Pentagon. Mr. Augustine would memorably label this dinner the Last Supper.
Mr. Aspin and several other high-ranking Pentagon officials had brought the group together to send a tough message. With the Berlin Wall gone, the Soviet Union dissolved — and the Pentagon budget flat-lining — the Defense Department was no longer willing, as Mr. Augustine later recounted, “to pay the ballooning overhead” of all those contractors. In no uncertain terms, Mr. Aspin told the group that they needed to start merging.
“The rest is history,” Mr. Augustine later wrote. “General Electric Aerospace merged with Martin Marietta, which combined with Lockheed. McDonnell Douglas joined Boeing. Grumman joined Northrop. When the dust had cleared, there were only a few firms left standing.” Five, to be exact.

William Perry, who convened the Last Supper, has since issued several warnings against further defense industry consolidation, “saying the current huge and dominant companies have led to ‘less effective competition’”.

This is why the spurious allegation that Airbus and European nations are responsible for the decline of the US defense industrial base is laughable.
In reality, it was caused by US policies that were totally divorced from reality, and founded instead on Reagan’s faith-based voodoo economics.

And while it may be convenient for the author – a lobbyist and well-known consultant for some of the largest US defense contractors -- to blame Europe, the truth is that the US industry’s obsessive focus on profit as the one and only measure of corporate success is what has led to the current situation, in much the same way that it has led to crumbling national infrastructure and to many of the nation’s other ills.)


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