Ominous signs for defense, aerospace industries as Congress scrambles to fund government

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AIA CEO Melcher: The defense drawdown has resulted in lost suppliers, changes in competition, market structure, and industrial base turmoil.

WASHINGTON — A protracted battle over federal spending priorities shows no sign of resolution.

Unstable budget cycles have become the norm in a deeply divided Washington, although so far the impact on the economy has not been noticeable. The unpredictability of funding, however, is taking a toll on industries that heavily depend on government work.

The leader of the influential trade association that represents the U.S. aerospace and defense industry said these sectors are showing cracks and weakness after years of fiscal volatility.

During the recent defense drawdown the number of vendors doing business with the Department of Defense declined by 17,000 or almost 20 percent, said David Melcher, president and CEO of the Aerospace Industries Association.

“Clearly, the decade-long defense drawdown has resulted in lost suppliers, changes in competition and market structure, and further industrial base turmoil,” Melcher said Thursday at the association’s annual media lunch event.

With the stocks of top defense contractors trading at all-time highs, it may be hard to square this with the idea that the industry is fraying, but Melcher insisted the situation is dire.

He cited new data from the Center of Strategic and International Studies. At the start of the defense drawdown in 2011 and 2012, average annual Defense Department contract obligations dropped by 5 percent compared to 2009 and 2010. When the Budget Control Act went into effect in fiscal year 2013, Pentagon contract obligation plummeted by 15 percent from 2012. And average annual defense contracts fell 23 percent between 2013 and 2015.

President Trump in July issued an executive order to begin a study of the impact of funding cuts on the defense industry. “We hope the assessment, and its ensuing policy recommendations will provide a strong roadmap for strengthening industrial base health,” said Melcher.

Until budgets recover, the industry could continue to shrink. “I suspect there will be more consolidation,” Melcher told reporters. “Less, if defense budgets rise, and more if defense budgets remain stagnant,” he added. “Bad things begin to happen when supply chains weaken. We have to watch that.” And Melcher predicts more defense companies will merge with commercial businesses. “It’s an inexorable march toward more integration of classic defense companies and commercial.”

Despite the president’s campaign promise to dramatically increase military spending, the budget is poised to stay flat. “I’m very concerned about how our nation has come to accept several anchors that are dragging our industry down,” Melcher said. “This industry’s capacity to rapidly respond to urgent national needs is imperiled by many factors. These include unnecessary and costly burdens and the cumulative impacts of years of budget austerity.”

Trump this week signed a 2018 defense authorization bill that calls for a $700 billion military budget. But the 2011 budget law caps 2018 defense spending at $549 billion.

Republicans are willing to increase defense but not other government agencies, making it tough if not impossible to reach a compromise with Democrats. And now comes the prospect of a big tax cut that could deepen the federal deficit and further starve the government of resources.

Melcher said AIA supports the GOP tax reforms but recognized that, in order to fix defense, all the “legs of the stool” need to be taken into account.

“We are not going to solve the deficit issue, nor will AIA,” he said. “But we believe we have gone for too long on an austerity program relative to the defense budget.”

Deficits are a “legitimate concern,” he said. “But I do believe that there is a way to think through this problem, if the government has the moral courage to address how the whole of government is funded, and where the revenues come from. And there has to be a better way than how we’re doing it now, which tends to be band-aids patched here and there.”

Agencies like the State Department, NASA and the Federal Aviation Administration perform important national security functions as well, he noted. “The government needs to be funded in a reliable way in more than just the Department of Defense.”

Melcher complimented the administration’s space policy. “By directing that NASA once again return to the Moon, as part of its long-term space exploration program, the president has given the space agency the clear focus it needs.”

This project will require bigger budgets for NASA, however. “And we hope this initiative is adequately resourced.”

Melcher said he is encouraged by “strong policies across the board for civil, commercial and national security space activities to help ensure continued U.S preeminence in space.”

But he criticized the administration and Congress for not supporting the Export-Import Bank, which “drags our industry down.”

American civil aviation and space systems manufacturers face fierce international competition, Melcher said. “It is hard to believe that the U.S. still doesn’t have a fully functioning Export-Import Bank.” Today, it lacks a full complement of directors and can’t approve export deals over $10 million.

In the five years from 2011 to 2015 when Ex-Im was fully operating, it supported on average $9.5 billion in export sales a year. Now that figure is down to $57 million. “Think of all the jobs that are being lost at exporting aerospace companies because of the new status quo.”

This hurts the commercial space sector badly, said Melcher. “A company that produces space payloads needs outlets to the international market when the domestic demand is not enough to keep your scientists, engineers and production lines,” he said. “It’s a killer for commercial space enterprises that would sell with the backing of the Ex-Im bank and now can’t do that.”

For now, Congress is focused on passing tax cuts and averting a government shutdown when temporary funding runs out Dec. 22. The House Appropriations Committee introduced a continuing resolution Wednesday that lifts spending caps for defense but kicks the rest of the non-defense budgets to mid-January. This proposal “will die or be significantly altered in the Senate,” predicts industry analyst Byron Callan, of Capital Alpha Partners.

Lawmakers have until midnight Dec. 22 to reach agreement on how to fund the entire government to avoid a shutdown.