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Some fear cuts may hurt U.S. defense industry base

By David Alexander

WASHINGTON (Reuters) - When the British Royal Navy decided to build a new class of nuclear attack submarines in 1997, it wasted years before discovering its shipbuilding industry no longer had the design and production skills to finish the job.

Prime contractor BAE Systems ultimately turned to the U.S. Navy's main submarine builder, General Dynamics Electric Boat, to provide the expertise the United Kingdom had lost due to Cold War defense cuts and changing technologies.

Some analysts see the story of the HMS Astute, which was formally commissioned one year ago, as a cautionary tale about what could happen to the Pentagon unless the U.S. government protects critical elements of the defense industry as it begins to cut hundreds of billions in spending over the next decade.

"If we end up in this situation ... exactly who are we going to go to? The Chinese? The Russians?" asked Barry Watts, a defense analyst at the Center for Strategic and Budgetary Assessments think tank. "You don't want to end up here."

It is not an empty concern. Even before President Barack Obama and Congress agreed on a deal that could reduce defense spending by as much as $1 trillion over 10 years, the United States already had lost some significant capabilities.

Back in 2008, then-Defense Secretary Robert Gates and his Energy Department counterpart, Samuel Bodman, said the United States could no longer make nuclear bombs.

"While the service lives of existing warhead types are being extended through refurbishment, at present the United States does not have the ability to produce new nuclear weapons," they wrote in a paper on the U.S. nuclear deterrent.

The loss of that capacity was one issue that drove Republican demands for more U.S. nuclear modernization funding during last December's debate over the New START nuclear weapons treaty with Russia.

Other U.S. capabilities are on the edge. Cutbacks at NASA have put U.S. production of solid fuel rocket engines at risk, said Tom Captain, head of the aerospace and defense unit Deloitte LLP. The dwindling number of military jet projects is threatening competition in the engine market, he said.

WHAT WILL BUDGET CUTS BRING?

In today's budget climate, the health of the defense industrial base is suddenly in the spotlight. But some are skeptical of the dire warnings, seeing them as an excuse for sparing defense budgets that have expanded enormously in the last decade.

"To my mind there's just a fantastic amount of hyperventilating about this issue," said Gordon Adams, an American University professor who oversaw defense budgets at the White House during the post-Cold War military build-down.

"Every time, people come out of the woodwork and start tearing their hair and rending their garments. And every time, at the end of a build-down we end up with the world's dominant military force and technology that is generations ahead of anybody else," he said. "So it's kind of like crying wolf."

Adams said only the top six or seven U.S. defense contractors, like Lockheed, Raytheon and Northrop Grumman, are dependent on the U.S. Defense Department for 75 percent or more of their revenues. The second- and third-tier firms, he said, are well-diversified between defense and commercial work.

Critical engineering and design skills would be fairly safe at smaller firms because they can switch from defense to commercial work in lean times, he said.

"Anybody who says $1 trillion (in spending reductions) is the end of Western civilization doesn't understand that $1 trillion is just 16 percent of (the Defense Department's) projected resources," Adams said. "Properly managed, it's a cake walk."

So far Obama and Congress have approved $350 billion in reductions to national security spending. If a congressional "super committee" fails to reach a deficit deal by year-end, automatic across-the-board cuts could take another $600 billion from security spending.

Those cuts, analysts said, could lead to a loss of capabilities. Once the skill and know-how to produce a sophisticated defense system is lost, it is difficult and expensive to reconstitute.

While it is "technically and physically" possible to rebuild part of the industrial base once it has been allowed to die, outgoing Joint Chiefs of Staff Chairman Admiral Mike Mullen said, the reality is "it doesn't come back."

"People go away, skills go away and the enormity of the investment to bring it back if you've got that wrong, it's not going to be there," Mullen told a business group.

Given the potential size of the coming defense spending cuts, some analysts say the United States could lose strategically important people and technologies unless it effectively manages the build-down.

JOB LOSSES

Captain estimated that if the Pentagon is forced to implement the full $1 trillion in spending cuts, then the defense industry could see the loss of some 160,000 jobs.

"By reducing the defense budget, it's actually cutting jobs, a very significant number of high-paying jobs," he said.

But in the current economic climate, with unemployment over 9 percent and U.S. budget deficits running at some $1.3 trillion annually, there is little public sympathy for going deeper in the hole just to keep big defense contractors flush with new projects so they can retain their engineers.

That's not what the industry wants or expects, said Mark Valerio, who deals with space and satellite technologies as vice president of Lockheed Martin Surveillance and Navigation Systems.

"We fully understand the current budget environment and would not advocate for government funding solely for the purpose of keeping an engineering workforce engaged," he said in an email.

In an era of few new satellite and space projects, there are still things the government can do to help industry, such as upgrading products and stabilizing project spending so that it does not fluctuate widely from year to year.

But Watts, and his CSBA colleague Todd Harrison, said companies would ultimately have difficulty justifying continued spending on high-priced assets -- like a cadre of top engineers -- if they are not regularly engaged in new programs.

Watts said when he worked at Northrop Grumman in the late 1990s the company determined that it cost about $100 million annually to maintain a state-of-the-art design team for advanced combat aircraft.

"If you're not getting most of that money from a program say like the JSF (Joint Strike Fighter) or a future bomber program ... the inclination from a business standpoint is to divest yourself of that expense," Watts said.

(Editing by Warren Strobel and Bill Trott)

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