White House report: Defense industry faces ‘unprecedented challenges,’ China’s ‘economic aggression’ a threat to national security

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White House report on the U.S. defense industrial base: "China represents a significant and growing risk to the supply of materials and technologies deemed strategic and critical to U.S. national security."

WASHINGTON — What stands out in the Trump administration’s 140-page report on the state of the U.S. defense industrial base is the blistering rhetoric against China.

Titled “Assessing and Strengthening the Manufacturing and Defense Industrial Base and Supply Chain Resiliency of the United States,” the study was directed by an executive order President Trump signed July 21, 2017. The work was led by the White House Office of Trade & Manufacturing Policy and the Defense Department but included participation from across the government.

According to the report, which the White House will release on Friday, the U.S. defense industry faces an “unprecedented set of challenges,” including uncertainty of federal spending, unintended consequences of U.S. government acquisition behavior and the loss of skills in the domestic workforce. But the Trump administration is this report directs most of its fire at China’s economic policies and relentless pursuit of technology — described as daunting threats to U.S. national security and to the defense industry.

“China’s capture of foreign technologies and intellectual property, particularly the systematic theft of U.S. weapons systems and the illicit and forced transfer of dual-use technology, has eroded the military balance between the U.S. and China,” the report says. China’s goal is a “qualitative technological advantage over the U.S. across key domains, including naval, air, space and cyber.”

The report highlights ways in which China has infiltrated the defense and aerospace supply chains. “A key finding of this report is that China represents a significant and growing risk to the supply of materials and technologies deemed strategic and critical to U.S. national security, a challenge shared by key allies such as Germany and Australia.”

U.S. industry has become dependent on China for “strategic” critical materials like rare earth metals that are used in advanced electronics, including military weapon systems and satellites. In some cases China is the sole source or primary supplier for critical energetic materials used in munitions and missiles. This illustrates how “Chinese economic aggression, guided by its strategic industrial policies” exploit vulnerabilities and gaps in America’s manufacturing and defense industrial base.

The study slams China for flooding the global market with rare earth materials at subsidized prices, driving out competitors and deterring new market entrants. “When China needs to flex its soft power muscles by embargoing rare earths, it does not hesitate, as Japan learned in a 2010 maritime dispute.”

True to form for an administration that is waging an escalating trade war, the report bashes China for stealing U.S. jobs, not just in traditional manufacturing but also in advanced research and development. “Many technology-intensive multinational corporations have established R&D facilities in countries like India and China for access to cheap, high skilled labor. As part of its industrial policy aggression, China has forced many American companies to offshore their R&D in exchange for access to the Chinese market.”

The administration claims credit for a healthy U.S. defense export market, which reached $41.9 billion in fiscal year 2017. But the report says U.S. firms nevertheless face “unfair” trade practices by China and the European Union.

The study sounds alarms about U.S. industry reliance on “sole foreign sources for unique and proprietary advanced materials” from countries other than China. Single foreign sources of carbon fibers from Japan and Europe represent “considerable DoD supply chain vulnerabilities,” the report says. “A sudden and catastrophic loss of supply would disrupt DoD missile, satellite, space launch, and other defense manufacturing programs. In many cases, there are no substitutes readily available. Replacing a carbon fiber factory is very expensive and time consuming. Of similar concern is the uncertainty of qualifying replacement suppliers.”

Another concern are China’s advances in “foundational dual-use industries such as semiconductors, chip materials, robotics, aviation and satellites,” the report says. As technical innovation moves abroad, “changing rules around intellectual property development will impede U.S. access to the latest manufacturing technologies.” At risk is America’s loss of leadership in industries of the future such as artificial intelligence, quantum computing and robotics, the report notes. “Over the remainder of this century, these emerging industries will help redefine the battlefield.”

One of China’s industrial initiatives, “Made in China 2025,” targets artificial intelligence, quantum computing, robotics, autonomous vehicles, high performance medical devices, high-tech ship components and other emerging industries critical to national defense, the report says. To obtain the capabilities needed to support these advanced technologies, China relies on “both legal and illicit means, including foreign direct and venture investments, open source collection, human collectors, espionage, cyber operations, and the evasion of U.S. export control restrictions to acquire intellectual property and critical technologies.”

National security space

With regard to the national security space sector that supplies military satellites and launch vehicles, advances in commercial technology is a positive trend, but the report cautions that commercial companies cannot meet all DoD demands. “While commercial space has similar needs to DoD, it does not require the same level of robustness, reliability and security in its products.”

The DoD space industrial base is a niche market with very specialized and capital-intensive capabilities, and the government has not managed its investments wisely, the report notes. “Many systems currently in planning and development rely on dated technology, skills, and fragile sources. Individual programs are reluctant to invest in and qualify new technology and sources, creating a need to sustain fragile domestic sources and to qualify new technologies and sources for next-generation systems.”

The DoD space industrial base in the lower tiers is fragile and under stress, says the report. Primary areas of concern are aerospace structures and fibers, radiation-hardened microelectronics, radiation test and qualification facilities, and satellite components and assemblies.

Because of DoD business practices, market trends, globalization and manufacturing costs, “future access to space qualified domestic industrial sources, including microelectronics, is uncertain.”

Other issues of concern to the space sector are increasing cyber threats, non-trusted supply-chains, foreign acquisitions, reliance on vulnerable foreign sources, industrial policies of competitor nations and erratic demand.

Industry feeling ‘bullwhip effect’

It’s a reality of the defense business that companies are at the mercy of fluctuations in Pentagon budgets. “With confirmed procurement and investments, suppliers will take on high fixed costs to develop expensive new capacity. When programs draw down, companies are left with highly specialized production capabilities that may go unused for decades.”

This “bullwhip effect” of DoD spending swings creates inefficiencies across the entire supply chain. The space sector has been especially affected by this trend, says the report. There was a spike of recapitalization in space programs from 2000 to 2010, followed by a precipitous decline from 2010 to 2015, which left suppliers with excess capacity.

The defense and space industries need fresh sources of supply and human capital, but the government also needs to eliminate existing barriers that discourage new competitors. “Companies that do not have existing relationships are further deterred from entering into business with the DoD due to the level of cost and volatility associated with the engagement, thus impacting the potential of new entrants into the market.”

The report mentions the culture of Pentagon procurement as an impediment to innovation. “A top-down and requirements-driven process” is preferred, “often to the detriment of innovation.” The current process “solicits solutions for specific capabilities rather than for outcomes, potentially imposing an opportunity cost on innovation.”

There appear to be few opportunities for companies to offer products or services that do not already fit within the DoD’s stated requirements and scope, the report says.

SecDef recommendations

The office of the secretary of defense proposed a number of actions in response to the problems identified in the report.

• Create an industrial policy to inform current and future acquisition practices.
• Expand direct investment in the lower tier of the industrial base to prevent “single points of failure.”
• Diversify away from sources of supply in politically unstable countries that may cut off U.S. access.
• Work with allies on joint industrial base challenges.
• Modernize Defense Department-owned industrial depots to ensure they can sustain fleets and meet emergency demands.
• Accelerate domestic workforce development efforts.
Reduce the personnel security clearance backlog.
Step up exploration of next generation defense technology.